Income Taxes

12 Months Ended

Dec. 31, 2019

The following table presents the composition of income tax expense (benefit) for the years ended December 31:



(dollars in thousands)	2019			2018			2017
Federal
Current	$	18,918		$	13,616		$	32,282
Deferred	(406		)	3,517			13,980
Total Federal	18,512			17,133			46,262
State
Current	589			720			323
Deferred	25			(8		)	(148		)
Total State	614			712			175
Total Federal and State	$	19,126		$	17,845		$	46,437

The provision for income taxes differs from the amount computed by applying the statutory federal income tax rate to income before income taxes. We ordinarily generate an annual effective tax rate that is less than the statutory rate of 21 percent primarily due to benefits resulting from certain partnership investments, such as low income housing and historic rehabilitation projects, tax-exempt interest, excludable dividend income and tax-exempt income on BOLI. The state tax provision is due to taxable business activities conducted at our loan production office in New York.

On December 22, 2017, H.R.1, originally known as the Tax Cuts and Jobs Act, or Tax Act, was signed into law. The Tax Act resulted in significant changes to the U.S. corporate tax system including a federal corporate rate reduction from 35 percent to 21 percent. The Tax Act also established new tax laws that became effective January 1, 2018. GAAP requires us to record the effects of a tax law change in the period of enactment. As a result, in 2017 we re-measured our deferred tax assets and liabilities and recorded a provisional adjustment of $13.4 million. This re-measurement adjustment was recognized as an increase to our income tax expense in the fourth quarter of 2017. The calculation over the income tax effects of the Tax Act was completed in the third quarter of 2018. We recognized a $3.0 million income tax benefit as a result of finalizing the calculation.

The following table presents a reconciliation of the statutory tax rate to the effective tax rate for the years ended December 31:



	2019		2018		2017
Statutory tax rate	21.0	%	21.0	%	35.0	%
Low income housing tax credits	(3.3	)%	(2.5	)%	(2.9	)%
Tax-exempt interest	(2.1	)%	(2.1	)%	(4.0	)%
Bank owned life insurance	(0.4	)%	(0.4	)%	(0.8	)%
Gain on sale of a majority interest of insurance business	—	%	0.7	%	—	%
Merger related expenses	0.3	%	—	%	—	%
Other	0.8	%	0.3	%	0.3	%
Impact of the Tax Act	—	%	(2.5	)%	11.3	%
Effective Tax Rate	16.3	%	14.5	%	38.9	%

The following table presents significant components of our temporary differences as of the dates presented:



	December 31,
(dollars in thousands)	2019			2018
Deferred Tax Assets:
Allowance for loan losses	$	13,798		$	13,463
Net unrealized losses on securities available-for-sale	—			1,091
Other employee benefits	3,039			2,712
Low income housing partnerships	3,494			3,249
Net adjustment to funded status of pension	5,438			5,173
Lease liabilities	11,257			—
State net operating loss carryforwards	5,134			4,573
Other	1,856			2,856
Gross Deferred Tax Assets	44,016			33,117
Less: Valuation allowance	(5,134		)	(4,573		)
Total Deferred Tax Assets	38,882			28,544
Deferred Tax Liabilities:
Net unrealized gains on securities available-for-sale	(2,570		)	—
Prepaid pension	(5,971		)	(6,164		)
Deferred loan income	(3,555		)	(3,219		)
Purchase accounting adjustments	(1,269		)	(100		)
Depreciation on premises and equipment	(592		)	(477		)
Right-of-use lease assets	(10,476		)	—
Other	(1,243		)	(1,375		)
Total Deferred Tax liabilities	(25,676		)	(11,335		)
Net Deferred Tax Asset	$	13,206		$	17,209

We establish a valuation allowance when it is more likely than not that we will not be able to realize the benefit of the deferred tax assets. Except for Pennsylvania net operating losses, or NOLs, we have determined that no valuation allowance is needed for deferred tax assets because it is more likely than not that these assets will be realized through future reversals of existing temporary differences and through future taxable income. The valuation allowance is reviewed quarterly and adjusted based on management’s assessments of realizable deferred tax assets. Gross deferred tax assets were reduced by a valuation allowance of $5.1 million in 2019 and $4.6 million in 2018 related to Pennsylvania income tax NOLs. The Pennsylvania NOL carryforwards total $51.4 million and will expire in the years 2020-2040.

Unrecognized Tax Benefits

The following table reconciles the change in Federal and State gross unrecognized tax benefits, or UTB, for the years ended December 31:



(dollars in thousands)	2019			2018			2017
Balance at beginning of year	$	768		$	909		$	804
Prior period tax positions	(10		)	(251		)	(37		)
Current period tax positions	293			110			142
Balance at End of Year	$	1,051		$	768		$	909
Amount That Would Impact the Effective Tax Rate if Recognized	$	848		$	607		$	770

We classify interest and penalties as an element of tax expense. We monitor changes in tax statutes and regulations to determine if significant changes will occur over the next 12 months. As of December 31, 2019, no significant changes to UTB are projected; however, tax audit examinations are possible. As of December 31, 2019, all income tax returns filed for the tax years 2016, 2017 and 2018 remain subject to examination by the IRS, and years 2015-2018 remain open for examination by the New York State Department of Taxation.