Note 13 – 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 (benefit) expense was as follows:

	2020			2019
	(In thousands)
Current
Federal	$	(59	)	$	(66	)
State		144			5
Deferred
Federal		7			(225	)
State		(499	)		(59	)
Total	$	(407	)	$	(345	)

Effective tax rates differ from the federal statutory rate of 21% applied to income before income taxes due to the following:

	2020			2019
	(In thousands)
Federal statutory rate times financial statement net (loss) income	$	(220	)	$	(115	)
Effect of:
State taxes, net of federal benefit		(7	)		(45	)
Earnings from bank owned life insurance		(10	)		(11	)
Merger-related expense		200			-
Low income housing credits		(117	)		(198	)
Tax benefit from tax positions taken in prior years		(273	)		-
Other, net		20			24
Total	$	(407	)	$	(345	)

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

	2020			2019
	(In thousands)
Deferred tax assets:
Allowance for loan losses	$	909		$	897
Accrued liabilities		139			137
State income taxes		58			36
Stock compensation		310			202
Net operating loss carryforward		3,437			3,614
Non‑accrual loan interest		1			1
Partnership investment		188			173
General business credit		1,969			1,859
Alternative minimum tax credit		34			94
Other		40			34
Total deferred tax assets		7,085			7,047
Deferred tax liabilities:
Section 481 Adjustments to bad debts		(334	)		(660	)
Deferred loan fees/costs		(651	)		(797	)
Basis difference on fixed assets		(18	)		(15	)
Net unrealized appreciation on available‑for‑sale securities		(138	)		(59	)
FHLB stock dividends		(266	)		(266	)
Mortgage servicing rights		(1	)		(3	)
Prepaid expenses		(44	)		(27	)
Total deferred tax liabilities		(1,452	)		(1,827	)
Net deferred tax assets	$	5,633		$	5,220

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, the amount of taxes paid in available carry‑back years, and the forecasts of future income and tax planning strategies. Based on this analysis, the Company determined that, as of December 31, 2020 and 2019, no valuation allowance was required on its deferred tax assets, which totaled $5.6 million and $5.2 million, respectively.

On June 29, 2020, the Assembly Bill No. 85 (AB 85) was signed into law by California Governor Gavin Newsom to raise additional income tax revenue to assist in balancing the California budget caused by the COVID-19 pandemic. The most significant provision of this bill is the suspension of the net operating loss (NOL) deduction for tax years beginning on or after January 1, 2020 and before January 1, 2023. The existing 20-year carry forward period for NOLs (10 years for losses incurred in the tax years 2000 through 2007) would be extended for up to three years if losses are not used due to the NOL suspension. This means the Bank cannot take California NOL deductions for 2020-2022 if its California taxable income is more than $1 million. The life of the 2011 NOL will be extended for up to three years. This also means the Bank could have more cash tax liability for 2020-2022.

As of December 31, 2020, the Company had federal net operating loss carryforwards of $5.4 million and California net operating loss carryforwards of $27.0 million, which begin expiring in 2032 through 2037 and 2032 through 2037, respectively. The Company also has federal general business credits of $2.0 million, expiring beginning in 2030 through 2040.

Prior to 2018, the Company computed its bad debt deduction for income tax purposes under the reserve method. In 2018, the Company requested, and the IRS consented to a change in accounting method used for computing its tax bad debt deduction from the reserve method to the charge-off method as defined under Internal Revenue Code Section 166. As a result, the Company computes its tax bad debt deduction under the new method and recaptures its excess tax bad debt reserve of $4.3 million into taxable income evenly over a 4 year period starting in 2018.

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

	2020			2019
	(In thousands)
Balance at beginning of year	$	475		$	475
Additions for tax positions of current year		-			-
Additions for tax positions of prior year		-			-
Reductions for tax positions of prior years		(475	)	‑
Balance at end of year	$	-		$	475

At December 31, 2020 and 2019, the Company had zero and $475 thousand in unrecognized tax benefits, respectively. During the second quarter of 2020, the Company recognized an income tax benefit of $273 thousand as a result of a favorable settlement of uncertain tax positions with the California Franchise Tax Board (“FTB”). During 2020 and 2019, zero and $8 thousand were accrued during each period for potential interest related to these unrecognized tax benefits, respectively.

Federal tax years 2017 through 2020 remain open for the assessment of Federal income tax. California tax years 2016 through 2020 remain open for the assessment of California franchise tax. The Company was under examination by California FTB for the 2009, 2010, and 2011 tax years. On July 15, 2020, the examination closing agreement was executed by the Company and California FTB, which resulted in a favorable settlement. The Company recognized a tax benefit of $273 thousand in 2020.