1.	Income Taxes

The provision for income taxes consists of the following for the years ended December 31:



(In thousands)		2012		2011
Current Tax expense:
Federal	$	417	$	233
State		96		670
	$	513	$	903
Deferred tax expense/(benefit):
Federal	$	22	$	(1,291)
State		378		(247)
	$	400	$	(1,538)
Income tax expense/(benefit) for the year	$	913	$	(635)

The reconciliation between the statutory federal income tax rate and effective income tax rate is as follows:



	2012	2011
Federal statutory rate	35.0%	35.0%
Tax-exempt income on securities and loans	(11.9)	(30.7)
Tax-exempt BOLI income	(11.2)	(12.1)
State income tax, net of federal tax benefit	7.9	6.3
Tax credits	(10.1)	(22.5)
Other	6.7	2.7
	16.4%	(21.3%)

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Corporation’s temporary differences as of December 31 are as follows:



(In thousands)		2012		2011
Deferred tax assets:
Allowance for loan losses	$	6,446	$	7,862
Deferred loan fees		70		134
Deferred compensation		704		624
Federal and State Tax loss carry forwards		5,289		4,291
AMT and Other carry forwards		1,712		985
Unrealized loss on investment securities available-for-sale		8,771		8,935
Pension/SERP		1,677		935
Other than temporary impairment on investment securities		5,937		5,965
Other real estate owned		1,243		1,836
Other		1,874		1,716
Total deferred tax assets		33,723		33,283
Valuation allowance		(1,471)		(1,364)
Total deferred tax assets less valuation allowance		32,252		31,919
Deferred tax liabilities:
Amortization of goodwill and core deposit intangible		(1,857)		(1,507)
Depreciation		(1,409)		(1,601)
Other		(104)		(100)
Total deferred tax liabilities		(3,370)		(3,208)
Net deferred tax assets	$	28,882	$	28,711

State income tax expense amounted to $.5 million during 2012 and $.4 million during 2011.

In assessing the ability to realize deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of the deferred tax assets is dependent upon the generation of future taxable income of the appropriate character (for example, ordinary income or capital gain) within the carry-back or carry-forward period available under the tax law during the periods in which temporary differences are deductible. The Corporation has considered future market growth, forecasted earnings, future taxable income, and feasible and permissible tax planning strategies in determining whether it will be able to realize the deferred tax asset. If the Corporation was to determine that it would not be able to realize a portion of its net deferred tax asset in the future for which there is currently no valuation allowance, an adjustment to the net deferred tax asset would be charged to earnings in the period such determination was made. Conversely, if the Corporation was to make a determination that it is more likely than not that the deferred tax assets for which there is a valuation allowance would be realized, the related valuation allowance would be reduced and a benefit would be recorded.

At December 31, 2012 the Corporation has federal net operating losses (“NOL”) of approximately $10.0 million and West Virginia NOLs of approximately $5.3 million for which deferred tax assets of $3.5 million and $0.2 million, respectively, have been recorded at December 31, 2012. The federal and West Virginia NOLs were created in 2011 and 2010 and will begin expiring in 2030. Management has determined that a deferred tax valuation allowance is not required for 2012 on the Federal and West Virginia NOLs because we believe it is more likely than not that these deferred tax assets can be realized prior to expiration of their carry-forward period. This determination is based primarily on the ability of the Corporation to immediately generate approximately $13.4 million of taxable income through tax planning strategies, irrespective of any additional future operating income. At December 31, 2012 these strategies include the ability to generate approximately $4.1 million in taxable gains through the sale of investment securities, approximately $8.0 million in taxable gains through the sale of its Bank Owned Life Insurance and approximately $1.3 million in taxable gains through the sale of its fixed rate mortgage portfolio.

The Corporation has Maryland net operating loss carry-forwards of $28.4 million for the NOL of the Parent Company for which a deferred tax asset of $1.5 million has been recorded at December 31, 2012. There has been and continues to be a full valuation allowance on the Parent Company’s NOL based on the fact that it is more likely than not that this deferred tax asset will not be realized because the Parent company files a separate tax return and has recurring tax losses and will not generate sufficient taxable income in the future to utilize them before they expire beginning in 2019. The valuation allowance of $1.5 million at December 31, 2012 reflects an increase of $.1 million from the level at December 31, 2011.

In addition, based on our evaluation of the four sources of taxable income, we have concluded that no valuation allowance is deemed necessary for the Corporation’s remaining Federal and State deferred tax assets at December 31, 2012 as it is more likely than not (defined a level of likelihood that is more than 50 percent) that they will be realized based on the expected reversal of deferred tax liabilities, the generation of future income sufficient to realize the deferred tax assets as they reverse and the ability to implement tax planning strategies to prevent the expiration of any carry-forward periods.