| (17) | Income Taxes |
Income tax expense is as follows for the years indicated (in thousands):
| Year Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| Current | $ | 5,451 | $ | 2,609 | $ | 5,140 | ||||||
| Deferred | 60,951 | 59,160 | 37,685 | |||||||||
| Increase in valuation allowance | 413 | 567 | 611 | |||||||||
| Expense due to enactment of federal tax reform | 38,198 | - | - | |||||||||
| Total income tax expense | $ | 105,013 | $ | 62,336 | $ | 43,436 | ||||||
The differences between the provision for income taxes and the amount computed by applying the statutory federal income tax rate of 35% to income before income taxes are as follows for the years indicated (in thousands):
| Year Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| Pretax income at statutory rates | $ | 60,492 | $ | 57,047 | $ | 40,255 | ||||||
| Add (deduct): | ||||||||||||
| State taxes, net of federal benefit | 4,139 | 5,013 | 3,537 | |||||||||
| Bank owned life insurance earnings | (1,141 | ) | (572 | ) | (348 | ) | ||||||
| Adjustment to reserve for uncertain tax positions | 59 | (58 | ) | (136 | ) | |||||||
| Tax-exempt interest revenue | (1,199 | ) | (573 | ) | (662 | ) | ||||||
| Equity compensation | (799 | ) | 976 | - | ||||||||
| Transaction costs | 408 | 92 | 509 | |||||||||
| Tax credit investments | (89 | ) | (149 | ) | (190 | ) | ||||||
| Change in state statutory tax rate | 81 | 250 | 340 | |||||||||
| Increase in valuation allowance | 413 | 567 | 611 | |||||||||
| Release of disproportionate tax effects related to de-designated cash flow hedges | 3,400 | - | - | |||||||||
| Expense due to enactment of federal tax reform | 38,198 | - | - | |||||||||
| Other | 1,051 | (257 | ) | (480 | ) | |||||||
| Total income tax expense | $ | 105,013 | $ | 62,336 | $ | 43,436 | ||||||
The Tax Act reduced the corporate federal tax rate from 35% to 21% effective January 1, 2018. As a result, United was required to re-measure, through income tax expense, the deferred tax assets and liabilities using the enacted rate at which they are expected to be recovered or settled. The re-measurement of the net deferred tax asset resulted in additional income tax expense of $38.2 million. As explained in Note 1, pursuant to SAB 118, United continues to analyze the Tax Act, including the impact on deductibility of certain executive compensation and alternative minimum tax credits disclosed further below, and any refinements to the provisional accounting will be completed within one year of the tax enactment date.
The following summarizes the sources and expected tax consequences of future taxable deductions (revenue) which comprise the net deferred tax asset as of the dates indicated (in thousands):
| December 31, | ||||||||
| 2017 | 2016 | |||||||
| Deferred tax assets: | ||||||||
| Allowance for loan losses | $ | 14,092 | $ | 23,025 | ||||
| Net operating loss carryforwards | 56,428 | 112,805 | ||||||
| Deferred compensation | 7,760 | 9,778 | ||||||
| Loan purchase accounting adjustments | 14,478 | 10,529 | ||||||
| Reserve for losses on foreclosed properties | 402 | 822 | ||||||
| Nonqualified share based compensation | 1,182 | 1,567 | ||||||
| Accrued expenses | 4,290 | 4,420 | ||||||
| Investment in partnerships | 956 | 1,417 | ||||||
| Unamortized pension actuarial losses and prior service cost | 2,008 | 2,365 | ||||||
| Unrealized losses on securities available-for-sale | 2,430 | 3,982 | ||||||
| Unrealized losses on cash flow hedges | 108 | 561 | ||||||
| Derivatives | - | 609 | ||||||
| Premises and equipment | 1,040 | 764 | ||||||
| Other | 3,065 | 2,965 | ||||||
| Total deferred tax assets | 108,239 | 175,609 | ||||||
| Deferred tax liabilities: | ||||||||
| Acquired intangible assets | 3,734 | 3,485 | ||||||
| Loan origination costs | 3,881 | 5,885 | ||||||
| Prepaid expenses | 468 | 689 | ||||||
| Servicing asset | 3,757 | 3,437 | ||||||
| Derivatives | 773 | - | ||||||
| Uncertain tax positions | 3,163 | 3,892 | ||||||
| Total deferred tax liabilities | 15,776 | 17,388 | ||||||
| Less valuation allowance | 4,414 | 3,885 | ||||||
| Net deferred tax asset | $ | 88,049 | $ | 154,336 | ||||
The change in the net deferred tax asset includes an increase of $43.8 million due to current year merger and acquisition activity.
At December 31, 2017, United has state net operating loss carryforwards of approximately $3.73 million that begin to expire in 2018, $10.5 million that begin to expire in 2022 and $398 million that begin to expire in 2030, if not previously utilized. United has $36.7 million in federal net operating loss carryforwards that begin to expire in 2031, if not previously utilized. United has $109 million in federal net operating loss carryforwards subject to annual limitation under IRC Section 382 that begin to expire in 2027, if not previously utilized. United has $3.23 million of federal general business tax credits that begin to expire in 2028, if not previously utilized. United has $13.1 million of federal alternative minimum tax credits which do not expire, and are now carried as tax receivables since, under the Tax Act, the company expects to recover the entire amount by 2022 via reduction of regular tax liability or refund. United has $1.23 million of federal alternative minimum tax credits, which do not expire, subject to annual limitation under IRC Section 382 that are not expected to be recovered until after 2022 and remain classified as deferred tax assets. United has $5.91 million of state tax credits that begin to expire in 2018, if not previously utilized.
At December 31, 2017 and 2016, based on the assessment of all the positive and negative evidence, management concluded that it is more likely than not that nearly all of the net deferred tax asset will be realized based upon future taxable income. The valuation allowance of $4.41 million is related to specific state income tax credits that have short carryforward periods and an acquired state net operating loss, both of which are expected to expire unused.
The valuation allowance could fluctuate in future periods based on the assessment of the positive and negative evidence. Management’s conclusion at December 31, 2017 that it was more likely than not that the net deferred tax asset of $88.0 million will be realized is based on management’s estimate of future taxable income. Management’s estimate of future taxable income is based on internal forecasts which consider historical performance, various internal estimates and assumptions, as well as certain external data all of which management believes to be reasonable although inherently subject to significant judgment. If actual results differ significantly from the current estimates of future taxable income, even if caused by adverse macro-economic conditions, the valuation allowance may need to be increased for some or all the deferred tax asset. Such an increase to the deferred tax asset valuation allowance could have an adverse effect on United’s financial condition and results of operations.
A reconciliation of the beginning and ending unrecognized tax benefit related to uncertain tax positions is as follows for the years indicated (in thousands):
| 2017 | 2016 | 2015 | ||||||||||
| Balance at beginning of year | $ | 3,892 | $ | 3,981 | $ | 4,195 | ||||||
| Additions based on tax positions related to the current year | 441 | 400 | 371 | |||||||||
| Decreases resulting from a lapse in the applicable statute of limitations | (351 | ) | (489 | ) | (585 | ) | ||||||
| Remeasurement due to enactment of federal tax reform | (819 | ) | - | - | ||||||||
| Balance at end of year | $ | 3,163 | $ | 3,892 | $ | 3,981 | ||||||
Approximately $2.76 million of this amount would increase income from continuing operations, and thus affect United’s effective tax rate, if ultimately recognized into income.
It is United’s policy to recognize interest and penalties accrued relative to unrecognized tax benefits in their respective federal or state income taxes accounts. There were no penalties and interest related to income taxes recorded in the income statement in 2017, 2016 or 2015. No amounts were accrued for interest and penalties on the balance sheet at December 31, 2017 or 2016.