Note 9 - Income Taxes

12 Months Ended

Dec. 31, 2019

Notes to Financial Statements

Income Tax Disclosure [Text Block]

(9) Income Taxes

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

Years Ended December 31, (in thousands)	2019			2018			2017
Current income tax expense:
Federal	$	14,673		$	11,567		$	12,622
State		772			732			546
Total current income tax expense		15,445			12,299			13,168
Deferred income tax expense (benefit) :
Federal		(746	)		(52	)		3,783
State		(2,872	)		(289	)		(4	)
Total deferred income tax expense (benefit)		(3,618	)		(341	)		3,779
Change in valuation allowance		(2,234	)		73			192
Total income tax expense	$	9,593		$	12,031		$	17,139

Components of income tax (benefit) expense recorded directly to stockholders’ equity were as follows:

Years Ended December 31, (in thousands)	2019			2018			2017
Unrealized (loss) gain on securities available for sale	$	1,757		$	(812	)	$	(531	)
Reclassification adjustment for securities losses realized in income		—			—			81
Unrealized gain on derivatives		(120	)		46			112
Minimum pension liability adjustment		(58	)		46			(9	)
Total income tax (benefit) expense recorded directly to stockholders' equity	$	1,579		$	(720	)	$	(347	)

An analysis of the difference between statutory and ETRs from operations follows:

Years Ended December 31,	2019			2018			2017
U.S. federal statutory income tax rate		21.0	%		21.0	%		35.0	%
Kentucky state income tax enactments		(5.2	)		—			—
Net deferred tax asset remeasurement		—			(0.5	)		10.8
Excess tax benefits from stock-based compensation arrangements		(1.0	)		(0.8	)		(2.6	)
Increase in cash surrender value of life insurance		(0.9	)		(0.4	)		(1.5	)
Tax credits		(1.9	)		(1.8	)		(14.4	)
Tax exempt interest income		(0.3	)		(0.4	)		(1.2	)
Amortization/impairment of investments in tax credit partnerships		0.3			0.4			3.4
State income taxes, net of federal benefit		0.7			0.8			0.7
Other, net		—			(0.5	)		0.9
Effective tax rate		12.7	%		17.8	%		31.1	%

Currently, state income tax expense represents tax owed to the state of Indiana. Kentucky and Ohio state bank taxes are currently based on capital levels, and are recorded as other non-interest expense.

In March 2019, the Kentucky Legislature passed HB354 requiring financial institutions to transition from a capital based franchise tax to the Kentucky corporate income tax beginning in 2021. Historically, the franchise tax, a component of non-interest expenses, was assessed at 1.1% of net capital and averaged $2.5 million annually over the prior two year-end periods. The Kentucky corporate income tax will be assessed at 5% of Kentucky taxable income and will be included as a component of current and deferred state income tax expense. Associated with this change, predominantly during the first quarter of 2019, Bancorp established a Kentucky state DTA related to existing temporary differences estimated to reverse after the effective date of the law change. Bancorp recorded a corresponding state tax benefit, net of federal tax impact of $1.2 million, or approximately $0.06 per diluted share for 2019. While this is positive in the short-term, Bancorp anticipates an unfavorable impact of approximately $200,000 per year beginning in 2021.

In April 2019, the Kentucky Legislature passed HB458 allowing entities filing a combined Kentucky income return to share certain tax attributes, including net operating loss carryforwards. The combined filing beginning in 2021 will allow Bancorp’s Holding Company net operating loss carryforwards to offset against net revenue generated by the Bank up to 50% of the Bank’s Kentucky taxable income and reduce Bancorp’s tax liability. Bancorp recorded a state tax benefit, net of federal tax impact of $2.7 million, predominantly in the second quarter of 2019, or approximately $0.12 per diluted share for 2019. The losses are expected to be utilized when Bancorp begins filing a combined Kentucky income tax return. A valuation allowance is maintained for the loss that will expire in 2020.

The TCJA was enacted on December 22, 2017 and reduced the federal corporate tax rate from 35% to 21%, effective January 1, 2018. Bancorp incurred a charge of $5.9 million to income tax expense during 2017 representing the decrease in value of its net DTA upon enactment of the TCJA.

In December 2017, the SEC released 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 allowed a measurement period not to extend beyond one year from the tax reform’s enactment date to complete the necessary accounting.

The effects of temporary differences that gave rise to significant portions of DTAs and DTLs follows:

December 31, (in thousands)	2019			2018
Deferred tax assets
Allowance for loan loss	$	6,633		$	5,567
Deferred compensation		5,758			4,703
Operating lease liability		3,427			—
State net operating loss		2,550			2,201
Accrued expenses		1,486			968
Securities		—			756
Investments in tax credit partnerships		655			543
Loans		501			434
Other assets		228			181
Write-downs and costs associated with other real estate owned		22			7
Total deferred tax assets		21,260			15,360
Deferred tax liabilities
Property and equipment		1,054			1,154
Right-of-use operating lease asset		3,154			—
Securities		748			—
Loan costs		767			632
Mortgage servicing rights		299			193
Leases		266			336
Core deposit intangible		202			230
Other liabilities		183			267
Total deferred tax liabilities		6,673			2,812
Valuation allowance		(121	)		(2,355	)
Net deferred tax asset	$	14,466		$	10,193

A valuation allowance is recognized for a DTA if, based on the weight of available evidence, it is more likely than not that some portion of the entire DTA will not be realized. Ultimate realization of DTAs is dependent upon generation of future taxable income during periods in which those temporary differences become deductible. Management considers scheduled reversal of DTLs, 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 periods which the temporary differences resulting in remaining DTAs 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, 2019.

Realization of DTAs associated with investment in tax credit partnerships is dependent upon generating sufficient taxable capital gain income prior to their expiration and net operating losses that will not be utilized prior to their expiration. A valuation allowance of $121,000 and $2.4 million reflects management’s estimate of the temporary deductible differences that may expire prior to their utilization and has been recorded as of December 31, 2019 and 2018. The losses are expected to be utilized when Bancorp begins filing a combined Kentucky income tax return with the Bank. A valuation allowance is maintained for the loss that will expire in 2020. The loss carryforward is $64.7 million and expires over varying periods through 2039.

Kentucky DTAs amounts and the related valuation allowance for Bancorp’s net operating losses were previously reported as net due to a full valuation allowance and immaterial amounts. The 2018 amounts reported herein have been revised to report the items gross.

GAAP provides guidance on financial statement recognition and measurement of tax positions taken, or expected to be taken, in tax returns. 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. As of December 31, 2019 and 2018, the gross amount of unrecognized tax benefits was immaterial to Bancorp’s consolidated financial statements. Federal and state income tax returns are subject to examination for the years after 2015.