Note 11 - Income Taxes

12 Months Ended

Dec. 31, 2019

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% effective January 1, 2018. U.S. GAAP required that the tax impact of the rate change on existing tax account balances be recognized in the 2017 provision. A reasonable estimate of the rate change effect on QNB’s existing deferred tax asset/liability accounts (DTA/DTL) was made and a $2,054,000 adjustment to the 2017 tax provision was recorded. A portion of the DTA/DTL tax rate change effect related to QNB’s unrealized gains(losses) on available for sale securities, net of their expected deferred tax benefit, included in AOCI and created a “stranded tax effect” of $805,000. In February 2018, FASB issued ASU 2018-02, as discussed in Note 1, allowing a one-time reclassification of such “stranded tax effect” from AOCI to retained earnings. In the first quarter of 2018, QNB reclassified $805,000 of deferred tax benefits from AOCI to retained earnings as reflected in the Consolidated Statements of Shareholders’ Equity.

In 2018, QNB’s 2017 Federal tax return was filed and included an election to change tax methods for bad debt conformity and for loan originations costs. This resulted in a tax benefit of $415,000 related to the change in the tax rate from 34% to 21%. These discrete tax items were recorded in 2018.

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

Year ended December 31,	2019			2018			2017
Current Federal income taxes	$	2,789		$	1,742		$	3,454
Current state income taxes		380			57			124
Deferred Federal income taxes (benefits)		(207	)		363			268
Deferred state income taxes (benefits)		(112	)		(105	)		—
Other		—			(85	)		—
Net provision prior to discrete tax adjustments		2,850			1,972			3,846
DTL writeoff due to change in tax methods		—			(415	)		—
Net DTA revaluation for change in tax rate under 2017 Tax Reform		—			—			2,054
Net provision	$	2,850		$	1,557		$	5,900

At December 31, 2019 and 2018, the tax effects of temporary differences that represent the significant portion of deferred tax assets and liabilities are as follows:

December 31,	2019		2018
Deferred tax assets
Allowance for loan losses	$	2,076	$	1,855
Net unrealized holding losses on investment securities available-for-sale		—		1,896
Fair value adjustment on equity securities		—		190
Non-accrual interest income		54		76
Deferred rent		—		59
Deferred revenue		71		121
Incurred but not reported medical expense		31		33
Bonus		218		178
State net operating loss carryforward		—		29
Other		33		27
Total deferred tax assets		2,483		4,464
Deferred tax liabilities
Deferred loan costs		369		361
Depreciation		289		179
Mortgage servicing rights		92		95
Net unrealized holding losses on investment securities available-for-sale		68		—
Fair value adjustment on equity securities		32		—
Prepaid expenses		151		92
Deferred rent		23		—
Other		18		13
Total deferred tax liabilities		1,042		740
Net deferred tax asset	$	1,441	$	3,724

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 rates of 21% for 2019 and 2018 and 34% for 2017 and the actual tax provision was as follows:

Year ended December 31,	2019						2018						2017
	Dollar			%			Dollar			%			Dollar			%
Provision at statutory rate	$	3,193			21.0	%	$	2,707			21.0	%	$	4,825			34.0	%
Tax-exempt interest and dividend income		(538	)		(3.5	)		(577	)		(4.5	)		(948	)		(6.7	)
Bank-owned life insurance		(61	)		(0.4	)		(61	)		(0.4	)		(100	)		(0.7	)
Life insurance proceeds		—			—			—			—			(18	)		(0.1	)
Stock-based compensation expense		20			0.1			17			0.1			19			0.1
State income tax		205			1.3			(19	)		(0.1	)		82			0.6
Other		31			0.2			(95	)		(0.8	)		(14	)		(0.1	)
Net provision prior to discrete tax adjustments		2,850			18.7			1,972			15.3			3,846			27.1
DTL writeoff for change in tax methods		—			—			(415	)		(3.2	)		—			—
Net DTA revaluation for change in tax rate under 2017 Tax Reform		—			—			—			—			2,054			14.5
Net provision	$	2,850			18.7	%	$	1,557			12.1	%	$	5,900			41.6	%