Note 9 - Income Taxes

12 Months Ended

Dec. 31, 2012

Income Tax Disclosure [Text Block]

9.  Income Taxes

The components of income tax expense are as follows:

December 31, (In thousands)	2012			2011			2010
Currently payable	$	3,953		$	1,580		$	5,429
Deferred		(1,043	)		(2,227	)		(3,392	)
Total applicable to operations		2,910			(647	)		2,037
Deferred tax charged (credited) to components of shareholders’ equity:
Unfunded status of postretirement benefits		(92	)		(500	)		643
Net unrealized securities gains		214			3,593			(2,239	)
Total income taxes	$	3,032		$	2,446		$	441

An analysis of the difference between the effective income tax rates and the statutory federal income tax rate follows.

December 31,	2012			2011			2010
Federal statutory rate		35.0	%		35.0	%		35.0	%
Changes from statutory rates resulting from:
Tax-exempt interest		(7.6	)		(51.5	)		(15.3	)
Nondeductible interest to carry tax-exempt obligations		.4			3.6			1.3
Nondeductible legal expense		.5			-			-
Tax credits		(1.8	)		(13.0	)		(2.5	)
Premium income not subject to tax		(2.5	)		(5.5	)		(3.9	)
Company-owned life insurance		(3.5	)		(15.2	)		8.2
Uncertain tax position		(.9	)		14.3			-
Other, net		(.3	)		1.4			(.1	)
Effective tax rate on pretax income		19.3	%		(30.9	)%		22.7	%

The tax effects of the significant temporary differences that comprise deferred tax assets and liabilities at December 31, 2012 and 2011 are as follows:

December 31, (In thousands)	2012		2011
Assets
Allowance for loan losses	$	8,571	$	9,907
Deferred directors’ fees		281		280
Postretirement benefit obligations		5,633		5,057
Other real estate owned		2,398		1,422
Partnership investments		1,444		1,395
Self-funded insurance		164		169
Paid time off		705		656
Depreciation		676		140
Intangibles		3,526		3,749
Other		44		82
Total deferred tax assets		23,442		22,857
Liabilities
Unrealized gains on available for sale investment securities, net		5,066		4,854
Prepaid expenses		505		628
Federal Home Loan Bank stock dividends		1,087		1,080
Deferred loan fees		811		852
Lease financing operations		366		758
Total deferred tax liabilities		7,835		8,172
Net deferred tax asset	$	15,607	$	14,685

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.  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.  Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment.  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 believes it is more likely than not the Company will realize the benefits of these deductible differences at December 31, 2012.

The Internal Revenue Code grants preferential treatment to the interest income derived from debt issued by states and political subdivisions in that it is not subject to Federal taxation. As a financial institution, the Company is not allowed a tax deduction for a pro rata portion of the interest expense incurred to purchase debt with tax-free attributes. The amount of disallowed interest expense is determined by the total amount of debt issued during the calendar year by the issuer and dependent upon the issuer being considered a qualified small issuer. Debt purchased by a financial institution that meets the requirements to be designated a “qualified tax exempt obligation” has a lower interest expense disallowance than debt that does not meet the “qualified tax exempt obligation” designation. As part of the normal due diligence for a loan with tax-free attributes, the Company relies on the attestation of the borrower, legal counsel for the borrower, and the legal counsel for the Company concerning the representations of the borrower for their debt.  During the fourth quarter of 2010 the Company became aware that the qualified status of the debt issued by a customer was being reviewed by the Internal Revenue Service (“IRS”). The customer had previously made representations that their debt was qualified.

During the first quarter of 2011 the Company became aware that this customer had received verbal notification of the IRS’s intent to issue an adverse ruling regarding the qualified status of the financing.  At that time, the Company had a potential accumulated tax liability of $402 thousand at risk related to the determination for the tax years 2007 through 2010.   Under ASC 740, “Income Taxes”, the Company is required to recognize a tax position when it is more likely than not that the position would be sustained in a tax examination, with the tax examination being presumed to occur.  Additionally, ASC 740 indicates that a subsequent change in facts and circumstances should be recognized in the period in which the change occurs.   As such, the Company recorded an accrual of $449 thousand including the $402 thousand accumulated tax liability and interest of $47 thousand in the first quarter of 2011. The amount of this tax liability has been reduced by $272 thousand since the initial recording of the liability due to the statute of limitations expiring on a portion of the potential tax payment.

The original loan contract contains provisions that the customer will indemnify the Company for any penalties, taxes or interest thereon for which the Company becomes liable as a result of a determination of taxability.  The Company intends to exercise its rights under the contract; however, due to the contingent nature of the indemnification provisions, the Company will not record the effects of the indemnification until it is realized.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

(In thousands)	2012			2011
Balance, beginning of year	$	266		$	-
Additions (reductions) to tax positions of prior years		(112	)		266
Balance, end of year	$	154		$	266

The $154 thousand at year-end 2012 represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in future periods.  The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months. 

The Company’s policy is to record the accrual of interest or penalties relative to unrecognized tax benefits, if any, in its income tax expense accounts. The total amount of interest recorded in the income tax expense (benefit) line item of the income statement for the year ended December 31, 2011 was $32 thousand. This interest amount was reduced by $9 thousand during 2012 due to the statute of limitations expiring on a portion of the potential tax payment. There was no interest recorded for 2010. The amount accrued for interest at December 31, 2012 and 2011 was $23 thousand and $32 thousand, respectively. No penalties were accrued or recorded during the three year period.

The Company files U.S. federal and various state income tax returns. The Company is no longer subject to income tax examinations by taxing authorities for the years before 2009.