Note 14—INCOME TAXES
Income tax expense for the years ended December 31, 2017, 2016 and 2015 consists of the following:
| Year ended December 31 | ||||||||||||
| (Dollars in thousands) | 2017 | 2016 | 2015 | |||||||||
| Current | ||||||||||||
| Federal | $ | 1,665 | $ | 2,491 | $ | 2,116 | ||||||
| State | 92 | 36 | 387 | |||||||||
| 1,757 | 2,627 | 2,503 | ||||||||||
| Deferred | ||||||||||||
| Federal | 1,573 | (460 | ) | (227 | ) | |||||||
| State | — | — | — | |||||||||
| 1,573 | (460 | ) | (227 | ) | ||||||||
| Income tax expense | $ | 3,330 | $ | 2,167 | $ | 2,276 | ||||||
Reconciliation from expected federal tax expense to effective income tax expense (benefit) for the periods indicated are as follows:
| Year ended December 31 | ||||||||||||
| (Dollars in thousands) | 2017 | 2016 | 2015 | |||||||||
| Expected federal income tax expense | $ | 3,109 | $ | 3,009 | $ | 2,857 | ||||||
| State income tax net of federal benefit | 61 | 90 | 255 | |||||||||
| Tax exempt interest | (593 | ) | (608 | ) | (531 | ) | ||||||
| Increase in cash surrender value life insurance | (212 | ) | (206 | ) | (139 | ) | ||||||
| Valuation allowance | 216 | 2 | 35 | |||||||||
| Merger expenses | 92 | — | — | |||||||||
| Low income housing tax credits | (186 | ) | (186 | ) | (186 | ) | ||||||
| Excess tax benefit of stock compensation | (197 | ) | — | — | ||||||||
| Deferred tax adjustment resulting from tax rate change | 1,247 | — | — | |||||||||
| Other | (207 | ) | 66 | (15 | ) | |||||||
| $ | 3,330 | $ | 2,167 | $ | 2,276 | |||||||
The following is a summary of the tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities:
| December 31, | ||||||||
| (Dollars in thousands) | 2017 | 2016 | ||||||
| Assets: | ||||||||
| Allowance for loan losses | $ | 1,250 | $ | 1,798 | ||||
| Excess tax basis of deductible intangible assets | 554 | 293 | ||||||
| Excess tax basis of assets acquired | 184 | 215 | ||||||
| Net operating loss carry forward | 891 | 424 | ||||||
| Unrealized loss on available for sale securities | 118 | 642 | ||||||
| Compensation expense deferred for tax purposes | 909 | 1,286 | ||||||
| Deferred loss on other-than-temporary-impairment charges | 5 | 8 | ||||||
| Tax credit carry-forwards | 73 | 17 | ||||||
| Other | 351 | 675 | ||||||
| Total deferred tax asset | 4,335 | 5,358 | ||||||
| Valuation reserve | 705 | 489 | ||||||
| Total deferred tax asset net of valuation reserve | 3,630 | 4,869 | ||||||
| Liabilities: | ||||||||
| Tax depreciation in excess of book depreciation | 358 | 357 | ||||||
| Excess financial reporting basis of assets acquired | 1,211 | 1,310 | ||||||
| Total deferred tax liabilities | 1,569 | 1,667 | ||||||
| Net deferred tax asset recognized | $ | 2,061 | $ | 3,202 | ||||
At December 31 2017 the Company has approximately $15.2 million in State net operating losses. A valuation allowance is established to fully offset the deferred tax asset related to these net operating losses of the holding company as well as capital losses of $103 thousand for which realizability is uncertain. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which the temporary differences become deductible. Management considers the scheduled reversal of deferred income tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Additional amounts of these deferred tax assets considered to be realizable could be reduced in the near term if estimates of future taxable income during the carry forward period are reduced. The net deferred asset is included in other assets on the consolidated balance sheets.
On December 22, 2017, the Tax Cuts and Jobs Act was signed into law. The Tax Cuts and Jobs Act reduces the corporate tax rate to 21% from 35%, effective for 2018, among other things. As a result of the change in tax rates we revalued our deferred tax assets and liabilities to reflect realization at the lower rate effective December 22, 2017, the date the law was enacted. The impact of this adjustment was to increase our deferred tax expense by approximately $1.2 million for the year ended December 31, 2017. The lower tax rate will decrease the overall tax rate in future periods.
A portion of the change in the net deferred tax asset relates to unrealized gains and losses on securities available-for-sale. The change in the tax expense related to the change in unrealized losses on these securities of $524 thousand has been recorded directly to shareholders’ equity. The portion of the change on unrealized losses on the securities related directly to the change in tax rates was adjusted through tax expense and amounted to approximately $149 thousand and it is included in the overall $1.2 million adjustment related to the tax rate change. The balance in the change in net deferred tax asset results from the current period deferred tax expense of $617 thousand, purchase accounting adjustments of $216 thousand and net deferred tax assets acquired in the Cornerstone transaction of approximately $1.2 million. At December 31, 2017 the Company had a federal net operating loss carryforward in the amount of $1.4 million acquired in the Cornerstone transaction. There are statutory limitations on the amount that can be utilized in each year. It is anticipated that all of the net operating loss will be utilized prior to expiration.
Tax returns for 2014 and subsequent years are subject to examination by taxing authorities.
As of December 31, 2017, the Company had no material unrecognized tax benefits or accrued interest and penalties. It is the Company’s policy to account for interest and penalties accrued relative to unrecognized tax benefits as a component of income tax expense.