NOTE 15. INCOME TAXES

The following table provides information on components of income tax expense for each of the three years ended December 31.


(Dollars in thousands)	2016		2015		2014
Current tax expense (benefit):
Federal	$	525	$	247	$	-
State		19		287		225
		544		534		225
Deferred income tax expense (benefit):
Federal		4,486		3,369		2,516
State		1,230		505		320
		5,716		3,874		2,836

Total income tax expense (benefit)	$	6,261	$	4,408	$	3,061

The following table provides a reconciliation of tax computed at the statutory federal tax rate to the actual tax expense (benefit) for each of the three years ended December 31.


(Dollars in thousands)	2016		2015		2014
Tax at federal statutory rate	35.0	%	34.0	%	34.0	%
Tax effect of:
Tax-exempt income	(0.8)		(0.4)		(0.9)
Other non-deductible expenses	0.3		0.2		0.3
State income taxes, net of federal benefit	5.1		4.5		4.4
Other	(0.2)		(0.1)		(0.1)

Actual income tax expense (benefit) rate	39.4	%	38.2	%	37.7	%

The following table provides information on significant components of the Company’s deferred tax assets and liabilities as of December 31.


(Dollars in thousands)	2016		2015
Deferred tax assets:
Allowance for credit losses	$	3,486	$	3,316
Reserve for off-balance sheet commitments		122		121
Net operating loss carry forward		2,232		9,069
Write-downs of other real estate owned		387		308
Deferred income		1,011		1,155
Unrealized gains on available-for-sale securities		672		48
Accrued expenses		-		946
AMT Credits		869		-
Other		1,192		191
Total deferred tax assets		9,971		15,154
Deferred tax liabilities:
Depreciation		239		271
Amortization on loans FMV adjustment		156		140
Purchase accounting adjustments		2,019		1,988
Deferred capital gain on branch sale		401		411
Other		116		212
Total deferred tax liabilities		2,931		3,022
Net deferred tax assets	$	7,040	$	12,132

The Company’s deferred tax assets consists of gross net operating loss carryovers for federal and state of $2.2 million and $27.3 million that will be used to offset taxable income in future periods. The Company’s federal and state net operating loss carryovers are available for use through December 31, 2033 while its state net operating losses will begin to expire in the year ended December 31, 2026 with limited amounts available through December 31, 2034. Additionally, the Company has $869 thousand of alternative minimum tax credit carryforwards as of December 31, 2016 which may be carried forward indefinitely.

No valuation allowance on these deferred tax assets was recorded at December 31, 2016 and December 31, 2015 as management believes it is more likely than not that all deferred tax assets will be realized based on the following positive material factors: 1) The Company was profitable for all four quarters of 2014, 2015 and 2016 on a GAAP basis. The net operating loss was originally created in the third quarter of 2013 and was solely attributable to the former Talbot Bank’s sale of loans and other real estate owned (the “Asset Sale”), which is considered non-recurring. 2) The Company had pre-tax income of $15.9 million and $11.5 million for the years ended December 31, 2016 and 2015, providing further evidence that the Asset Sale was producing positive results and confirming the expectation of utilizing the deferred tax assets. Alternatively, the Company has reviewed negative factors which would influence the conclusion of realizing the deferred tax assets. These factors include the following: 1) The Company could be subject to Section 382 of the Internal Revenue Code (“IRC”), which could further limit the realization of the net operating loss-related deferred tax asset (“NOL-DTA”). 2) Although the local economy of the market in which the Company operates has been showing continued signs of improvement over the past four years, if this trend flattens or reverses, there is a potential that this potential negative evidence could outweigh the prevailing positive factors.

Based on the aforementioned considerations, the Company has concluded that the predominance of observable positive evidence outweighs the future potential of negative evidence and therefore it is more likely than not that the Company will be able to realize in the future all of the net deferred tax assets.