Note 10- Income Taxes

On December 22, 2017, the U.S. government enacted the Tax Act, a comprehensive tax legislation which, among other things, reduced the federal income tax rate for corporations from 34% to 21% effective on January 1, 2018. The Tax Act makes broad and complex changes to the Internal Revenue Code which will impact the Company, including reduction of the U.S. corporate income tax rate as well as introduction of business-related exclusions, deductions and credits. The effects of the Tax Act have been recorded in the fourth quarter of 2017 and its impact to the Company’s Consolidated Financial Statements are included and described within this footnote.

The Company’s deferred federal and state income tax and related valuation accounts represents the estimated impact of temporary differences between how we recognize our assets and liabilities under GAAP and how such assets and liabilities are recognized under federal and state tax law. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates which will be in effect when these differences reverse. As a result of the reduction in the U.S. corporate income tax rate from 34% to 21% under the Tax Act, the Company revalued its ending net deferred tax assets at December 31, 2017. The Company recognized a $262,000 net tax expense in the Company’s Consolidated Statements of Income for the year ended December 31, 2017 as a result of the Tax Act, of which the expense recorded is primarily attributable to the revaluation of net deferred tax assets.

The deferred tax liability related to available for sale (“AFS”) security gains that were revalued as of December 31, 2017 as a result of the Tax Act, created “stranded tax effects” in Accumulated Other Comprehensive Income (“AOCI”). In February 2018, FASB issued ASU 2018-02 “Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (Topic 220)” (“ASU 2018-02”), which allows an entity to elect to reclassify from AOCI to retained earnings the stranded tax effects resulting from the Tax Act. The Company has elected not to early adopt the provisions of the ASU 2018-02. The Company will retrospectively record a one-time reclassification of $156,000 from AOCI to retained earnings for stranded tax effects resulting from the newly enacted corporate tax rate in the first quarter 2018. The amount of the reclassification represents the difference between the 34 percent historical corporate tax rate and the newly enacted 21 percent corporate tax rate.

The provision for income tax expense consists of the following:


		Years Ended December 31,
		2017		2016		2015
		(Dollars in thousands)

Current:
Federal		$	960	$	989	$	526
State			6		8		(67)
Total Current			966		997		459

Deferred:
Federal
	Federal - expected		(43)		(222)		63
	Federal - Deferred tax asset remeasurement(1)		262		-		-
State			-		-		194
Total Deferred			219		(222)		257

Total Income Tax Expense		$	1,185	$	775	$	716

⁽¹⁾

Represents a charge to write-down deferred tax assets due to the enactment of the Tax Act.

A reconciliation of the statutory federal income tax at a rate of 34% to the income tax expense included in the statements of income is as follows:


	Years Ended December 31,
	2017		2016		2015

Federal income tax at statutory rate	34.0	%	34.0	%	34.0	%
State benefit, net of federal expense	(2.2)		(0.8)		(1.9)
Tax-exempt interest income	(12.3)		(14.7)		(17.1)
Deferred tax valuation allowance	2.3		1.0		4.0
Deferred tax remeasurement due to Tax Act	5.8		-		-
Life insurance income	(2.7)		(2.2)		(2.3)
Other	1.1		0.8		1.0
Total Income Tax Expense	26.0	%	18.1	%	17.7	%

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


	December 31,
	2017		2016
	(Dollars in thousands)
Deferred tax assets:
Deferred compensation	$	1,062	$	1,510
Allowance for loan losses		838		1,087
Net Operating Loss ("NOL")		223		105
Alternative Minimum Tax ("AMT") credit		180		324
Impairment of equity investments		128		189
Accrued expenses		103		147
Stock options granted		5		2
Other		5		42
Total Deferred Tax Assets		2,544		3,406

Deferred tax liabilities:
Deferred loan origination costs		(801)		(1,138)
Depreciation		(296)		(502)
Unrealized gains on securities available for sale		(251)		(712)
Prepaid expenses		(92)		(141)
Total Deferred Tax Liabilities		(1,440)		(2,493)

Deferred tax valuation allowance		(502)		(396)

Net Deferred Tax Asset	$	602	$	517

The net deferred tax asset was recorded in other assets on the consolidated statements of financial condition at December 31, 2017 and 2016. In assessing the ability of the Company to realize the benefit of the 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. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, availability of operating loss carry-backs, projected future taxable income and tax planning strategies in making this assessment. Based upon the level of historical taxable income, the opportunity for net operating loss carry-backs, and projections for future taxable income over the periods which deferred tax assets are deductible, management believes it is more likely than not the Company will generate sufficient taxable income to realize the benefits of these deductible differences at December 31, 2017, except for the following:

Valuation allowance of $128,000 on the deferred tax asset for the 2011 other than temporary impairment charge; and

Valuation allowance of $374,000 on state deferred tax assets.

Management believes that the Company will not generate sufficient income of the appropriate character (i.e. capital gains) to utilize any of the deferred tax asset created by the 2011 other than temporary impairment charge. Management believes that it is more likely than not that the Company will not realize its state deferred tax assets because of reform in New York State corporate tax law. Beginning in 2015, the most significant change in the tax law allows the Company to deduct up to 50% of its net interest income received from qualifying loans. This change effectively eliminates the Company’s New York State tax on income resulting in the Company being taxed on its apportioned capital. Because of this tax reform, the Company will not generate sufficient taxable income within New York State to realize its existing state deferred tax assets and therefore, a deferred tax valuation allowance of $167,000 and $43,000 was recorded during 2017 and 2016, respectively.

The accounting for the effects of the tax rate change resulting from the Tax Act on deferred tax balances is complete and no provisional amounts were recorded for this item.

Reconciliation of income tax provision for the year ended December 31, 2017 (dollars in thousands):


Income tax expense (34% federal tax rate)	$	923
Income tax expense due to net deferred tax asset remeasurement resulting from enactment of Tax Act		262
Total Income Tax Expense	$	1,185

Under prior federal law, tax bad debt reserves created prior to January 1, 1998 were subject to recapture into taxable income should the Company fail to meet certain qualifying asset and definition tests. The 1996 federal legislation eliminated these thrift related recapture rules. However, under current law, pre-1988 reserves remain subject to recapture should the Company make certain non-dividend distributions or cease to maintain a thrift or bank charter. Management has no intention of taking any such actions. At December 31, 2017 and 2016, the Company’s total pre-1988 tax bad debt reserve was $2.2 million. This reserve reflects the cumulative effect of federal tax deductions by the Company for which no federal income tax provision has been made.

ASC 740 “Income Taxes” prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company recognized no adjustment for unrecognized income tax benefits for the years ended December 31, 2017 and 2016. As of December 31, 2017, there has been no material change in any uncertain tax position. The Company’s policy is to recognize interest and penalties on unrecognized tax benefits in income tax expense in the Consolidated Statements of Income.

The Company’s Federal and New York State tax returns, constituting the returns of the major taxing jurisdictions, are subject to examination by the taxing authorities for all open years as prescribed by applicable statute. No waivers have been executed that would extend the period subject to examination beyond the period prescribed by statute. The federal tax returns for the years ended December 31, 2014, 2015 and 2016 remain subject to examination by the IRS. The tax returns for the years ended December 31, 2014, 2015 and 2016 for New York State also remain subject to examination.