Atlantic Coast Financial CORP

NOTE 14. INCOME TAXES

Income tax expense for the years ending December 31, 2017, 2016 and 2015 was as follows:

	December 31,		December 31,		December 31,
	2017		2016		2015
	(Dollars in Thousands)
Current – federal	$	1,751	$	961	$	–
Current – state		344		139		–
Deferred – federal		630		2,409		(684)
Deferred – state, net of federal tax effect		77		226		(31)
Provisional tax adjustment related to deferred tax assets devaluation from Tax Cuts and Jobs Act		1,641		–		–
Increase (decrease) in valuation allowance – federal		109		(93)		(7,905)
Increase (decrease) in valuation allowance – state		7		(10)		(887)
Income tax expense (benefit)	$	4,559	$	3,632	$	(9,507)

The effective tax rate differs from the statutory federal income tax rate for the years ending December 31, 2017, 2016 and 2015 as follows:

	December 31,			December 31,			December 31,
	2017			2016			2015
	(Dollars in Thousands)
Income taxes at current statutory rate of 34%	$	2,627		$	3,417		$	(608)
Increase (decrease) from:
State income tax, net of federal tax effect		278			318			(22)
Tax-exempt income		(35)			(32)			(31)
Increase in cash surrender value of bank owned life insurance		(160)			(158)			(163)
Nondeductible merger expenses		115			–			–
Stock option expense		–			171			6
Change related to Internal Revenue Code § 382 net operating loss carryover limitations		–			4			80
Provisional tax adjustment related to deferred tax assets devaluation from Tax Cuts and Jobs Act		1,641			–			–
Change in federal valuation allowance		109			(93)			(7,905)
Change in state valuation allowance		7			(10)			(887)
Other, net		(23)			15			23
Income tax expense (benefit)	$	4,559		$	3,632		$	(9,507)
Effective tax rate		59.0	%		36.1	%		n/a

Deferred tax assets and liabilities as of December 31, 2017 and 2016 were as follows:

	December 31, 2017		December 31, 2016
	(Dollars in Thousands)
Deferred tax assets:
Allowance for portfolio loan losses	$	2,183	$	3,027
Other real estate owned		15		894
Net operating loss carryover – limited by Internal Revenue Code § 382		1,257		2,010
Net unrealized loss on securities available-for-sale		233		518
Deferred loan fees		159		210
Alternative minimum tax credit		527		527
Other		785		936
Total deferred tax assets		5,159		8,122
Valuation allowance – federal		(90)		(24)
Valuation allowance – state		(12)		(3)
Total deferred tax assets, net of valuation allowance		5,057		8,095

Deferred tax liability:
Depreciation		(332)		(514)
Deferred loan costs		(223)		(271)
Prepaid expenses		(151)		(272)
Other		(243)		(286)
Total deferred tax liability		(949)		(1,343)
Net deferred tax asset	$	4,108	$	6,752

The Tax Cuts and Jobs Act (Tax Reform) was enacted on December 22, 2017. The Tax Reform reduced the corporate income tax rate to 21% effective January 1, 2018 and changed certain other provisions. Accounting guidance required the Company to remeasure its deferred tax assets and deferred tax liabilities using the new enacted tax rate. The Company has recorded additional expense of $1.6 million to reflect changes that resulted from the enactment of the Tax Reform. Notwithstanding the foregoing, we are still analyzing certain aspects of the new law and refining our calculations, which could affect the measurement of these assets and liabilities or give rise to new deferred tax amounts.

The Company considers at each reporting period all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance is needed to reduce its deferred tax assets to an amount that is more likely than not to be realized. A determination of the need for a valuation allowance for the deferred tax assets is dependent upon management’s evaluation of both positive and negative evidence.

As of both December 31, 2017 and 2016, the Company evaluated the expected realization of its federal and state deferred tax assets. Based on these evaluations, it was concluded that no valuation allowance was required for the federal and state deferred tax assets, with the exception of the remaining deferred tax asset related to a capital loss carryover, which resulted in a valuation allowance of $102,000 and $27,000 as of December 31, 2017 and 2016, respectively.

During the years ended December 31, 2017 and 2016, the Company used $0.3 million and $4.1 million of federal net operating loss carryover, while no federal net operating loss carryover was used during the year ended December 31, 2015. During the years ended December 31, 2017, 2016 and 2015, the Company used $0.3 million, $2.6 million and $0.1 million, respectively, of state net operating loss carryover.

Under the rules of Internal Revenue Code section 382 (IRC § 382), a change in the ownership of the Company occurred during the first quarter of 2013. During the third quarter of 2013, the Company became aware of the change in ownership based on applicable filings made by stockholders with the Securities and Exchange Commission (the SEC). In accordance with IRC § 382, the Company determined the gross amount of federal net operating loss carryover that it could utilize was limited to approximately $325,000 per year, excluding any net operating loss carryover that may be generated in the future. For federal purposes, only pre-change net operating loss carryforward remains. For state purposes, post-change, non-limited net operating loss carryforward remains. During the year ended December 31, 2017, $0.6 million of state net operating losses were generated.

As of December 31, 2017, the Company has a federal net operating loss carryover of $5.0 million which will expire between 2027 and 2033. There is no valuation allowance on this carryover. As of December 31, 2017, the Company has a state net operating loss carryover of $5.6 million which will expire between 2018 and 2033. There is no valuation allowance on this carryover.