INCOME TAXES

The following table presents the components of income tax expense (benefit) of continuing operations for the periods indicated:



	Year Ended December 31,
($ in thousands)	2018			2017			2016
Current income taxes:
Federal	$	5,720		$	(2,215	)	$	(3,044	)
State	5,035			6,006			11,180
Total current income tax expense	10,755			3,791			8,136
Deferred income taxes:
Federal	(4,418		)	(25,938		)	6,699
State	(1,493		)	(4,434		)	(1,086		)
Total deferred income tax expense	(5,911		)	(30,372		)	5,613
Income tax expense (benefit)	$	4,844		$	(26,581	)	$	13,749

The following table presents a reconciliation of the recorded income tax expense (benefit) of continuing operations to the amount of taxes computed by applying the applicable statutory Federal income tax rate of 21.0 percent to income from continuing operations before income taxes for the year ended December 31, 2018, and 35.0 percent for the years ended December 31, 2017 and 2016:



	Year Ended December 31,
	2018		2017		2016
Computed expected income tax expense (benefit) at Federal statutory rate	21.0	%	35.0	%	35.0	%
Increase (decrease) resulting from:
Proportional amortization	4.3	%	5.1	%	0.4	%
Other permanent book-tax differences	0.4	%	(2.1	)%	0.2	%
State tax expense, net of federal benefit	5.9	%	3.7	%	6.4	%
Income tax credits	(25.4	)%	(149.5	)%	(33.9	)%
Basis reduction in investment in alternative energy partnership	2.2	%	24.9	%	5.8	%
Write-off of Goodwill for discontinued operations	—	%	2.7	%	—	%
Bank owned life insurance policies	(1.0	)%	(3.0	)%	(0.8	)%
Equity compensation windfall tax benefits	(0.5	)%	(7.0	)%	—	%
Remeasurement from the Tax Cuts and Jobs Act	—	%	(7.8	)%	—	%
Reserve for uncertain tax positions	0.1	%	1.9	%	—	%
Other, net	3.3	%	(2.7	)%	0.6	%
Effective tax rates	10.3	%	(98.8	)%	13.7	%

The Company’s effective tax rate of continuing operations for the year ended December 31, 2018 was higher than the effective tax rate of continuing operations for the year ended December 31, 2017 mainly due to the reduction in the recognition of tax credits on investments in alternative energy partnerships of $9.6 million, partially offset by tax expense from tax basis reduction of $1.0 million related to investments in alternative energy partnerships for the year ended December 31, 2018, compared to $38.2 million of tax credits recognized, partially offset by tax expense from tax basis reduction of $6.7 million for the year ended December 31, 2017. The reduction in tax credits received by the Bank on the investments in alternative energy partnerships is due to less new equipment being placed into service by the investments. The higher effective tax rate was also partially offset by the decrease in the federal statutory tax rate from 35% to 21% as a result of the Tax Cuts and Jobs Act, which became effective on January 1, 2018. The Company’s effective tax rate of continuing operations for the year ended December 31, 2017 was lower than the effective tax rate of continuing operations for the year ended December 31, 2016 mainly due to the increase in the recognition of tax credits on investments in alternative energy partnerships of $38.2 million, partially offset by tax expense from tax basis reduction of $6.7 million related to investments in alternative energy partnerships for the year ended December 31, 2017, compared to $33.4 million of tax credits recognized, partially offset by tax expense from tax basis reduction of $5.8 million for the year ended December 31, 2016. The lower pre-tax book income of $34.1 million for the year ended December 31, 2017 compared to $149.4 million for 2016 also enlarged the impact of the tax credits to the effective tax rate. The Company uses the flow-through income statement method to account for the tax credits earned on investments in alternative energy partnerships. Under this method, the tax credits are recognized as a reduction to income tax expense and the initial book-tax difference in the basis of the investments are recognized as additional tax expense in the year they are earned.

On December 22, 2017, the Tax Cuts and Jobs Act (the “Tax Act”) was enacted into law in the United States. The legislation provides for significant changes to the IRC that impact corporate taxation requirements, such as the reduction of the federal income tax rate for corporations from 35 percent to 21 percent and changes or limitations to certain tax deductions. As of

December 31, 2017, the Company remeasured its deferred tax assets and liabilities based on the reduced federal corporate

income tax rate of 21 percent which resulted in an income tax benefit of $2.1 million to continuing operations. At December 31,

2017, the Company was able to make reasonable estimates of the tax effects on enactment of the Tax Cuts and Jobs Act and

completed its analysis for the tax effects of enactment of the Tax Act on all items.

At December 31, 2018, the Company had $2.2 million of available unused federal net operating loss (NOL) carryforwards that may be applied against future taxable income through 2031. The Company had available at December 31, 2018, $9.1 million of unused state NOL carryforwards that may be applied against future taxable income through 2031. Utilization of these NOL carryforwards are subject to annual limitations set forth in Section 382 of the U.S. Internal Revenue Code (IRC). The tax attributes acquired in Gateway Bancorp acquisitions are subject to an annual IRC Section 382 limitation of $474 thousand.

In addition, as of December 31, 2018 and 2017, the Company had income tax credit carryforwards of $26.9 million and $27.4 million, respectively. The tax credits, if unused, will expire on December 31, 2037.

The following table presents the tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities as of the dates indicated:



	December 31,
($ in thousands)	2018			2017
Deferred tax assets:
Allowance for loan and lease losses	$	18,813		$	15,178
Stock-based compensation expense	2,249			2,899
Accrued expenses	2,678			1,465
Reserve for loss on repurchased loans	736			2,031
Federal net operating losses	471			571
State net operating losses	759			871
Federal income tax credits	27,087			27,550
Unrealized loss on securities available-for-sale	10,046			—
Deferred loan fees	2,446			—
Amortization of intangible assets	1,101			732
Prior year state tax deduction	1,272			1,527
Other deferred tax assets	3,456			3,468
Total deferred tax assets	71,114			56,292
Deferred tax liabilities:
Investments in partnerships	(5,317		)	(237		)
Mortgage servicing rights	(520		)	(9,337		)
Deferred loan fees and costs	(8,528		)	(7,005		)
Depreciation on premises and equipment	(4,710		)	(3,797		)
Unrealized gain on securities available-for-sale	—			(2,368		)
Other deferred tax liabilities	(2,635		)	(2,474		)
Total deferred tax liabilities	(21,710		)	(25,218		)
Valuation allowance	—			—
Net deferred tax assets	$	49,404		$	31,074

Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more-likely-than-not that some portion, or all, of the deferred tax asset will not be realized. In assessing the realization of deferred tax assets, management will continue to evaluate both positive and negative evidence on a quarterly basis, including the reversal of its taxable temporary differences, the existence of its historical earnings, the amounts of future projected earnings as well as the tax expiration periods of its income tax credits. Based on this analysis, management determined that it was more likely than not that all of the deferred tax assets would be realized. Therefore, the Company recorded no valuation allowance against net deferred tax assets at December 31, 2018 and 2017, respectively. Based on this analysis, management determined that it was more likely than not the Company believes it will generate sufficient future taxable income to realize net deferred tax assets.

During the year ended December 31, 2018, estimated taxable income before utilization of NOLs of $64.5 million allowed the Company to utilize $474 thousand and $1.4 million, respectively, of federal and state NOLs (representing approximately 16.8 percent of the total NOLs included in the Company’s deferred tax assets), $9.6 million of alternative energy investment tax credits, $400 thousand of Federal research credits, and $500 thousand of state research tax credits. The Company believes that the utilization of a significant portion of tax credits in 2018, along with the Company’s projection of future taxable income should be considered significant positive evidence that the deferred tax assets for income tax credits will be realized in future periods prior to their expiration dates.

ASC 740-10-25 relates to the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. ASC 740-10-25 prescribes a threshold and a measurement process for recognizing in the financial statements a tax position taken or expected to be taken in a tax return and also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company had unrecognized tax benefits of $1.2 million and $1.0 million, respectively, at December 31, 2018 and 2017. The Company does not believe that the unrecognized tax benefits will change within the next twelve months. As of December 31, 2018, the total unrecognized tax benefit that, if recognized, would impact the effective tax rate was $1.0 million.

At December 31, 2018 and 2017, the Company had no accrued interest or penalties, respectively. The table below summarizes the activity related to the Company's unrecognized tax benefits for the periods indicated:



	Year Ended December 31,
($ in thousands)	2018		2017		2016
Beginning balance	$	1,047	$	—	$	—
Increase related to prior year tax positions	—		867		—
Increase in current year tax positions	180		180		—
Ending balance	$	1,227	$	1,047	$	—

In the event the Company is assessed interest and/or penalties by federal or state tax authorities, such amounts will be classified on the consolidated financial statements as income tax expense.

The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax in multiple state jurisdictions. The Company is no longer subject to examination by U.S. federal taxing authorities for years before 2015. The statute of limitations for the assessment of California franchise taxes has expired for tax years before 2014 (other state income and franchise tax statutes of limitations vary by state).

The Company accounts for qualified affordable housing investments under the proportional amortization method. The gross investments in these limited partnerships amounted to $29.3 million and the unfunded portion was $11.5 million at December 31, 2018. The balances of these investments were $20.0 million and $22.0 million as of December 31, 2018 and 2017, respectively. The Company utilized $1.9 million of tax deductions from these investments in 2018, but the $1.8 million of low income housing tax credits generated in 2018 were limited and not utilized in 2018. Thus, there were $2.7 million and $849 thousand of unused tax credit carryforwards as of December 31, 2018 and 2017, respectively. Investment book proportional amortization amounted to $2.0 million, $1.4 million and $394 thousand for the years ended December 31, 2018, 2017 and 2016, respectively.

The Company early adopted ASU 2018-02 effective January 1, 2018. ASU 2018-02 permits companies to reclassify stranded

tax effects due to the Tax Cuts and Jobs Act from accumulated other comprehensive income to retained earnings. As a result of

the adoption, the Company recorded an increase in accumulated other comprehensive income of $496 thousand and reduced

retained earnings by $496 thousand to eliminate the stranded tax effects at that date from the reduction in the federal statutory

tax rate that was enacted in December 2017 and became effective January 1, 2018.