Effective Tax Planning

The Accounting Review (2022)

https://doi.org/10.2308/TAR-2019-0020

C. Schwab, B. Stomberg, and B. Williams.

Abstract: We use data envelopment analysis (DEA) to develop a measure of effective tax planning that is theoretically aligned with the Scholes-Wolfson paradigm and captures how efficiently firms maximize after-tax returns given their operating, investing, and financing decisions. We then (1) document the measure is associated with higher after-tax returns to provide assurance DEA achieves its objective in our setting, (2) demonstrate the measure is incremental to cash ETRs in predicting after-tax returns, (3) validate the measure by showing its association with lower tax and non-tax costs, and (4) provide evidence the measure captures something about taxes distinct from overall firm performance. This measure is useful to researchers given the known limitations of ETRs as a measure of tax planning.

Tax effectiveness scores are provided on Brian Williams' website:

https://sites.google.com/view/brianmwilliams/tax-effectiveness-scores

What determines ETRs? The relative influence of tax and other factors

Contemporary Accounting Research (2021)

https://onlinelibrary.wiley.com/doi/10.1111/1911-3846.12720

C. Schwab, B. Stomberg, and J. Xia.

Abstract: Many studies use GAAP effective tax rates (ETR) as proxies for tax avoidance and rely on the maintained assumption that very low (high) ETRs represent the greatest (least) tax avoidance. We provide large-sample empirical evidence on how well ETRs capture cross sectional differences in tax avoidance versus other factors. Using income tax footnote disclosures from 2008 through 2016, we document that items most related to firm performance explain a large portion of the deviation from the statutory tax rate for ETRs below 5% and above 40%. Cash ETRs and multi-year GAAP ETRs suffer similar limitations. Our findings inform researchers about factors not primarily related to tax avoidance that drive significant deviations in ETRs from the statutory tax rate. Understanding the drivers of ETRs is of increasing importance as the number of studies examining the consequences of very high and very low ETRs grows.

How do IRS resources affect the corporate audit process?

The Accounting Review (2020)

https://doi.org/10.2308/accr-52520

M. Nessa, C. Schwab, B. Stomberg, and E. Towery

Abstract: This study investigates how Internal Revenue Service resources affect the IRS audit process for publicly traded corporations. Using confidential IRS audit data, we examine the effect of IRS resources on the incidence and magnitude of proposed deficiencies and settlement outcomes. We find that IRS resources are positively associated with both the likelihood and magnitude of proposed deficiencies, but negatively associated with the proportion of proposed deficiencies collected. These results are consistent with the IRS focusing on fewer positions, but targeting positions supported by weaker taxpayer facts when resources are more limited. Based on our findings, we estimate the loss in tax collections from audits of LB&I corporate tax returns alone exceeds the savings from reductions in the IRS enforcement budget. This study contributes to the literature examining the strategic game between tax authorities and corporate taxpayers and has important implications for policymakers, particularly in light of recent IRS budget cuts.

Financial Constraints and Cash Tax Savings

The Accounting Review (2016)

https://doi.org/10.2308/accr-51282

A. Edwards, C. Schwab, and T. Shevlin

Abstract: We investigate the association between financial constraints and cash savings generated through tax planning. We predict that an increase in financial constraints leads firms to increase internally generated funds via tax planning. We measure financial constraints based on changes in firm-specific and macroeconomic measures. We find that firms facing increases in financial constraints exhibit increases in cash tax planning. Our results indicate that among profitable firms, firm-years with the largest increases in firm-specific constraints are associated with declines in firms’ cash effective tax rates ranging from 3.00 to 5.14 percent, which equate to between 2.87 and 4.82 percent of operating cash flows. We also find that (1) the impact of financial constraints on tax planning is greatest among firms with low cash reserves, and (2) constrained firms achieve a substantial portion of their current tax savings via deferral-based tax planning strategies, despite the lack of a financial statement benefit.

The Effect of Political Sensitivity and Bargaining Power on Taxes:

Evidence from Federal Contractors

The Accounting Review (2013)

https://doi.org/10.2308/accr-50368

L. Mills, S. Nutter, and C. Schwab

Abstract: We investigate whether politically sensitive contractors pay higher taxes and whether their bargaining power reduces these tax costs. Using federal contractor data, we develop a new composite measure of political sensitivity that captures both the political visibility arising from federal contracts and the importance of federal contracts to the firm. We proxy for bargaining power using the firm-level proportion of contract revenues not subject to competition, the firm-level proportion of contract revenues arising from defense contracts, and industry-level concentration ratios. We find that politically sensitive firms pay higher federal taxes, all else equal. However, firms with greater bargaining power incur fewer tax-related political costs. Our study provides new evidence on the political cost hypothesis in a tax setting and the first evidence of the interactive effects of a firm’s political sensitivity and bargaining power on tax-related political costs.

Noncompliance with Mandatory Disclosure Requirements: The Magnitude and

Determinants of Undisclosed Permanently Reinvested Earnings

The Accounting Review (2015)

https://doi.org/10.2308/accr-50853

B. Ayers, C. Schwab, and S. Utke

Abstract: We develop estimates of a firm’s foreign earnings designated as permanently reinvested (PRE) and the unrecorded deferred tax liability (TAX) associated with PRE that are independent of whether a firm explicitly discloses this information. We then investigate firms’ noncompliance with Accounting Standards Codification (ASC) 740 provisions that require financial statement disclosure of PRE and either the tax associated with PRE or a statement that calculating the tax is not practicable. We find that a nontrivial portion of firms do not comply with the PRE disclosure requirements and that the amounts of undisclosed PRE and the related tax are substantial in magnitude. Cross-sectional evidence suggests managers opportunistically choose when to disclose PRE and TAX and that compliance with PRE disclosure requirements increased following the American Jobs Creation Act of 2004, which increased incentives to disclose PRE.

The accuracy of disclosures for complex estimates:

Evidence from reported stock option fair values

Accounting, Organizations and Society (2016)

http://dx.doi.org/10.1016/j.aos.2015.09.001

B. Bratten, R. Jennings, and C. Schwab

Abstract: In this study, we exploit the unique reporting requirements for employee stock options to provide large sample evidence on the accuracy of footnote disclosures related to a specific complex estimate, the fair value of options granted. We first document the frequency and magnitude of differences between (1) the reported weighted-average fair value of options granted and (2) the calculated option fair value using the disclosed weighted-average valuation model inputs and the Black-Scholes option pricing model. In a sample of 23,358 firm-year observations between 2004 and 2011, we find that 23.9 percent have reported and calculated option fair values that differ by more than ten percent, and that these differences are sticky and are frequently significant as a percentage of net income. We also find that fair value differences are larger for firms that (1) exhibit anomalous stock option footnote disclosures that likely result from disclosure errors, (2) have more complex and hence error-prone stock option programs, and (3) have lower quality financial reporting. Taken together this evidence is consistent with large fair value differences that are primarily due to unintentional errors in the stock option footnote disclosures. To document the consequences of these fair value differences, we provide evidence that errors in the reported fair values prevent financial statement users from using the reported values to reliably estimate future stock option expense for many firms. Consistent with this result, we also find that analyst forecasts are less accurate and more disperse for firms with larger fair value differences.