INCOME TAXES

Income taxes for the years ended December 31, 2013, 2012, and 2011 were as follows, in thousands:



	2013		2012		2011
Current:
Federal	$	5,025	$	11,513	$	4,639
State	2,549		5,366		1,300
Total current	$	7,574	$	16,879	$	5,939
Deferred:
Federal	$	2,447	$	404	$	2,905
State	314		101		1,458
Total deferred	$	2,761	$	505	$	4,363
Total income tax expense	$	10,335	$	17,384	$	10,302

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 $98,000, $222,000, and $108,000 in 2013, 2012, and 2011 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, 2013 and 2012, were as follows, in thousands:



	2013			2012
Deferred tax assets:
Tax effect of net unrealized loss on securities available for sale reflected in stockholders’ equity	$	9,766		$	—
Tax effect of net unrealized loss on derivatives reflected in stockholders’ equity	$	1,270		$	2,280
Securities	1,257			1,865
Allowance for loan and lease losses	15,766			14,908
Deferred compensation	4,674			3,547
Organization and acquisitions costs	393			289
Net operating loss carryforwards	4,463			3,691
Non-accrual loan interest	830			939
OREO writedowns	1,781			3,340
Rehab tax credit projects	2,438			2,162
Mortgage repurchase obligation	882			998
Other	778			246
Gross deferred tax assets	44,298			34,265
Valuation allowance	(4,615		)	(4,167		)
Total deferred tax assets	$	39,683		$	30,098



Deferred tax liabilities:
Tax effect of net unrealized gain on securities available for sale reflected in stockholders’ equity	$	—		$	(12,353	)
Premises, furniture and equipment	(8,660		)	(7,877		)
Tax bad debt reserves	(523		)	(600		)
Purchase accounting	(5,323		)	(2,085		)
Prepaid expenses	(621		)	(604		)
Mortgage servicing rights	(8,996		)	(6,421		)
Deferred loan fees	(75		)	(134		)
Other	(324		)	(318		)
Gross deferred tax liabilities	$	(24,522	)	$	(30,392	)
Net deferred tax asset (liability)	$	15,161		$	(294	)

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. Beginning in 2013, Heartland had a federal low-income housing tax credit carryforward of approximately $217,000 that expires in 2033, and an alternative minimum tax (“AMT”) credit carryforward of approximately $256,000 available to reduce future federal income taxes over an indefinite period. As a result of acquisitions, Heartland had net operating loss carryforwards for federal income tax purposes of approximately $6.0 million at December 31, 2013, and $4.6 million at December 31, 2012. The associated deferred tax asset was $2.0 million at December 31, 2013, and $1.6 million at December 31, 2012. These net carryforwards expire beginning December 31, 2026, through December 31, 2033, and are subject to an annual limitation of approximately $524,000. Net operating loss carryforwards for state income tax purposes were approximately $41.6 million at December 31, 2013, and $38.4 million at December 31, 2012. The associated deferred tax asset, net of federal tax, was $2.4 million at December 31, 2013, and $2.1 million at December 31, 2012. These carryforwards expire beginning December 31, 2021, through December 31, 2033. A valuation allowance against the deferred tax asset due to the uncertainty surrounding the utilization of these state net operating loss carryforwards was $1.9 million at December 31, 2013, and $2.0 million at December 31, 2012. During both 2013 and 2012, Heartland had book writedowns on investments that, for tax purposes, would generate capital losses upon disposal. Due to the uncertainty of Heartland's ability to utilize the potential capital losses, a valuation allowance for these potential losses totaled $2.4 million at December 31, 2013, and $2.2 million at December 31, 2012. 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, in thousands:



	2013			2012			2011
Computed “expected” tax on net income	$	16,493		$	23,511		$	13,421
Increase (decrease) resulting from:
Nontaxable interest income	(5,622		)	(4,539		)	(3,725		)
State income taxes, net of federal tax benefit	1,861			3,099			2,056
Nondeductible goodwill and other intangibles	—			—			—
Tax credits	(1,696		)	(6,669		)	(798		)
Valuation allowance	209			1,851			—
Other	(910		)	131			(652		)
Income taxes	$	10,335		$	17,384		$	10,302
Effective tax rates	21.9		%	25.9		%	26.9		%

Heartland's income taxes included federal historic rehabilitation tax credits totaling $898,000 during 2013 and $5.8 million during 2012. Additionally, investments in certain low-income housing partnerships at Dubuque Bank and Trust Company totaled $4.3 million at December 31, 2013, $4.5 million at December 31, 2012, and $7.6 million at December 31, 2011. These investments generated federal low-income housing tax credits of $798,000 for the years ended December 31, 2013, 2012, and 2011. These investments are expected to generate federal low-income housing tax credits of approximately $798,000 for 2014, $755,000 for 2015, $581,000 for 2016 through 2019 and $241,000 for 2020.

On December 31, 2013, the amount of unrecognized tax benefits was $779,000, including $96,000 of accrued interest and penalties. On December 31, 2012, the amount of unrecognized tax benefits was $773,000, including $80,000 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, 2013 and 2012, follows, in thousands:



	2013			2012
Balance at January 1	$	773		$	751
Additions for tax positions related to the current year	65			241
Additions for tax positions related to prior years	188			67
Reductions for tax positions related to prior years	(247		)	(286		)
Balance at December 31	$	779		$	773

The tax years ended December 31, 2010, and later remain subject to examination by the Internal Revenue Service. For state purposes, the tax years ended December 31, 2009, and later remain open for examination. Income tax reviews are currently underway with the Colorado Department of Revenue for the years 2008 through 2011 and with the Illinois Department of Revenue for the years 2010 and 2011. During 2012, an income tax review was completed with the Illinois Department of Revenue for the years 2007 and 2008, which resulted in a net tax refund of $29,000. Heartland does not anticipate any significant increase or decrease in unrecognized tax benefits during the next twelve months.