17. INCOME TAXES

 

The Company files a consolidated federal income tax return. The provision for income taxes for the years ended December 31, 2017, 2016, and 2015 includes the following:

 

 

A reconciliation from the expected federal income tax expense computed at the statutory federal income tax rate to the actual income tax expense included in the consolidated statements of income is as follows:

 

 

Items that give rise to significant portions of the deferred tax accounts at December 31, 2017 and 2016 are as follows:

 

 

The passage of H.R. 1 on December 22, 2017 lowered the federal corporate tax rate to 21% from 35%.  Under ASC 740, the effects of changes in tax rates and laws on deferred tax balances are recorded as a component of income tax expense related to continuing operations for the period in which the law was enacted, even if the assets and liabilities related to items of accumulated other comprehensive income.  The Company re-measured its net deferred tax assets at the current 21% federal corporate tax rate and, as a result, the Company recorded a one-time charge of $13.1 million of income tax expense during the year ended December 31, 2017.  In addition, the FASB issued ASU 2018-02 related to the reclassification of certain tax effects stranded in accumulated OCI that would require the amounts to be reclassified to retained earnings.  As of December 31, 2017, the Company had $5.0 million of tax effects stranded in accumulated OCI as a result of the passage of H.R. 1.  The Company intends to comply with the final FASB guidance and will reclassify the amount stranded in accumulated OCI to retained earnings in the first quarter of 2018.

 

As of December 31, 2017, the Company had net deferred tax assets totaling $23.0 million. These deferred tax assets can only be realized if the Company generates sufficient taxable income in the future.  If it cannot, a valuation allowance is established. The Company regularly evaluates the reliability of deferred tax asset positions. In determining whether a valuation allowance is necessary, the Company considers the level of taxable income in prior years to the extent that carry backs are permitted under current tax laws, as well as estimates of future pre-tax and taxable income and tax planning strategies that would, if necessary, be implemented. The Company currently maintains a valuation allowance for certain state net operating losses that management believes it is more likely than not that such deferred tax assets will not be realized. The Company expects to realize the remaining deferred tax assets over the allowable carry back and/or carry forward periods. Therefore, no valuation allowance is deemed necessary against its remaining federal or remaining state deferred tax assets as December 31, 2017. However, if an unanticipated event occurs that materially changes pre-tax and taxable income in future periods, an increase in the valuation allowance may become necessary and it could be material to the Company’s financial statements.

 

As of December 31, 2017, the Company had state and local net operating loss carryovers of $15.3 million resulting in deferred tax assets of $608 thousand. These state and local net operating loss carryovers begin to expire after December 31, 2017 if not utilized. A valuation allowance of $608 thousand for these deferred tax assets had been recorded as of December 31, 2017 as management believes it is more likely than not that such deferred tax assets will not be realized.

 

During the years ended December 31, 2017 and 2016, $727 thousand in net deferred tax liabilities and $539 thousand of net deferred tax assets, respectively, were recorded as adjustments to other comprehensive income tax accounts.

 

The Company accounts for uncertain tax positions in accordance with FASB ASC Topic 740 for Income Taxes. The guidance clarifies the accounting and reporting for income taxes where interpretation of the tax law may be uncertain. The FASB prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of income tax uncertainties with respect to positions taken or expected to be taken in income tax returns. The uncertain tax liability for uncertain tax positions was zero at December 31, 2017 and December 31, 2016. The tax year 2016 remains subject to examination by the IRS. The 2013 through 2016 tax years remain subject to examination by various state and local taxing authorities. For 2017, the Bank’s maximum federal income tax rate was 35%.

 

The Company recognizes, when applicable, interest and penalties related to unrecognized tax positions in the provision for income taxes in the consolidated statement of income. No interest or penalties were incurred during the years ended December 31, 2017 and 2016.

 

Pursuant to accounting guidance, the Company is not required to provide deferred taxes on its tax loan loss reserve as of December 31, 1987. As of December 31, 2017 and 2016, the Company had unrecognized deferred income taxes of approximately $1.4 million with respect to this reserve. This reserve could be recognized as taxable income and create a current and/or deferred tax liability using the income tax rates then in effect if one of the following occur: (1) the Bank’s retained earnings represented by this reserve are used for distributions in liquidation or for any other purpose other than to absorb losses from bad debts; (2) the Bank fails to qualify as a Bank, as provided by the Internal Revenue Code; or (3) there is a change in federal tax law.