Note 13 – Income Taxes

The Company and its subsidiaries are subject to U.S. federal and state income taxes. Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

Income tax expense (benefit) was as follows:

	2013			2012

	(In thousands)
Current
Federal	$	-		$	(29	)
State		4			8
Deferred
Federal		(286	)		431
State		(267	)		(282	)
Change in valuation allowance		553			701


Total	$	4		$	829

Effective tax rates differ from the federal statutory rate of 34% applied to income before income taxes due to the following:

	2013			2012

	(In thousands)
Federal statutory rate times financial statement income (loss)	$	(101	)	$	482
Effect of:
State taxes, net of federal benefit		(19	)		104
Enterprise zone net interest deduction		(285	)		(356	)
Earnings from bank owned life insurance		(28	)		(32	)
Low income housing credits		(211	)		(167	)
Change in valuation allowance		553			701
Other, net		95			97


Total	$	4		$	829

Year-end deferred tax assets and liabilities were due to the following:

	2013			2012

	(In thousands)
Deferred tax assets:
Allowance for loan losses	$	3,040		$	3,235
Accrued liabilities		120			191
State income taxes		42			40
Deferred compensation		407			404
Stock compensation		270			251
Real estate owned		157			623
Unrealized gain/loss on loans held for sale		-			131
Net operating loss carryforward		6,752			5,767
Non-accrual loan interest		485			501
Basis difference on fixed assets		109			117
Partnership investment		27			-
General business credit		725			470
Alternative minimum tax credit		113			113
Other		28			29


Total deferred tax assets		12,275			11,872


Deferred tax liabilities:
Deferred loan fees/costs		(1,699	)		(1,754	)
Net unrealized appreciation on available-for-sale securities		(198	)		(295	)
FHLB stock dividends		(574	)		(644	)
Mortgage servicing rights		(50	)		(58	)
Partnership investment		-			(5	)
Prepaid expenses		(69	)		(82	)


Total deferred tax liabilities		(2,590	)		(2,838	)
Valuation allowance		(9,685	)		(9,034	)


Net deferred tax assets	$	-		$	-

Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion, or all, of the deferred tax asset will not be realized. In assessing the realization of deferred tax assets, management evaluates both positive and negative evidence, including the existence of cumulative losses in the current year and the prior two years, the amount of taxes paid in available carry-back years, the forecasts of future income and tax planning strategies. This analysis is updated quarterly. Based on this analysis, the Company determined that a valuation allowance of $9.7 million was required as of December 31, 2013, resulting in $0 net deferred tax assets. The Company had recorded a valuation allowance of $9.0 million and $0 net deferred tax assets as of December 31, 2012.

As of December 31, 2013, the Company has federal net operating loss carryforwards of $13.3 million, expiring beginning in 2031 through 2033 and California net operating loss carryforwards of $31.1 million, expiring beginning in 2029 through 2033. The Company also has federal general business credit of $725 thousand, expiring beginning in 2030 through 2033, and alternative minimum tax credit carryforwards of $113 thousand, which can be carried forward indefinitely.

Section 382 of the Internal Revenue Code imposes limitations on a corporation's ability to utilize net operating loss carryovers, tax credit carryovers and other income tax attributes when there is an ownership change. Generally, the rules provide that an ownership change is deemed to have occurred when the cumulative increase of each 5% or more stockholder and certain groups of stockholder's treated as 5% or more shareholders, as determined under Section 382, exceeds 50% over a specified "testing" period, generally equal to three years. Section 382 applies rules regarding the treatment of new groups of stockholders treated as 5% shareholders due to issuances of stock and other equity transactions, which may cause a change of control to occur. The Company has performed an analysis of the potential impact of Section 382 related to the recapitalization occurred on August 22, 2013, and has determined that the Company did not undergo an ownership change and any potential limitations imposed under Section 382 do not apply.

Federal income tax laws previously allowed the Company additional bad debt deductions based on the reserve method of computing the federal bad debt deduction. This method of computing the Company's federal bad debt deduction was permitted to be used by the Company until the end of 1987. As of December 31, 1987, the tax bad debt reserve balance totaled $3.0 million. Accounting standards do not require a deferred tax liability to be recorded on this amount, which otherwise would total $1.0 million at year end 2013 and 2012. If the Bank were liquidated, or otherwise ceases to be a bank, or if tax laws were to change, this amount would be expensed.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

	2013			2012

	(In thousands)
Balance at beginning of year	$	431		$	323
Additions based on tax positions related to the current year		86			108
Additions for tax positions of prior year		-			-
Reductions for tax positions of prior years		(29	)		-
Settlements		-			-


Balance at end of year	$	488		$	431

Of this total, $488 thousand represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the income tax provision in future periods. The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months. Prior to 2013, the Company recognized interest and/or penalties related to income tax matters in income tax expense. Beginning in 2013, interest related to income tax matters is recorded as interest expense. During 2013 and 2012, $3 thousand and $4 thousand were accrued for potential interest related to these unrecognized tax benefits.

Federal tax years 2010 through 2013 remain open for the assessment of Federal income tax. California tax years 2009 through 2013 remain open for the assessment of California income tax. The Company is currently under examination by federal Internal Revenue Service ("IRS") for the 2010 tax year and California Franchise Tax Board ("FTB") for the 2009, 2010, and 2011 tax years. The IRS and FTB have issued and the Company has responded to the standard initial Information Documentation Requests. The IRS and FTB have not yet raised any issues.