(

) Income Taxes

Components of income tax expense (benefit) from operations were as follows:

(In thousands)	2017			2016		2015

Current tax expense
Federal	$	12,622		$	14,270	$	15,478
State		546			698		608
Total current tax expense		13,168			14,968		16,086

Deferred tax expense (benefit)
Federal		3,783			192		748
State		(4	)		36		54
Total deferred tax expense (benefit)		3,779			228		802
Change in valuation allowance		192			48		45
Total income tax expense	$	17,139		$	15,244	$	16,933

Components of income tax

(benefit) expense recorded directly to stockholders’ equity were as follows:

(In thousands)	2017			2016			2015
Unrealized (loss) gain on securities available for sale	$	(531	)	$	(1,171	)	$	(839	)
Reclassification adjustment for securities losses realized in income		81			–			–
Reclassification adjustment for securities impairment realized in income		–			–			36
Unrealized (loss) gain on derivatives		112			24			(41	)
Minimum pension liability adjustment		(9	)		1			61
Compensation expense for tax purposes in excess of amounts recognized for financial reporting purposes		–			(1,705	)		(673	)
Total income tax (benefit) expense recorded directly to stockholders ’ equity	$	(347	)	$	(2,851	)	$	(1,456	)

An analysis of the difference between the statutory and effective tax rates from operations follows:

	Year ended December 31,
	2017			2016			2015
U.S. federal income tax rate		35.0	%		35.0	%		35.0	%
Tax credits		(14.4	)		(9.7	)		(2.5	)
Net deferred tax asset remeasurement		10.8			–			–
Amortization/impairment of investments in tax credit partnerships		3.4			2.8			0.4
Stock based compensation		(2.6	)		–			–
Cash surrender value of life insurance		(1.5	)		(0.9	)		(0.8	)
Tax exempt interest income		(1.2	)		(1.2	)		(1.4	)
Other, net		0.9			0.3			(0.2	)
State income taxes		0.7			0.8			0.8
Effective tax rate		31.1	%		27.1	%		31.3	%

he increase in effective tax rate from

2016

2017

was the result of the

one

-time, non-cash charge resulting from the remeasurement of deferred taxes as a result of tax reform somewhat offset by higher utilization of tax credits during the year. The Tax Cuts and Jobs Act was enacted in

December 2017

requiring an immediate recalculation of Bancorp’s net deferred tax asset which resulted in

$5.9

million of additional income tax expense in the

fourth

quarter of

2017.

The effective tax rate in

2017

was also reduced by the adoption of ASU

2016

“Compensation – Stock Compensation Improvements to Employee Share-Based Payment Accounting”. The new standard requires excess tax benefits and deficiencies related to share-based payment awards to be reflected in the statement of operations as a component of the provision for income taxes. For

2017

Bancorp recorded a benefit of

$1.5

million for such excess benefits against the provision for income tax expense. Prior to adoption of ASU

2016

09,

these tax benefits were recorded directly to additional paid-in capital. Tax benefits recorded to capital for

2016

and

2015

were

$1.7

million and

$673

thousand, respectively.

The decrease in the effective tax rate from

2015

2016

was largely the result of higher utilization of tax credits in

2016.

Bancorp invests in certain partnerships that yield federal income tax credits. The tax benefit of these investments exceeds the amortization and impairment expense associated with them, resulting in a positive impact on income.

December 2017,

the U.S. Securities and Exchange Commission (“SEC”) released Staff Accounting Bulletin

No.

118

(“SAB

118”

) to address any uncertainty or diversity of views in practice in accounting for the income tax effects of tax reform in situations where a registrant does

not

have the necessary information available, prepared or analyzed in reasonable detail to complete this accounting in the reporting period that includes the enactment date. SAB

118

allows a measurement period

not

to extend beyond

one

year from the tax reform’s enactment date to complete the necessary accounting.

two

areas, Bancorp recorded provisional amounts of deferred taxes where the information was

not

available to complete the accounting:

) the Company

’s deferred tax assets of

$565

thousand for temporary differences in certain tax credit investments is awaiting receipt of Schedule K-

from outside preparers.

) Bancorp estimated that

reductions are required to deferred tax assets included in the

$19

thousand of future deductions for compensation that might be subject to new limitations under Code Sec.

162

(m) which, generally, limits to

million annual deductions for certain compensation paid to certain executives. There is uncertainty in applying new rules to existing contracts, and Bancorp is seeking clarification before finalizing its analysis. In a

third

area, the Company recorded

provisional amounts to its deferred tax liability for temporary differences between the tax and financial reporting bases of certain property and equipment items. These cannot be reasonably estimated. Bancorp’s deferred tax liability of

$541

thousand for temporary differences between the tax and financial reporting bases of fixed assets is awaiting completion of a cost segregation study to take advantage of additional depreciation deductions available through tax reform. Bancorp will complete and record income tax effects of tax reform during the period the necessary information becomes available. This measurement period will

not

extend beyond

December 22, 2018.

The effects of temporary differences that gave rise to significant portions of deferred tax assets and deferred tax liabilities follows:

	December 31,
(In thousands)	2017			2016
Allowance for loan loss	$	5,422		$	8,581
Deferred compensation		4,148			5,589
Accrued expenses		798			1,360
Investments in partnerships		565			905
Write-downs and costs associated with other real estate owned		39			29
Loans		442			685
Other-than-temporary impairment		–			37
Securities		121			–
Other assets		186			185
Total deferred tax assets		11,721			17,371

Securities		–			438
Property and equipment		764			1,409
Loan costs		588			923
Mortgage servicing rights		161			280
Leases		149			381
Core deposit intangible		267			502
Other liabilities		260			408
Total deferred tax liabilities		2,189			4,341
Valuation allowance		(326	)		(134	)

Net deferred tax asset	$	9,206		$	12,896

A valuation allowance is recognized for a deferred tax asset if, based on the weight of available evidence, it is more-likely-than-

not

that some portion of the entire deferred tax asset will

not

be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projection for future taxable income over the periods which the temporary differences resulting in the remaining deferred tax assets are deductible, management believes it is more-likely-than-

not

that Bancorp will realize the benefits of these deductible differences, net of the valuation allowance, at

December 31,

201

Realization of deferred tax assets associated with the investment in tax credit partnerships is dependent upon generating sufficient taxable capital gain income prior to their expiration. A valuation allowance

$326

thousand and

$134

thousand to reflect management’s estimate of the temporary deductible differences that

may

expire prior to their utilization has been recorded as of

December 31, 2017

and

2016,

respectively.

US GAAP provides guidance on financial statement recognition and measurement of tax positions taken, or expected to be taken, in tax returns. As

December 31, 2017

and

2016,

the gross amount of unrecognized tax benefits, including penalties and interest, was

$40

thousand. If recognized, tax benefits would reduce tax expense and accordingly, increase net income. The amount of unrecognized tax benefits

may

increase or decrease in the future for various reasons including adding amounts for current year tax positions, expiration of open income tax returns due to statutes of limitation, changes in management’s judgment about the level of uncertainty, status of examination, litigation and legislative activity and addition or elimination of uncertain tax positions. Federal and state income tax returns are subject to examination for the years after

2013.

A reconciliation of the amount of unrecognized tax benefits follows:

(In thousands)	2017			2016
Balance as of January 1	$	40		$	40
Increases - current year tax positions		11			11
Increases - prior year tax positions		–			–
Settlements		–			–
Lapse of statute of limitations		(11	)		(11	)
Balance as of December 31	$	40		$	40