Note 10. Income Taxes

The provision for income taxes is based upon the results of operations, adjusted for the effect of certain tax-exempt income and non-deductible expenses. Certain items of income and expense are reported in different periods for financial reporting and tax return purposes resulting in temporary differences. The tax effects of these temporary differences are recognized currently in the deferred income tax provision or benefit.

Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities. These differences will result in deductible or taxable amounts in a future year(s) when the reported amounts of assets or liabilities are recovered or settled. Deferred tax assets and liabilities are stated at tax rates expected to be in effect in the

year(s) the differences reverse. A valuation allowance is recorded against all or a portion of deferred tax assets when it is more likely than not that all or a portion of the asset will not be realized.

Net deferred tax assets as of September 30, 2012 were $4.4 million. As of that date, the company assessed the need for a valuation allowance, evaluating both positive and negative evidence.

As part of its evaluation as of September 30, 2012, the company considered the following positive evidence:

·	The company is in a positive cumulative pre-tax income position for the period since the merger with First Bankshares.

·	The company’s quarterly pre-tax operating results have improved each of the prior four quarters ending September 30, 2012.

·	The company’s financial projections are sufficient to absorb net deferred tax assets.

·	The company expects to generate taxable income, before the utilization of net operating losses, in 2012 and in future years.

·	Deferred tax assets include $2.3 million related to $6.8 million of net operating losses, which under current law, can be carried forward for 20 years from the date reported.

The company believes it has not experienced a “change in control,” as defined under Internal Revenue Code Section 382 and related regulations, since the effective date of the merger with First Bankshares in 2009. Accordingly, the company believes it has incurred no limitations on the use of its net operating losses since the date of the merger.

·	The company believes its allowance for loan and lease losses plus its discounts recorded on acquired loans to be adequate to avoid significant charges to net income related to problem loans.

·	A significant portion of the company’s net interest income is based on long-term contracts with a significant number of customers.

As part of its evaluation as of September 30, 2012, the company considered the following negative evidence:

·	The company does not have taxable income in carryback periods available to offset existing deferred tax assets..

·	The company has no executable tax planning strategies to utilize future tax deductible amounts.

·	The company operates in a competitive and highly-regulated industry, which could impact its future profitability.

Based on the weight of available evidence as of September 30, 2012, the company believes it is more likely than not that its net deferred tax asset will be utilized in future periods; therefore, at September 30, 2012, the company reversed the $4.4 million valuation allowance. In the three and nine months ended September 30, 2012, the company reported a deferred tax benefit of $5.0 million in net income and a deferred tax expense of $0.6 million in other comprehensive income.

For the year ended December 31, 2011, net deferred tax assets were $5.2 million for which a full valuation was recorded.