Note 10 – Income Taxes

The Company and its subsidiary 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 was as follows:

	2016			2015
	(In thousands)
Current
Federal	$	-		$	-
State		11			20
Deferred
Federal		163			1,238
State		128			505
Change in valuation allowance		(2,527	)		(6,337	)

Total	$	(2,225	)	$	(4,574	)

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

	2016			2015
	(In thousands)
Federal statutory rate times financial statement net income	$	427		$	1,529
Effect of:
State taxes, net of federal benefit		91			323
Earnings from bank owned life insurance		(24	)		(25	)
Low income housing credits		(212	)		(212	)
Change in valuation allowance		(2,527	)		(6,337	)
Other, net		20			148

Total	$	(2,225	)	$	(4,574	)

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

	2016			2015
	(In thousands)
Deferred tax assets:
Allowance for loan losses	$	84		$	311
Accrued liabilities		218			222
State income taxes		46			51
Deferred compensation		494			475
Stock compensation		156			110
Net operating loss carryforward		5,886			6,141
Non-accrual loan interest		9			14
Partnership investment		175			125
General business credit		1,282			1,091
Alternative minimum tax credit		209			185
Other		37			531

Total deferred tax assets		8,596			9,256

Valuation allowance		-			(2,527	)

Deferred tax liabilities:
Deferred loan fees/costs		(1,125	)		(1,246	)
Real estate owned		-			(15	)
Basis difference on fixed assets		(57	)		(59	)
Net unrealized appreciation on available-for-sale securities		(90	)		(164	)
FHLB stock dividends		(371	)		(574	)
Mortgage servicing rights		(13	)		(17	)
Prepaid expenses		(33	)		(60	)

Total deferred tax liabilities		(1,689	)		(2,135	)

Net deferred tax assets	$	6,907		$	4,594

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 evaluated 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. Based on this analysis, the Company determined that as of December 31, 2016, no valuation allowance was required on its deferred tax assets, which totaled $6.9 million. The Company recorded a valuation allowance of $2.5 million and reported $4.6 million in net deferred tax assets as of December 31, 2015.

As of December 31, 2016, the Company has federal net operating loss carryforwards of $11.3 million and California net operating loss carryforwards of $28.6 million, which begin expiring in 2031 through 2036 and 2029 through 2036, respectively. The Company also has federal general business credits of $1.3 million, expiring beginning in 2030 through 2036, and alternative minimum tax credit carryforwards of $192 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 approximately $1.0 million at year end 2016 and 2015. 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:

	2016		2015
	(In thousands)
Balance at beginning of year	$	475	$	475
Additions based on tax positions related to the current year		-		-
Additions for tax positions of prior year		-		-
Reductions for tax positions of prior years		-		-
Settlements		-		-

Balance at end of year	$	475	$	475

The $475 thousand balance at December 31, 2016 represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the income tax provision in future periods. The Company expects that the total amount of unrecognized tax benefits may decrease significantly within the next twelve months due to expected settlement with the state taxing authorities. During 2016 and 2015, $4 thousand and $5 thousand were accrued during each period for potential interest related to these unrecognized tax benefits.

Federal tax years 2013 through 2016 remain open for the assessment of Federal income tax. With the exception of the issues under protest for the years listed below, California tax years 2012 through 2016 remain open for the assessment of California income tax. The Company is currently under examination by the California Franchise Tax Board ("FTB") for the 2009, 2010, and 2011 tax years. The FTB has proposed adjustments to the Company's California net operating loss carryforwards for items which the Company has established an unrecognized tax benefit. The Company has protested the FTB's adjustments and does not expect that significant additional tax expense will result.