Northwest Bancshares, Inc.

Income Taxes

Total income tax was allocated for the years ended December 31, 2017, 2016 and 2015 as follows:



	Years ended December 31,
	2017			2016		2015
Income before income taxes	$	41,444		21,648		27,960
Shareholders’ equity for unrealized (loss)/ gain on securities available-for-sale	(3,403		)	(1,871	)	(85	)
Shareholders’ equity for tax benefit for excess of fair value above cost of stock benefit plans	—			(1,425	)	(332	)
Shareholders’ equity for pension adjustment	(213		)	(2,455	)	(848	)
Shareholders’ equity for swap fair value adjustment	585			539		699
Unallocated income tax	$	38,413		16,436		27,394

Income tax expense applicable to income before taxes consists of:



	Years ended December 31,
	2017		2016	2015
Current	$	30,127	18,914	21,670
Deferred	11,317		2,734	6,290
Total income tax expense	$	41,444	21,648	27,960

A reconciliation of the expected federal statutory income tax rate to the effective rate, expressed as a percentage of pretax income for the years ended December 31, 2017, 2016 and 2015, is as follows:



	Years ended December 31,
	2017		2016		2015
Expected tax rate	35.0	%	35.0	%	35.0	%
Tax-exempt interest income	(1.5	)%	(3.3	)%	(3.0	)%
State income tax, net of federal benefit	3.2	%	1.2	%	2.9	%
Bank-owned life insurance	(1.6	)%	(2.6	)%	(1.7	)%
Stock-based compensation	(0.9	)%	—	%	—	%
Dividends on stock plans	(1.1	)%	(2.0	)%	(0.8	)%
Low income housing and historic tax credits	(0.5	)%	(1.0	)%	(1.4	)%
Non-deductible acquisition expense	—	%	—	%	0.5	%
ESOP termination	—	%	3.4	%	—	%
Adjustment to net deferred tax liabilities for enacted changes in tax laws and rates	(2.3	)%	—	%	—	%
Other	0.2	%	(0.3	)%	0.1	%
Effective tax rate	30.5	%	30.4	%	31.6	%

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



	December 31,
	2017		2016
Deferred tax assets:
Deferred rent	$	87	187
Deferred compensation expense	1,040		2,893
Bad debts	10,277		18,823
Other reserves	953		1,823
Accrued postretirement benefit cost	413		641
Stock benefit plans	744		1,085
Writedown of investment securities	104		2,875
Accrued expenses	35		95
Pension and postretirement benefits	13,033		18,491
Unrealized loss on the fair value of derivatives	223		958
Unrealized loss on the fair value of securities available-for-sale	2,160		—
Purchase accounting	—		1,215
Deferred income	1,001		253
Other	141		153
Total deferred tax assets	30,211		49,492
Deferred tax liabilities:
Pension expense	5,542		8,689
Unrealized gain on the fair value of securities available-for-sale	—		252
Purchase accounting	303		—
Intangible assets	13,546		21,927
Mortgage servicing rights	777		1,559
Fixed assets	4,940		8,107
Net deferred loan fees	4,690		—
Other	274		635
Total deferred tax liabilities	30,072		41,169
Net deferred tax asset	$	139	8,323

We recorded a valuation allowance against state deferred tax assets of a Northwest subsidiary since the subsidiary is not expected to utilize its deferred tax assets in the foreseeable future. This valuation allowance is netted against other deferred tax assets in the preceding table.

Other than stated above, we have determined that no valuation allowance is necessary for the deferred tax assets because it is more likely than not that these assets will be realized through future reversals of existing temporary differences and through future taxable income. We will continue to review the criteria related to the recognition of deferred tax assets on a regular basis.

We utilize a comprehensive model to recognize, measure, present and disclose in our financial statements uncertain tax positions that the company has taken or expects to take on a tax return. At December 31, 2017, there were no unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate. We recognize interest accrued and penalties (if any) related to unrecognized tax benefits in income tax expense. During the year ended December 31, 2017, we did not accrue any interest. At December 31, 2017, we had no amount accrued for interest or the payment of penalties.

We are subject to routine audits of our tax returns by the Internal Revenue Service as well as all states in which we conduct business. We are subject to audit by the Internal Revenue Service for the tax periods ended December 31, 2017, 2016, 2015 and 2014 and subject to audit by any state in which we conduct business for the tax periods ended December 31, 2017, 2016, 2015 and 2014. The New York State audit of the Company's 2011to 2014 tax years was finalized in 2016, resulting in an additional tax liability of $444,000. The Internal Revenue Service audit of the 2013 tax year of LNB was concluded in 2016 and resulted in no additional tax liability.

The Act reduces our corporate federal tax rate from 35.0% to 21.0% effective January 1, 2018. As a result we are required to re-measure, through income tax expense, our deferred tax assets and liabilities using the enacted rate at which we expect them to be recovered or settled. The re-measurement of our net deferred tax liability resulted in a 2017 income tax benefit of $3.1 million.

Also on December 22, 2017, the U.S. Securities and Exchange Commission (“SEC”) released Staff Accounting Bulletin No. 118 (“SAB 118”) to address any uncertainty or diversity of views in practice in accounting for the income tax effects of the Act in situations where a registrant does not have the necessary information available, prepared, or analyzed in reasonable detail to complete this accounting in the reporting period that includes the enactment date. SAB 118 allows for a measurement period not to extend beyond one year from the Act’s enactment date to complete the necessary accounting.

We recorded provisional amounts of deferred income taxes using reasonable estimates in five areas where information necessary to complete the accounting was not available, prepared, or analyzed: (i) our deferred tax liability for temporary differences between the tax and financial reporting bases of fixed assets is awaiting completion and implementation of software updates to process the calculations associated with the Act's provisions allowing for 100% bonus depreciation on fixed assets purchased and placed in service after September 27, 2017; (ii) our deferred tax asset for temporary differences associated with accrued compensation is awaiting final determinations of amounts that will be paid on or before March 15, 2018 and deducted on the 2017 income tax returns; (iii) our deferred tax liability for temporary differences associated with equity investments in partnerships is awaiting receipt of Schedules K-1 from outside preparers, which is necessary to determine our 2017 tax impact from these investments; (iv) our deferred tax liability for temporary differences related to our qualified pension plan is based upon actuarial reports from our third party provider, however we are still in the process of determining if a contribution related to the 2017 plan year will be made; (v) our deferred tax liability for temporary differences related to deferred loans fees is based upon the assumption the IRS will accept the tax treatment requested in the consent change in tax accounting method filed in 2017.

In a sixth area, we made no adjustments to deferred tax assets representing future deductions for accrued compensation that may be subject to new limitations under Internal Revenue Code Section 162(m) which, generally, limits the annual deduction for certain compensation paid to certain employees to $1 million. There is uncertainty in applying the newly-enacted rules to existing contracts, and we are seeking further clarifications before completing our analysis. We will complete and record the income tax effects of these provisional items during the period the necessary information becomes available. This measurement period will not extend beyond December 22, 2018.