Do Firms Use Tax Cushion Reversals to Meet Earnings Targets? Evidence from the Pre- and Post-FIN 48 Periods

Gupta, Sanjay; Laux, Rick; Lynch, Dan

doi:10.2139/ssrn.1163842

Cited by 35 publications

(40 citation statements)

References 33 publications

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“…26 See Gupta and Laux (2008) for a discussion of the tax contingency disclosure and recognition requirements prior to FIN 48. Gleason and Mills (2002) Overall, there is some evidence that the tax expense accrual is used to manage earnings.…”

Section: Are Earnings Managed Through the Tax Accounts?mentioning

confidence: 99%

“…However, whether it is managed is hard to test because of lack of disclosure before FIN 48. Evidence in Gupta and Laux (2008) suggests that the pre-FIN 48 tax contingency reserve, when disclosed by firms, was used to manage earnings to meet or exceed analyst forecasts.FIN 48 requires disclosure of the tax contingency reserve, renamed in the interpretation as "unrecognized tax benefit" or UTB. 27 Recent disclosures by firms following the implementation of 26 See Gupta and Laux (2008) for a discussion of the tax contingency disclosure and recognition requirements prior to FIN 48.…”

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A review of tax research

Hanlon¹,

Heitzman²

2010

Journal of Accounting and Economics

2,127

646

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Abstract: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 paper was prepared for the 2009 Journal of Accounting and Economics Conference. We appreciate comments from Scott Dyreng, Mihir Desai (discussant), S.P. Kothari (editor), John Long, Ed Maydew, Lillian Mills, Tom Omer, Sonja Rego, Doug Shackelford, Terry Shevlin, Joel Slemrod, Cliff Smith, David Weber, Ryan Wilson, Jerry Zimmerman, George Zodrow, and conference participants at the JAE Conference as well as at the 2009 University of North Carolina Tax Symposium and the discussant there, Bill Gentry. All errors and omissions are our own. * Corresponding author: 100 Main Street, Cambridge, MA. email: mhanlon@mit.edu. 1 A Review of Tax Research IntroductionIn this paper, we review tax research in accounting as well as tax research in economics and finance to the extent that it is related to or is affected by research in accounting. Shackelford and Shevlin (2001) provide a careful and thorough review of empirical tax research in accounting in the prior Journal of Accounting and Economics review volume. Shackelford and Shevlin limit their review to research published in accounting outlets and describe the development of the relatively young archival, microeconomic-based income tax literature that arose from the Scholes andWolfson framework. In his discussion of the review, Maydew (2001) emphasizes the need for tax researchers in accounting to think more broadly and to incorporate more theory and evidence from economics and finance. We agree. Tax research has a long history in many disciplines; this fact cannot be ignored. Our goal in this paper is to integrate the theoretical and empirical tax research from accounting, economics, and finance, to summarize what is known and unknown, and to offer suggestions for future research.The multidisciplinary nature of tax research is what makes tax research exciting (yes, exciting), yet difficult. Tax research can be difficult not only because one has to follow tax studies in accounting, finance, economics, and law (through academic institutions, governmental agencies, and policy think tanks), but also because different disciplines often use different languages and have different perspectives. 1 For example, economists generally focus on tax compliance, tax incidence (such as who bears the corporate tax), investment and economic growth effects (such as how taxes 1 Slemrod (1992a) characterizes these differences as economists studying what corporations actually do and accountants stud...

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Section: Are Earnings Managed Through the Tax Accounts?mentioning

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A review of tax research

Hanlon¹,

Heitzman²

2010

Journal of Accounting and Economics

2,127

646

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“…Two concurrent studies by Blouin and Tuna (2007) and Gupta and Laux (2008) expense is simply a function of pretax earnings, so dividing net income changes into its pretax and tax expense components may appear unnecessary. However, in the setting of examining firms across extremes in book-tax differences, future effective tax rates are not expected to remain constant, and it is an empirical question as to whether any eamings growth/BTD relation is due to changes in pretax income or changes in tax expense.…”

Section: Temporary Differencesmentioning

confidence: 99%

Book-Tax Differences and Earnings Growth

Jackson

2011

SSRN Journal

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I examine the relation between book-tax differences (BTDs) and earnings growth.Because financial accounting rules afford managers more flexibility and discretion in repOliing than tax accounting rules, prior studies suggest that large differences between book and taxable income indicate lower quality (or less persistent) earnings. Lev and Nissim and Hanlon provide evidence that BTDs contain infonnation about future finn performance, but the nature of the causality in this relation is not clear. While BTDs could proxy for earnings quality, they may also reveal underlying economic events or management's private information about future perfonnance or simply predict future reversals in effective tax rates.I divide total BTDs into their measurable components: temporary (defelTed taxes) and non-temporary (pennanent differences and tax accruals), and test their relation with the components of net income changes: pretax earnings changes and tax expense changes. I hypothesize that the non-temporary component ofBTDs is negatively related IV to future changes in tax expense, whereas the temporary component ofBTDs is negatively related to changes in future pretax eall1ings. I also examine the maintained hypothesis that the lower earnings growth for large BTD finTIs is due to earnings management. I use various proxies from prior literature to identify fin11s potentially managing earnings and test whether the presence or absence of suspected earnings management activity alters the relation between BTDs and earnings changes.My results provide compelling evidence that pell11anent BTDs are related only to future changes in tax expense, and temporary BTDs are related to changes in pretax eall1ings. These results are robust to multiple sensitivity analyses, including a replication of the sample and methodology of Lev and Nissim. The results also hold in the case of fill11s not suspected of eall1ings management. In fact, I find only limited evidence that the results are stronger in the presence of earnings management. Overall, my study suggests that it is only the temporary component of BTDs that is related to future firm performance, with non-temporary differences being related to future tax expense changes, and that these results are primarily due to underlying economic factors, not eall1ings management.CURRICULUM VITAE

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“…According to Gupta and Laux (2008), accounting practices at companies such as Enron suggest that internal control weaknesses and tax-related deficiencies lead to a larger gap between book income and taxable income. Furthermore, the Joint Committee on Taxation reports that Enron management fostered an aggressive corporate culture that would use off-balance sheet structures and off-shore entities to achieve both income-increasing and tax-decreasing objectives (US Congress, 2003).…”

Section: Internal Control Quality and Tax Avoidancementioning

confidence: 99%

Internal Control Quality as an Explanatory Factor of Tax Avoidance

Bauer

2011

SSRN Journal

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Do Firms Use Tax Cushion Reversals to Meet Earnings Targets? Evidence from the Pre- and Post-FIN 48 Periods

Cited by 35 publications

References 33 publications

A review of tax research

A review of tax research

Book-Tax Differences and Earnings Growth

Internal Control Quality as an Explanatory Factor of Tax Avoidance

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