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:

	2014			2013
	(In thousands)
Current
Federal	$	—		$	—
State		3			4
Deferred
Federal		530			(286	)
State		324			(267	)
Change in valuation allowance		(854	)		553

Total	$	3		$	4

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

	2014			2013
	(In thousands)
Federal statutory rate times financial statement net income (loss)	$	861		$	(101	)
Effect of:
State taxes, net of federal benefit		183			(19	)
Enterprise zone net interest deduction		—			(285	)
Earnings from bank owned life insurance		(27	)		(28	)
Low income housing credits		(212	)		(211	)
Change in valuation allowance		(854	)		553
Other, net		52			95

Total	$	3		$	4

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

	2014			2013
	(In thousands)
Deferred tax assets:
Allowance for loan losses	$	1,833		$	3,040
Accrued liabilities		286			120
State income taxes		44			42
Deferred compensation		513			407
Stock compensation		275			270
Real estate owned		—			157
Net operating loss carryforward		7,341			6,752
Non-accrual loan interest		58			485
Basis difference on fixed assets		—			109
Partnership investment		60			27
General business credit		938			725
Alternative minimum tax credit		113			113
Other		33			28

Total deferred tax assets		11,494			12,275

Deferred tax liabilities:
Deferred loan fees/costs		(1,633	)		(1,699	)
Real estate owned		(86	)		—
Basis difference on fixed assets		(80	)		—
Net unrealized appreciation on available-for-sale securities		(222	)		(198	)
FHLB stock dividends		(574	)		(574	)
Mortgage servicing rights		(26	)		(50	)
Prepaid expenses		(67	)		(69	)

Total deferred tax liabilities		(2,688	)		(2,590	)
Valuation allowance		(8,806	)		(9,685	)

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 $8.8 million was required as of December 31, 2014, resulting in $0 net deferred tax assets. The Company had recorded a valuation allowance of $9.7 million and $0 net deferred tax assets as of December 31, 2013.

As of December 31, 2014, the Company had federal net operating loss carryforwards of $14.8 million, expiring beginning in 2032 through 2034 and California net operating loss carryforwards of $32.1 million, expiring beginning in 2030 through 2034. The Company also had federal general business credits of $938 thousand, expiring beginning in 2031 through 2034, and alternative minimum tax credit carryforwards of $113 thousand, which can be carried forward indefinitely.

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 2014 and 2013. If the Bank were liquidated, or otherwise ceases to be a bank, the $3.0 million tax bad debt reserve may need to be recaptured into taxable income and income tax expense would need to be provided.

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

	2014			2013
	(In thousands)
Balance at beginning of year	$	488		$	431
Additions based on tax positions related to the current year		—			86
Additions for tax positions of prior year		—			—
Reductions for tax positions of prior years		(13	)		(29	)
Settlements		—			—

Balance at end of year	$	475		$	488

The $475 thousand balance at December 31, 2014 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 2014 and 2013, $3 thousand was accrued during each period for potential interest related to these unrecognized tax benefits.

Federal tax years 2011 through 2014 remain open for the assessment of Federal income tax. California tax years 2009 through 2014 remain open for the assessment of California income tax. The Company is currently under examination by the 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 Information Documentation Requests.