INCOME TAXES

Components of Income Tax Expense

(Dollar amounts in thousands)



	Years Ended December 31,
	2018			2017			2016
Current income tax expense (benefit):
Federal	$	13,497		$	93,540		$	46,748
State	(619		)	104			790
Total	12,878			93,644			47,538
Deferred income tax expense (benefit):
Federal	14,489			(12,219		)	(7,786		)
State	11,820			8,142			6,419
Total	26,309			(4,077		)	(1,367		)
Total income tax expense	$	39,187		$	89,567		$	46,171

Federal income tax reform was enacted on December 22, 2017. The new law enacted various changes to the federal corporate income tax, the most impactful being the reduction in the corporate tax rate to a flat 21%. In conjunction with federal income tax reform, the SEC staff issued Staff Accounting Bulletin No. 118 ("SAB 118") to provide guidance on the accounting for the tax law change under GAAP. SAB 118 requires that the final determination of the impacts of federal income tax reform be completed within a measurement period not to exceed one year from the date of enactment. In compliance with that mandate, the Company has completed its accounting for the impact of federal income tax reform in the fourth quarter of 2018. As of December 31, 2017, the Company's revaluation of its deferred tax assets and liabilities at the newly enacted 21% rate resulted in additional tax expense of $26.6 million. Upon further refinement of our calculations, a benefit of $8.7 million was recorded in the year ended December 31, 2018.

Federal income tax expense and the related effective income tax rate are influenced by the amount of tax-exempt income derived from investment securities and BOLI in relation to pre-tax income as well as state income taxes. State income tax expense and the related effective income tax rate are driven by both the amount of state tax-exempt income in relation to pre-tax income and state tax rules for consolidated/combined reporting and sourcing of income and expense. In addition to the impacts of federal income tax reform mentioned above, the Company recognized a $2.8 million benefit in 2017 as a result of changes in Illinois income tax rates.

Components of Effective Tax Rate

(Dollar amounts in thousands)



	Years Ended December 31,
	2018					2017					2016
	Amount			% of Pretax Income		Amount			% of Pretax Income		Amount			% of Pretax Income
Statutory federal income tax	$	41,382		21.0	%	$	65,784		35.0	%	$	48,482		35.0	%
(Decrease) increase in income taxes resulting from:
Deferred tax asset revaluation	(8,721		)	(4.4	)	23,709			12.6		—			—
Tax-exempt income, net of interest expense disallowance	(3,104		)	(1.6	)	(5,065		)	(2.7	)	(5,439		)	(3.9	)
State income tax, net of federal income tax effect	8,846			4.5		5,069			2.7		4,323			3.1
Other	784			0.4		70			0.1		(1,195		)	(0.9	)
Total	$	39,187		19.9	%	$	89,567		47.7	%	$	46,171		33.3	%

The decrease in income tax expense and the effective tax rate from the years ended December 31, 2017 to 2018 was due primarily to the decrease in the applicable federal income tax rate from 35% to 21% and the 2018 recognition of $8.7 million of income tax benefits resulting from federal income tax reform, partially offset by higher pre-tax income subject to tax at statutory rates and a decrease in tax-exempt income. The increase in income tax expense and the effective tax rate from the years ended December 31, 2016 to 2017 resulted primarily from downward revaluation of deferred tax assets by $26.6 million as a result of federal income tax reform, higher pre-tax income subject to tax at statutory rates, and a decrease in tax-exempt income, partly offset by a $2.8 million benefit due to a change in the Illinois income tax rate.

As of December 31, 2018, the Company's retained earnings included an appropriation for an acquired thrift's tax bad debt reserves of approximately $5.8 million, as well as $2.5 million for both December 31, 2017 and 2016, for which no provision for federal or state income taxes has been made. If, in the future, this portion of retained earnings were distributed as a result of the liquidation of the Company or its subsidiaries, federal and state income taxes would be imposed at the then applicable rates.

Differences between the amounts reported in the consolidated financial statements and the tax basis of assets and liabilities result in temporary differences for which deferred tax assets and liabilities were recorded.

Deferred Tax Assets and Liabilities

(Dollar amounts in thousands)



	As of December 31,
	2018			2017
Deferred tax assets:
Allowance for credit losses	$	19,591		$	20,285
Deferred gain on sale-leaseback transaction	13,752			15,668
Federal net operating loss ("NOL") carryforwards	8,871			—
Equity based compensation	3,971			3,605
State NOL carryforwards	3,293			3,384
Non-equity based compensation	2,210			897
OREO	1,460			2,089
Deferred incentives	1,382			29
Property valuation adjustments	1,214			69
AMT and other credit carryforwards	244			667
Other	8,179			12,419
Total deferred tax assets	64,167			59,112
Deferred tax liabilities:
Accrued retirement benefits	(8,502		)	(3,517		)
Fixed assets	(7,322		)	(1,660		)
Deferred loan fees and costs	(4,985		)	(4,169		)
Cancellation of indebtedness income	—			(641		)
Acquisition adjustments	(686		)	2,489
Other	(2,823		)	(2,449		)
Total deferred tax liabilities	(24,318		)	(9,947		)
Deferred tax valuation allowance	—			—
Net deferred tax assets	39,849			49,165
Tax effect of adjustments related to other comprehensive (loss) income	20,280			15,571
Net deferred tax assets including adjustments	$	60,129		$	64,736
NOL carryforwards available to offset future taxable income:
Federal gross NOL carryforwards, begin to expire in 2028	$	42,242		$	—
Illinois gross NOL carryforwards, begin to expire in 2024	209,802			188,995
Indiana gross NOL carryforwards, begin to expire in 2025	14,260			16,174
Wisconsin gross NOL carryforwards, begin to expire in 2032	1,212			—
AMT credits	—			410

During the year ended December 31, 2018, the Company recorded net deferred tax assets of $17.0 million related to the Northern States acquisition. During the year ended December 31, 2017, the Company recorded net deferred tax assets of $41.5 million related to the Standard acquisition and a measurement period adjustment related to finalizing the fair values of the assets acquired and liabilities assumed in the NI Bancshares acquisition.

During the years ended December 31, 2018 and 2017, the Company transferred certain loans into Real Estate Mortgage Investment Conduit trusts which are classified as loans in the financial statements and as securities for tax purposes.

Net deferred tax assets are included in other assets in the accompanying Consolidated Statements of Financial Condition. Management believes that it is more likely than not that net deferred tax assets will be fully realized and no valuation allowance is required.

Uncertainty in Income Taxes

The Company files a U.S. federal income tax return and state income tax returns in various states. Income tax returns filed by the Company are no longer subject to examination by federal and state income tax authorities for years prior to 2015, except for amended changes to 2014 federal and Illinois tax returns.

Rollforward of Unrecognized Tax Benefits

(Dollar amounts in thousands)



	Years Ended December 31,
	2018			2017			2016
Beginning balance	$	16,248		$	2,039		$	1,408
Additions for tax positions relating to the current year	1,209			845			640
Additions for tax positions relating to prior years	582			13,389			—
Reductions for tax positions relating to prior years	(60		)	(25		)	(9		)
Reductions for settlements with taxing authorities	(1,629		)	—			—
Ending balance	$	16,350		$	16,248		$	2,039
Interest and penalties not included above⁽¹⁾:
Interest (income) expense, net of tax effect, and penalties	$	(21	)	$	118		$	49
Accrued interest and penalties, net of tax effect, at end of year	170			191			73


⁽¹⁾	Included in income tax expense in the Consolidated Statements of Income.

The Company does not anticipate that the amount of uncertain tax positions will significantly increase or decrease in the next twelve months. Included in the balance as of December 31, 2018, 2017, and 2016 are tax positions totaling $13.1 million, $12.9 million and $1.4 million, respectively, which would favorably affect the Company's effective tax rate if recognized in future periods.