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The Demographics of the CAMT: Insights from Tax Return Data
Evidence suggests a large proportion of profitable U.S. firms have low effective tax rates (i.e., an ETR between 0 and 10%). Despite widespread interest in how firms avoid paying taxes, we do not know how most firms attain low ETRs and whether they are primarily benefiting from benign or aggressive tax positions. Using a research design that explicitly examines low ETR firms, we predict and find that the majority are primarily benefiting from a benign tax position: large net operating loss carryforwards (NOLs). We also find that large NOLs allow firms to persistently retain low ETRs year after year. In contrast, we find that multinationals and tax haven firms, which should have more opportunities for aggressive tax planning, have a lower probability of attaining a low ETR (relative to domestic and non-tax haven firms). Collectively, these findings suggest that the typical low ETR firm does not incur significant tax risk. Consistent with this, we find that low ETR firms accrue unrecognized tax benefits at a similar rate as firms that pay the statutory tax rate and do not experience higher future tax rate volatility. Overall, the results shed light on the profile of the average low ETR firm and provide evidence that the majority are utilizing large NOLs rather than aggressive tax planning.
We investigate a tax avoidance strategy where firms use the ambiguity inherent in tax reporting to classify indirect costs as research and development (R&D) expenditures to take advantage of the R&D tax credit. We label this tax practice “strategic R&D classification”. We find a one standard deviation increase in strategic R&D classification leads, on average, to a 1.7% (1.5%) reduction in GAAP (cash) effective tax rates, suggesting this practice provides significant tax savings. However, we also find strategic R&D classification is related to both the level and changes in uncertain tax benefit liabilities required to be recognized under FIN 48, suggesting this practice comes with financial reporting costs. Our study contributes to the literature by documenting some of the costs and benefits associated with a previously unexplored tax strategy, and highlights the limitations faced by tax authorities in monitoring firms’ R&D tax credit.
Loss firms are an economically significant and growing segment of the population of publicly traded corporations. Relatively little is known about the tax positions of loss firms because the firms are typically dropped from tax avoidance studies. We develop a new measure of corporate cash tax avoidance that is meaningful for all observations and reflects the extent to which a firm is tax-favored. We examine the extent to which inferences about corporate tax avoidance over the past twenty-seven years change when we examine the full population of firms, as opposed to a profitable and/or taxable subsample. In contrast to prior research findings, our results suggest that on average firms are tax-disfavored, by which we mean cash taxes paid exceed the product of the firm’s pre-tax book income and the statutory tax rate. In addition, many industries that appear to be tax-favored in profitable subsamples are tax-disfavored when the entire population is examined. We also find that the extent to which firms are tax-disfavored is increasing over time, and that domestic firms are more tax-disfavored than multinationals.
Prior research has documented a “kink” in the earnings distribution: too few firms report small losses, too many firms report small profits. We investigate whether boosting of discretionary accruals to report a small profit is a reasonable explanation for this “kink.” Overall, we are unable to confirm that boosting of discretionary accruals is the key driver of the kink. We caution the use of the ratio of small profit firms to small loss firms as a measure of earnings management. We investigate and discuss a number of alternative explanations for the kink. Peer Reviewed http://deepblue.lib.umich.edu/bitstream/2027.42/47741/1/11142_2004_Article_5127187.pdf
This paper discusses the issues surrounding the proposals to conform financial accounting income and taxable income. The two incomes diverged in the late 1990s with financial accounting income becoming increasingly greater than taxable income through the year 2000. While the cause of this divergence is not known for certain, many suspect that it is the result of earnings management for financial accounting and/or the tax sheltering of corporate income. Our paper outlines the potential costs and benefits of one of the proposed "fixes" to the divergence: the conforming of the two incomes into one measure. We review relevant research that sheds light on the issues surrounding conformity both in the U.S. as well as evidence from other countries that have more closely aligned book and taxable incomes. The extant empirical literature reveals that it is unlikely that conforming the incomes will reduce the amount of tax sheltering by corporations and that having only one measure of income will result in a loss of information to the capital markets.
There are past and proposed tax law changes that contain provisions that affect financial reporting. These include calls for book-tax conformity, proposals to increase the links between financial accounting and taxable incomes, and actions by Congress that make direct alterations to U.S. GAAP. I submit that these tax law changes potentially threaten financial reporting quality. I discuss my concerns about why such provisions have not attracted attention from accountants to the extent they should and make a case for more awareness and more research going forward.
Using a novel empirical approach and newly available administrative data on US tax filings, we estimate the corporate elasticity of taxable income, decompose the elasticity into economic responses versus other tax-motivated “accounting” transactions, and determine how responsiveness varies depending on accounting method, firm size, and interest rate. In response to a 10 percent increase in the expected marginal tax rate, private US firms decrease taxable income by 9.1 percent, which indicates a discernibly more elastic response than prevailing estimates. This response reflects a decrease in taxable income of 3.0% arising from real economic responses to a firm's scale of operations and 6.1% arising from accounting transactions via (e.g.) revenue and expense timing. Responsiveness to the corporate tax rate is more elastic if a firm uses cash (9.9%) rather than accrual accounting (7.4%), if the firm is small (9.9%) rather than large (8.6%), and if the firm discounts future cash flows at a lower rate.
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This paper considers recent domestic and international proposals to use financial statement earnings as the basis for imposing additional or minimum taxes on corporate income and to reallocate corporate profits among jurisdictions. It reviews prior research undertaken in the context of previous proposals to partially substitute financial accounts for taxable income and considers how valid critiques of prior proposals are with respect to current initiatives. It concludes by noting that the concerns raised about earlier proposals have neither been fully considered nor addressed in the recent initiatives.
Effective tax rates (ETRs) are often used to compare tax avoidance across firms and time. Using firms’ detailed tax footnote data, we find that the effect of valuation allowances (VA) related to prior-period losses biases GAAP ETRs. This downward bias explains almost all of the downward trend in domestic firms’ ETRs over the last 20 years. We also find that VAs explain cross-sectional differences in ETRs for both domestic and multinational firms. We show this bias extends to cash ETRs and the Henry and Sansing (2018) tax avoidance measure. We develop a methodology for substantially reducing the bias in both time-series and cross-sectional analyses of cash and GAAP ETRs. Overall, our results suggest firms’ loss histories and GAAP rules influence inferences from tax avoidance proxies.
We investigate systematic changes in corporate effective tax rates over the past 25 years and find that effective tax rates have decreased significantly. Contrary to conventional wisdom, the decline in effective tax rates is not concentrated in multinational firms; effective tax rates have declined at approximately the same rate for both multinational and domestic firms. Moreover, within multinational firms, both foreign and domestic effective rates have decreased. Finally, changes in firm characteristics and declining foreign statutory tax rates explain little of the overall decrease in effective rates.
We use aggregate Schedule M-3 tax return data from Subchapter C corporations to provide descriptive evidence on book-tax differences from 2004 to 2013. Across the sample period, our primary findings are: (1) total book-tax differences increase, (2) a substantial amount of book-tax differences are explained by firms’ operations and financing, as well as economic incentives, (3) firms report a substantial but decreasing amount of book-tax differences in the “other” categories, (4) the frequency and magnitude of reportable transactions decreases significantly, and (5) foreign earnings and repatriations increase. However, the relative amount of foreign earnings repatriated decreases substantially after 2009.
We examine the financial reporting practices of small privately held businesses that are not subject to SEC regulation. Specifically, we determine the factors associated with the production and use of financial statements for firms that have discretion in the preparation of financial statements and do not face the demands of public equity markets. In addition, for firms that prepare financial statements, we determine the factors associated with the sophistication of the financial statements in terms of whether the financials are compiled, reviewed, and/or audited by a professional accountant and whether the firm produces accrual-based financial statements. Finally, we examine the potential benefits afforded firms producing financial statements, having audited financial statements, and having accrual-based financial statements. We find that firms with audited financial statements benefit in the form of greater access to credit and that firms with accrual-based financial statements benefit in the form of a lower cost of credit.
We provide archival evidence on firms' book‐tax reporting differences using tax return data on public and private manufacturing firms. Prior research suggests that managers should report conforming book income to minimize tax‐related costs. However, reporting conformity can also impose nontax costs. We find evidence that public firms have generally higher financial‐reporting costs that result in larger book‐tax differences. In addition, we find that higher debt levels impose greater nontax costs on firms that are privately held or more financially distressed. Finally, our tests of differences among public firms suggest that nontax costs associated with bonus plan thresholds and book income patterns affect their book‐tax reporting. Our tests extend prior studies that focus on whether firms engage in specific conforming transactions. From a tax policy perspective, our results suggest that book‐tax differences may be a less useful indicator of private firms' aggressive tax positions because they have fewer i...
This paper presents a new reconciliation of financial to taxable income, drawing from public financial statement and Schedule M-3 data for a panel of firms. The reconciliation compares the financial statement income of a firm's consolidated financial statement entities to the financial statement income of a firm's tax return entities on a worldwide, domestic, and foreign income basis. This analysis highlights the relation between these various measures of corporate income to better understand the magnitudes of, and differences between, domestic and global corporate income.
Discontinuities in earnings distributions at zero have been widely cited as evidence of earnings management but not without controversy. Recent research suggests discontinuities may be mere artifacts of certain research design choices. We find that the well-known zero-earnings discontinuity disappears soon after passage of the Sarbanes-Oxley Act (SOX) and has not returned. We also find that neither the discontinuity nor its disappearance require the effects of widely cited alternative (non-earnings management) explanations for the zero-earnings discontinuity.
This study hypothesizes that because shareholders have a liquidation option, losses are not expected to perpetuate. They are thus less informative than profits about the firm's future prospects. The results are consistent with the hypothesis. They also show that the documented increase in the earnings response coefficent as the cumulation period increases appears to be due exclusively to the effect of losses. The liquidation option effect extends to profitable cases where earnings are low enough to make the option attractive. Alternating explanations for the low informativeness of losses such as mean reversal of earnings are not supported by the tests.
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.
Earnings provide important information for investment decisions. Thus, executives--who are monitored by investors, directors, customers, and suppliers--acting in self-interest and at times for shareholders, have strong incentives to manage earnings. The authors introduce behavioral thresholds for earnings management. A model shows how thresholds induce specific types of earnings management. Empirical explorations identify earnings management to exceed each of three thresholds: report positive profits, sustain recent performance, and meet analysts' expectations. The positive profits threshold proves predominant. The future performance of firms suspect for boosting earnings just across a threshold is poorer than that of control group firms. Copyright 1999 by University of Chicago Press.
This paper provides a review of the empirical earnings management literature. In particular, it presents a review of the factors that induce and constrain earnings management through accounting decisions. The consequences of actual or assumed earnings management are also discussed. The far majority of the literature focuses on the Anglo-Saxon context. However, major differences exist between Anglo-Saxon and continental European countries. This may result in differences in the importance of various incentives of and constraints on earnings management. In particular, we argue that explicit contracts and a firm's relations with capital markets may be less important sources of earnings management in continental Europe. Implicit contracts and the political and regulatory process may however be of major importance. We question further whether a firm's ownership and internal governance structure and the quality of the external auditor can constrain the ability to manage earnings in continental European countries.
A vast and often confusing economics literature relates competition to investment in innovation. Following Joseph Schumpeter, one view is that monopoly and large scale promote investment in research and development by allowing a firm to capture a larger fraction of its benefits and by providing a more stable platform for a firm to invest in R&D. Others argue that competition promotes innovation by increasing the cost to a firm that fails to innovate. This lecture surveys the literature at a level that is appropriate for an advanced undergraduate or graduate class and attempts to identify primary determinants of investment in R&D. Key issues are the extent of competition in product markets and in R&D, the degree of protection from imitators, and the dynamics of R&D competition. Competition in the product market using existing technologies increases the incentive to invest in R&D for inventions that are protected from imitators (e.g., by strong patent rights). Competition in R&D can speed the arrival of innovations. Without exclusive rights to an innovation, competition in the product market can reduce incentives to invest in R&D by reducing each innovator's payoff. There are many complications. Under some circumstances, a firm with market power has an incentive and ability to preempt rivals, and the dynamics of innovation competition can make it unprofitable for others to catch up to a firm that is ahead in an innovation race.
The Case for Reviving the Corporate AMT
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Accounting Profs Decry Corporate Minimum Tax
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Estimating the Minimum Tax on Book Income Liability Using Public Data.” Working paper. University of North Carolina
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Back to the Future for C Corporations? Examining the Choice of Entity Analysis after TCJA
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