WINTRUST FINANCIAL CORP

Income Taxes

Income tax expense (benefit) for the years ended December 31, 2017, 2016 and 2015 is summarized as follows:



	Years Ended December 31,
(Dollars in thousands)	2017		2016			2015
Current income taxes:
Federal	$	54,977	$	98,272		$	62,584
State	12,852		20,041			9,417
Foreign	1,243		(10		)	(39		)
Total current income taxes	$	69,072	$	118,303		$	71,962
Deferred income taxes:
Federal	$	51,668	$	4,464		$	15,550
State	10,403		(14		)	5,962
Foreign	1,172		2,226			1,542
Total deferred income taxes	$	63,243	$	6,676		$	23,054
Total income tax expense	$	132,315	$	124,979		$	95,016

The Company's income before income taxes in 2017, 2016 and 2015 includes $7.8 million, $7.0 million and $3.9 million, respectively, of foreign income attributable to its Canadian subsidiary.

The tax effect of fair value adjustments on securities available-for-sale and derivative instruments in cash flow hedges are recorded directly to shareholders' equity as part of other comprehensive income (loss) and are reflected on the Consolidated Statements of Comprehensive Income. In addition, a tax benefit (expense) of $230,000 and $(1.9) million in 2016 and 2015, respectively, related to stock-based compensation, reflecting the excess (deficit) of realized tax benefits over expected tax benefits, was recorded directly to shareholders' equity. In 2017, this excess tax benefit on stock-based compensation was $6.2 million and was recorded in tax expense.

A reconciliation of the differences between taxes computed using the statutory Federal income tax rate of 35% and actual income tax expense is as follows:



	Years Ended December 31,
(Dollars in thousands)	2017			2016			2015
Income tax expense using the statutory Federal income tax rate of 35% on income before income taxes	$	136,499		$	116,149		$	88,118
Increase (decrease) in tax resulting from:
Tax-exempt interest, net of interest expense disallowance	(4,658		)	(3,634		)	(2,878		)
State taxes, net of federal tax benefit	15,115			13,017			9,996
Income earned on bank owned life insurance	(1,167		)	(1,198		)	(1,562		)
Excess tax benefits on share based compensation	(5,470		)	—			—
Enactment of Tax Cuts and Jobs Act
Re-measurement of net deferred tax liabilities	(10,402		)	—			—
Transition tax on deferred foreign earnings	2,850			—			—
Meals, entertainment and related expenses	1,710			1,439			1,283
Foreign subsidiary, net	(271		)	(264		)	148
Tax benefits related to tax credit investments, net	(698		)	(572		)	(778		)
Other, net	(1,193		)	42			689
Income tax expense	$	132,315		$	124,979		$	95,016

The Tax Cuts and Jobs Act (the “Tax Act”) was enacted on December 22, 2017, and ASC 740 requires us to reflect the changes associated with the Tax Act’s provisions in the fourth quarter of 2017. The Tax Act is complex and has extensive implications for the Company’s federal, state and foreign taxes. Among other things, the Tax Act reduces the corporate federal income tax rate from 35% to 21% and creates a territorial tax system with a one-time mandatory tax on previously deferred foreign earnings. Also on December 22, 2017, the SEC issued Staff Accounting Bulletin 118 (SAB 118), which provides guidance on accounting for the Tax Act’s impact. SAB 118 provides a measurement period, not to extend beyond one year from the date of enactment during which a company, acting in good faith, may complete the accounting for the impacts of the Tax Act. At December 31, 2017, the Company’s accounting for the impact of the Tax Act on its net deferred tax liabilities and its deferred foreign earnings at its Canadian subsidiary is based upon reasonable estimates of the tax effects of the Tax Act; however, these estimates may change as additional information and interpretive guidance regarding the provisions of the Tax Act become available. In 2017, the Company recognized a provisional tax benefit of $7.6 million to reflect the impact of enactment of the Tax Act. The Company will complete its accounting for the Tax Act during 2018 as provided in SAB 118 and will reflect any adjustments to its provisional amounts as an adjustment to the provision for taxes in the reporting period in which the amounts are finally determined.

Included in the provisional tax benefit recorded for the re-measurement of the Company’s net deferred tax liabilities were deferred items for which the tax effects were originally established through OCI. This results in a disproportionate tax effect for those items still recorded in AOCI. Under current GAAP, those items would continue to be reported in AOCI until such time as the underlying transactions were settled and would then be reclassified as a component of the provision for income taxes. However, in February 2018, the FASB issued an ASU that permits entities to reclassify the tax effects stranded in AOCI as a result of the Tax Act to retained earnings. The guidance is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption in any period permitted. The Company did not early adopt this guidance in 2017. The Company is currently evaluating the impact of adopting this new guidance on the consolidated financial statements.

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31, 2017 and 2016 are as follows:




(Dollars in thousands)	2017			2016
Deferred tax assets:
Allowance for credit losses	$	36,442		$	46,519
Deferred compensation	12,310			28,125
Net unrealized losses on securities included in other comprehensive income	7,465			19,036
Stock-based compensation	6,898			9,704
Loans	4,943			5,055
Other real estate owned	4,019			7,151
Federal net operating loss carryforward	3,063			7,624
AMT credit carryforward	1,199			1,872
Nonaccrued interest	983			1,884
Mortgage banking recourse obligation	722			2,025
Covered assets	—			18,484
Foreign net operating loss carryforward	—			3,476
Other	2,307			2,408
Total gross deferred tax assets	80,351			153,363
Deferred tax liabilities:
Equipment leasing	42,681			28,440
Premises and equipment	23,211			31,053
Capitalized servicing rights	8,916			7,326
Goodwill and intangible assets	7,619			10,085
Deferred loan fees and costs	3,531			5,131
Net unrealized gains on derivatives included in other comprehensive income	3,197			2,732
Fair value adjustments on loans	3,143			3,163
FHLB stock dividends	—			346
Other	3,433			6,334
Total gross deferred liabilities	95,731			94,610
Net deferred tax assets (liabilities)	$	(15,380	)	$	58,753

Management has determined that a valuation allowance is not required for the deferred tax assets at December 31, 2017 because it is more likely than not that these assets could be realized through future reversals of existing taxable temporary differences, tax planning strategies and future taxable income. This conclusion is based on the Company's historical earnings, its current level of earnings and prospects for continued growth and profitability.

The Company has a Federal alternative minimum tax (“AMT”) credit carryforward of $1.2 million which is subject to IRC Section 383 annual limitation. The AMT credit has no expiration date and pursuant to the Tax Act will be fully refundable by 2021. The Company has a Federal net operating loss (“NOL”) carryforward of $14.6 million that begins to expire in 2028 through 2035 and is subject to IRC Section 382 annual limitation. The AMT credit and the NOL carryforwards were a result of acquisitions made in 2012, 2013, 2015 and 2016. Management believes it is more likely than not that it will be able to fully utilize the AMT Credit and NOL carryforwards in future tax years.

The Company accounts for uncertainties in income taxes in accordance with ASC 740, Income Taxes. The following table provides a reconciliation of the beginning and ending amounts of gross unrecognized tax benefits:



	Years Ended December 31,
(Dollars in thousands)	2017			2016		2015
Unrecognized tax benefits at beginning of year	$	11,626		$	—	$	—
Gross increases for tax positions taken in current period	—			—		—
Gross (decreases) increases for positions taken in prior periods	(805		)	11,626		—
Unrecognized tax benefits at end of the year	$	10,821		$	11,626	$	—

At December 31, 2017, the Company had $8.5 million of unrecognized tax benefits related to uncertain tax positions that, if recognized, would impact the effective tax rate. Interest and penalties on unrecognized tax positions are recorded in income tax expense. Total interest income accrued at December 31, 2017 and 2016 on unrecognized tax benefits was $921,000 and $521,000, respectively, net of tax effect. Interest and penalties are included in the liability for uncertain tax positions, but are not included in the unrecognized tax benefits rollforward presented above. The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months.

The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax in numerous state jurisdictions and in Canada. In the ordinary course of business we are routinely subject to audit by the taxing authorities of these jurisdictions. Currently, the Company's U.S. federal income tax returns are open and subject to audit for the 2014 tax return year forward, and in general, the Company's state income tax returns are open and subject to audit from the 2014 tax return year forward, subject to individual state statutes of limitation. The Company's Canadian subsidiary's Canadian income tax returns are also subject to audit for the 2014 tax return year forward.