Entity Structure and Taxes: An Analysis of Embedded Pass-Through Entities

Abstract

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

The Relevance of Non‐Income Tax Relief*

“…Because the universe of firms that do not receive non‐income tax relief in GJF is large and diverse, we use entropy balancing to construct a comparable benchmark group when we examine determinants that impact the receipt of non‐income tax relief and whether the relief is associated with future firm performance. Entropy balancing is increasingly used in archival studies (e.g., Edwards et al 2019; Agarwal et al 2020). It ensures covariate balance between treatment and control groups by reweighting control observations so that mean and variance for the groups are virtually equivalent 12 .…”

Foreign Holding Companies and the US Taxation of Foreign Earnings: Evidence from the Tax Increase Prevention and Reconciliation Act of 2005*

“…Despite this anecdotal evidence on complex foreign organizational structures, little research examines the determinants or consequences of foreign subsidiary choices. The limited evidence suggests that foreign subsidiary choices are an important tax planning consideration (Agarwal et al 2021; Demeré et al 2020). I analyze whether and to what extent MNCs alter their foreign organizational structure in response to changes in US tax policy by increasing their number of holding companies.…”

“…US multinationals (MNCs) operate through complex foreign organizational structures, yet little research examines the determinants or consequences of foreign subsidiary decisions. The limited evidence shows that organizational structure decisions are a key element of certain tax planning strategies, such as special purpose entities (Demeré et al 2020), flow‐through entity classifications (Agarwal et al 2021), and arranging foreign affiliates within the equity supply chain (Dyreng et al 2015). In this study, I examine firms' reliance on foreign holding companies, separate legal entities that facilitate internal financing and tax planning.…”

“…I document that MNCs responded to a reduction in the scope of US taxation in TIPRA by creating more expansive networks of holding companies, thereby increasing the complexity of foreign organizational structures. In addition, Agarwal et al (2021) and Demeré et al (2020) argue that firm organizational structures are of first‐order importance to many stakeholders (e.g., investors and policy‐makers). However, our understanding of how firms organize their global affiliates and the tax effects of these decisions remains incomplete.…”

A hybrid entity structure for tax optimization of foreign direct investment in the U.S.

“…The question arises whether such an ideal legal structure is possible for the foreign individual. The entity structure is an important factor influencing the tax burden (Agarwal et al., 2021). Furthermore, the taxation system influences the choice of the corporate and capital structure and allows for structuring options (Faccio & Xu, 2015; Luna & Murray, 2010).…”