Income Taxes

12 Months Ended

Dec. 31, 2019

INCOME TAXES

The current income tax provision reflects the tax consequences of revenue and expenses currently taxable or deductible on various income tax returns for the year reported. The deferred income tax provision generally reflects the net change in deferred income tax assets and liabilities during the year, excluding any deferred income tax assets and liabilities of acquired businesses. The components of the provision for income taxes for the years ended December 31, 2019, 2018, and 2017 were as follows, in thousands:


	2019		2018		2017
Current:
Federal	$	24,106	$	16,769	$	25,532
State	11,298		8,686		5,025
Total current expense	$	35,404	$	25,455	$	30,557
Deferred:
Federal	$	760	$	2,615	$	12,370
State	(1,174)		145		893
Total deferred expense (benefit)	$	(414)	$	2,760	$	13,263
Total income tax expense	$	34,990	$	28,215	$	43,820

In response to the enactment of the Tax Cuts and Jobs Act on December 22, 2017, which reduced the corporate federal tax rate from a graduated maximum 35% to a flat 21%, Heartland recorded $10.4 million of income tax expense in 2017 to adjust the value of its deferred tax assets and liabilities.

Temporary differences between the amounts reported in the financial statements and the tax basis of assets and liabilities result in deferred taxes. Deferred tax assets and liabilities at December 31, 2019 and 2018, were as follows, in thousands:


	2019		2018
Deferred tax assets:
Tax effect of net unrealized loss on securities carried at fair value reflected in stockholders’ equity	$	—	$	11,148
Tax effect of net unrealized loss on derivatives reflected in stockholders’ equity	563		—

Allowance for loan losses	17,686		16,682
Deferred compensation	8,071		7,042
Organization and acquisitions costs	337		319
Net operating loss carryforwards	18,459		14,495
Non-accrual loan interest	853		863
OREO write-downs	921		1,469
Tax credit projects	4,252		5,254


Other	2,643		1,961
Gross deferred tax assets	53,785		59,233
Valuation allowance	(12,379)		(12,125)
Gross deferred tax assets	$	41,406	$	47,108


Deferred tax liabilities:
Tax effect of net unrealized gain on securities carried at fair value reflected in stockholders’ equity	$	(279)	$	—
Tax effect of net unrealized gain on derivatives reflected in stockholders’ equity	—		(160)
Securities	(4,240)		(2,332)
Premises, furniture and equipment	(6,232)		(6,514)

Tax bad debt reserves	(422)		(427)
Purchase accounting	(7,824)		(6,339)
Prepaid expenses	(2,176)		(203)
Servicing rights	(1,421)		(7,933)
Deferred loan fees	(3,342)		(3,321)
Other	(1,870)		(380)
Gross deferred tax liabilities	$	(27,806)	$	(27,609)
Net deferred tax asset	$	13,600	$	19,499

The deferred tax assets (liabilities) related to net unrealized gains (losses) on securities available for sale and on derivatives had no effect on income tax expense as these gains and losses, net of taxes, were recorded in other comprehensive income (loss), other than for the effect of the federal tax rate. In 2017, the effect of the enacted change in the federal corporate tax rate resulted in tax expense totaling $4.5 million to adjust the deferred tax assets (liabilities) related to net unrealized gains (losses) on securities available for sale and on derivatives.

As a result of acquisitions, Heartland had net operating loss carryforwards for federal income tax purposes of approximately $31.9 million at December 31, 2019, and $24.4 million at December 31, 2018. The associated deferred tax asset was $6.7 million at December 31, 2019, and $5.1 million at December 31, 2018. These net carryforwards expire during the period from December 31, 2026, through December 31, 2039, and are subject to an annual limitation of approximately $6.8 million. Net operating loss carryforwards for state income tax purposes were approximately $163.7 million at December 31, 2019, and $121.1 million at December 31, 2018. The associated deferred tax asset, net of federal tax, was $11.8 million at December 31, 2019, and $9.4 million at December 31, 2018. These carryforwards have begun to expire and will continue to do so until December 31, 2039.

A valuation allowance against the deferred tax asset due to the uncertainty surrounding the utilization of these state net operating loss carryforwards was $10.1 million at December 31, 2019, and $8.1 million at December 31, 2018. During both 2019 and 2018, Heartland had book write-downs on investments that, for tax purposes, would generate capital losses upon disposal. Due to the uncertainty of Heartland's ability to utilize the potential capital losses, a valuation allowance for these potential losses totaled $2.3 million at December 31, 2019, and $4.0 million at December 31, 2018. In 2019, Heartland released valuation allowances of $1.9 million on deferred tax assets for capital losses it expects to realize on the disposal of partnership investments. Heartland generated capital gains from its 2019 strategic developments, which included various branch sales not conducted in the ordinary course of its business strategy. As a result of its net capital gains, Heartland was able to realize the benefit of its capital losses.

Realization of the deferred tax asset over time is dependent upon the existence of taxable income in carryback periods or the ability to generate sufficient taxable income in future periods. In determining that realization of the deferred tax asset was more likely than not, Heartland gave consideration to a number of factors, including its taxable income during carryback periods, its recent earnings history, its expectations for earnings in the future and, where applicable, the expiration dates associated with its tax carryforwards.

The actual income tax expense from continuing operations differs from the expected amounts for the years ended December 31, 2019, 2018, and 2017, (computed by applying the U.S. federal corporate tax rate of 21% for 2019 and 2018 income before income taxes and 35% for 2017 income before income taxes) are as follows, in thousands:


	2019			2018			2017
Computed "expected" tax on net income	$	38,665		$	30,495		$	41,682
Increase (decrease) resulting from:
Nontaxable interest income	(3,281)			(4,423)			(9,282)
State income taxes, net of federal tax benefit	8,509			6,976			3,846

Tax credits	(6,860)			(4,085)			(2,390)
Valuation allowance	(1,648)			23			405
Excess tax benefit on stock compensation	(229)			(657)			(1,130)
Deferred tax adjustment due to Tax Cuts and Jobs Act enactment	—			—			10,396
Other	(166)			(114)			293
Income taxes	$	34,990		$	28,215		$	43,820
Effective tax rates	19.0		%	19.4		%	36.8		%

Heartland's income taxes included solar energy credits totaling $4.0 million, $2.9 million, and $449,000 during 2019, 2018 and 2017, respectively. Federal historic rehabilitation tax credits included in Heartland's income taxes totaled $1.8 million during 2019, $0, and $713,000 in 2019, 2018, and 2017, respectively. Additionally, investments in certain low-income housing partnerships totaled $6.1 million at December 31, 2019, $6.9 million at December 31, 2018, and $7.8 million at December 31, 2017. These investments generated federal low-income housing tax credits of $1.1 million during 2019 and $1.2 million for the years ended December 31, 2018 and 2017. These investments are expected to generate federal low-income housing tax credits of approximately $779,000 for 2020, $538,000 for 2021 through 2023, $322,000 for 2024, $86,000 for 2025 and $34,000 for 2026.

On December 31, 2019, the amount of unrecognized tax benefits was $657,000, including $69,000 of accrued interest and penalties. On December 31, 2018, the amount of unrecognized tax benefits was $611,000, including $66,000 of accrued interest and penalties. If recognized, the entire amount of the unrecognized tax benefits would affect the effective tax rate.

The tax years ended December 31, 2016, and later remain subject to examination by the Internal Revenue Service. For state purposes, the tax years ended December 31, 2014, and later remain open for examination. Heartland does not anticipate any significant increase or decrease in unrecognized tax benefits during the next twelve months.