The predictive ability of tax contingencies for future income tax cash outflows

Contemporary Accounting Research · 2023 · 19 citations

• Business
• Monetary economics
• Economics

Abstract Prior research shows that contingent liabilities do not accurately predict future cash payments due to the managerial discretion afforded by accounting standards. We examine the extent to which current accounting guidance for a material contingent liability—the reserve for unrecognized tax benefits (UTBs) under Financial Interpretation No. 48 (FIN 48)—generates accruals that are predictive of future income tax cash outflows. We document that UTBs fully unwind as cash tax payments over the subsequent 5 years, suggesting that managers, on average, accurately incorporate their expectations of future tax liabilities. This result persists for firms that are (1) most affected by the implementation of FIN 48, (2) unable to impound detection risk into their reserves, (3) engaged in relatively more ex ante tax avoidance, (4) suspected to have engaged in earnings management through the tax accounts, and (5) subject to plausibly exogenous shocks to tax reporting. Overall, our results suggest that current accounting guidance under FIN 48 for contingent tax liabilities enables managers to accurately report, and financial statement users to reliably predict, future cash obligations.

Street versus <scp>GAAP</scp>: Which Effective Tax Rate Is More Informative?*

Contemporary Accounting Research · 2020 · 26 citations

• Business
• Accounting
• Monetary economics

ABSTRACT This study investigates how sophisticated market participants use tax‐based information by examining whether analysts' street effective tax rates (ETRs) are informative. When assessing firm performance, analysts exclude items they believe do not reflect current performance, resulting in “street” metrics such as street ETR. However, evidence on the properties of the components of street earnings is limited. Examining the informativeness of street ETRs is important because taxes are a significant component of earnings, and the extent to which analysts understand taxes and incorporate them into their analyses is not clear. Using a hand‐collected sample of analyst reports, we find that while approximately 35% of street ETRs have at least one tax‐specific exclusion, over 90% reflect the tax effects of pre‐tax exclusions. Further, both tax‐specific exclusions and the tax effects of pre‐tax exclusions significantly contribute to differences between GAAP and street ETRs. Consistent with analysts' understanding of the implications of tax and nontax exclusions, our results suggest that street tax metrics exhibit greater predictive ability about future tax outcomes and provide more information to investors than GAAP tax metrics. We also find that ETR exclusions are of higher quality when the magnitude of the potentially excluded item is greater and when managers disclose pro forma earnings. Collectively, our findings suggest that analysts understand taxes, but selectively exert effort to incorporate tax‐based information into their assessment of firm performance. Our study should be informative to regulators and users of financial information because it provides evidence regarding the usefulness of street earnings metrics.

The Shareholder Response to Corporate Tax Planning Advice Regulation

SSRN Electronic Journal · 2020 · 1 citations

• Computer Science
• Business
• Accounting