INCOME TAXES

Income taxes for the years ended December 31, 2011, 2010, and 2009, were as follows:



(Dollars in thousands)
	2011		2010			2009
Current:
Federal	$	4,639	$	10,338		$	8,086
State	1,300		2,244			1,709
Total current	$	5,939	$	12,582		$	9,795
Deferred:
Federal	$	2,905	$	(2,121	)	$	(3,021	)
State	1,458		(615		)	422
Total deferred	$	4,363	$	(2,736	)	$	(2,599	)
Total income tax expense	$	10,302	$	9,846		$	7,196

The income tax provisions above do not include the effects of income tax deductions resulting from exercises of stock options and the vesting of stock awards in the amounts of $108,000, $28,000, and $18,000 in 2011, 2010 and 2009, respectively, which were recorded as increases to stockholders’ equity.

Temporary differences between the amounts reported in the financial statements and the tax basis of assets and liabilities result in deferred taxes. Deferred tax assets and liabilities at December 31, 2011 and 2010, were as follows:



(Dollars in thousands)
	2011			2010
Deferred tax assets:
Tax effect of net unrealized loss on derivatives reflected in stockholders’ equity	$	2,211		$	797
Securities	1,225			1,227
Allowance for loan and lease losses	13,754			16,042
Deferred compensation	2,330			2,032
Organization and acquisitions costs	467			541
Net operating loss carryforwards	2,026			1,673
Non-accrual loan interest	1,326			1,418
OREO writedowns	4,444			5,356
Other	64			237
Gross deferred tax assets	27,847			29,323
Valuation allowance	(1,964		)	(1,242		)
Total deferred tax assets	$	25,883		$	28,081



Deferred tax liabilities:
Tax effect of net unrealized gain on securities available for sale reflected in stockholders’ equity	(9,603		)	(5,963		)
Premises, furniture and equipment	(6,402		)	(5,549		)
Lease financing	(93		)	(281		)
Tax bad debt reserves	(326		)	(424		)
Purchase accounting	(3,434		)	(3,450		)
Prepaid expenses	(664		)	(558		)
Mortgage servicing rights	(4,599		)	(4,546		)
Deferred loan fees	(194		)	(241		)
Other	(325		)	(233		)
Gross deferred tax liabilities	$	(25,640	)	$	(21,245	)
Net deferred tax asset	$	243		$	6,836

The deferred tax assets (liabilities) related to net unrealized gains (losses) on securities available for sale and the deferred tax assets and liabilities related to net unrealized gains (losses) on derivatives had no effect on income tax expense as these gains and losses, net of taxes, were recorded in other comprehensive income. Net operating loss carryforwards for state income tax purposes were approximately $40.0 million at December 31, 2011, and $35.0 million at December 31, 2010. The associated deferred tax asset, net of federal tax, was $2.0 million at December 31, 2011, and $1.7 million at December 31, 2010. These carryforwards expire beginning December 31, 2013, through December 31, 2031. A valuation allowance against the deferred tax asset due to the uncertainty surrounding the utilization of these state net operating loss carryforwards was $2.0 million at December 31, 2011, and $1.2 million at December 31, 2010. Realization of the deferred tax asset over time is dependent upon the existence of taxable income in carryback periods or the ability to generate sufficient taxable income in future periods. In determining that realization of the deferred tax asset was more likely than not, Heartland gave consideration to a number of factors including its taxable income during carryback periods, its recent earnings history, its expectations for earnings in the future and, where applicable, the expiration dates associated with its tax carryforwards.

The actual income tax expense from continuing operations differs from the expected amounts (computed by applying the U.S. federal corporate tax rate of 35% to income before income taxes) as follows:



(Dollars in thousands)
	2011			2010			2009
Computed “expected” tax on net income	$	13,421		$	11,812		$	4,816
Increase (decrease) resulting from:
Nontaxable interest income	(3,725		)	(3,055		)	(2,700		)
State income taxes, net of federal tax benefit	2,056			1,059			1,385
Nondeductible goodwill and other intangibles	—			574			4,487
Tax credits	(798		)	(554		)	(212		)
Other	(652		)	10			(580		)
Income taxes	$	10,302		$	9,846		$	7,196
Effective tax rates	26.9		%	29.2		%	52.3		%
Effective tax rates exclusive of goodwill impairment charge	26.9		%	27.8		%	27.2		%

Heartland had investments in certain low-income housing projects totaling $7.6 million at December 31, 2011, $8.4 million as of December 31, 2010, and $5.4 million as of December 31, 2009. These investments generated federal low-income housing tax credits of $798,000 in 2011, $554,000 in 2010 and $212,000 in 2009. These investments are expected to generate federal low-income housing tax credits of approximately $798,000 for 2013 and 2014, $755,000 for 2015, $581,000 for 2016 through 2019 and $241,000 for 2020.

On December 31, 2011, the amount of unrecognized tax benefits was $751,000, including $113,000 of accrued interest and penalties. On December 31, 2010, the amount of unrecognized tax benefits was $1.2 million, including $217,000 of accrued interest and penalties. If recognized, the entire amount of the unrecognized tax benefits would affect the effective tax rate. A reconciliation of the beginning and ending balances for liabilities associated with unrecognized tax benefits for the years ended December 31, 2011 and 2010, follows:



(Dollars in thousands)
	2011			2010
Balance at January 1	$	1,198		$	1,127
Additions for tax positions related to the current year	104			315
Additions for tax positions related to prior years	31			63
Reductions for tax positions due to settlement with taxing authorities	—			—
Reductions for tax positions related to prior years	(582		)	(307		)
Balance at December 31	$	751		$	1,198

The tax years ended December 31, 2008, and later remain subject to examination by the Internal Revenue Service. For state purposes, the tax years ended December 31, 2007, and later remain open for examination. A income tax review is currently underway with the Illinois Department of Revenue for the years 2007 and 2008. Wisconsin Community Bank, one of Heartland’s bank subsidiaries, has undergone a franchise tax review for the years ended December 31, 2002 and 2003. In dispute was $1.1 million of deducted expenditures. During the process of appealing the field audit report, a settlement agreement was reached, which included a payment of $260,000 in taxes and $90,000 in interest and penalties. In addition to the years initially under review, the settlement included the years ended December 31, 2004, 2005, 2006 and 2007. The settlement payment was made during the first quarter of 2009. Heartland does not anticipate any significant increase or decrease in unrecognized tax benefits during the next twelve months.