NOTE 11 - INCOME TAXES

The components of the income tax expense included in the consolidated statements of operations are as follows:

	For the years ended December 31,
(In thousands)	2011		2010		2009
Income tax expense
Current	$	-	$	-	$	648
Deferred		-		-		(174	)
Income tax expense	$	-	$	-	$	474

The difference between the applicable income tax expense and the amount computed by applying the statutory federal income tax rate of 35% in 2011, 2010, and 2009 is as follows:

	For the years ended December 31,
(In thousands)	2011			2010			2009
Computed tax benefit at statutory rate	$	(2,997	)	$	(8,432	)	$	(11,474	)
Tax-exempt income		(2	)		(28	)		(120	)
Nondeductible expense		29			29			58
Bank owned life insurance		(137	)		(133	)		1,306
Bank owned life insurance excise penalty		-			-			474
Increase in valuation allowance		3,107			8,564			10,230
Applicable income tax expense	$	-		$	-		$	474

Deferred tax assets and liabilities consist of the following:

	As of December 31,
(In thousands)	2011			2010
Deferred tax assets
Allowance for loan and lease losses	$	5,998		$	7,395
Tax net loss carryforward		10,046			9,984
Asset valuation reserves		431			431
Security writedowns		1,929			1,943
OREO writedowns		7,462			5,564
Investment in partnerships		3,761			2,398
Accrued pension liability		5,453			4,588
Accrued stock-based compensation		812			780
Net operating loss carryovers from Knoblauch State Bank		1,232			1,232
Non-accrual interest		678			2,029
Capital loss carryover		1,589			-
Other		8			8
Deferred tax assets before valuation allowance		39,399			36,352
Less valuation allowance		(36,233	)		(33,479	)

Less valuation allowance for accumulated other comprehensive income items		(134	)		-
Total deferred tax assets		3,032			2,873
Deferred tax liabilities
Penalties on delinquent tax certificates		398			596
Unrealized gains on investment securities available for sale		1,337			1,228
Accretion on investments		650			127
Prepaid deductions		270			545
Other		(37	)		(37	)
Total deferred tax liabilities		2,618			2,459
Net deferred tax assets, included in other assets	$	414		$	414

As of December 31, 2011 the Company had net operating income tax loss carryforwards of approximately $28.7 million which are available to be carried forward to future tax years. These loss carryforwards will expire in 2031 if not utilized.

The Company has approximately $22.0 million of net operating loss carryovers from the acquisition of Knoblauch State Bank (“KSB”) of which $3.5 million was available to be utilized as of December 31, 2011. The utilization of these losses is subject to limitation under Section 382 of the Internal Revenue Code.

The Company recognizes deferred tax assets and liabilities for the future tax consequences related to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for tax credits. The deferred tax assets, net of valuation allowances, totaled $414,000 at December 31, 2011 and 2010. Management evaluated the deferred tax assets for recoverability using a consistent approach which considers the relative impact of negative and positive evidence, including historical profitability and projections of future reversals of temporary differences and future taxable income. The Company is required to establish a valuation allowance for deferred tax assets and record a charge to income or shareholders' equity if management determines, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. In evaluating the need for a valuation allowance, the Company estimates future taxable income based on management approved business plans and ongoing tax planning strategies. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws or variances between projected operating performance, actual results and other factors.

As of December 31, 2011, the Company was in a cumulative book taxable loss position for the three-year period ended December 31, 2011. For purposes of establishing a deferred tax asset valuation allowance, this cumulative book taxable loss position is considered significant objective evidence that the Company may not be able to realize some portion of the deferred tax assets in the future. The cumulative book taxable loss position was caused by the negative impact on results from the banking operations, investment impairments and loan and lease losses over the past three years. These conditions deteriorated dramatically during the three month period ended December 31, 2008 and continued throughout 2009, 2010 and 2011, causing a significant increase in the pre-tax losses due in part to much higher credit losses, and downward revisions to projections of future results.

As of December 31, 2011, 2010 and 2009, management concluded that it was more likely than not that the Company would not generate sufficient future taxable income to realize all of the deferred tax assets. Management's conclusion was based on consideration of the relative weight of the available evidence and the uncertainty of future market conditions on results of operations. As a result, the Company recorded a non-cash charge of $15.5 million in the consolidated statements of operations in the period ended December 31, 2008 related to the establishment of a valuation allowance for the deferred tax asset for the portion of the future tax benefit that more likely than not will not be utilized in the future. During 2009, 2010 and 2011, the Company established additional valuation allowances of $10.2 million, $7.7 million, and $3.0 million, respectively, which was a result of the net operating losses for each year and the portion of the future tax benefit that more likely than not will not be utilized in the future. The additional valuation allowance did not impact the net loss as no tax benefit was recorded during 2011 or 2010. As of December 31, 2011 the valuation allowance for deferred tax assets totaled $36.4 million. The net deferred tax asset of $414,000 relates to projected reversals of temporary differences in 2012 that are projected to be carried back to a prior year.

The Company is subject to income taxes in the U. S. and various state and local jurisdictions. As of December 31, 2011, tax years 2005 through 2011 are subject to examination by various taxing authorities. Tax regulations are subject to interpretation of the related tax laws and regulations and require significant judgment to apply.