(12) FEDERAL INCOME TAXES

Income tax expense was comprised of the following:



	Year Ended
	December 31
(Dollars in thousands)	2017		2016
Current tax expense:
Federal	$	3,121	$	1,515
State		6		10
Deferred income tax (benefit) expense:
Federal		2,329		344
Income tax expense	$	5,456	$	1,869

The effective income tax rates of 40.71% for 2017 and 27.29% for 2016 were different than the applicable statutory Federal income tax rate of 34%. The reason for these differences follows:



	Year Ended
	December 31
(Dollars in thousands)	2017		2016
Federal income taxes at statutory rate	$	4,557	$	2,328
Decrease resulting from:
Tax-exempt interest and dividend preference		(469)		(643)
Rate change		1,846		-
Stock Options		(331)		-
Bank owned life insurance		(145)		(77)
Other, net (decrease) increase		(2)		261
Income tax expense	$	5,456	$	1,869

The tax effects of temporary differences that give rise to deferred tax assets and deferred tax liabilities are presented below:



	December 31
(Dollars in thousands)	2017		2016
Deferred tax assets:
Allowance for credit losses	$	1,227	$	1,827
Unrealized losses on securities		372		560
Unrealized losses on reclassified securities		-		2
Unrealized loss on pension obligation		388		609
Capital loss disallowance		2		4
State net operating losses		739		620
Unvested stock awards		70		103
Deferred compensation (SERP)		435		680
Nonqualified stock options		11		48
Depreciation		-		123
Pension		24		6
Non-accrued interest		501		661
Provision for unfunded loans		73		117
OREO write-downs		38		52
Core deposit intangible		11		16
Accrued expenses		57		165
Purchase accounting loan general credit mark		584		1,482
Purchase accounting loan specific credit mark		51		273
Purchase accounting loan interest rate mark		84		96
Purchase accounting CD rate mark		60		236
Purchase accounting term FHLBP advances		34		163
Organization costs		10		23
Other reserves - reserve for unfunded		-		29
Total gross deferred tax assets		4,771		7,895
Deferred tax liabilities:
Depreciation		(180)		-
Pension expense		-		-
Bank shares tax credit		(140)		(204)
Prepaid expenses		(173)		(313)
Mortgage servicing rights		(29)		(44)
Deferred gain from insurance proceeds		-		(401)
Bad debt reserve		(117)		(241)
Market discount accretion		-		(18)
Purchase accounting core deposit intangible		(83)		(165)
Prepaid expenses (acquired)		-		(23)
Other reserves - reserve for unfunded		(6)		-
Purchase accounting deferred loan fees		(323)		(615)
Total gross deferred tax liabilities		(1,051)		(2,024)
Valuation allowance		(740)		(621)
Net deferred tax asset	$	2,980	$	5,250

As of December 31, 2017, DNB had no material unrecognized tax benefits or accrued interest and penalties. It is DNB’s policy to account for interest and penalties accrued relative to unrecognized tax benefits as a component of income tax expense. Federal and state tax years 2014 through 2016 were open for examination as of December 31, 2017. On December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which provides guidance on accounting for the tax effects of the Tax Cuts and Jobs Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Cuts and Jobs Act’s enactment date for companies to complete the accounting under ASC 740, Income Taxes. The Company’s financial results reflect the income tax effects of the Tax Cuts and Jobs Act for which the accounting under ASC Topic 740 is complete. On December 22, 2017, commonly known as the Tax Cuts and Jobs Act, was signed into law. The Act includes many provisions that will effect DNB’s income tax expenses, including reducing the corporate federal tax rate from 34% to 21% effective January 1, 2018. As a result of the rate reduction, DNB was required to re-measure, through income tax expense in the period of enactment, its deferred tax assets and liabilities using the enacted rate at which DNB expects them to be recovered or settled. The re-measurement of the net deferred tax asset resulted in additional income tax expense of $1.8 million.

DNB had net state operating loss carryovers with the Commonwealth of Pennsylvania of $10.5 million and $8.7 million at December 31, 2017 and 2016, respectively for which a full valuation allowance has been established. These carryovers will begin to expire in 2021.