Income Taxes

Income tax expense is substantially due to Federal income taxes as the provision for the state of Oregon income taxes is insignificant. Income tax expense for the years ended December 31, 2014, 2013 and 2012 consisted of the following:



	Years Ended December 31,
	2014			2013			2012
	(In thousands)
Current tax expense	$	9,992		$	4,344		$	5,916
Deferred tax (benefit) expense	(3,087		)	326			185
(Decrease) increase in valuation allowance	—			(77		)	77
Income tax expense	$	6,905		$	4,593		$	6,178

A reconciliation of the Company's effective income tax rate with the Federal statutory income tax rate of 35% is as follows:



	Years Ended December 31,
	2014			2013			2012
	(In thousands)
Income tax expense at Federal statutory rate	$	9,772		$	4,959		$	6,804
Tax-exempt instruments	(1,598		)	(858		)	(649		)
Non-deductible acquisition costs	373			469			—
Federal tax credits (1)	(812		)	—			—
Effects of BOLI	(159		)	(25		)	(28		)
Tax position resolution (2)	(728		)	—			—
Valuation allowance	—			(77		)	77
Other, net	57			125			(26		)
Income tax expense	$	6,905		$	4,593		$	6,178

(1)

Federal tax credits are provided for under the New Market Tax Credit program. A subsidiary of Heritage Bank was awarded an allocation of New Market Tax Credit investments consisting of three tranches totaling $25.0 million. Gross tax credits related to these tranches totaling $9.8 million are available through 2020. The subsidiary is required to fund 85 percent of a tranche to claim the entire tax credit, and it has until May 15, 2015 to complete the funding. Tax benefits related to these credits were recognized for financial reporting purposes in the same period that the credits were recognized in the Company's income tax returns. The Company has analyzed the three tranches and believes that it is more likely than not that all tranches will be funded to 85 percent by May 15, 2015. The Company believes that these tax credits will be realized and therefore has reflected the impact of these credits in its estimated annual effective tax rate for 2014.


(2)	Washington Banking Company had recorded a liability for certain tax positions prior to the merger effective date, which the Company assumed as part of the Washington Banking Merger. These tax positions were resolved as of December 31, 2014, resulting in a decrease of the Company's income tax expense for the year ended December 31, 2014.

The following table presents major components of the deferred income tax asset (liability) resulting from differences between financial reporting and tax basis:



	December 31, 2014			December 31, 2013
	(In thousands)
Deferred tax assets:
Allowance for loan losses	$	5,460		$	7,003
Accrued compensation	1,382			821
Stock compensation	818			524
Capital loss carryforward	30			95
Unrealized losses charged to earnings on other than temporarily impaired investment securities	338			622
Net unrealized losses charged to other comprehensive income on securities	—			626
Goodwill and other intangible assets	—			2,107
Market discount on purchased loans	17,949			6,767
Foregone interest on nonaccrual loans	2,337			1,026
Net operating loss carryforward acquired from NCB	553			588
Difference in amounts reflected in financial statements and income tax basis of certain liabilities assumed in business combinations	3,492			—
Other deferred tax assets	1,394			705
Total deferred tax assets	33,753			20,884
Deferred tax liabilities:
Deferred loan fees, net	(1,982		)	(867		)
Premises and equipment	(1,937		)	(1,520		)
FHLB stock	(2,768		)	(1,039		)
Net unrealized gains charged to other comprehensive income on securities	(1,832		)	—
Indemnification asset	(392		)	(1,539		)
Goodwill and other intangible assets	(1,560		)	—
Federal tax credits	(439		)	—
Junior subordinated debentures	(2,349		)	—
Other deferred tax liabilities	(730		)	(248		)
Total deferred tax liabilities	(13,989		)	(5,213		)
Deferred income tax asset, net	$	19,764		$	15,671

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. A valuation allowance is required to be recognized for the portion of the deferred tax asset that will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management expects to realize the benefits of these deductible differences at December 31, 2014.

The Company had a net operating loss carryforward of $1.6 million and $1.7 million at December 31, 2014 and 2013, respectively, that will expire in 2033. The Company is limited to the amount of the net operating loss carryforward that it can deduct each year. The Company also had $85,000 and $270,000 of federal capital loss carryforwards as of December 31, 2014 and 2013, respectively, which will expire in 2018. A tax planning strategy has been developed that will enable the Company to deduct all of the net operating loss and capital loss carryforwards prior to their respective expirations. Based on these estimates, management has not recorded a valuation allowance as of December 31, 2014. During the year ended December 31, 2013, management reversed the valuation allowance that was established in the prior year resulting in no valuation allowance at December 31, 2013.

As of December 31, 2014 and December 31, 2013, the Company had an insignificant amount of unrecognized tax benefits, none of which would materially affect its effective tax rate if recognized. The Company does not anticipate that the amount of unrecognized tax benefits will significantly increase or decrease in the next 12 months. The amount of interest and penalties accrued as of December 31, 2014 and 2013 and for the years ended December 31, 2014, 2013 and 2012 were immaterial.

The Company has qualified under provisions of the Internal Revenue Code to compute income taxes after deductions of additions to the bad debt reserves when it was registered as a Savings Bank. At December 31, 2014, the Company had a taxable temporary difference of approximately $2.8 million that arose before 1988 (base-year amount). In accordance with FASB ASC 740, a deferred tax liability of an estimated $980,000 has not been recognized for the temporary difference. Management does not expect this temporary difference to reverse in the foreseeable future.

The Company and its subsidiary file a United States consolidated federal income tax return and an Oregon State income tax return, and the tax years subject to examination by the Internal Revenue Service are the years ended December 31, 2014, 2013, 2012 and 2011.