Income Taxes

12 Months Ended

Jun. 30, 2019

Note 9: Income Taxes

ASC 740, “Income Taxes,” requires the affirmative evaluation that it is more likely than not, based on the technical merits of a tax position, that an enterprise is entitled to economic benefits resulting from positions taken in income tax returns. If a tax position does not meet the more-likely-than-not recognition threshold, the benefit of that position is not recognized in the financial statements. Management has determined that there were no unrecognized tax benefits to be reported in the Corporation’s consolidated financial statements for the years ended June 30, 2019 and 2018.

On December 22, 2017, the U.S. Government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act amends the Internal Revenue Code to reduce tax rates and modify policies, credits, and deductions for individuals and businesses. For businesses, the Tax Act reduces the corporate federal tax income rate from a maximum of 35 percent to a flat 21 percent. The federal corporate tax rate reduction was effective January 1, 2018. Since the Corporation has a fiscal year end of June 30^th, the reduced federal corporate income tax rate for its fiscal year 2018 resulted in the application of a blended federal statutory income tax rate of 28.06 percent, which was based on the applicable tax rates before and after the Tax Act and corresponding number of days in the fiscal year before and after enactment, and then a flat 21 percent tax rate thereafter.

Under generally accepted accounting principles, the Corporation uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. At June 30, 2017, the Corporation’s deferred tax assets and liabilities were determined based on the then-current enacted federal tax rate of 35 percent. As a result of the reduction in the federal corporate income tax rate under the Tax Act, the Corporation revalued its deferred tax assets and liabilities at December 31, 2017. Deferred tax assets and liabilities realized in fiscal year 2018 and prior fiscal years were re-measured using the aforementioned blended rate. These re-measurements collectively resulted in a discrete tax expense of $1.8 million that was recognized in fiscal 2018. Deferred tax assets and liabilities realized in fiscal 2019 were re-measured using the statutory federal rate of 21 percent.

The estimated combined federal and state statutory tax rates, before discrete items, for fiscal years 2019 and 2018 are as follows:

Statutory Tax Rates	FY2019	FY2018
Federal Tax Rate	21.00%	28.06%
State Tax Rate	10.84%	10.84%
Combined Statutory Tax Rate ⁽¹⁾	29.56%	35.86%

⁽¹⁾ The combined statutory tax rate is net of the federal tax benefit for the state tax deduction.

The Corporation’s effective tax rate may differ from the estimated statutory tax rates described above due to discrete items such as further adjustments to net deferred tax assets, excess tax benefits derived from stock option exercises and non-taxable earnings from bank owned life insurance, among other items.

The Corporation utilizes the asset and liability method of accounting for income taxes whereby deferred tax assets are recognized for deductible temporary differences and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis.

Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effect of changes in tax laws and rates on the date of enactment. The provision for income taxes for the periods indicated consisted of the following:

	Year Ended June 30,
(In Thousands)	2019		2018
Current:
Federal	$	445	$	2,271
State		408		960
		853		3,231
Deferred:
Federal		478		582
State		172		(417	)
		650		165
Provision for income taxes	$	1,503	$	3,396

The Corporation's tax benefit from non-qualified equity compensation recognized in the Consolidated Statements of Operations in connection with the adoption of ASU 2016-09 for fiscal 2019 and 2018 was $147,000 and $206,000, respectively.

The provision for income taxes differs from the amount of income tax determined by applying the applicable U.S. statutory federal income tax rate to net income before income taxes as a result of the following differences for the periods indicated:

		Year Ended June 30,
		2019					2018
(In Thousands)		Amount			Tax Rate		Amount			Tax Rate
Federal income tax at statutory rate		$	1,243		21.00	%	$	1,551			28.06	%
State income tax, net of federal income tax benefits		456			7.70	%	429				7.77	%
Changes in taxes resulting from:
	Bank-owned life insurance	(39		)	(0.66	)%	(50		)		(0.90	)%
	Non-deductible expenses	21			0.35	%	30				0.53	%
	Non-deductible stock-based compensation	(2		)	(0.03	)%	15				0.26	%
	Excess tax benefit on stock-based compensation	(104		)	(1.77	)%	(189		)		(3.41	)%
	Deferred tax asset revaluation due to the Tax Act	—			—	%	1,765				31.93	%
	Return to provision adjustment	(77		)	(1.29	)%	—				—	%
	Other⁽¹⁾	5			0.08	%	(155		)		(2.81	)%
Effective income tax		$	1,503		25.38	%	$	3,396			61.43	%

⁽¹⁾ Tax benefit resulting from the corporate tax rate reduction in fiscal 2018.

Deferred tax assets at June 30, 2019 and 2018 by jurisdiction were as follows:

(In Thousands)	June 30,
	2019			2018
Deferred taxes - federal	$	2,178	$		2,636
Deferred taxes - state	1,361		1,532
Total net deferred tax assets	$	3,539	$		4,168

Net deferred tax assets at June 30, 2019 and 2018 were comprised of the following:

(In Thousands)		June 30,
		2019			2018
Loss reserves		$	2,685		$	2,873
Non-accrued interest		483			502
Deferred compensation		2,396			2,509
Accrued vacation		124			224
Depreciation		95			99
Litigation reserves		876			1,441
Other		588			358
	Total deferred tax assets	7,247			8,006

FHLB - San Francisco stock dividends		(664		)	(664		)
Unrealized gain on derivative financial instruments, at fair value		—			(123		)
Prepaid expenses		(56		)	(49		)
Unrealized gain on investment securities		(63		)	(82		)
Unrealized gain on interest-only strips		(5		)	(6		)
Deferred loan costs		(2,723		)	(2,806		)
State tax		(197		)	(108		)
	Total deferred tax liabilities	(3,708		)	(3,838		)
	Net deferred tax assets	$	3,539		$	4,168

The net deferred tax assets were included in prepaid expenses and other assets in the Consolidated Statements of Financial Condition. The Corporation analyzes the deferred tax assets to determine whether a valuation allowance is required based on the more likely than not criteria that such assets will be realized principally through future taxable income. This criteria takes into account the actual earnings and the estimates of future profitability. The Corporation may carryback net federal tax losses to the preceding five taxable years and forward to the succeeding 20 taxable years. At June 30, 2019 and 2018, the Corporation had no federal and state net tax loss carryforwards. Based on management's consideration of historical and anticipated future income before income taxes, as well as the reversal period for the items giving rise to the deferred tax assets and liabilities, a valuation allowance was not considered necessary at June 30, 2019 and 2018 and management believes it is more likely than not the Corporation will realize its deferred tax asset.

Retained earnings at June 30, 2019 and 2018 includes approximately $9.0 million (pre-1988 bad debt reserve for tax purposes) for which federal income tax of $3.1 million has not been provided. If the amounts that qualify as deductions for federal income tax purposes are later used for purposes other than for bad debt losses, including distribution in liquidation, they will be subject to federal income tax at the then-current corporate tax rate. If those amounts are not so used, they will not be subject to tax even in the event the Bank were to convert its charter from a thrift to a bank.

The Corporation files income tax returns for the United States and California jurisdictions. The Internal Revenue Service has audited the Bank’s income tax returns through 1996 and the California Franchise Tax Board has audited the Bank through 1990. Also, the Internal Revenue Service completed a review of the Corporation’s income tax returns for fiscal 2006 and 2007; and the California Franchise Tax Board completed a review of the Corporation’s income tax returns for fiscal 2009 and 2010. Fiscal years of 2015 and thereafter remain subject to federal examination, while the California state tax returns for fiscal years 2014 and thereafter are subject to examination by state taxing authorities.

It is the Corporation’s policy to record any penalties or interest charges arising from federal or state taxes as a component of income tax expense. For the fiscal year ended June 30, 2019, there was an $18,000 penalty that was non-tax deductible due to the nature of the expenses and no interest charges; during fiscal 2018, there were no tax penalties or interest charges.