NOTE 16 – INCOME TAXES

Following is a summary of the major items comprising the differences in taxes from continuing operations computed at the federal statutory rate and as recorded in the consolidated statement of income:


	Years Ended December 31,
(dollars in thousands)	2017			2016			2015
Provision at statutory rate of 35%	$	59,032		$	70,149		$	57,013
Tax-exempt income:
Tax-exempt interest		(15,026	)		(14,356	)		(13,111	)
Section 291/265 interest disallowance		289			191			142
Company-owned life insurance income		(3,029	)		(2,968	)		(3,011	)

Tax-exempt income		(17,766	)		(17,133	)		(15,980	)

Reserve for unrecognized tax benefits		—			(1	)		(5	)
State income taxes		998			3,461			4,173
Tax credit investments—federal		(8,500	)		(321	)		(411	)
Estimated revaluation of deferred tax assets		39,300			—			—
ONB Insurance Group, Inc. nondeductible goodwill		—			8,328			—
Effect of Illinois branch sale		—			—			1,835
Other, net		(125	)		1,679			(448	)

Income tax expense	$	72,939		$	66,162		$	46,177

Effective tax rate		43.3	%		33.0	%		28.3	%

The higher effective tax rate in 2017 when compared to 2016 is the result of $39.3 million of additional tax expense to estimate the revaluation of deferred tax assets due to the lowering of the federal corporate tax rate to 21%, partially offset by an increase in federal tax credits available. On December 22, 2017, the Tax Cuts and Jobs Act (“H.R. 1”) was enacted into legislation. Under ASC 740, the effects of changes in tax rates and laws are recognized in the period in which the new legislation is enacted. Accordingly, Old National has recorded an estimated $39.3 million for the revaluation of Old National’s deferred tax assets.

Shortly after the enactment date, the SEC issued Staff Accounting Bulletin (“SAB”) 118, which addresses the situations where the accounting for changes in tax laws is complete, incomplete but can be reasonably estimated, and incomplete and cannot be reasonably estimated. SAB 118 also permits a measurement period of up to one year from the date of enactment to refine the provisional accounting. Old National continues to analyze H.R. 1, including the impact on alternative minimum tax credits disclosed further below, as well as the acquisition accounting of Anchor (MN), and expects any refinements to the provisional accounting to be complete in 2018.

The higher effective tax rate in 2016 when compared to 2015 is primarily the result of the sale of ONI in May 2016 and the associated tax expense of $8.3 million to record a deferred tax liability relating to ONI’s nondeductible goodwill.

The provision for income taxes consisted of the following components for the years ended December 31:


	Years Ended December 31,
(dollars in thousands)	2017		2016		2015
Income taxes currently payable:
Federal	$	—	$	23,735	$	17,385
State		—		2,242		769
Deferred income taxes related to:
Federal		31,915		35,955		24,664
Estimated revaluation of deferred tax assets		39,300		—		—
State		1,724		4,230		3,359

Deferred income tax expense		72,939		40,185		28,023

Income tax expense	$	72,939	$	66,162	$	46,177

Net Deferred Tax Assets

Significant components of net deferred tax assets (liabilities) were as follows at December 31:


(dollars in thousands)	2017			2016
Deferred Tax Assets
Allowance for loan losses, net of recapture	$	12,958		$	19,773
Benefit plan accruals		11,080			23,846
Alternative minimum tax credit		25,084			19,523
Unrealized losses on benefit plans		108			205
Net operating loss carryforwards		39,631			66,917
Federal tax credits		5,516			35
Other-than-temporary impairment		1,424			3,606
Acquired loans		29,669			40,522
Lease exit obligation		1,337			2,060
Unrealized losses on available-for-sale investment securities		14,011			23,365
Unrealized losses on held-to-maturity investment securities		3,630			7,118
Unrealized losses on hedges		923			4,116
Other real estate owned		369			3,310
Other, net		829			2,675

Total deferred tax assets		146,569			217,071

Deferred Tax Liabilities
Accretion on investment securities		(493	)		(700	)
Purchase accounting		(16,718	)		(17,552	)
Loan servicing rights		(6,058	)		(9,627	)
Premises and equipment		(10,052	)		(4,800	)
Prepaid expenses		(1,277	)		—
Tax credit investments		(168	)		—
Other, net		(946	)		(2,529	)

Total deferred tax liabilities		(35,712	)		(35,208	)

Net deferred tax assets	$	110,857		$	181,863

Through the acquisition of Anchor (WI) in the second quarter of 2016 and Lafayette Savings Bank in the fourth quarter of 2014, both former thrifts, Old National Bank’s retained earnings at December 31, 2017 include base-year bad debt reserves, created for tax purposes prior to 1988, totaling $52.8 million. Of this total, $50.9 million was acquired from Anchor (WI), and $1.9 million was acquired from Lafayette Savings Bank. Base-year reserves are subject to recapture in the unlikely event that Old National Bank (1) makes distributions in excess of current and accumulated earnings and profits, as calculated for federal income tax purposes, (2) redeems its stock, or (3) liquidates. Old National Bank has no intention of making such a nondividend distribution. Accordingly, under current accounting principles, a related deferred income tax liability of $13.0 million has not been recognized.

No valuation allowance was recorded at December 31, 2017 or 2016 because, based on current expectations, Old National believes it will generate sufficient income in future years to realize deferred tax assets. Old National has federal net operating loss carryforwards totaling $130.7 million at December 31, 2017 and $162.9 million at December 31, 2016. This federal net operating loss was acquired from the acquisition of Anchor (WI) in 2016. If not used, the federal net operating loss carryforwards will expire from 2028 to 2033. Old National has alternative minimum tax credit carryforwards totaling $25.1 million at December 31, 2017 and $19.5 million at December 31, 2016. The enactment of H.R.1 eliminates the parallel tax system known as the alternative minimum tax and allows any existing alternative minimum tax credits to be used to reduce regular tax or be refunded from 2018 to 2021. ASC 740 may allow for the reclassification of the alternative minimum tax credit from a deferred tax asset to a current tax asset. Old National has not completed its analysis of its alternative minimum tax credit classification, and accordingly is maintaining its alternative minimum tax credit in the deferred asset classification at December 31, 2017. Old National has federal tax credit carryforwards of $5.5 million at December 31, 2017 and $35 thousand at December 31, 2016. The federal tax credits consist mainly of federal historic credits, low income housing credits, and research and development credits that, if not used, will expire from 2027 to 2037. Old National has recorded state net operating loss carryforwards totaling $203.6 million at December 31, 2017 and $206.3 million at December 31, 2016. If not used, the state net operating loss carryforwards will expire from 2024 to 2037. Old National has state tax credits totaling $1.3 million at December 31, 2017. The state tax credits will not expire.

The federal and recorded state net operating loss carryforwards are subject to an annual limitation under Internal Revenue Code section 382. Old National believes that all of the recorded net operating loss carryforwards will be used prior to expiration.

Unrecognized Tax Benefits

Unrecognized state income tax benefits are reported net of their related deferred federal income tax benefit.

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


	Years Ended December 31,
(dollars in thousands)	2017			2016			2015
Balance at beginning of period	$	777		$	124		$	77
Additions based on tax positions related to the current year		162			118			51
Additions based on tax positions related to prior years		—			537			—
Reductions due to statute of limitations expiring		(173	)		(2	)		(4	)
Revaluation due to Tax Reform		108			—			—

Balance at end of period	$	874		$	777		$	124

If recognized, approximately $0.9 million of unrecognized tax benefits, net of interest, would favorably affect the effective income tax rate in future periods. Old National expects the total amount of unrecognized tax benefits to decrease by approximately $0.2 million in the next twelve months.

It is our policy to recognize interest and penalties accrued relative to unrecognized tax benefits in their respective federal or state income tax accounts. We recorded interest and penalties in the income statement of $10 thousand in 2017, $0.1 million in 2016, and $0.4 thousand in 2015. The amount accrued for interest and penalties in the balance sheet was $0.1 million at December 31, 2017 and 2016.

Old National and its subsidiaries file a consolidated U.S. federal income tax return, as well as filing various state returns. The 2014 through 2017 tax years are open and subject to examination.

Old National reversed $0.2 million in 2017 related to uncertain tax positions accounted for under FASB ASC 740-10 (FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes) (“ASC Topic 740-10”). The $0.2 million income tax reversal related to the 2013 statute of limitations expiring in the third quarter of 2017. As a result, Old National reversed a total of $0.2 million from its unrecognized tax benefit liability.