7. INCOME TAXES

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are summarized as follows:


(in thousands)	2018		2017
Deferred tax assets:
Tax discounting of unpaid losses and settlement expenses	$	18,327	$	20,020
Unearned premium offset		17,864		16,528
Deferred compensation		2,700		1,435
Stock option expense		2,702		2,283
Other		616		578
Deferred tax assets before allowance	$	42,209	$	40,844
Less valuation allowance		—		—
Total deferred tax assets	$	42,209	$	40,844

Deferred tax liabilities:
Net unrealized appreciation of securities	$	22,177	$	51,448
Deferred policy acquisition costs		17,836		16,320
Discounting of unpaid losses and settlement expenses - TCJA implementation offset		5,203		9,466
Book/tax depreciation		3,133		3,159
Intangible assets		1,711		584
Undistributed earnings of unconsolidated investees		15,811		13,431
Other		576		204
Total deferred tax liabilities	$	66,447	$	94,612
Net deferred tax liability	$	(24,238)	$	(53,768)

Income tax expense (benefit) attributable to income from operations for the years ended December 31, 2018, 2017 and 2016, differed from the amounts computed by applying the U.S. federal tax rate of 21 percent, 35 percent and 35 percent, respectively, to pretax income from continuing operations as demonstrated in the following table:


(in thousands)	2018				2017				2016
Provision for income taxes at the statutory federal tax rates	$	14,192	21.0	%	$	29,606	35.0	%	$	54,979	35.0	%
Increase (reduction) in taxes resulting from:
Enactment of Tax Cuts and Jobs Act (TCJA)		(2,268)	(3.4)	%		(32,821)	(38.8)	%		—	—	%
Excess tax benefit on share-based compensation		(4,533)	(6.7)	%		(5,798)	(6.9)	%		—	—	%
Dividends received deduction		(775)	(1.1)	%		(2,025)	(2.4)	%		(2,216)	(1.4)	%
ESOP dividends paid deduction		(1,184)	(1.8)	%		(2,905)	(3.4)	%		(3,302)	(2.1)	%
Tax-exempt interest income		(1,795)	(2.7)	%		(4,671)	(5.5)	%		(4,263)	(2.7)	%
Unconsolidated investee dividends		—	—	%		(1,351)	(1.6)	%		(2,772)	(1.8)	%
Other items, net		(235)	(0.3)	%		(474)	(0.6)	%		(264)	(0.2)	%
Total	$	3,402	5.0	%	$	(20,439)	(24.2)	%	$	42,162	26.8	%

Our effective tax rates were 5.0 percent, -24.2 percent and 26.8 percent for 2018, 2017 and 2016, respectively. Effective rates are dependent upon components of pretax earnings and the related tax effects. While the effective rate was low in 2018, it was significantly lower in 2017 as a result of the impact of tax reform. Major factors contributing to the low rate in 2018 are the inclusion of unrealized losses from equity securities in pretax earnings in 2018, a reduced federal tax rate and adjustments to provisional deferred tax amounts recorded in 2017.

Among other provisions, the TCJA lowered the federal corporate tax rate from 35 percent to 21 percent effective January 1, 2018. Our deferred tax items were revalued as of year-end 2017 to reflect the lower rate, which reduced our net deferred tax liability and income tax expense by $32.8 million and decreased the effective tax rate by 38.8 percent.

Except for two aspects, the accounting for the tax effects of the enactment of the TCJA were completed as of December 31, 2017. The first provisional item recorded in 2017 was related to an expected disallowance of deductions for certain performance based compensation, including bonuses and stock options. At the time of enactment, there was a lack of clarity on whether some amounts could be grandfathered in as deductible. The Internal Revenue Service (IRS) and Treasury Department provided additional guidance and we were able to finalize the accounting in 2018 by recording a $2.3 million deferred tax benefit to restore the deferred tax assets related to those performance based compensation amounts. The second provisional item related to discount factors on loss reserves that the IRS had not yet published. The IRS published the factors in the fourth quarter of 2018 and we were able to complete the accounting for the effects of the enactment of the TCJA. While there was no net impact to the deferred tax amount that was recorded at December 31, 2017, we implemented the new discounting methodology and will recognize the adjustment ratably over the allowed eight-year period beginning in 2018.

New accounting guidance required the excess tax benefit on share-based compensation to flow through income tax expense beginning in 2017. Prior to the adoption, excess tax benefits on share-based compensation were recorded directly to shareholders’ equity and had no impact on the effective tax rate. Due to the new accounting method, we recognized a $4.5 million and $5.8 million tax benefit in 2018 and 2017, respectively, which decreased the effective tax rate by 6.7 percent and 6.9 percent, respectively.

Our net earnings include equity in earnings of unconsolidated investees, Maui Jim and Prime. The investees do not have a policy or pattern of paying dividends. As a result, we record a deferred tax liability on the earnings at the recently revised corporate capital gains rate of 21 percent in anticipation of recovering our investments through means other than through the receipt of dividends, such as a sale. In the fourth quarter of 2017, Maui Jim gave notification that a $9.9 million dividend would be paid in January 2018. Even though no dividend was received in 2017, we were aware that the lower tax rate applicable to affiliated dividends (7.4 percent in 2018) would be applied when the dividend was paid in 2018 and we therefore recorded a $1.4 million tax benefit in 2017. We received a $9.9 million dividend from Maui Jim in the fourth quarter of 2016 and recognized a $2.8 million tax benefit from applying the lower tax rate applicable to affiliated dividends (7.0 percent in 2016), as compared to the corporate capital gains rate on which the deferred tax liabilities were based. Standing alone, the dividends resulted in a 1.6 percent and 1.8 percent reduction to the 2017 and 2016 effective tax rates, respectively. As no additional dividends were declared from unconsolidated investees in 2018, there was no impact to the 2018 effective tax rate.

Dividends paid to our Employee Stock Ownership Plan (ESOP) also result in a tax deduction. Dividends paid to the ESOP in 2018, 2017 and 2016 resulted in tax benefits of $1.2 million, $2.9 million and $3.3 million, respectively. These tax benefits reduced the effective tax rate for 2018, 2017 and 2016 by 1.8 percent, 3.4 percent and 2.1 percent, respectively.

We have recorded our deferred tax assets and liabilities using the statutory federal tax rate of 21 percent. We believe it is more likely than not that all deferred tax assets will be recovered, given the carry back availability as well as the results of future operations, which will generate sufficient taxable income to realize the deferred tax asset. In addition, we believe when these deferred items reverse in future years, our taxable income will be taxed at an effective rate of 21 percent.

Federal and state income taxes paid in 2018, 2017 and 2016, amounted to $16.4 million, $10.4 million and $26.9 million, respectively.

Although we are not currently under audit by the IRS, tax years 2015 through 2018 remain open and are subject to examination.