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The Influence of Tax and Nontax Factors on Banks' Choice of Organizational Form
Abstract
This paper identifies tax and nontax factors that influence commercial banks' conversion from taxable C-corporation to nontaxable S-corporation from 1997 to 1999, after a 1996 tax-law change allowed banks to convert to S-corporations for the first time. We find that banks are more likely to convert when conversion saves dividend taxes, avoids alternative minimum taxes, and minimizes state income taxes. Banks are less likely to convert when conversion restricts access to equity capital, nullifies corporate tax loss carry forwards, and creates potential penalty taxes on unrealized gains existing at the conversion date. Banks with significant deferred tax assets are less likely to convert, presumably because the write-off of deferred taxes at conversion decreases regulatory capital and exposes the bank to costly regulatory intervention. We also investigate the strategic choices banks make before converting to S-corporations. Converting banks alter their capital structures, deliberately sell appreciated assets, and strategically set dividends to augment net conversion benefits.
... A major stream of empirical studies in this eld use the evidence from US (e.g. MacKie-Mason and Gordon (1994Gordon ( , 1997, Plesko (1994), Goolsbee (1998Goolsbee ( , 2004, Omer et al. (2000), Hodder et al. (2003), Liu (2014)). The impact of taxes on the choice of business organization and on income-shifting in a European setting was studied among others by Romanov (2006), de Mooij and Nicodéme (2008), Thoresen and Alstadsaeter (2010), Elschner (2013) and Edmark and Gordon (2013). ...
... Furthermore, the studies on the choice of the Polish special form of a limited partnership (chapter 4 and 5) by examining tax costs on conversion, that stem from the potential taxation of retained earnings, add new empirical insights on another source of tax-related costs as well as on the role of the tax law ambiguity with regard to the organizational shift decision to the existing literature (Plesko (1994(Plesko ( , 1995, Omer et al. (2000) and Hodder et al. (2003)). ...
... The composition of the tax costs usually depends on the specic setting of the study. Omer et al. (2000) and Hodder et al. (2003), for instance, examine conversions from taxable C corporations to nontaxable S corporations after the 1986 and 1996 tax-law changes in the natural resource and banking industry in the US and link the tax costs to the loss of specic tax attributes by the converting rm as well as to tax law restrictions and penalties introduced by new tax legislation. ...
This thesis explores analytically and empirically the impact of taxes on the choice of organizational form of business owners using evidence from Poland. It focuses in general on the influence of tax legislation on the choice of legal forms that offer considerable tax benefits compared to other legal organizations. Furthermore, it tackles the question of how tax law ambiguity and resulting court decisions as well as changes in tax legislation affect the choice with regard to a tax-preferred organizational form. Tax law ambiguity presents a dimension of empirical tax research that has not received much attention yet. Two essays in this thesis deal in particular with the Polish partnership limited by shares as a tax optimal business organization and with the aspect of the tax law ambiguity during the period from 2003 to 2014, whereas the other two studies analyze the organizational shifts to the Polish special form of limited partnership in the context of the changes in tax legislation during the period from 2001 to 2015.
... However, external governance also plays an important role. Tax policy specifically can guide corporate behaviors like investments (e.g., Albertus et al. 2022;Harris 1993) and entity structure (e.g., Burke 2019; Hodder et al. 2003;Ayers et al. 1996). Our study provides evidence on the role of tax policy and corporate governance in the context of an important structural decision-location of incorporation. ...
... We also look at changing federal and state legislation around the cannabis industry and how that has influenced inversions in the post-TCJA period (2018)(2019)(2020)(2021)(2022). We present our findings grouped by these three distinct policy time periods (pre-Jobs Act, (1982-2003, post-Jobs Act and pre-TCJA, (2004)(2005)(2006)(2007)(2008)(2009)(2010)(2011)(2012)(2013)(2014)(2015)(2016)(2017), and post-TCJA (2018-2022)), to clearly highlight the relationship between national-level policy and firm-level corporate governance. ...
This study develops a recent database of corporate inversions, and we descriptively explore three different corporate inversion timeframes from 1982 to 2022. We examine how the external governance mechanism of the legal environment has impacted the structure, destination countries, industry preference, and firm-level effects of inverting firms over these timeframes. In addition, we highlight the various internal corporate governance mechanisms (board characteristics) and common accounting variables and ratios during these same periods. We find that inverting firms’ boards during our later inversion period of 2018–2022 are smaller and less experienced and accounting ratios exhibit riskier profiles than the earlier inversion time periods. Besides building on the inversion literature, our findings should be of interest to practitioners and regulators who are interested in the current trends of inversions and we highlight new industry clustering in the manufacturing and service sectors and new inversions comprise mostly cannabis companies in the wake of conflicting federal, state and securities laws.
... Second, our study provides novel evidence for the effect of taxes on organizational form choices by identifying international taxation as an important determinant of these decisions when taken by MNCs. This result contrasts prior studies on domestic or standalone firms either finding that non-tax factors dominate organizational choices (Ayers, Cloyd, & Robinson, 1996;Gordon & MacKie-Mason, 1994;MacKie-Mason & Gordon, 1997) or documenting tax effects that are limited to industry-specific tax incentives (Hodder, McAnally, & Weaver, 2003;Petroni & Shackelford, 1995;Utke, 2019). Further, by showing that the effect of international taxation varies with the relative importance of tax-motivated income shifting, limited liability, legal independence, and local knowledge, our study sheds light on the trade-offs MNCs face in organizational form choices. ...
... Other studies focus on single industries and find that industry-specific tax incentives can outweigh the non-tax costs of organizational forms in narrow settings. For example, Hodder et al., (2003) Figure 1 International Taxation and Organizational Forms. Note: This figure outlines the three layers of international taxation. ...
We investigate the relation between international taxation and the organizational form of foreign direct investment (FDI). Using micro-level data on inbound FDI relations in Germany, we find that a higher tax burden on income earned in a corporate subsidiary increases the probability that a multinational corporation (MNC) conducts foreign investment through a non-corporate flow-through. This effect is economically meaningful and varies with the relative importance of tax-motivated income shifting, a subsidiary’s non-tax benefits of limited liability and legal independence, and an MNC’s local knowledge. Moreover, we examine potential real effects of organizational form choices and document that affiliates established as flow-throughs exhibit a lower loss propensity and are less profitable than affiliates established as subsidiaries. Taken together, our findings inform policy makers about the potential response of MNCs to tax-law changes and suggest that the chosen organizational form can shape the future characteristics of investments abroad.
... Founders typically do not have substantial other wealth or business experience, and as such require external financing 2 Several papers use aggregate time series (Goolsbee 1998;Gordon and Mackie-Mason 1994;Mackie-Mason and Gordon 1997) or geographical variation in organizational form choices (Luna and Murray 2010;Goolsbee 2004), to show that the attractiveness of the corporate form decreases as the incremental tax burden increases. Other studies find that firm-level organizational choices vary predictably with changes in the tax benefits (Plesko 1996;Guenther 1992) or costs (Hodder et al. 2003) associated with the corporate and non-corporate forms. Finally other work examines specific industries and finds that tax considerations influence the choice to convert from C-corp to S-corp status (Donohoe et al. 2019;Omer et al. 2000). ...
... In choosing between the C-corp and LLC, many of these differences are eliminated, allowing for a cleaner identification of the non-tax factors affecting the observed choices. Second, because we are observing the choice at inception as opposed to a switch later in the firm's life (e.g., Hodder et al. 2003), we have relatively stable potential costs and benefits for the sample firms. Third, as we show later, because VC investments are held in a portfolio, the potential tax benefits from the LLC are substantially higher than if we were examining firms on a stand-alone basis. ...
We examine the choice of organizational structure for VC-backed startup firms. These firms overwhelmingly organize as C-corporations rather than as tax advantaged limited liability companies (LLCs). This results in foregone tax savings of $43.9 billion, or 4.9% of the total equity invested in the sample firms. The decision is puzzling, given plausible estimates of the direct costs involved, but appears related to “hassle” and other transition costs generated by participants implementing a new form. Firms with more employees and investors are likely to choose the C-corporation. VCs appear to prefer the C-corporation form, as receiving VC money is associated with most LLC firms switching to a C-corporation within 30 days. Greater VC preferences for C-corporations are linked to a preference for familiarity, and less attention to taxes.
... After conversion, there is an increase in the dividend payout rates that lead to lower levels of capital. Hodder et al. (2003) examine the motivation behind the conversion to subchapter S and find that banks choose this status to avoid double taxation of dividends and to avoid alternative minimum taxes. They use a logistic regression and find that banks are less likely to convert to subchapter S when the conversion restricts access to equity capital and nullifies corporate tax-loss carryforwards. ...
... For example,Hodder et al. (2003) find that banks are likely to convert to Subchapter S when conversion saves dividend taxes, avoids alternative minimum taxes, and minimizes state income taxes.Cyree et al. (2010) find that banks adopting the Subchapter S status have higher dividend payout rates, higher profit growth, lower capital, and rely more on core deposits.2 The favorable tax treatment should interest all banks in adopting subchapter S status, but there are certain conditions that must be satisfied in order to qualify. ...
The Small Business Job Protection Act of 1996 allows US banks to adopt subchapter S status. Banks use this status to avoid double taxation. However, the Act restricts the number of shareholders for subchapter S banks to 100. Many banks adopt subchapter S and then transition back to C banks. We investigate why Subchapter S banks convert to C banks. We find that when these subchapter S banks are in financial distress, they convert to C banks to access additional equity capital needed to write off losses and rebalance their asset portfolio. Post-conversion, we observe a marked increase in equity, a decline in risk factors, and an improvement in profitability ratios.
... De seguida, temos o artigo de Hodder et al (2003) que conta com 16 citações. Hodder et al. (2003) A análise fornece provas de que existe uma relação assimétrica entre impostos diferidos e pagamento de impostos futuros. Guenther et al. (2004), com 14 citações, compararam dois atributos de um passivo por imposto diferido resultante de diferenças na aplicação dos métodos de depreciação contabilístico e fiscal. ...
... Academic literature suggests that taxation is a fundamental determinant of corporate financing decisions (see, ex multis: Wrightsman, 1978;Gupta, 1982;Cordes & Sheffrin, 1983;Hodder et al., 2003;Overesch & Wamser, 2014;Schepens, 2016;Abel, 2018;Fisher & Jensen, 2019). The NDTS are an essential part of the tax system of many jurisdictions and are able to influence both the composition and the cost of the capital structure (Graham & Tucker, 2006). ...
... De seguida, temos o artigo de Hodder et al (2003) que conta com 16 citações. Hodder et al. (2003) A análise fornece provas de que existe uma relação assimétrica entre impostos diferidos e pagamento de impostos futuros. Guenther et al. (2004), com 14 citações, compararam dois atributos de um passivo por imposto diferido resultante de diferenças na aplicação dos métodos de depreciação contabilístico e fiscal. ...
The International Workshop Accounting and Taxation (IWAT2021) is an international scientific meeting, that gathers researchers from all around the world, with the purpose of provide a debate on the current and relevant themes in the accounting and taxation. Moreover, this intensive, diversified and original event intends to be a reference in the scientific community in the future.
... De seguida, temos o artigo de Hodder et al (2003) que conta com 16 citações. Hodder et al. (2003) A análise fornece provas de que existe uma relação assimétrica entre impostos diferidos e pagamento de impostos futuros. Guenther et al. (2004), com 14 citações, compararam dois atributos de um passivo por imposto diferido resultante de diferenças na aplicação dos métodos de depreciação contabilístico e fiscal. ...
Objective/Purpose: The main objective of the work carried out is the feasibility of a management accounting system based on Activity-Based Costing (ABC) application in Higher Education Institutions (HEIs), mainly analyzing the advantages of implementing this costing system. Just as the costs computing has evolved, Management Accounting has also adapted itself to the new current needs. In the first costing system to emerge, the traditional one, applied in a large scale due to the ease of implementation and also the fact that, at the time, most of the companies produced a limited variety of products, where direct costs were predominant.
With the increase of the need for variety in the productions’ portfolios and with that the indirect costs relevance in the costs’ composition, the traditional costing system become obsolete emerging the need for more accurate and developed methods, centered on the high complexity of the correct distribution of the indirect costs, focused specially in the industrial ones, becoming the management accounting great topic of discussion: How to distribute them correctly, precisely, fairly, among the various items produced?
Derived from the traditional costing system single base criteria appear, followed by the multiple base ones. The latter, established as more elaborate, allow a more adequate and assertive categorization and, consequently, giving rise to a more correct and fair cost allocation, being the main seed of the Cost Centers or more specifically Homogeneous Sections.
Thus, we reach the central point of this work, the ABC method, which arises precisely to fill the existing gaps in the treatment of indirect costs, intensifying the investment of companies in the quality of internal decision-making information, allowing for a balance between cost reduction without jeopardizing the quality of the services provided, making it essential that Institutions implement tools that would provide information so that decision-making can be carried out in an optimized manner. Currently, in an economic context of high instability and growing budgetary constraints, it becomes increasingly important for HEIs to manage their resources through an appropriate accounting support to management, aided by the most
current tools. The Accounting Standardization System for Public Administration (SNC-AP) itself imposes numerous limitations on accountability, constantly demanding more
transparency in the information disclosed, such as, for example, the cost per student, the cost per department, etc.
Methodology: The methodology adopted for carrying out the work, with the objective, based on explanatory research, seeks to articulate concepts in order to establish cause-effect relationships between several variables, combining theory with a practical case referring to the HEIs’ reality specifics due to the need of knowledge to and about this institutions.
For the literature review, at an initial stage, the main concepts and objectives of this theme will be identified and characterized, as well as the most relevant analysis methodologies. For the state of the art of the themes incorporated in this work were duly analyzed, scientific articles related to the theme of costing systems, as well as works and reports previously carried out by other authors. The practical case exemplifies the implementation of an ABC system in a HEIs, starting with a brief overview of these last one and ending with the proposal to system implementation.
Originality: Globalization and the technology systematic advances make the product costs’ management much more efficient, where increasingly issues, such as the profile of consumers and market needs, influence their strategic management. Due to these special circumstances, the optimization of resources is now, more than ever, extremely important, so this work presents a theme that is not only current but also relevant, hoping that it will contribute to a better definition of the methods to be implemented.
Among the main contributions of this work, it is worth mentioning the critical analysis of the main concepts related to ABC, the valuation of indicators that promote a systematic analysis to the detriment of the traditional financial logic and more relevant to value the use of this technique as an important indicator that will allow the identification of strategic actions and add value to the operational activity.
Results: In order to guarantee efficient and viable costing systems, the entities must focus on improving their quality and use what best applies to their reality.
In the course of this work, the various costing systems were defined, their evolution, their drivers, implementation methodologies, advantages and limitations, proceeding to the comparison with the ABC, being determined as the best adaptation to the current days, in the inclusion of indirect costs and the obtaining of information, making it ideal in aiding decision-making process. Finally, the possibility of implementing the ABC in a HEI was evaluated, testing the advantages, taking into account not only the current situation of society, but also the characterization of the HEI in order to compare the current structure
observed and the one that would exist after the process implementation. Thus, in terms of future research work, the high relevance of studying the implementation of the ABC in different sectors of activity is identified, in order to compare its performance and relevance in different areas.
... Two paths of empirical accounting research were highlighted during this decade: the first is concerned with the more widespread use of non-earnings measures of accounting to test information content and value-relevance of accounting information with new methodological issues and other contexts such as performance evaluation, compensation (Aboody et al., 2004a;Craighead et al., 2004); accounting information and tax (Hodder et al., 2003); financial disclosure, and economic consequence (Botosan & Plumlee, 2013); the second refers to the apparent attempts to move forward to international financial reporting standard (IFRS). Since the IASB, global accounting issues could be well dealt with. ...
It is indispensable to improve decision usefulness for decision-making process for business. This study attempts to seek a framework of expanding a concept of decision usefulness (DU) through a regulatory-process check and a review of financial information literature and the extent to which future research opportunities could emerge from this DU concept for the improved decision usefulness (IDU). The regulatory process and research trends on financial information show that financial-information decision has evolved from reliability-driven to relevance-driven financial-information theories and moves forward to international accounting standardization issues. To this end, the development of ‘synthesis’ theories and approaches in financial information offers many future empirical-study chances for improved decision usefulness. Keywords: Decision Usefulness; Financial Information; Reliability-Driven Financial Information; Relevance-Driven Financial Information; International Accounting Standardization.
... Tax shield gives leverage to the bank and hence increasing the profitability (Vidmiou, Lawrence & Milne, 2005) (Buser, Chen & Kane, 1981). Tax policies consider the cost and benefits which alternatively increases the firm's profitability (Davies, Egger & Egger, 2010).Also bank's organizational form is associated with tax matters (Hodder, McAnally & Weaver, 2003). ...
In this research paper, the determinants of profitability are analyzed in the Pakistani Banking Sector. Return on Assets (ROA) is the most widely used ratio in this regard. The period under analysis for 5 years was selected mainly because during this period, the world banking sector showed a huge declining trend in profitability due to global economic recession with many renowned banks filing for liquidation and this affected the Pakistani banking scenario as well, and the nation’s banks both public and private showed a declining trend. The other reason for choosing this period was due to the sectors specific changes that occurred inside Pakistan, mergers, and acquisitions to name a few. Our analysis is mainly concerned with calculating Leverage, Tax Rate, and capital adequacy of the selected 10 banks and then comparing them with ROA. Along with it, the impact of variables will also be analyzed in order to see how much fluctuation is made in a bank's profitability and what kind of role is played by these variables. After this analysis
positive and negative trends and their effects are examined because of these variables. When these trends and effects are known to the banking sector and government they will take measures that will uphold the sector as well as the country’s economy.
... Tax shield gives leverage to the bank and hence increasing the profitability (Vidmiou, Lawrence & Milne, 2005) (Buser, Chen & Kane, 1981). Tax policies consider the cost and benefits which alternatively increases the firm's profitability (Davies, Egger & Egger, 2010).Also bank's organizational form is associated with tax matters (Hodder, McAnally & Weaver, 2003). ...
The study examines the effects of consumer perception and trust on effectiveness of internet banking habit in Pakistan. Our group completed the survey from 120 respondents and makes a very comprehensive model of the questionnaire to examine the Effectiveness of E-Banking sector. The findings from the study shows that the “Consumer Trust” and “Consumer Perception” should not be negative for the effectiveness of E-banking positive the attitudes of the customer is good for Internet banking sector. The study also contributes the literature by establishing the perception and trust positively that’s intention to make the Effective E-Banking Service.
... Tax shield gives leverage to the bank and hence increasing the profitability (Vidmiou, Lawrence & Milne, 2005) (Buser, Chen & Kane, 1981). Tax policies consider the cost and benefits which alternatively increases the firm's profitability (Davies, Egger & Egger, 2010).Also bank's organizational form is associated with tax matters (Hodder, McAnally & Weaver, 2003). ...
n this research paper the determinants of profitability are analyzed in Pakistani Banking Sector. Return on Assets (ROA) is the most widely used ratio in this regard. The period under analysis for 5 years was selected mainly because during this period, the world banking sector showed a huge declining trend in profitability due to global economic recession with many renowned banks filing for liquidation and this affected the Pakistani banking scenario as well, and the nation’s banks both public and private showed a declining trend. The other reason for choosing this period was due to the sectors specific changes that occurred inside Pakistan, mergers and acquisitions to name a few. Our analysis is mainly concerned with calculating Leverage, Tax Rate and capital adequacy of the selected 10 banks and then comparing them with ROA. Along with it, the impact of variables will also be analyzed in order to see how much fluctuation that is made in banks profitability and what kind of role is played by these variables. After this analysis positive and negative trends and their effects are examined because of these variables. When these trends and effects are known to banking sector and government they will take measures which will uphold the sector as well as country’s economy.
... Hodder, McAnally and Weaver (2003) investigate the motivation behind the conversion to Subchapter S status and finds that the banks elect Subchapter S status to avoid double taxation of dividends and to avoid alternative minimum taxes. They use logistic regression to show that banks are more likely to adopt Subchapter S status as the tax benefits of conversion increase, and are less likely to convert as the costs of conversion increase as a result of restricted access to equity capital and loss of corporate tax-loss carry forwards. ...
In this paper we investigate the effect of tax exemption to Subchapter S Banks on its stakeholders which we identify as the bank owners, bank’s customers, employees of bank and the government- which gives tax relief to these banks. Utilizing a unique dataset that provides detailed information about the year of adoption of Subchapter S status by banks, we use difference-in-difference estimation to investigate the effect of Subchapter S status adoption on stakeholders of the bank. We find that the tax exemptions to Subchapter S banks do not create new jobs. Our results show that tax exemption does not lead to higher employment opportunities in these banks. We find that the tax exemption has not resulted in any benefits to the bank customers in the form of higher deposit rate or lower loan rates. We also find that tax exemption has not benefitted the employees in the form of increased salaries and benefits. We find that the growth of assets for Subchapter S banks is not significantly different from Non Subchapter S banks. The results indicate that the shareholders or the owners of the bank are the sole beneficiary of tax benefits as the return on equity increases significantly after the bank adopts the Subchapter S status.
The Tax Cuts and Jobs Act (TCJA) of 2017 dramatically reshaped the tax landscape for companies and reduced incentives for multinationals to leave foreign earnings abroad. We study a provision of the law that allowed some multinationals to take simple measures to reduce their tax burden more than other firms. The TCJA levied a tax on accumulated income held in foreign subsidiaries of U.S. firms. The implementation of this tax left firms an avenue to protect shareholder wealth, as foreign income retained as “cash” was taxed at a higher rate (15.5 percent) than foreign income retained in other asset classes (8 percent). Measurement rules allowed some firms significantly more time to shift foreign cash holdings to “noncash” assets and lower their tax burden. Using staggered, firm-specific measurement dates, we find that fiscal year-end firms with more time to respond to the law reduced their cash levels more than other firms.
JEL Classifications: E62; H21; H25.
Purpose
This paper investigates the significant increase in S corporation banks converting to C corporations following the 2017 Tax Cuts and Jobs Act (TCJA) and the shift in motivations behind these conversions.
Design/methodology/approach
The paper uses bank-level panel data from Federal Deposit Insurance Corporation (FDIC) Call Reports to analyze the determinants of S bank conversions after the TCJA, comparing post-TCJA conversion trends with pre-TCJA trends utilizing an ordinary least squares (OLS) and logistics model.
Findings
The study finds that post-TCJA conversions are primarily driven by financially stable banks seeking improved tax conditions and relaxed shareholder restrictions as C corporations. This contrasts with pre-TCJA conversions, which were predominantly driven by financially distressed S corporation banks seeking new equity capital to maintain solvency.
Research limitations/implications
The findings necessitate a comprehensive reconsideration of the Subchapter S status' sustained relevance for smaller institutions, especially in light of the comparative benefits now offered by the C corporation status post-TCJA. The results underscore the importance of ongoing academic investigation to deepen the understanding of the evolving fiscal landscape's effects on community banks, thereby contributing to the knowledge of the resilience and health of the US economy.
Practical implications
This research nudges policymakers and regulators to contemplate the ongoing relevance and advantages of the S corporation status. Given the substantial benefits conferred by the C corporation status in the post-TCJA environment, this study suggests that retaining the S corporation status may not offer the same appeal for smaller community banks as it once did.
Originality/value
This paper contributes to the broader understanding of the impact of tax policy on businesses' organizational choices, particularly in the banking industry and emphasizes the need for a comprehensive review of the S corporation status to assess its ongoing applicability in fostering small and community-focused financial institutions in light of the evolved corporate tax landscape.
This chapter discusses the role of deferred tax in pass-through entities and examines how Czech limited partnerships, which can be classified as partly pass-through, approach deferred tax reporting. It is found that Czech partnerships mostly acknowledge their tax position for deferred tax purposes and comply with basic deferred tax accounting principles, with desirable outcomes being more frequent among partnerships audited by any of the Big Four accounting firms. This chapter also presents a proposed method of deferred tax computation for partly pass-through entities which is formulated on the background of interperiod income tax allocation.KeywordsDeferred taxLimited partnershipPass-through entity
This study examines whether the tax incentives of home-country shareholders influence the organizational form changes of foreign operations. While a corporation and a limited company (LC) in South Korea are treated the same for Korean tax purposes, an LC can be treated as a pass-through entity for U.S. tax purposes. This tax treatment of LCs can create incentives for U.S. owners to convert their Korean corporations to LCs. We find that private corporations owned by U.S. shareholders are more likely to convert to LCs than those owned by non-U.S. shareholders. We also find that the tax costs and benefits of conversion affect the likelihood of LC conversion for U.S.-owned firms. Overall, our results suggest that multinational corporations use organizational form changes as a tool for international tax strategies.
Little is known about the effects of accounting regulation on private insurers. In this paper, we examine the uniqueness of the tax deductibility of insurers' loss accruals. We find that private insurers' overstatement of loss accruals in tax planning significantly decreases after adoption of the Statement of Statutory Accounting Principles (SSAP) 101, which mandates that insurance companies recognize and measure tax contingencies. Relative to public insurers' loss reserve errors, those of private insurers decrease by an estimated 0.8%–1.1% of total assets, implying a forfeited tax benefit of 1.79–4.4 million per firm, per year. We also find that the decrease is mitigated for insurers with lower IRS monitoring or in states where the insurance industry comprises a greater part of state employment. Additionally, insurers with independent boards, or those with independent, external actuaries are more responsive to the adoption of SSAP 101.
Corporate finance decisions, measurement of accounting profits, and market valuations are invariably made within the framework of a taxation system(s). Previous research indicates both ambiguity over the influence of taxation on managers’ behaviour and limitations in the ability of shareholders to process tax information. The establishment of the UK's Real Estate Investment Trust (REIT) regime in 2006 allowed quoted companies to opt out of company level taxation. We examine managers’ and shareholders’ responses, that is, their ability to process information. When compared with shareholders, managers demonstrated a greater knowledge of the legislation, and of its applicability. For example, managers appeared to pre‐empt the effects of the legislation. Our findings have implications for tax policy makers and taxpayers, acting as a warning of the potential downside of increased cooperation when trying to make more appropriately formed legislation. Further, managers appeared to be willing to trade off the interests of shareholders for their own personal gain, which is surprising given the visibility of the REIT conversion process and illustrates the limitations of shareholder control over managers’ behaviour. We find shareholders were able to accurately assess the general effects of the legislation but were unable to identify specific companies likely to benefit. Without any increase in shareholder sophistication, concerns exist over the effectiveness of shareholders in acting as monitors of managers’ decision making.
I review the research on master limited partnerships (“MLPs”) in the accounting, economics, and finance literature. I begin by outlining the scope of the review and providing a brief background on the structure, taxation, and governance of master limited partnerships. Next, I describe the various sources from which MLP data is derived. I then review the research, aggregating it into four broad categories: (1) taxes and organizational form; (2) taxes, capital structure, and payout policy; (3) valuation; and (4) governance research. Within each section, I present possible avenues for future research in accounting, economics, and finance.
We examine the effect of pass-through entities embedded in corporate structures on tax avoidance, tax uncertainty, and tax noncompliance using unique, confidential tax return data that link corporations and pass-through entities together through Schedules K-1. We develop measures of the use of pass-through entities such as the number and “connectedness” of pass-throughs within the structure, the presence of loss pass-throughs or asymmetric allocations of such losses, and connections to entities external to the firm. We predict and find that these features are associated with lower effective tax rates, higher current-year additions to tax reserves, and larger amounts of proposed IRS audit adjustments, controlling for probability of audit selection. This large-sample evidence could help the IRS understand how pass-throughs affect compliance and financial statements users anticipate the tax effects related to entity structure.
JEL Classifications: H20; H26; L22; M41.
In this study, we examine the effect of increased tax transparency on the tax planning behavior of European banks. In 2014, the European Union introduced public country‐by‐country reporting requirements to the banking industry. Treating this new requirement as an exogenous shock, we find limited evidence consistent with a decline in income‐shifting by the banks’ financial affiliates in the post‐adoption period (starting from 2015). We do not, however, find robust evidence of a significant change in the consolidated book effective tax rates among the affected banks. Our findings suggest that increased transparency from public country‐by‐country reporting can deter tax‐motivated income shifting but that it did not appear to materially influence the banks’ overall tax avoidance. Our findings have policy implications for the ongoing debate between the European Parliament, the Organisation for Economic Co‐operation and Development, and accounting standard‐setting bodies on whether to require multinationals to publish country‐by‐country reports.
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Using the shadow insurance setting, we study the interplay between tax and nontax incentives in income shifting. Shadow insurance involves intercompany transactions designed to help firms meet regulatory capital requirements. However, prior to the Tax Cuts and Jobs Act of 2017 (TCJA), foreign-owned life insurance firms could save taxes by using shadow insurance to shift U.S. profits to tax havens. Consistent with expectations, we find that, while nontax incentives appear to be the dominant factor behind firms' use of shadow insurance, tax considerations also played a role for certain firms. We also find shadow insurance is associated with lower liquid asset holdings and increased credit risk. Overall, our results suggest taxes were an important incentive for foreign-owned life insurance firms to use shadow insurance pre-TCJA. Moreover, in this setting, nontax considerations appeared to have motivated U.S.-owned firms' use of tax havens.
Subchapter C of the U.S. Internal Revenue Code levies an entity‐level tax on corporate profits, whereas Subchapter S allows corporations meeting specific criteria to elect out of this tax. Despite these differences, C and S corporations regularly compete for customers and capital. We examine whether and the extent to which competition from S corporations influences the future organizational form choice of rival C corporations, and explore outcomes of this choice. Using data for 4,462 private U.S. commercial banks grouped by Metropolitan Statistical Area during 1997–2010, we find that greater competition from S corporation banks increases the likelihood that rival C corporation banks convert to Subchapter S status. We estimate that the aggregate first‐year tax savings from S conversion exceed $372 million. Consistent with these savings being used to maintain comparative parity with rivals, we find that converting banks increase their interest rates on customer deposits and advertising intensity. Our findings provide insight into whether competition from tax‐advantaged firms influences the organizational form choice of rival tax‐disadvantaged firms.
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I examine the role of heterogeneous shareholder-level taxes in organizational form decisions and in subsequent changes in investor stock ownership. Specifically, I investigate the decision to form a master limited partnership (MLP), which is a tax-advantaged entity for tax-sensitive shareholders, but a tax-disadvantaged entity for tax-exempt shareholders. Consistent with shareholder-level taxes influencing organizational form decisions, I find that firms owned by more tax-exempt shareholders are less likely to carve-out MLPs. Consistent with shareholder-level taxes influencing stock ownership, I find that tax-sensitive investors, on average, decrease their ownership in the parent and hold a relatively larger ownership share in the MLP than in the parent after the carve-out. In contrast, tax-exempt investors own less of the MLP than of the parent. These results provide evidence that firms cater to investors' shareholder-level taxes in making organizational form decisions and that investors sort on tax characteristics inherent to organizational form.
JEL Classifications: G32; H24; H25.
Data Availability: Data used in this study are available from public sources identified in the paper.
Interest in corporate tax planning has accelerated in recent years as a combination of political, economic, and technological factors have fueled the public’s awareness of corporate tax activities. Academic research on corporate tax planning has grown in step with this public interest. This paper provides a survey of that literature, with a focus on developments over the last decade. In the survey, we highlight key contributions, provide a framework for links among studies, and reference some areas in which our understanding is still limited.
We examine how the corporate tax system, through its treatment of loan losses, affects bank financial reporting. Exploiting cross-country and intertemporal variation in income tax rates and loan loss provision deductibility, we find that loan loss provisions are increasing in the tax rate for countries that permit general provision tax deductibility. When general provisions are deductible, a 1 percentage point rate increase leads to a provision increase of 4.9% of the sample average. This effect is driven by the tax system’s encouragement of timelier loan loss recognition, suggesting that corporate taxation is an important determinant of bank financial reporting transparency.
In this paper, we present a review of tax research. We survey four main areas of the literature: (1) the informational role of income tax expense reported for financial accounting, (2) corporate tax avoidance, (3) corporate decision-making including investment, capital structure, and organizational form, and (4) taxes and asset pricing. We summarize the research areas and questions examined to date and what we have learned or not learned from the work completed thus far. In addition, we provide our opinion as to the interesting and important issues for future research.
This study investigates whether the ability to choose simplified methods of tax accounting is an important consideration in legal form decisions. Most European countries provide simplified, cash-based rules of tax accounting for small firms that considerably deviate from their general accrual tax accounting rules. The small business sector is thereby sought to be protected from disproportionally high compliance burdens. Simplified tax accounting, however, is only available for non-corporate businesses. If simplified tax accounting is indeed associated with a net benefit, its (un-)availability can change the relative gain to incorporation. We test this conjecture using data on corporate shares of business in 27 European countries over the period 2004–2010. Exploiting variation in eligibility thresholds for simplified tax accounting over time, the results suggest that small businesses indeed consider the option to choose simplified tax accounting in their choice of legal form.
This study investigates the factors that induce an organizational form change in a private corporation into a limited company (LC) from the disclosure incentive perspective. Using 1500 firm-year observations from 2007 to 2012, we find that private corporations with low leverage, non-clean audit opinions, high foreign ownership, high abnormal profits, and high-technology industry membership are more likely to change their organizational form into LCs. This finding suggests that if private corporations have low incentives for financial disclosure, then they initiate organizational form changes into LCs to avoid the costs incurred from the disclosure requirement mandated by law.
The Small Business Job Protection Act of 1996 allows U.S. banks to adopt the Subchapter S status. We investigate if the Subchapter S banks use tax benefits for the intended purposes of “protecting jobs,” “creating opportunities” and “increasing take home pay of workers.” We find that the tax benefits: (a) are not used in expenses related to protection of jobs, (b) do not lead to greater employment opportunities within the Subchapter S banks, and (c) do not benefit the employees in the form of increased salaries and benefits. Our results indicate that bank owners are sole beneficiaries of the tax exemption benefits.
An S corporation, for United States federal income tax purposes, is a corporation that makes a valid election to be taxed under Subchapter S (Title 26; Subtitle A; Chapter 1; Subchapter S; Part 1; Section 1361) of the Internal Revenue Code. While S Corporations do not pay any income taxes, the corporation's income or losses are divided among and passed through to its shareholders; the shareholders report the income or loss on their own individual income tax returns. This concept avoids double taxation where both the corporation's profits, and the shareholders' dividends are taxed. This chapter reviews the various strands of research that have evolved regarding subchapter S Corporations. The first is the accounting literature regarding this corporate form. The second looks at the economic literature. The accounting literature focuses on tax and legal issues surrounding the ownership form, while the economic literature focuses on balance sheet choices and income statement results that evolve out of the agency effect that eminates for both the direct tax impact and the small ownership pool. The chapter concludes with the profitability and growth considerations that the literature finds within the ownership type.
We examine the risk consequences of the S-corporation election, a tax-motivated organizational form, on banks' risk-taking behaviors and extreme adverse outcomes. S-corporations' single level of taxation increases access to after-tax internal capital and likely enhances S-corporation monitoring efforts. However, S-corporations face strict organizational restrictions on the number and type of allowable shareholders. Given banks' rigid capital criteria and active regulatory environment, this differential access to external capital is likely to influence S-corporations' risk-taking behavior. Our evidence suggests that the organizational restrictions necessary to qualify for S-corporation status reduce risk-taking behaviors and limits some extreme adverse outcomes.
We review the changing economic significance of various business entity types since the Tax Reform Act of 1986 (TRA86) and the implications of these changes for the design of tax policy. In particular, we focus on the increased role of pass-through entities and the declining significance of the taxable corporate form. Our analysis suggests that significant reductions in the corporate tax rate, absent changes in the personal tax rate, will likely reverse the organizational form incentives that have existed since TRA86. Further, if the loss in revenue from a rate reduction is offset by a broadening of the tax base, most business entities, comprising most business income, are likely to face an overall increase in their tax burden.
This paper reviews domestic and multinational corporate tax research. For each topic, the theoretical arguments explaining how taxes can affect corporate decision-making and firm value are reviewed, followed by a summary of the related empirical evidence and a discussion of unresolved issues. Tax research generally supports the hypothesis that high-tax rate firms pursue policies that provide tax benefits. Many issues remain unresolved, however, including understanding whether tax effects are of first-order importance, why firms do not pursue tax benefits more aggressively, and whether corporate actions are affected by investor-level taxes.
Scholes et al. (2005) predict that S corporations, and other conduit entities, such as partnerships and LLCs, can sell for a tax-driven purchase price premium relative to C corporations. We test this conjecture by comparing purchase price multiples in a sample of taxable stock acquisitions of S corporations to purchase price multiples for a matched set of taxable stock acquisitions of privately held C corporations. Consistent with Scholes et al.'s predictions, we find evidence that the organizational form of the target influences acquisition tax structure and acquisition price. Specifically, the evidence supports the conclusion that conduit entities (S corporations) fetch a tax-based purchase price premium relative to similar C corporations. Furthermore, our estimates indicate that average tax benefits in S corporation acquisitions are equal to approximately 12-17 percent of deal value.
This paper presents the results of a moderated multiple regression analysis to show that, all else held equal, there exists a positive premium in the valuation of S Corporations over C Corporations in the period of January 2000 to November 2006. The results of the regression show that the magnitude of the “S Corporation premium” is indeed dependent on the level of interactions of several independent variables. In particular, the results of this study found that (a) the premium depends positively on net sales; (b) the premium is higher for the cases in which the transaction is done through Asset sales (rather than Stock sales); and (c) the premium is higher for the cases in which firms are bought by Private Buyers (rather than Public buyers).
Recently, there has been a marked increase in the number of banks choosing to operate as Subchapter-S Corporations. The apparent motivation is tax savings as Subchapter-S firms do not pay federal income taxes on income at the firm level, but transfer income to stockholders where it is taxed as individual income at personal tax rates. Given the apparent advantages of Sub-S status, there must be mitigating reasons for not choosing this organizational form. We empirically investigate factors affecting the choice of Subchapter-S status and key performance differences between Sub-S banks and those taxed as C-corporations. Empirical findings indicate that Sub-S banks are significantly smaller, pay higher dividends, have lower taxable income before Sub-S formation, higher profitability, lower capital and loan loss reserves, rely more on core deposits, and have higher agricultural but lower commercial and total loans. Sub-S banks are more likely to be rural and less likely to be de novo, or have publicly-traded stock.
This paper investigates the effect at the bank and industry level of a 1996 tax law change allowing commercial banks to elect S-corporation status. By the end of 2007, roughly one in three commercial banks had either opted for or converted to the S-corporation form of organization. Our study analyzes the effect of this conversion on bank dividend payouts. It also examines the effect S-corporation status has on a community bank’s likelihood of sell-off and measures a firm’s sensitivity to tax rates based on its choice of organizational form. We document that dividend payouts increase substantially after a bank’s conversion to S status. Moreover, community banks that convert are significantly less likely to be sold than their C-corporation peers. We estimate a tax rate elasticity of conversion in the range of 2 to 3 percent for every 1-percentage-point change in relative tax rates. Overall, our results provide evidence that Subchapter S status has significant effects on bank conduct and industry structure.
This paper studies optimal real estate organizational forms as a means of enhancing real estate values in the ongoing subprime crisis. We model the organizational response to stakeholder conflicts and regulatory changes to show how they evolve to an optimal form and undertake an optimal capital structure to enhance the welfare of investors. Using the examples of the REIT and RELP organizational forms, we show how the rivalry between taxable and institutional investors shapes the UPREIT form. We employ a two-period partial equilibrium model to demonstrate that UPREITs adapt to regulatory changes by (i) meticulously acquiring a hybrid form (containing the desirable features of both REITs and RELPs), and (ii) efficiently trading off debt claims (between their constituent investor bases). This adaptation enhances welfare by mitigating administrative costs, agency costs, bankruptcy costs, illiquidity costs and taxes.
This paper provides a first step toward joint evaluation of taxation and financial reporting in the standard economic analyses
of corporate behavior. It develops a framework that formalizes the idea that the attractiveness of some investment decisions
is enhanced because they provide managers with discretion over the timing of taxable income and/or book income. It then examines
from this perspective several current examples of tax and accounting issues.
KeywordsTaxation–Accounting–Corporate behavior–Discretion
ABSTRACT This study investigates the influence of TRA86, pre-TRA86 tax strategies, and firm characteristics,on,S conversions,in the natural resource,industry. TRA86 shifted substantial individual tax costs to corporations, inviting conversions, but also low- ered corporate,marginal,tax rates and,changed,aspects,of the built-in gain provision to reduce,conversion,benefits. Built-in gain changes,affect industries differently be- cause,of differences,in asset composition,and,economic,conditions. The natural resource,industry had,substantial built-in gain potential and,was,consolidating,and restructuring during the mid-80s, making built-in gain realization likely. Our results suggest,that built-in gains negatively influenced,conversions,in the natural resource industry. This study enhances,our understanding,of the interaction between,TRA86 rate changes,and,other provisions,on incentives,to convert,from C to S corporate status. It also contributes,to the organizational,form,literature by identifying factors related to TRA86, S corporation operating restrictions, firm characteristics, and tax strategies that influence conversion,decisions.
This article provides estimates of the effects of corporate taxation on the financial characteristics of firms. For a large number of corporations the corporate tax is voluntary, as they have the choice of operating as an S corporation—a pass-through entity similar to a partnership. Given that firms appear to volunteer to pay an additional tax, this article examines the behavior of firms to identify the relationship between their choice to be subject to the corporate tax and tax minimizing strategies. Analyzing firms with positive and negative income separately, the results suggest that the probability a firm has chosen to be taxable increases with firm size and with activity consistent with mitigating both the corporate and individual tax on corpo rate income. In addition, there is strong evidence that the additional administrative burden caused by a lack of conformity between state and federal tax treatment of S corporations provides a significant disincentive to the use of pass-through corporations.
We study changes in the real estate industry among organizational forms with varying degrees of restrictiveness and document the associated changes in profitability, free cash flow, debt, dividends, and investment policies. All troubled firms in our sample move to a more flexible organizational structure, with subsequent reductions in dividends, improvements in performance, and increases in asset sales and investments. Healthy firms that move to a tighter structure have larger free cash flows before the change; they increase dividends, reduce free cash flows and improve profitability after the change. We document evidence of tax considerations in organizational changes.
In this paper we examine the effects of differential state taxation of U.S. Government obligations (USOs) on how banks structure their investment and financing portfolios, the riskiness of banks' assets, and how implicit tax effects are impounded in investments' returns. Twenty‐seven states tax USOs (taxing states) and 23 states and the District of Columbia do not (nontaxing states). We find that banks in taxing states hold significantly greater amounts of USOs, which are among the least risky assets banks can hold, and we find that these banks hold a less risky mix of assets. Consistent with compensating for the lower risk of their asset mix, we also find that these banks hold less capital. Taken together, these results are consistent with effective bank regulation enforcement, since banks have similar capital to risk‐weighted asset ratios in spite of differing tax‐based incentives to hold riskless assets. We also examine the impact of implicit taxes on banks' USO holdings and related accounts and find that in taxing states banks' USO investments are decreasing in their state tax rate. We also find corresponding increases in asset riskiness for which banks do not appear to fully compensate in the highest state‐tax‐rate states. Finally, the effects shown in this paper are economically significant. For example, we find that banks operating in taxing states hold, on average, 40 percent less USOs than do banks in nontaxing states.
It is often asserted that the income tax encourages the use of debt because of the deductibility of interest expense. We examine this conjecture by analyzing the interest incurred by a large sample of small, closely held corporations. We estimate regressions of the level of interest on proxies for expected future tax rates, interactions between the tax rate proxies and nondebt tax shields, and other determi-nants of debt utilization. Our evidence is consistent with prior studies in that we find that firms with high tax rates pay more interest than firms with low tax rates. In addition, firms for which additional tax shields might reasonably lower tax rates exhibited significant substitution between nondebt tax shields and debt tax shields.
Prior studies have shown that Limited Partnerships (LPs) use less debt than corporations and conclude this is due to tax induced corporate borrowing. We suggest these observed differences result from risk differences between LPs. LPs formed around natural resource assets use less debt than LPs formed around non-natural resource assets because uncertainty over future resource prices disproportionately increases the natural resource general partners' risk of loss in the event of LP bankruptcy. Our results support this explanation and show that differences observed in prior studies are due to the differential debt use between natural resource and non-natural resource LPs. Debt use by non-natural resource LPs is not significantly different from debt use by our corporate comparison groups. Our analysis provides an alternate explanation of corporate and LP capital structure differences which should be considered in future investigations of factors affecting capital structure decisions.
In this paper we examine how the realizations of securities gains and losses by banks owned by an interstate multibank holding company are related to the tax, earnings, and capital management objectives of the consolidated group and of the individual subsidiaries. We find that while subsidiary banks manage their gain realizations to reduce their own state tax, they also behave strategically with respect to their tax cost in relation to other members of their consolidated group so as to reduce the groups'state tax expense. We find evidence suggesting that banks also use the realization of securities gains and losses to manage their subsidiaries' earnings, and that they coordinate their gains and losses to manage the earnings of the group.
Publicly Traded Partnerships (PTPs), also known as Master Limited Partnerships, are similar to U.S. corporations, yet they are not subject to corporate taxes. Given their mixture of corporate and partnership characteristics, PTPs provide an experiment for studying taxation and firm financial decisions. This paper compares the financial structure and dividend policies of PTPs and corporations in the oil and gas exploration industry. The results are consistent with hypotheses about taxes and financial decisions: controlling for other factors, PTPs pay more dividends and borrow less than similar corporations.
We analyze the effect of tax-based transaction structure on the acquisition price of corporate subsidiaries. For a sample of 200 subsidiary stock acquisitions, the evidence weakly supports the conclusion that acquisition premiums are higher in transactions accompanied by an I.R.C. section 338(h)(10) election. Specifically, purchase prices, as manifested in accounting acquisition multiples are higher in subsidiary stock sales accompanied by the section 338(h)(10) election than in subsidiary stock sales made in the absence of the election, but not uniformly so. We also find that divesting parent abnormal stock returns are higher in subsidiary stock sales in which the section 338(h)(10) election was made than in those deals in which the election was not made. Further, we find that the tax benefits generated by the section 338(h)(10) election are positively correlated with divesting parent abnormal stock returns. Finally, a review of corporate disclosures made by acquirers and divesting parent firms in subsidiary stock sales provides compelling anecdotal evidence that acquirer's pay a premium to sellers for the tax benefits derived from a section 338(h)(10) election. Overall, this study indicates that the tax structure of a subsidiary sale influences the price paid in the transaction, and the tax structure selected is a function of a divesting parent's tax basis in the subsidiary's stock and net assets. Key Words: Taxes; Valuation; Mergers; Acquisitoins; Divesitures
This study investigates the effects of state taxes and regulation on an organizational structure decision for expanding property-casualty insurers (subsidiary versus license). Tests are conducted of the relation between the organizational structure of 2335 property-casualty insurers and state tax and regulatory conditions in 1991. Evidence is provided that property-casualty insurers structure their cross-state expansion to mitigate both state tax and regulatory costs.
The authors test the proposition that corporate control considerations motivate the means of investment financing-cash (and debt) or stock. Corporate insiders who value control will prefer financing investments by cash or debt rather than by issuing new stock, which dilutes their holdings and increases the risk of losing control. Their empirical results support this hypothesis: in corporate acquisitions, the larger the managerial ownership fraction of the acquiring firm the more likely the use of cash financing. Also, the previously observed negative bidders' abnormal returns associated with stock financing are mainly in acquisitions made by firms with low managerial ownership. Copyright 1990 by American Finance Association.