NOTE 13 - INCOME TAXES

Income tax expense for the years ended December 31, 2013, 2012 and 2011 consisted of the following:

(dollars in thousands)	2013		2012			2011
Current federal	$	17,181	$	15,181		$	15,845

Deferred federal		183		1,175			(1,863	)

Current state		1,387		877			1,413

Deferred state		808		(51	)		(677	)

Total income tax expense	$	19,559	$	17,182		$	14,718

Income tax expense included an expense (benefit) of $43,000, ($150,000) and ($67,000) applicable to security transactions for 2013, 2012 and 2011. The differences between financial statement tax expense and amounts computed by applying the statutory federal income tax rate of 35% for 2013, 2012 and 2011 to income before income taxes were as follows:

(dollars in thousands)	2013			2012			2011
Income taxes at statutory federal rate of 35%	$	20,439		$	18,402		$	15,883
Increase (decrease) in taxes resulting from:
Tax exempt income		(1,222	)		(1,122	)		(1,376	)
Nondeductible expense		180			182			213
State income tax, net of federal tax effect		1,396			554			490
Captive insurance premium income		(391	)		0			0
Tax credits		(243	)		(253	)		(153	)
Bank owned life insurance		(578	)		(340	)		(348	)
Reserve for unrecognized tax benefits		(25	)		(45	)		22
Other		3			(196	)		(13	)
Total income tax expense	$	19,559		$	17,182		$	14,718

The net deferred tax asset recorded in the consolidated balance sheets at December 31, 2013 and 2012 consisted of the following:

(dollars in thousands)	2013		2012
Deferred tax assets:
Bad debts	$	19,902	$	21,810
Pension and deferred compensation liability		1,215		916
Non-qualified stock options		638		581
Nonaccrual loan interest		1,760		1,700
Long-term incentive plan		1,605		1,038
Other		32		302
		25,152		26,347
Deferred tax liabilities:
Accretion		152		147
Depreciation		3,336		3,075
Loan servicing rights		1,080		1,223
State taxes		963		1,229
Deferred loan fees		63		46
Intangible assets		1,925		2,005
FHLB stock dividends		88		92
REIT spillover dividend		1,178		1,219
Prepaid expenses		895		848
		9,680		9,884
Valuation allowance		0		0
Net deferred tax asset	$	15,472	$	16,463

In addition to the net deferred tax assets included above, the deferred income tax asset/liability allocated to the unrealized net gain/(loss) on securities available for sale included in equity was ($895,000) and $4.7 million for 2013 and 2012. The deferred income tax liability allocated to the pension plan and SERP included in equity was $924,000 and $1.2 million for 2013 and 2012.

During the second quarter of 2013, the Indiana legislature approved new tax rates for financial institutions which will lower their state income tax rate from 8.5% to 6.5%. The decrease will be phased in over four years, beginning in 2014. This lower state tax rate going forward will reduce the benefit provided by the Company’s existing deferred tax items. As a result of the revaluation of the Company’s state deferred tax items, the Company recorded a non-cash adjustment for state tax expense of $465,000.

Unrecognized Tax Benefits

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

(dollars in thousands)	2013			2012
Balance January 1,	$	89		$	134
Additions based on tax positions related to the current year		5			15
Additions for tax positions of prior years		0			0
Reductions for tax positions of prior years		0			0
Reductions due to the statute of limitations		(30	)		(60	)
Settlements		0			0
Balance at December 31,	$	64		$	89

The balance of $64,000 at December 31, 2013 represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the Company’s effective income tax rate in future periods. The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months.

No interest or penalties were recorded in the income statement and no amount was accrued for interest and penalties for the period ending December 31, 2013 and 2012. Should the accrual of any interest or penalties relative to unrecognized tax benefits be necessary, it is the Company’s policy to record such accruals in its income taxes accounts.

The Company and its subsidiaries file a consolidated U.S. federal tax return and a combined unitary return in the States of Indiana and Michigan. These returns are subject to examinations by authorities for all years after 2009.