(11) FEDERAL INCOME TAXES

Income tax expense was comprised of the following:



	Year Ended
	December 31
(Dollars in thousands)	2018		2017
Current tax expense:
Federal	$	2,035	$	3,121
State		8		6
Deferred income tax (benefit) expense:
Federal		247		2,329
Income tax expense	$	2,290	$	5,456

The effective income tax rates of 17.65% for 2018 and 40.71% for 2017 were different than the applicable statutory Federal income tax rate of 21% for 2018 and 34% for 2017. The reason for these differences follows:



	Year Ended
	December 31
(Dollars in thousands)	2018		2017
Federal income taxes at statutory rate	$	2,725	$	4,557
Decrease resulting from:
Tax-exempt interest and dividend preference		(258)		(469)
Rate change		-		1,846
Stock Options		(112)		(331)
Bank owned life insurance		(47)		(145)
Other, net decrease		(18)		(2)
Income tax expense	$	2,290	$	5,456

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)	2018		2017
Deferred tax assets:
Allowance for credit losses	$	1,402	$	1,227
Unrealized losses on securities		446		372
Unrealized loss on pension obligation		344		388
Capital loss disallowance		2		2
State net operating losses		960		739
Unvested stock awards		45		70
Deferred compensation (SERP)		506		435
Nonqualified stock options		-		11
Pension		8		24
Non-accrued interest		197		501
Provision for unfunded loans		83		73
OREO write-downs		76		38
Core deposit intangible		11		11
Accrued expenses		-		57
Purchase accounting loan general credit mark		451		584
Purchase accounting loan specific credit mark		30		51
Purchase accounting loan interest rate mark		68		84
Purchase accounting CD rate mark		23		60
Purchase accounting term FHLBP advances		17		34
Organization costs		5		10
Total gross deferred tax assets		4,674		4,771
Deferred tax liabilities:
Depreciation		(167)		(180)
Bank shares tax credit		(131)		(140)
Prepaid expenses		(219)		(173)
Mortgage servicing rights		(27)		(29)
Bad debt reserve		(67)		(117)
Purchase accounting core deposit intangible		(66)		(83)
Accrued expenses		(4)		-
Other reserves - reserve for unfunded		(4)		(6)
Purchase accounting deferred loan fees		(267)		(323)
Total gross deferred tax liabilities		(952)		(1,051)
Valuation allowance		(960)		(740)
Net deferred tax asset	$	2,762	$	2,980

As of December 31, 2018, 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 2015 through 2017 were open for examination as of December 31, 2018. 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, 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 $11.4 million and $10.5 million at December 31, 2018 and 2017, respectively for which a full valuation allowance has been established. These carryovers will begin to expire in 2021.