SEVERN BANCORP INC

Note 15 – Income Taxes

Our income tax expense (benefit) consists of the following for the years ended December 31:

	2017		2016
	(dollars in thousands)
Current	$	228	$	67
Deferred		4,794		(10,081	)
Income tax expense	$	5,022	$	(10,014	)

The income tax expense (benefit) is reconciled to the amount computed by applying the federal corporate tax rate of 34% to the net income before taxes as follows for the years ended December 31:

	2017						2016
	Amount			Rate			Amount			Rate
	(dollars in thousands)
Tax at statutory federal rate	$	2,666			34.0	%	$	1,879			34.0	%
Change in valuation allowance		-			-			(12,485	)		(225.9	)%
Adjustment for rate change		1,887			24.1	%		-			-
State tax net of Federal income tax benefit		616			7.9	%		323			5.8	%
Other adjustments		(147	)		(1.9	)%		269			4.9	%
	$	5,022			64.1	%	$	(10,014	)		(181.2	)%

The tax effects of temporary differences between the financial reporting basis and income tax basis of assets and liabilities relate to the following at December 31:

	2017		2016
Deferred tax assets:	(dollars in thousands)
Net operating loss carryforward	$	3,446	$	7,148
Allowance		3,201		4,636
Reserve on real estate acquired through foreclosure		135		161
Reserve for uncollected interest		108		433
Reserve for contingent liability		31		56
Charitable contributions		127		297
Unrealized losses on AFS securities		15		-
AMT		351		192
Total gross deferred tax assets		7,414		12,923
Deferred tax liabilities:
FHLB stock dividends		61		82
Loan origination costs		534		801
Accelerated depreciation		1,122		1,473
Prepaid expenses		239		264
MSRs		140		220
Other		16		2
Total gross deferred tax liabilities		2,112		2,842
Net deferred tax assets	$	5,302	$	10,081

At December 31, 2017, federal net operating losses totaled $10.8 million and expire in 2033 and 2034. The state net operating losses totaled $17.9 million and expire at various times from 2023 through 2033.

In assessing the realizability of federal or state deferred tax assets at December 31, 2017, management considered whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during periods in which those temporary differences become deductible. Management considered the scheduled reversal of deferred tax liabilities, projected future taxable income and prudent, feasible, and permissible, as well as available, tax planning strategies in making this assessment. Given the consistent earnings and improving asset quality, the Company’s analysis concluded that, as of December 31, 2017, it was more likely than not that it will generate sufficient taxable income within the applicable carry-forward periods to realize its net deferred tax asset. The Company will continue to have the benefit of the net operating loss carryforward relating to the deferred tax asset and will have the ability to utilize the carryforward against future federal and state income taxes.

Management performed a similar analysis at June 30, 2016, with the same result and reversed the full valuation allowance carried on the net deferred tax asset at the time of $11.8 million to income tax expense.

On December 22, 2017, H.R.1, commonly known as the Tax Cut and Jobs Act (“Tax Act”), was signed into law. The Tax Act includes many provisions that will effect the Company’s income tax expenses, including reducing the corporate federal tax rate from 34% to 21% effective January 1, 2018. As a result of the rate reduction, the Company was required to re-measure, through income tax expense in the period of enactment, its deferred tax assets and liabilities using the enacted rate at which the Company expects them to be recovered or settled. The re-measurement of the net deferred tax asset resulted in additional income tax expense of $1.9 million.

The statute of limitations for Internal Revenue Service examination of the Company’s federal consolidated tax returns remains open for tax years 2014 through 2017.

Our income tax returns are subject to review and examination by federal and state taxing authorities. We are no longer subject to examination by federal tax authorities for the years ended before 2013. The years open to examination by state taxing authorities vary by jurisdiction.