Note 15 - Income Taxes

The components of income tax (benefit) expense are summarized as follows:



		Years Ended December 31,
		2013		2012		2011
		(In Thousands)

Current income tax expense (benefit):
Federal	$	6,887	$	(2,366)	$	4,382
State		496		263		836

		7,383		(2,103)		5,218

Deferred income tax expense (benefit):
Federal		(1,653)		802		(1,592)
State		821		(951)		(253)

		(832)		(149)		(1,845)

Total Income Tax (Benefit) Expense	$	6,551	$	(2,252)	$	3,373

Note 15 - Income Taxes (Continued)

The tax effects of existing temporary differences that give rise to significant portions of the deferred income tax assets and deferred income tax liabilities are as follows:



		December 31,
		2013		2012
Deferred income tax assets:
Allowance for loan losses	$	6,436	$	5,537
Other real estate owned expenses		295		435
Depreciation		137		137
Other than temporary impairment on security		1,191		1,191
Non-accrual interest		380		455
Benefit Plans		52		424
Benefit Plan-accumulated other comprehensive loss		322		912
Valuation adjustment on loans receivable acquired		1,121		812
Valuation adjustment on securities		681		371
Valuation adjustment on time deposits acquired		51		138
Net operating loss carry forwards (net of valuation allowances)		353		1,069
Other		738		134

		11,757		11,615

Deferred income tax liabilities:

Unrealized gain on securities available for sale		411		59
Valuation adjustment on premises and equipment acquired		1,404		1,503

		1,815		1,562

Net Deferred Tax Asset	$	9,942	$	10,053

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. In making this assessment, management has considered the profitability of current core operations, future market growth, forecasted earnings, future taxable income, and ongoing, feasible and permissible tax planning strategies. If the Company was to determine that it would not be able to realize a portion of its net deferred tax asset in the future for which there is currently no valuation allowance, an adjustment to the net deferred tax asset would be charged to earnings in the period such determination was made. Conversely, if the Company was to make a determination that it is more likely than not that the deferred tax assets for which there is a valuation allowance would be realized, the related valuation allowance would be reduced and a benefit to earnings would be recorded. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which temporary differences are deductible and carry forwards are available.

At December 31, 2013, gross deferred tax assets related to net operating loss carry forwards totaled $438,000, consisting of $353,000 of federal assets acquired in the 2011 acquisition of Allegiance and $85,000 in state assets related to the stand-alone Company. Comparable amounts at December 31, 2012, were gross deferred tax assets of $1,128,000 consisting of $345,000 of federal assets acquired in the Allegiance acquisition, $724,000 in state assets related to the Bank, and $59,000 in state assets related to the stand-alone Company.

At December 31, 2013 and 2012, the stand-alone Company had $1,457,000 and $1,000,000, respectively, of state net operating loss carry forwards, with related gross deferred tax assets of $85,000 and $59,000, respectively. Due to the uncertainty regarding the ability to realize these carry forwards within the statutory time limits, the related deferred tax asset has been fully offset by valuation allowances of $85,000 and $59,000, respectively, at December 31, 2013 and 2012.

In conjunction with the Company’s acquisition of Allegiance in 2011, the Company acquired a federal net operating loss carry forward of $1.2 million. This carry forward is available for use through 2030; however, in accordance with Internal Revenue Code Section 382, usage of the carry forward is limited to $235,000 annually on a cumulative basis (portions of the $235,000 not used in a particular year may be added to subsequent usage). At December 31, 2013 and 2012, the Company had approximately $1,009,000 remaining of this federal net operating loss carry forward available to offset future taxable income for federal tax reporting purposes; Based on the current profitability or core operations and expectations that such profitability will continue, the Company’s expects to fully utilize this federal net operating loss carry forward by 2016.

Note 15 - Income Taxes (Continued)

At December 31, 2012, the Bank had $10.9 million of state net operating loss carry forwards. The additional $10.9 million at December 31, 2012, was generated in 2012 and will expire, to the extent not utilized, in 2032. The Bank’s 2012 state net operating loss was the largely the result of two planned transactions designed to enhance the future operations of the Company and the Bank; as discussed in Note 6, the Bank engaged in two bulk sales of impaired loans at a realized loss of $10.8 million. Similar transactions in future periods are not contemplated or anticipated. The Bank, when consolidated with its investment company subsidiary, has generated consistently strong core earnings and projects similarly strong results going forward. The Bank currently employs a state tax planning strategy designed to reduce state taxes by taking advantage of the lower corporate tax rates applicable to investment companies. Accordingly, most of the state taxable income of the consolidated Bank resides in its investment company subsidiary. The Bank utilized the 2012 net operating loss carry forward in 2013.

The following table presents a reconciliation between the reported income tax expense and the income tax expense which would be computed by applying the normal federal income tax rate of 35% in 2013, 2012, and 2011 to income before income tax expense:



		Years Ended December 31,
		2013			2012			2011
		(In Thousands)

Federal income tax (benefit) expense at statutory rate	$	5,588		$	(1,510)		$	3,298
Increases (reductions) in income taxes resulting from:
State income tax (benefit), net of federal income tax effect		856			(451)			380
Merger related items		-			-			(219)
Other items, net		107			(291)			(86)

Effective Income Tax	$	6,551		$	(2,252)		$	3,373

Effective Income Tax Rate		41.0	%		(52.2)	%		35.8	%