FIRST MERCHANTS CORP

INCOME TAX

The reconciliation between income tax expense expected at the U.S. federal statutory tax rate and the reported income tax expense is summarized in the following table for years ended December 31, 2017, 2016, 2015:



	2017			2016			2015
Reconciliation of Federal Statutory to Actual Tax Expense:
Federal Statutory Income Tax at 35%	$	46,758		$	38,031		$	31,867
Tax-exempt Interest Income	(11,127		)	(8,749		)	(7,083		)
Basis Difference on Sale of Insurance Subsidiary							2,252
Stock Compensation	(893		)	(61		)	(31		)
Earnings on Life Insurance	(2,302		)	(1,486		)	(1,012		)
Tax Credits	(811		)	(564		)	(583		)
Tax Cuts and Jobs Act - Rate Reform Impact	5,120
Other	779			438			255
Income Tax Expense	$	37,524		$	27,609		$	25,665

Income tax expense consists of the following components for the years ended December 31, 2017, 2016, 2015:



	2017		2016		2015
Income Tax Expense for the Year Ended December 31:
Currently Payable:
Federal	$	22,001	$	18,998	$	21,221
State
Deferred:
Federal	9,969		8,233		3,952
Tax Cuts and Jobs Act - Rate Reform Impact	5,120
State	434		378		492
Income Tax Expense	$	37,524	$	27,609	$	25,665

Significant components of the net deferred tax assets (liabilities) resulting from temporary differences were as follows at December 31, 2017 and 2016:



	2017			2016
Deferred Tax Asset at December 31:
Assets:
Differences in Accounting for Loan Losses	$	19,526		$	26,315
Differences in Accounting for Loan Fees	1,458			1,918
Differences in Accounting for Loans and Securities	3,681			5,689
Deferred Compensation	4,448			3,471
Difference in Accounting for Pensions and Other Employee Benefits				83
Federal & State Income Tax Loss Carryforward and Credits	10,829			16,643
Other	365			4,210
Total Assets	40,307			58,329
Liabilities:
Differences in Depreciation Methods	5,245			8,216
Difference in Accounting for Pensions and Other Employee Benefits	823
State Income Tax	58			237
Net Unrealized Gain on Securities Available for Sale	2,898			557
Gain on FDIC Modified Whole Bank Transaction	602			1,126
Other	3,897			623
Total Liabilities	13,523			10,759
Net Deferred Tax Asset Before Valuation Allowance	26,784			47,570
Valuation allowance:
Beginning Balance	(9,815		)	(15,736		)
Decrease/(Increase) During the Year	2,849			5,921
Ending Balance	(6,966		)	(9,815		)
Net Deferred Tax Asset	$	19,818		$	37,755

The $17,937,000 decrease in the Corporation’s net deferred tax asset was due a combination of a decrease in deferred tax assets and an increase in deferred tax liabilities. The largest deferred tax asset decrease was associated with the impact of the Tax Cuts and Jobs Act ("TCJA"). Signed into law on December 22, 2017, the TCJA makes permanent a reduction in the federal corporate income tax rate from 35 percent to 21 percent. Under ASC 740, the Corporation is required to adjust its net deferred tax asset at December 31, 2017 to the enacted tax rate of 21 percent. As of December 31, 2017, the Corporation has substantially completed its accounting for the tax effects of enactment of the TCJA. Tax adjustments resulted in a decrease to the net deferred tax asset of $5,120,000. The Corporation continues to analyze certain aspects of the TCJA and further refinements are possible, which could potentially affect the measurement of these balances or potentially give rise to new deferred tax amounts. However, the Corporation does not expect these adjustments to materially impact our financial statements.

Other decreases not related to the TCJA were associated with federal and state net operating loss carryforwards and other employee benefits of $2,323,000 and $2,080,000, respectively. Increases in deferred tax liabilities associated with the accounting for acquisitions and accounting for unrealized gains on available for sale securities further decreased the net deferred tax asset by $4,106,000 and $4,273,000, respectively.

As of December 31, 2017, the Corporation has approximately $45,196,000 of state NOL carryforwards available to offset future state taxable income, which will expire beginning in 2020. These NOL carryforwards along with normal timing differences between book and tax result in total state deferred tax assets of $7,400,000. Management believes it is more likely than not that the benefit from certain of these state NOL carryforwards and certain other state deferred tax assets will not be fully realized. In recognition of this risk, the Corporation has recorded a valuation allowance of $6,966,000 against its state deferred tax assets.

The Corporation has additional paid-in capital that is considered restricted resulting from the acquisitions of CFS and Ameriana of approximately $13,393,000 and $11,883,000, respectively. CFS and Ameriana qualified as banks under provisions of the Internal Revenue Code which permitted them to deduct from taxable income an allowance for bad debts which differed from the provision for losses charged to income. No provision for income taxes had been provided. If in the future this portion of additional paid-in capital is distributed, or the Corporation no longer qualifies as a bank for income tax purposes, income taxes may be imposed at the then applicable tax rates. The unrecorded deferred tax liability at December 31, 2017, would have been approximately $5,308,000.

The Corporation or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state jurisdictions. The Corporation is generally no longer subject to U.S. federal, state and local income tax examinations by tax authorities for tax years before 2014.