Showing papers in "Journal of The American Taxation Association in 2011"

Empirical Evidence on the Impact of Book-Tax Differences on Divergence of Opinion among Investors

Abstract: It is well known that the objectives of financial accounting and tax accounting sometimes conflict, resulting in book-tax differences (BTDs). In this study we test for associations between measures of BTDs and measures of market participants’ uncertainty regarding the information conveyed in financial reports. The measures of market participant uncertainty are: (1) share turnover, (2) analyst forecast dispersion, and (3) stock return variance. We find positive associations between levels and variability of total BTDs and the three measures. After disaggregating BTDs into their permanent and temporary components, we find that both are positively associated with market uncertainty, although the permanent component of BTDs is generally more strongly and consistently associated with measures of uncertainty than is the temporary component. We interpret these results, in part, as indicative of the possible effect of uncertainty contained in BTDs, especially permanent BTDs, on the precision of the info...

Is There an Association between Earnings Management and Auditor-Provided Tax Services?

Abstract: The issue of whether auditor-provided nonaudit services enhance or exacerbate financial reporting quality has been intensely debated among regulators, auditors, investors, academic researchers, and the media. In 2006, the SEC approved the rules proposed by the PCAOB limiting the tax services that incumbent auditors can offer to their clients. We contribute to this debate by examining whether auditor-provided tax services mitigate earnings management. We find a negative and significant relation between earnings management (loss avoidance) and tax fee paid to the incumbent auditor. Our results are consistent with knowledge spillover, i.e., when the same audit firm provides both audit and tax services, insight learned from providing tax services can contribute to audit quality.

The Effects of Increased Book-Tax Difference Tax Return Disclosures on Firm Valuation and Behavior

Abstract: We use event study techniques to gauge market participants' ex ante perceptions regarding the benefits and burdens of the Schedule M-3, and structural break analysis to investigate whether managers make ex ante or ex post changes in book-tax differences as a result of this mandatory change in federal tax return disclosures. We find evidence suggesting investors believe ex ante the substantial increase in book-tax difference disclosures will increase future tax burdens and/or tax-compliance costs. Investors also appear to believe the M-3 may be more costly for firms having the types of book-tax differences that attract additional IRS scrutiny (e.g., discretionary permanent differences) and when such firms are weakly monitored. Further, we find evidence of a substantial reduction in our proxy for discretionary permanent book-tax differences prior and subsequent to the implementation of the M-3 and other regulatory events, suggesting both ex ante and ex post real effects on firm behavior. JEL Classi...

Do Debt Constraints Influence Firms' Sensitivity to a Temporary Tax Holiday on Repatriations?

Abstract: We examine whether U.S. multinationals' private and public debt constraints influence their responses to a temporary reduction in repatriation taxes (tax holiday). Using a sample of 421 U.S. multinationals with permanently reinvested earnings, we find that external debt constraints played an important role in determining their responses to the tax holiday. Specifically, we find that firms subject to fewer financial covenants in their private debt agreements or with greater access to public bond markets repatriated significantly more of their eligible funds. Our results suggest that U.S. multinationals with greater access to external debt markets have more flexibility to time their repatriations around a tax holiday and, as such, they are the primary beneficiaries of any tax savings. It is unlikely that these firms were the intended target of the American Jobs Creation Act (AJCA) 2004, given the stated legislative goals of directing repatriated funds toward financial stabilization and previously u...

Effects of Dispositional Motivation on Knowledge and Performance in Tax Issue Identification and Research

Abstract: Previous accounting research on how motivation affects judgment/decision making performance has examined the influence of temporal incentives such as monetary rewards and accountability. We extend this line of research by examining dispositional motivation—the stable individual trait of achievement striving. We first examine whether dispositional motivation affects the extent to which beginning tax professionals acquire tax knowledge over the course of their academic pursuits and first year of professional practice. This aspect of knowledge acquisition has not previously been examined in accounting research. We expect that knowledge differences, in turn, will predict performance in tax issue identification and in tax research. In addition, we hypothesize dispositional motivation will have a direct effect on tax research performance, but not on issue identification. Finally, we hypothesize dispositional motivation will be mediated by task-relevant knowledge in tax research. With one exception, al...

Tax-Motivated Increases in Qualifying Distributions by Private Foundations

Abstract: We examine three categories of private foundations with tax incentives to increase their qualifying distributions: (1) foundations barely qualifying for the 1 percent tax rate on net investment income, (2) foundations barely avoiding the tax on undistributed income, and (3) foundations that pay an excise tax on undistributed income. We expect tax-motivated foundations to use allocations across expense categories and over time to increase their qualifying distributions. Our sample consists of a balanced panel of 1,974 private foundations over a 12-year period from 1995 through 2006, resulting in 23,688 foundation years. We find that foundations barely meeting the 1 percent tax benchmark use tax-motivated allocations both across expense categories and over time to increase qualifying distributions. In contrast, foundations barely avoiding or minimizing the tax on undistributed income use set-aside amounts to allocate distributions over time, but do not use allocations across expense categories to ...

Short-Term Incentive Effects of a Reduction in the NOL Carryback Period

Abstract: We examine whether the Taxpayer Relief Act of 1997 (TRA 1997), which reduced the net operating loss (NOL) carryback period from three to two years, created a short-term incentive effect to shift income to accelerate loss recognition in the tax year 1997. We find that our sample of NOL firms in the treatment year of 1997 display higher (lower) levels of income-decreasing (-increasing) earnings management, compared to a control sample of loss firms. When we focus strictly on the NOL firms in the transition year, we find that firms with higher reported income tax expense in fiscal year 1995 display greater income shifting to accelerate loss recognition. We also find that income shifting is greater for treatment NOL firms that expect to report losses in the post-TRA 1997 regime. Overall, our study highlights how changes in tax law provisions (as opposed to tax rate changes) affect firms' reporting behavior.

Tax equalization in mutual funds

Abstract: By making an annual tax election, open-ended mutual funds can treat redeeming shareholders as if they have been allocated a pro-rata share of taxable gains, when in fact they have not (known as “equalization”). Equalization provides significant benefits to shareholders and funds; however, it also leads to additional fund-level costs. In this study, we use equalization elections to examine how managers weigh the costs and benefits of tax minimization. Overall, our results suggest both are important in the decision-making process. Even though funds and investors both benefit, only 10 percent of funds use equalization. Funds in larger fund families and with higher expense ratios, both proxies for the additional infrastructure necessary to calculate equalization dividends, are more likely to use equalization. Equalization is also used when its benefits are highest, such as by funds with greater redemptions and larger unrealized gains. Data Availability: Contact the first author.

DISCUSSION OF Do Debt Constraints Influence Firms' Sensitivity to a Temporary Tax Holiday on Repatriations?

Abstract: A lbring, Mills, and Newberry (2010) (hereafter, AMN) study the relation between proxies of debt constraints and firms’ responses to the repatriation tax holiday in the American Jobs Creation Act of 2004 (AJCA). Specifically, they investigate whether the existence of a public debt rating and the number of covenants in private debt agreements are associated with the amount of foreign earnings repatriated. Ultimately, AMN find evidence that firms’ repatriations are increasing in the existence of a debt rating and decreasing in the number of private debt covenants. Given the ongoing debate regarding the efficacy of the AJCA, which reduced the maximum tax rate on the repatriations to 5.25 percent, AMN address a research question that will be of interest to academics and policy makers alike.

The Mutual Fund—An Institutional Investor that Acts Like an Individual

Abstract: We examine changes in the average mutual fund’s investments following the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRR). The JGTRR decreased the tax penalty on dividend and capital gains income. We hypothesize that mutual fund managers will respond to the investment preferences of the underlying shareholders and increase their ownership of dividend-paying firms. We present evidence supporting the hypothesis that mutual fund managers increased their ownership of dividend-paying firms following the JGTRR. However, we do not find evidence that the investment managers of other institutional investors increased their ownership of dividend-paying firms following the JGTRR. These results indicate that mutual funds are influenced by the tax preferences of their underlying investors, form tax clienteles, and exhibit different investment policies when compared to other types of institutional investors.