Income Taxes
The income tax provision for the years ended December 31 is as follows: |
| | | | | | | | | | | |
| 2017 | | 2016 | | 2015 |
| (dollars in thousands) |
Current tax provision | | | | | |
Federal | $ | 29,071 |
| | $ | 19,879 |
| | $ | 8,610 |
|
State | 274 |
| | 154 |
| | 68 |
|
Total current tax provision | 29,345 |
| | 20,033 |
| | 8,678 |
|
Deferred tax provision (benefit): | | | | | |
Federal | 19,237 |
| | 5,846 |
| | 12,158 |
|
State | (21 | ) | | (240 | ) | | — |
|
Total deferred tax provision | 19,216 |
| | 5,606 |
| | 12,158 |
|
Total tax provision | $ | 48,561 |
| | $ | 25,639 |
| | $ | 20,836 |
|
The statutory to effective tax rate reconciliation for the years ended December 31 is as follows:
|
| | | | | | | | | | | | | | | | | | | | |
| 2017 | | 2016 | | 2015 |
| Amount | | % of
Pretax
Income | | Amount | | % of
Pretax
Income | | Amount | | % of
Pretax
Income |
| (dollars in thousands) |
Tax at statutory rate | $ | 36,304 |
| | 35 | % | | $ | 29,830 |
| | 35 | % | | $ | 24,843 |
| | 35 | % |
Increase (decrease) resulting from: | | | | | | | | | | | |
State income tax, net of federal benefit | 164 |
| | — |
| | (56 | ) | | — |
| | 44 |
| | — |
|
Income from bank owned life insurance | (1,995 | ) | | (2 | ) | | (1,883 | ) | | (2 | ) | | (1,894 | ) | | (3 | ) |
Tax-exempt interest income, net | (2,709 | ) | | (3 | ) | | (2,434 | ) | | (3 | ) | | (2,232 | ) | | (3 | ) |
Tax credits | (11 | ) | | — |
| | — |
| | — |
| | (61 | ) | | — |
|
Enactment of federal tax reform | 16,709 |
| | 17 |
| | — |
| | — |
| | — |
| | — |
|
Other | 99 |
| | — |
| | 182 |
| | — |
| | 136 |
| | — |
|
Total tax provision | $ | 48,561 |
| | 47 | % | | $ | 25,639 |
| | 30 | % | | $ | 20,836 |
| | 29 | % |
The total tax provision for financial reporting differs from the amount computed by applying the statutory federal income tax rate to income before taxes. First Commonwealth ordinarily generates an annual effective tax rate that is less than the statutory rate of 35% due to benefits resulting from tax-exempt interest, income from bank owned life insurance, and tax benefits associated with low-income housing tax credits. The consistent level of tax benefits that reduce First Commonwealth’s tax rate below the 35% statutory rate produced an annual effective tax rate of 30% and 29% for the years ended December 31, 2016 and 2015, respectively. The annual effective tax rate is 47% for the year ended December 31, 2017, which is greater than the 35% statutory rate due to the enactment of federal tax reform.
On December 22, 2017, H.R.1, commonly known as the Tax Cuts and Jobs Act (the “Act”) was signed into law. The Act reduces the corporate federal tax rate from 35% to 21% effective January 1, 2018. As a result we are required to re-measure, through income tax expense, our deferred tax assets and liabilities using the enacted rate at which we expect them to be recovered or settled. The re-measurement of our net deferred tax asset resulted in additional income tax expense of $16.7 million.
Also on December 22, 2017, the U.S. Securities and Exchange Commission (“SEC”) released Staff Accounting Bulletin No. 118 (“SAB 118”) to address any uncertainty or diversity of views in practice in accounting for the income tax effects of the Act in situations where a registrant does not have the necessary information available, prepared, or analyzed in reasonable detail to complete this accounting in the reporting period that includes the enactment date. SAB 118 allows for a measurement period not to extend beyond one year from the Act’s enactment date to complete the necessary accounting.
We recorded provisional amounts of deferred income taxes using reasonable estimates in three areas where information necessary to complete the accounting was not available, prepared, or analyzed: 1) Our deferred tax liability for temporary differences between the tax and financial reporting bases of fixed assets principally due to the accelerated depreciation under the Act which allows for full expensing of qualified property purchased and placed in service after September 27, 2017. 2) Our deferred tax asset for temporary differences associated with accrued compensation will be finalized with payments made on or before March 15, 2018 and deducted on the 2017 income tax returns. 3) Our deferred tax assets and liabilities acquired from DCB Financial are awaiting completion of the final short period tax return from outside preparers, which is necessary to confirm the final acquired temporary differences.
In a fourth area, we made no adjustments to deferred tax assets representing future deductions for accrued compensation that may be subject to new limitations under Internal Revenue Code 162(m) which, generally, limits the annual deduction for certain compensation paid to employees to $1 million. There is uncertainty in applying the newly-enacted rules to existing contracts, and we are seeking further clarifications before completing our analysis.
The tax effects of temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities that represent significant portions of the deferred tax assets and liabilities at December 31 are presented below:
|
| | | | | | | |
| 2017 | | 2016 |
| (dollars in thousands) |
Deferred tax assets: | | | |
Allowance for credit losses | $ | 10,223 |
| | $ | 17,616 |
|
Postretirement benefits other than pensions | 345 |
| | 611 |
|
Alternative minimum tax credit carryforward | 201 |
| | — |
|
Unrealized loss on securities available for sale | 2,091 |
| | 3,905 |
|
Net operating loss carryforward | 6,145 |
| | — |
|
Writedown of other real estate owned | 878 |
| | 1,266 |
|
Deferred compensation | 1,514 |
| | 1,966 |
|
Accrued interest on nonaccrual loans | 1,017 |
| | 1,701 |
|
Accrued incentives | 1,277 |
| | 2,627 |
|
Unfunded loan commitments & other reserves | 1,098 |
| | 1,452 |
|
Deferred rent | 801 |
| | 1,285 |
|
Other | 1,224 |
| | 1,966 |
|
Total deferred tax assets | 26,814 |
| | 34,395 |
|
Deferred tax liabilities: | | | |
Income from unconsolidated subsidiary | (380 | ) | | (623 | ) |
Depreciation of assets | (587 | ) | | (28 | ) |
Other | (338 | ) | | (429 | ) |
Total deferred tax liabilities | (1,305 | ) | | (1,080 | ) |
Net deferred tax asset | $ | 25,509 |
| | $ | 33,315 |
|
The Company has approximately $29.0 million of federal net operating losses and $0.2 million of AMT carryforwards which are subject to an annual limitation under IRC Section 382. The net operating losses expire in 2030 and the Company expects to utilize the losses prior to expiration.
Management assesses all available positive and negative evidence to estimate if sufficient future taxable income will be generated to utilize the existing deferred tax assets. Based on our evaluation, as of December 31, 2017, management has determined that no valuation allowance is necessary for the deferred tax assets because it is more likely than not that these assets will be realized through future reversals of existing temporary differences and future taxable income.
In accordance with FASB ASC Topic 740-10, “Accounting for Uncertainty in Income Taxes”, the Company has no material unrecognized tax benefits or accrued interest and penalties as of December 31, 2017. We do not expect the total amount of unrecognized tax benefits to significantly increase in the next twelve months. The Company records interest and penalties on unrecognized tax benefits as a component of noninterest expense.
First Commonwealth is subject to routine audits of our tax returns by the Internal Revenue Service (“IRS”) as well as all states in which we conduct business. During 2015, the IRS completed an examination of our 2013 federal tax return. The examination was closed with no adjustments. Generally, tax years prior to the year ended December 31, 2014 are no longer open to examination by federal and state taxing authorities.