TAXES ON INCOME

The Company and its subsidiaries file a consolidated federal income tax return and separate state income tax returns. Our income tax provision consists of the following:



	Year ended December 31,
(Dollars in thousands)	2017		2016		2015
Current income taxes:
Federal taxes	$	36,005	$	23,857	$	24,237
State and local taxes	4,342		3,847		3,805
Deferred income taxes:
Federal taxes	17,899		5,135		2,283
State and local taxes	—		235		(52		)
Total	$	58,246	$	33,074	$	30,273

Current federal income taxes include taxes on income that cannot be offset by net operating loss carryforwards.

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. The following is a summary of the significant components of our deferred tax assets and liabilities as of December 31, 2017 and 2016:



(Dollars in thousands)	2017			2016
Deferred tax assets:
Unrealized losses on available-for-sale securities	$	2,084		$	4,170
Allowance for loan losses	8,526			13,913
Purchase accounting adjustments—loans	3,487			8,339
Reserves and other accruals	9,194			14,010
Provision for legal settlement	2,520			—
Deferred gains	589			1,109
Net operating losses	188			352
Derivatives	757			1,086
Reverse mortgages	606			2,262
Total deferred tax assets	$	27,951		$	45,241
Deferred tax liabilities:
Bad debt recapture	$	—		$	(545	)
Accelerated depreciation	(778		)	(1,049		)
Other	(326		)	(497		)
Bank-owned life insurance	(5,387		)	—
Deferred loan costs	(989		)	(1,079		)
Intangibles	(3,826		)	(5,946		)
Total deferred tax liabilities	(11,306		)	(9,116		)
Net deferred tax asset	$	16,645		$	36,125

Included in the table above is the effect of certain temporary differences for which no deferred tax expense or benefit was recognized. In 2017, such items consisted primarily of $2.1 million of unrealized losses on certain investments in debt and equity securities accounted for under ASC 320 along with $0.3 million of unrealized gains related to postretirement benefit obligations accounted for under ASC 715 and $0.8 million of unrealized losses on derivatives accounted for under ASC 815. In 2016, they consisted primarily of $4.2 million of unrealized losses on certain investments in debt and equity securities along with $0.3 million related to postretirement benefit obligations and $1.1 million of unrealized losses on derivatives.

On December 22, 2017 the Tax Reform Act was enacted. As a result, we were required to re-measure our existing net deferred tax asset (DTA) on that date based on the future federal corporate income tax rate of 21%. This DTA re-measurement resulted in a one-time charge to income tax expense in the amount of $14.5 million. We estimated the tax charge as of December 22, 2017 based on an initial analysis of the Tax Reform Act and it may be adjusted in future periods periods (not to extend beyond December 22, 2018) following our evaluation of the effects, if any, of implementation guidance or regulations that may be issued by the Internal Revenue Service on our initial analysis of the Tax Reform Act. The initial accounting is incomplete as certain information was not yet available or our analysis was not yet completed due to the close proximity of the date the Tax Reform Act was signed into law to the filing date of this Report. The additional information needed includes, but is not limited to, tax-related information pertaining to certain of our partnership investments, final computations of tax depreciation, final tax calculations for certain loan adjustments, and information related to certain payment accruals that is not expected to be available until later in 2018.

Based on our history of prior earnings and our expectations of the future, it is anticipated that operating income and the reversal pattern of our temporary differences will, more likely than not, be sufficient to realize a net deferred tax asset of $16.6 million at December 31, 2017.

As a result of the acquisition of Penn Liberty on August 12, 2016, we recorded a net deferred tax asset (DTA) of $7.4 million at closing. The deferred tax asset subsequently decreased by $0.9 million during the measurement period. Penn Liberty did not have any federal or state net operating loss (NOL) carryovers, and had $0.1 million of alternative minimum tax credit carryovers that have now been fully utilized. We expect to utilize all tax attributes acquired from Penn Liberty. See Note 2 for further information.

As a result of the acquisition of Alliance in 2015, we recorded a DTA of $7.7 million. Included in this DTA are $1.1 million of federal NOL’s carryovers, $2.6 million of state NOL carryovers and $1.7 million of alternative minimum tax credit carryovers. Such federal NOL’s expire beginning in 2035 while the state NOLs expire in 2017. The tax credits have an indefinite life. Although there is a limitation on the amount of Alliance’s net operating loss deduction and tax credit utilization (and certain other deductions) that we can utilize each tax year, we have now fully utilized these tax attributes and, therefore, no valuation allowance has been recorded against the DTA. Retained earnings at December 31, 2015 include approximately $7.1 million, representing prior Alliance bad debt deductions, for which no deferred income taxes have been provided.

As a result of the acquisition of the First National Bank of Wyoming (FNBW) in 2014, we recorded a net DTA of $3.1 million. Included in this DTA are $1.9 million of NOL carryovers and $0.3 million of alternative minimum tax credit carryovers. Although there is a limitation on the amount of FNBW’s net operating loss deduction (and certain other deductions) that we can utilize each tax year, we have now fully utilized these tax attributes and, therefore, no valuation allowance has been recorded against the DTA.

Due to the reduction in the corporate tax rate resulting from the Tax Reform Act, we have decided to surrender substantially all of our bank-owned life insurance (BOLI) policies. While the formal surrender will not occur until 2018, we are required under ASC 740 to record a deferred tax liability for the income tax effect of the surrender. We expect to owe approximately $8.0 million in federal income taxes and penalties in 2018 upon the BOLI surrender.

A reconciliation showing the differences between our effective tax rate and the U.S. Federal statutory tax rate is as follows:



	Year ended December 31,
Year Ended December 31,	2017		2016		2015
Statutory federal income tax rate	35.0	%	35.0	%	35.0	%
State tax, net of federal tax benefit	2.7		3.1		2.9
Adjustment to net deferred tax asset for enacted changes in tax laws and rates	13.4		—		—
Nondeductible acquisition costs	—		0.2		0.7
Tax-exempt interest	(1.9	)	(2.1	)	(1.9	)
Bank-owned life insurance income	(0.5	)	(0.3	)	(0.3	)
Excess tax benefits from share-based compensation	(2.0	)	(1.4	)	—
Surrender of bank-owned life insurance policies	7.3		—		—
Federal tax credits, net of amortization	(0.3	)	(0.5	)	(0.5	)
Other	—		—		0.2
Effective tax rate	53.7	%	34.0	%	36.1	%

As a result of the early adoption of ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting,” we recorded $2.3 million and $1.5 million of income tax benefits in 2017 and 2016, respectively, related to excess tax benefits from stock compensation. Prior to 2016, such excess tax benefits were recorded directly in stockholders’ equity. This new accounting standard will result in volatility to future effective tax rates.

We have $0.9 million of remaining Federal net operating losses. Such NOLs expire beginning in 2030 and, due to Internal Revenue Service (IRS) limitations, $0.1 million are being utilized each year. Accordingly, we fully expect to utilize all of these NOLs. We have no state NOLs.

We account for income taxes in accordance with ASC 740, Income Taxes (formerly Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes and FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109). ASC 740 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. Benefits from tax positions are recognized in the financial statements only when it is more-likely-than-not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold are recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold are derecognized in the first subsequent financial reporting period in which that threshold is no longer met. ASC 740 also provides guidance on the accounting for and disclosure of unrecognized tax benefits, interest and penalties.

We record interest and penalties on potential income tax deficiencies as income tax expense. Federal tax years 2014 through 2017 remain subject to examination as of December 31, 2017, while tax years 2014 through 2017 remain subject to examination by state taxing jurisdictions. No federal or state income tax return examinations are currently in process. We do not expect to record or realize any material unrecognized tax benefits during 2018.

ASC 740 prescribes a minimum probability threshold that a tax position must meet before a financial statement benefit is recognized. We recognize, when applicable, interest and penalties related to unrecognized tax benefits in the provision for income taxes in the Consolidated Financial Statements. Assessment of uncertain tax positions under ASC 740 requires careful consideration of the technical merits of a position based on our analysis of tax regulations and interpretations. There are no unrecognized tax benefits related to ASC 740 as of December 31, 2017 nor has there been any unrecognized tax benefit activity since December 31, 2012.

As a result of the adoption of ASU No. 2014-01, “Investments-Equity Method and Joint Ventures: Accounting for Investments in Qualified Affordable Housing Projects,” the amortization of our low-income housing credit investments has been reflected as income tax expense. Accordingly, $1.7 million of such amortization has been reflected as income tax expense for the year ended December 31, 2017, compared to $1.6 million and $1.9 million for the year ended December 31, 2016 and December 31, 2015, respectively.

The amount of affordable housing tax credits, amortization and tax benefits recorded as income tax expense for the year ended December 31, 2017 were $1.6 million, $1.7 million and $0.4 million, respectively. The carrying value of the investment in affordable housing credits is $13.8 million at December 31, 2017, compared to $15.4 million at December 31, 2016.