Note 9 - Income Taxes

12 Months Ended

Dec. 31, 2013

Income Tax Disclosure [Abstract]

Income Tax Disclosure [Text Block]

9. Income Taxes

The components of income tax expense are as follows:

December 31, (In thousands)	2013			2012			2011
Currently payable	$	4,908		$	3,953		$	1,580
Deferred		(473	)		(1,043	)		(2,227	)
Total applicable to operations		4,435			2,910			(647	)
Deferred tax charged (credited) to components of shareholders’ equity:
Unfunded status of postretirement benefits		1,589			(92	)		(500	)
Net unrealized securities (losses) gains		(7,019	)		214			3,593
Total income taxes	$	(995	)	$	3,032		$	2,446

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

December 31,	2013			2012			2011
Federal statutory rate		35.0	%		35.0	%		35.0	%
Changes from statutory rates resulting from:
Tax-exempt interest		(6.3	)		(7.6	)		(51.5	)
Nondeductible interest to carry tax-exempt obligations		.3			.4			3.6
Nondeductible legal expense		-			.5			-
Tax credits		-			(1.8	)		(13.0	)
Premium income not subject to tax		(1.3	)		(2.5	)		(5.5	)
Company-owned life insurance		(1.8	)		(3.5	)		(15.2	)
Uncertain tax position		(.5	)		(.9	)		14.3
Other, net		(.6	)		(.3	)		1.4
Effective tax rate on pretax income		24.8	%		19.3	%		(30.9	)%

The tax effects of the significant temporary differences that comprise deferred tax assets and liabilities at December 31, 2013 and 2012 are as follows:

December 31, (In thousands)	2013		2012
Assets
Allowance for loan losses	$	7,217	$	8,571
Deferred directors’ fees		285		281
Postretirement benefit obligations		4,459		5,633
Other real estate owned		3,568		2,398
Partnership investments		1,508		1,444
Self-funded insurance		213		164
Paid time off		701		705
Depreciation		798		676
Intangibles		3,179		3,526
Unrealized losses on available for sale investment securities, net		1,951		-
Other		232		44
Total deferred tax assets		24,111		23,442
Liabilities
Unrealized gains on available for sale investment securities, net		-		5,066
Prepaid expenses		596		505
Federal Home Loan Bank stock dividends		1,097		1,087
Deferred loan fees		772		811
Lease financing operations		136		366
Total deferred tax liabilities		2,601		7,835
Net deferred tax asset	$	21,510	$	15,607

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, 2013.

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 Topic 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 Topic 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 $371 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)	2013			2012
Balance at beginning of year	$	154		$	266
Reductions to tax positions of prior years		(88	)		(112	)
Balance at end of year	$	66		$	154

The $66 thousand at year-end 2013 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 and $11 thousand during 2013 due to the statute of limitations expiring on a portion of the potential

tax payment. The amount accrued for interest at December 31, 2013 and 2012 was $12 thousand and $23 thousand, respectively. No penalties were accrued or recorded during any year in the three years ended December 31, 2013.

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 2010.