Note 11 - Income Taxes

The Tax Cuts and Jobs Act (the “2017 Tax Reform Act”) was enacted on December 22, 2017. The 2017 Tax Reform Act reduced the U.S. federal corporate tax rate for QNB from 34% to 21%. At December 31, 2017, we have completed our accounting for the tax effects relating to the re-measurement of the Company’s deferred tax assets and liabilities as a result of enactment of the Act.

As presented below, we have made a reasonable estimate of the effects on our existing deferred tax balances as of December 31, 2017. We re-measured all of our deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future. We recognized $2,054,000 in our tax provision for the year ended December 31, 2017 related to the adjustment of deferred tax balances to reflect the new corporate tax rate.

Deferred tax asset/liability (DTA/DTL) related to available for sale (AFS) securities gains/(losses) that were revalued as of December 31, 2017 created a “stranded tax effect” in Accumulated Other Comprehensive Income (AOCI) due enactment of the 2017 Tax Reform Act. The issue arose due to the nature of GAAP recognition of tax rate change effects on the AFS DTA/DTL revaluation as an adjustment to income tax provision. In February 2018, FASB issued ASU 2018-02, as discussed in Note 1. When adopted, the provisions of the ASU 2018-02 will permit retrospective recording of a one-time reclassification of $805,000 from AOCI to retained earnings for stranded tax effects resulting from the newly enacted corporate tax rate. The amount of the reclassification represents the difference between the 34% historical corporate tax rate and the newly enacted 21% corporate tax rate. The Company expects to adopt the provisions of ASU 2018-02 in the first quarter of 2018.

The components of the provision for income taxes are as follows:

Year ended December 31,	2017		2016			2015
Current Federal income taxes	$	3,454	$	3,137		$	2,519
Current state income taxes		124		62			51
Deferred Federal income taxes (benefits)		268		(145	)		—
Net provision prior to tax reform adjustment		3,846		3,054			2,570
DTA writeoff for change in tax rate under 2017 Tax Reform		2,054		—			—
Net provision	$	5,900	$	3,054		$	2,570

At December 31, 2017 and 2016, the tax effects of temporary differences that represent the significant portion of deferred tax assets and liabilities are as follows:

December 31,	2017		2016
Deferred tax assets
Allowance for loan losses	$	1,647	$	2,514
Net unrealized holding losses on investment securities available-for-sale		1,255		1,852
Impaired securities		—		448
Non-credit OTTI on investment securities available -for-sale		45		84
Non-accrual interest income		324		545
Deferred rent		55		80
Deferred revenue		80		131
Incurred but not reported (IBNR) medical expense		18		42
Depreciation		—		68
Bonus		130		68
Other		16		27
Total deferred tax assets		3,570		5,859
Deferred tax liabilities
Depreciation		24		—
Mortgage servicing rights		101		169
Net unrealized holding gains on trading investment securities		21		34
Prepaid expenses		95		168
Other		10		15
Total deferred tax liabilities		251		386
Net deferred tax asset	$	3,319	$	5,473

The ability to realize deferred tax assets is dependent upon a variety of factors, including the generation of future taxable income, the existence of taxes paid and recoverable, the reversal of deferred tax liabilities and tax planning strategies. Based upon these and other factors, management believes it is more likely than not that QNB will realize the benefits of the above deferred tax assets.

A reconciliation of the tax provision on income before taxes computed at the statutory rate of 34% and the actual tax provision was as follows:

Year ended December 31,	2017						2016						2015
	Dollar			%			Dollar			%			Dollar			%
Provision at statutory rate	$	4,825			34.0	%	$	4,073			34.0	%	$	3,673			34.0	%
Tax-exempt interest and dividend income		(948	)		(6.7	)		(1,033	)		(8.6	)		(1,126	)		(10.4	)
Bank-owned life insurance		(100	)		(0.7	)		(105	)		(0.9	)		(104	)		(1.0	)
Life insurance proceeds		(18	)		(0.1	)		—			—			—			—
Stock-based compensation expense		19			0.1			30			0.3			29			0.3
State income tax		82			0.6			41			0.3			34			0.3
Other		(14	)		(0.1	)		48			0.4			64			0.6
Net provision prior to tax reform adjustment		3,846			27.1			3,054			25.5	%		2,570			23.8
Deferred tax revaluation for change in tax rate - 2017 Tax Reform		2,054			14.5			—			—			—			—
Net Provision	$	5,900			41.6	%	$	3,054			25.5	%	$	2,570			23.8	%