Note 15—Federal Income Taxes
Deferred tax assets (“DTA”) are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized. When determining the need for a valuation allowance, the Company assessed the possible sources of taxable income available under tax law to realize a tax benefit for deductible temporary differences and carryforwards, as defined by Accounting Standards Codification (“ASC”) Topic 740-10-30-18. This guidance related to when a valuation allowance on the DTA should be maintained, generally provides that the valuation allowance should be reversed, when in the judgment of management, it is more likely than not that the DTA will be realized. First Priority has determined that it is more likely than not that the net deferred tax asset will be realized, and therefore, in its judgment, a valuation allowance related to net deferred tax assets is not required.
When evaluating the Company’s deferred tax asset and related valuation allowance, management considered the four sources of taxable income identified in ASC Topic 740-10-30-18 including:
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Future reversals of existing taxable temporary differences. |
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Taxable income in prior carryback year(s) if carryback is permitted under the tax law. |
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Tax-planning strategies (see paragraph 740-10-30-19) that would, if necessary, be implemented |
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Future taxable income exclusive of reversing temporary differences and carryforwards |
Additionally, the Company also considers tax planning strategies which could accelerate taxable income and allow the Company to take advantage of future deductible differences. A qualified tax-planning strategy is an action that (a) is prudent and feasible; (b) a company ordinarily might not take, but would take to prevent an operating loss or tax credit carryforward from expiring unused; and (c) would result in the realization of deferred tax assets.
The components of the net deferred tax asset at December 31, 2017 and 2016 are as follows:
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December 31, |
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2017 |
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2016 |
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(Dollars in thousands) |
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Deferred tax assets: |
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Allowance for loan losses |
$ |
583 |
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|
$ |
701 |
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Organization and start-up costs |
|
35 |
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|
75 |
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Net operating loss carryforwards |
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- |
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|
833 |
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Net operating loss carryforwards--acquired |
|
231 |
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|
670 |
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Contribution carryforward |
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- |
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|
|
9 |
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|
Non-qualified stock option expense |
|
208 |
|
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|
283 |
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Other real estate owned deferred costs |
|
18 |
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|
215 |
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Unrealized loss on investment securities |
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3 |
|
|
|
21 |
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Alternative minimum tax carryforward |
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- |
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|
199 |
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Property and equipment |
|
35 |
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|
35 |
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Unfunded loan commitment reserve |
|
7 |
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12 |
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Total Deferred Tax Assets |
|
1,120 |
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|
3,053 |
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Deferred tax liabilities: |
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|
|
|
|
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Acquisition accounting |
|
66 |
|
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|
135 |
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Cash basis conversions |
|
120 |
|
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|
206 |
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Discount accretion on investment securities |
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11 |
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15 |
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Total Deferred Tax Liabilities |
|
197 |
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|
356 |
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Net Deferred Tax Asset |
$ |
923 |
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$ |
2,697 |
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First Priority’s net deferred tax asset as of December 31, 2017 includes $231 thousand related to net operating losses (“NOL”) acquired related to the acquisition of Prestige Community Bank and Affinity Bancorp which are subject to certain limitations and expire in 2028 and 2032, respectively, if not fully utilized. The acquired NOL carryforward balance of $1.1 million remains available to reduce future federal income taxes as of December 31, 2017.
The following table presents the income tax expense for the years ended December 31, 2017 and 2016.
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For the year ended December 31, |
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2017 |
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2016 |
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(Dollars in thousands) |
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Current tax expense: |
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Federal |
$ |
227 |
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$ |
94 |
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State |
|
19 |
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|
46 |
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Deferred Income tax expense: |
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|
|
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Federal |
|
1,755 |
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|
|
988 |
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Income tax expense |
$ |
2,001 |
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$ |
1,128 |
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Reconciliation of the statutory federal income tax expense computed at 34% to the income tax expense included in the consolidated statements of income is as follows:
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For the year ended December 31, |
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2017 |
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2016 |
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(Dollars in thousands) |
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Federal income tax expense at statutory rate of 34%: |
$ |
1,516 |
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$ |
1,165 |
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Increase (decrease) in taxes resulting from: |
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Tax exempt interest income, net |
|
(159 |
) |
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(109 |
) |
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Tax exempt income on bank owned life insurance |
|
(24 |
) |
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(26 |
) |
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Applicable state income taxes |
|
13 |
|
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|
30 |
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Stock compensation adjustment for expired options |
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(3 |
) |
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30 |
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Tax Cut and Jobs Act adjustment to deferred tax asset |
|
571 |
|
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- |
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Other |
|
87 |
|
|
|
38 |
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Federal income tax expense |
$ |
2,001 |
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$ |
1,128 |
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The year ended December 31, 2017 included a non-recurring non-cash reduction in the value of First Priority’s net deferred tax asset which resulted in a charge of $571 thousand and is included in the provision for income tax expense. This income tax adjustment was a result of the Tax Cuts and Jobs Act, enacted on December 22, 2017, which lowered First Priority’s future maximum corporate tax rate from 34 percent to 21 percent. Although this reduced rate will provide tax savings in future periods, this charge was required to write-down First Priority’s DTA which was previously valued based upon the projection of a 34 percent future tax benefit.
The Company’s policy for recording interest and penalties associated with audits is to record such items as a component of income before income taxes. Penalties are recorded in other expenses, net, and interest paid or received is recorded in interest expense or interest income, respectively, in the consolidated statement of income. As of December 31, 2017 and 2016, there was no interest or penalties accrued for the Company. With limited exception, tax years prior to 2014 are closed to examination by Federal and State taxing authorities.