18. Income Taxes

The components of income tax expense are as follows:

	Years Ended December 31
	2014		2013		2012
	(In Thousands)
Current:
Federal	$	9,198	$	7,751	$	7,862
State and local		144		9		(50)
Deferred		(179)		1,518		200
	$	9,163	$	9,278	$	8,012

The provision for income taxes differs from that computed at the statutory corporate tax rate as follows:

	Years Ended December 31
	2014		2013		2012
	(In Thousands)
Tax expense at statutory rate (35%)	$	11,709	$	11,030	$	9,337
Increases (decreases) in taxes from:
State income tax – net of federal tax benefit		94		4		(32)
Tax exempt interest income, net of TEFRA		(1,152)		(1,043)		(1,047)
Bank owned life insurance		(816)		(449)		(374)
Captive insurance		(390)		(415)		-
Other		(282)		151		128
Totals	$	9,163	$	9,278	$	8,012

Deferred federal income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.

Significant components of First Defiance’s deferred federal income tax assets and liabilities are as follows:

	December 31
	2014		2013
	(In Thousands)
Deferred federal income tax assets:
Allowance for loan losses	$	8,743	$	8,798
Postretirement benefit costs		1,149		1,013
Deferred compensation		1,629		1,412
Impaired loans		524		986
Capital loss carry-forward		-		555
Impaired investments		-		971
Accrued vacation		623		581
Allowance for real estate held for sale losses		333		277
Deferred loan origination fees and costs		311		265
Other		1,481		718
Total deferred federal income tax assets		14,793		15,576

Deferred federal income tax liabilities:
FHLB stock dividends		2,299		3,238
Goodwill		5,019		4,586
Mortgage servicing rights		3,181		3,211
Fixed assets		1,714		1,693
Other intangible assets		270		607
Loan mark to market		315		515
Net unrealized gains on available-for-sale securities		2,528		488
Prepaid expenses		622		617
Other		21		56
Total deferred federal income tax liabilities		15,969		15,011
Net deferred federal income tax asset (liability)	$	(1,176)	$	565

The realization of the Company’s deferred tax assets is dependent upon the Company’s ability to generate taxable income in future periods and the reversal of deferred tax liabilities during the same period and the ability to carryback any losses. The Company has evaluated the available evidence supporting the realization of its deferred tax assets and determined it is more likely than not that the assets will be realized and thus no valuation allowance was required at December 31, 2014.

The Company had capital loss carry-forwards of zero and $1.6 million as of December 31, 2014 and December 31, 2013. During 2014 the Company generated capital gains through the sale of FHLB stock which fully utilized the capital loss carry-forward.

Retained earnings at December 31, 2014 include approximately $11.0 million for which no tax provision for federal income taxes has been made. This amount represents the tax bad debt reserve at December 31, 1987, which is the end of the Company’s base year for purposes of calculating the bad debt deduction for tax purposes. If this portion of retained earnings is used in the future for any purpose other than to absorb bad debts, the amount used will be added to future taxable income. The unrecorded deferred tax liability on the above amount at December 31, 2014 was approximately $3.85 million.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (In Thousands):

Balance at January 1, 2012	$	141
Additions based on tax positions related to the current year		-
Additions for tax positions of prior years		-
Reductions for tax positions of prior years		-
Reductions due to the statute of limitations		(76)
Settlements		-
Balance at December 31, 2012	$	65

Balance at January 1, 2013	$	65
Additions based on tax positions related to the current year		-
Additions for tax positions of prior years		-
Reductions for tax positions of prior years		-
Reductions due to the statute of limitations		(65)
Settlements		-
Balance at December 31, 2013	$	-

Balance at January 1, 2014	$	-
Additions based on tax positions related to the current year		-
Additions for tax positions of prior years		-
Reductions for tax positions of prior years		-
Reductions due to the statute of limitations		-
Settlements		-
Balance at December 31, 2014	$	-

The Company does not expect the total amount of unrecognized tax benefits to significantly increase in the next twelve months.

The total amount of interest and penalties recorded in the income statement, net of the related federal tax effect, for the year ended December 31, 2014 was zero, and the amount accrued for interest and penalties (net of the related federal tax effect) at December 31, 2014 was zero.

The total amount of interest and penalties recorded in the income statement, net of the related federal tax effect, for the year ended December 31, 2013 was a net reversal of $26,000, and the amount accrued for interest and penalties (net of the related federal tax effect) at December 31, 2013 was zero.

The total amount of interest and penalties recorded in the income statement, net of the related federal tax effect, for the year ended December 31, 2012 was a net reversal of $22,000, and the amount accrued for interest and penalties (net of the related federal tax effect) at December 31, 2012 was $26,000.

The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax in the state of Indiana. The Company is no longer subject to examination by taxing authorities for years before 2010. The Company currently operates primarily in the states of Ohio and Michigan, which tax financial institutions based on their equity rather than their income.