NOTE 15. INCOME TAXES

The following table provides information on components of income tax expense for each of the three years ended December 31.

(Dollars in thousands)	2015		2014		2013
Current tax expense (benefit):
Federal	$	247	$	-	$	(459)
State		287		225		90
		534		225		(369)
Deferred income tax expense (benefit):
Federal		3,369		2,516		(4,592)
State		505		320		(1,540)
		3,874		2,836		(6,132)

Total income tax expense (benefit)	$	4,408	$	3,061	$	(6,501)

The following table provides a reconciliation of tax computed at the statutory federal tax rate of 34.0% to the actual tax expense (benefit) for each of the three years ended December 31.

(Dollars in thousands)	2015			2014			2013
Tax at federal statutory rate		34.0	%		34.0	%		(34.0)	%
Tax effect of:
Tax-exempt income		(0.4)			(0.9)			(0.4)
Other non-deductible expenses		0.2			0.3			0.2
State income taxes, net of federal benefit		4.5			4.4			(5.9)
Other		(0.1)			(0.1)			(0.2)

Actual income tax expense (benefit) rate		38.2	%		37.7	%		(40.3)	%

The following table provides information on significant components of the Company’s deferred tax assets and liabilities as of December 31.

(Dollars in thousands)	2015		2014
Deferred tax assets:
Allowance for credit losses	$	3,316	$	3,072
Reserve for off-balance sheet commitments		121		121
Net operating loss carry forward		9,069		13,265
Write-downs of other real estate owned		308		355
Deferred income		1,155		1,132
Unrealized gains on available-for-sale securities		48		-
Accrued expenses		946		918
Other		191		80
Total deferred tax assets		15,154		18,943
Deferred tax liabilities:
Depreciation		271		372
Amortization on loans FMV adjustment		140		-
Purchase accounting adjustments		1,988		1,751
Deferred capital gain on branch sale		411		425
Unrealized gains on available-for-sale securities		-		214
Other		212		437
Total deferred tax liabilities		3,022		3,199
Net deferred tax assets	$	12,132	$	15,744

The Company’s deferred tax assets primarily consist of net operating loss carryovers that will be used to offset taxable income in future periods through their statutory period of 20 years for federal tax purposes. As of December 31, 2015 18 years of the statutory period remain available to offset future taxable income. No valuation allowance on these deferred tax assets was recorded at December 31, 2015 and December 31, 2014 as management believes it is more likely than not that all deferred tax assets will be realized based on the following positive material factors: 1) The Company was profitable for all four quarters of 2015 and 2014 on a GAAP basis. The net operating loss was originally created in the third quarter of 2013 and was solely attributable to Talbot Bank’s sale of loans and other real estate owned (the “Asset Sale”), which is considered non-recurring. 2) The Company had pre-tax income of $11.5 million and $8.1 million for the years ended December 31, 2015 and 2014, providing further evidence that the Asset Sale was producing positive results and confirming the expectation of utilizing the deferred tax assets. 3) As a contingent opportunity, the Company has had discussions with certain investors about entering into a sales leaseback transaction for some of its branch locations which would generate a material taxable gain. The decision to act on this has been deferred; however, it would become a very viable option as a tax planning strategy if there was a risk that the net operating loss carryovers would expire before they were fully utilized. Alternatively, the Company has reviewed negative factors which would influence the conclusion of realizing the deferred tax assets. These factors include the following: 1) The Company could be subject to Section 382 of the Internal Revenue Code (“IRC”), which could further limit the realization of the net operating loss-related deferred tax asset (“NOL-DTA”). 2) Although the local economy of the market in which the Company operates has been showing continued signs of improvement over the past three years, if this trend flattens or reverses, there is a potential that this potential negative evidence could outweigh the prevailing positive factors.

Based on the aforementioned considerations, the Company has concluded that the predominance of observable positive evidence outweighs the future potential of negative evidence and therefore it is more likely than not that the Company will be able to realize in the future all of the net deferred tax assets.