State National Companies, Inc.

7. Income Tax Provision

The shareholders previously consented to elections for certain entities in the Company to be treated as S Corporations under Internal Revenue Code Section 1362(a). As a result of these elections, federal income taxes prior to June 25, 2014 are recorded only for State National Intermediate Holdings, Inc. (“SNIH”), State National Insurance Company, Inc. (“SNIC”), National Specialty Insurance Company (“NSIC”) and United Specialty Insurance Company (“USIC”), as they remained C Corporations and filed a consolidated federal income tax return. On June 25, 2014, the Company completed a private placement of common stock which resulted in termination of its S Corporation status. As a result, the Company is taxed as a C Corporation and filed a consolidated short period federal income tax return with its subsidiaries for the period June 26 through December 31, 2014. Income for the Company’s pass-through entities was taxed (for federal purposes) to the individual owners during the short period January 1 through June 25, 2014. The Company recorded a net deferred income tax benefit of $19.3 million related to this change in tax status.

The components of income tax expense for the years ended December 31 are as follows:


2016
($ in thousands)	Federal		State		Total
Federal and state income tax expense (benefit)
Current	$	28,457	$	1,626	$	30,083
Deferred		(2,431)		84		(2,347)
Total income tax expense (benefit)	$	26,026	$	1,710	$	27,736


2015
($ in thousands)	Federal		State		Total
Federal and state income tax expense (benefit)
Current	$	24,019	$	1,722	$	25,741
Deferred		(794)		(59)		(853)
Total income tax expense (benefit)	$	23,225	$	1,663	$	24,888


2014
($ in thousands)	Federal		State		Total
Federal and state income tax expense (benefit)
Current	$	10,827	$	687	$	11,514
Deferred		(21,156)		(54)		(21,210)
Total income tax expense (benefit)	$	(10,329)	$	633	$	(9,696)

Deferred income taxes reflect the effect of temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities. The components of the net deferred income tax asset are as follows at December 31:


($ in thousands)	2016		2015
Deferred income tax assets:
Allowance for policy cancellations	$	23,246	$	20,864
Unpaid losses and loss adjustment expenses		182		156
Deferred ceding fees		11,279		10,192
Management fee		37		111
Compensation		4,117		3,638
Intangible assets		514		376
Unrealized losses on equity securities		123		31
Unrealized losses on fixed maturities and other investment securities		1,261		1,305
Write-down of other-than-temporarily impaired investment securities		111		249
Other		33		116
Total deferred income tax assets		40,903		37,038

Deferred income tax liabilities:
Unearned premiums		8,412		7,522
Unrealized gains on equity securities		107		292
Unrealized gains on fixed maturities and other investment securities		2,001		1,920
Deferred acquisition costs		418		376
Fixed assets		131		302
Other		976		418
Total deferred income tax liabilities		12,045		10,830
Net deferred income tax asset	$	28,858	$	26,208

No valuation allowance was recorded at December 31, 2016 and 2015, as the temporary differences disclosed above relate to deferred income tax assets that are more-likely-than-not to be realized in future years.

In the second quarter of 2014, the Company revised its provision for income taxes to reflect a change in the federal statutory rate from 34.3% to 35.0%, effective January 1, 2014. A reconciliation of federal income tax expense computed by applying the federal statutory tax rate to income before federal income tax expense for the periods ended December 31 follows:


	2016				2015				2014
			Effective				Effective				Effective
($ in thousands)	Amount		Tax Rate		Amount		Tax Rate		Amount		Tax Rate
Expected tax expense (benefit)	$	26,885	35.0	%	$	24,344	35.0	%	$	461	35.0	%
Exclusion of Subchapter S income		—	—			—	—			8,465	643.0
Change in tax status		—	—			—	—			(19,316)	(1,467.2)
Change in federal statutory rate		—	—			—	—			(75)	(5.7)
Accrual/adjustment prior year		—	—			(175)	(0.2)			174	13.2
Tax-exempt income		(379)	(0.5)			(432)	(0.6)			(304)	(23.1)
State income taxes		1,140	1.5			1,060	1.5			826	62.8
Meals and entertainment		109	0.1			94	0.1			61	4.6
Other		(19)	—			(3)	—			12	0.8
Total income tax expense (benefit)	$	27,736	36.1	%	$	24,888	35.8	%	$	(9,696)	(736.6)	%

The Company recognizes interest and penalties related to uncertain tax positions in general and administrative expenses. There were no uncertain tax positions at December 31, 2016.

The Company had no net operating loss or capital loss carry-forwards at December 31, 2016.

As of December 31, 2016, the Company’s U.S. federal income tax returns for tax years that ended December 31, 2013 through December 31, 2015, remain open under the normal three year statute of limitations and, therefore, are subject to examination by the Internal Revenue Service.