Note 9.

Income taxes

The following summarizes the tax effects of temporary differences which comprise net deferred tax assets and liabilities at December 31, 2016 and 2015 (in thousands):

	2016		2015
Deferred tax assets
Net operating loss carryforward	$	7,471	$	8,475
Capital loss carryforward		14		69
State net operating loss carryfoward		50		11
Allowance for loan losses		1,147		1,211
Unrealized loss on available-for-sale securities		93		226
Interest on nonaccrual loans		41		50
Expenses and writedowns related to foreclosed property		883		991
Stock compensation		253		140
Employee benefits		1,079		1,015
Pension expense		31		35
Depreciation		144		-
Lease Obligation		74		-
Other, net		71		38
Goodwill		23		39

Total deferred tax assets		11,374		12,300

Deferred tax liabilities
Depreciation		-		43
Amortization of intangibles		1		34
Total deferred tax liabilities		1		77

Net deferred tax asset prior to valuation allowance		11,373		12,223

Less Unrealized gain on available-for-sale securities		-		(226)

Net deferred tax asset subject to valuation allowance		-		11,997

Less valuation allowance		-		11,997

Net deferred tax asset	$	11,373	$	226

The net deferred tax asset is included in other assets on the consolidated balance sheet. Accounting Standards Codification Topic 740, Income Taxes, requires that companies assess whether a valuation allowance should be established against their deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard. Management considers both positive and negative evidence and analyzes changes in near-term market conditions as well as other factors which may impact future operating results. In making such judgments, significant weight is given to evidence that can be objectively verified. The deferred tax assets are analyzed quarterly for changes affecting realization.

There was an $11,172,000 income tax benefit recorded for the year ended December 31, 2016 compared to no tax expense for the year ended December 31 2015. The income tax benefit in 2016 was primarily due to the reversal of an $11,997,000 valuation allowance previously recorded against the net deferred tax asset. This valuation allowance was first recorded in the fourth quarter of 2011 due to the uncertainty of whether or not the Company would be able to realize the asset.

In assessing the Company’s ability to realize its net deferred tax asset, management considers whether it is more likely than not that some portion or all of the net deferred tax asset will or will not be realized. The Company’s ultimate realization of the net deferred tax asset is dependent upon the generation of future taxable income during the periods in which temporary differences become deductible. Management considers the nature and amount of historical and projected future taxable income, the scheduled reversal of deferred tax assets and liabilities, and available tax planning strategies in making this assessment. The amount of net deferred taxes recognized could be impacted by changes to any of these variables.

Each quarter, the Company weighs both the positive and negative information with respect to realization of the net deferred tax asset and analyzes its position as to whether or not a valuation allowance is required. Over the past several quarters, the positive information has been increasing while the negative information has been decreasing. Over the last seven quarters, the Company has demonstrated consistent earnings while its level of non-performing assets, which was the primary cause of the Company’s losses, has steadily decreased. Additionally, the Federal Reserve Bank of Richmond (the “Reserve Bank”), the FDIC and the Virginia Bureau of Financial Institutions have terminated their formal agreements with the Company and the Bank, reducing regulatory risk.

Given the consistent earnings and improving asset quality, the Company’s analysis concluded that, it is more likely than not that the Company will generate sufficient taxable income within the applicable carry-forward periods to realize its net deferred tax asset. As such, the full valuation allowance of $11,997,000 was released.

The net operating losses available to offset future taxable income amounted to $21,974,000 at December 31, 2016 and begin expiring in 2028; $1,257,000 of such amount is subject to a limitation by Section 382 of the Internal Revenue Code of 1986, as amended, to $908,000 per year.

The income tax expense (benefit) charged to operations for the years ended December 31, 2016, 2015 and 2014 consists of the following (in thousands):

	2016		2015		2014

Current tax expense (benefit)	$	12	$	-	$	67
Deferred tax expense (benefit)		813		277		(401)
Valuation allowance		(11,997)		(277)		334

Provision (benefit) for income taxes	$	(11,172)	$	-	$	-

A reconciliation of income taxes computed at the federal statutory income tax rate to total income taxes is as follows for the years ended December 31, 2016, 2015 and 2014 (in thousands):

	2016		2015		2014

Net income (loss) before income taxes	$	2,341	$	646	$	(1,037)

Computed "expected" tax expense (benefit)	$	796	$	220	$	(352)
Valuation allowance change		(11,997)		(277)		334
State taxes, net of fed		(39)		-		44
Cash surrender value of life insurance		(63)		(62)		(62)
Other		131		119		36

Provision (benefit) for income taxes	$	(11,172)	$	-	$	-

Commercial banking organizations conducting business in Virginia are not subject to Virginia income taxes. Instead, they are subject to a franchise tax based on bank capital. The Company recorded franchise tax expense of approximately $75,000 for the year ended December 31, 2016. Due to the Company’s adjusted capital level, we were not subject to franchise tax expense for the years ended December 31, 2015 and 2014.