Daniel P. Lynch

Do Firms Use Tax Reserves to Meet Analysts’ Forecasts? Evidence from the Pre- and Post-FIN 48 Periods

We examine whether firms use tax reserve decreases to meet analysts’ quarterly earnings forecasts in the period prior to the passage of FIN 48 and whether that behavior changed following the enactment of FIN 48. In the pre-FIN 48 period, we observe that firms reduce their tax reserves (i.e., increase income) when pre-managed earnings are below analysts’ forecasts. Specifically, we find that approximately 78% of firm-quarters that missed the earnings target without the benefit of the tax reserve decrease subsequently meet the earnings target after including the benefit. Further, we find that the amount of the decrease in the tax reserves is significantly associated with the magnitude of the deviation between pre-managed earnings and analysts’ forecasts. In contrast, in the post-FIN 48 period we do not find any evidence that firms use changes in the tax reserves to manage earnings around analysts’ forecasts. Thus, our results suggest that FIN 48 has, at least initially, curtailed earnings management through the tax reserves.

Do Property Taxes Affect Real Operating Decisions and Market Prices for Crude Oil

This study investigates the effect of property taxes on real business decisions. Consistent with tax avoidance, we posit that personal property tax rates are associated with decreases (increases) in inventory prior to (following) assessment dates. We empirically test this prediction using both United States and Canadian monthly crude oil inventory data. We find that in locations where raw materials inventory is subject to taxation, total and refinery-level crude oil inventories are reduced prior to assessment dates and increased in the following period, when compared to locations with no (or lower) tax rates. The results provide empirical evidence that property taxes play a role in the operating decisions of firms. We also examine the pricing implications of these tax driven changes in crude oil inventory and find that the market seemingly adjusts crude oil prices around assessment dates demonstrating that the market acts as if it understands these changes in crude oil inventory are not simply due to supply/demand effects.

The Effects of the Tax Cuts & Jobs Act of 2017 on Defined Benefit Pension Contributions

This study examines the effect of the Tax Cuts & Jobs Act of 2017 (TCJA) on corporate defined benefit pension contributions. The TCJA decreases the corporate tax rate from 35 in 2017 to 21 percent in 2018, and thereafter. This change incentivizes firms to increase 2017 pension contributions to take advantage of tax deductions at a higher rate. Consistent with this incentive, we find firms increase defined benefit pension contributions by an average of 25 to 31 percent in 2017 compared to earlier years. We also find that taxpaying firms are the primary contributors. Further, taxpaying firms with high levels of pension-related deferred tax assets contribute over three times as much as taxpaying firms with low levels of pension-related deferred tax assets. We also find firms that increase in pension contributions in 2017 reduce 2018 contributions, consistent with intertemporal income shifting rather than a permanent change in pension funding strategy.

The Association between Internal Information Quality and State Tax Planning

This study examines if internal information quality facilitates state tax planning. Due to the considerable number of tax jurisdictions, variety of tax rules, and enforcement mechanisms, state taxes are one of the most complex areas for tax planning. Prior literature finds that internal information quality is positively associated with summary measures of tax planning. However, we know little about what specific forms of tax planning drive this association. We conjecture that the complex area of state tax planning is one of the forms of tax planning that benefits from strong internal information quality. Consistent with this conjecture, we find that higher internal information quality is positively associated with state tax planning. We also find that domestic firms drive this relation, consistent with multinational firms focusing more on international tax planning. Finally, using a structural equation model that allows different forms of tax planning to covary with each other, we find a positive association between higher levels of internal information quality and both state and foreign tax planning. We fail to find a significant association between internal information quality and federal tax planning. Taken together, our results imply that internal information quality is most important for complex, multi-jurisdictional areas of tax planning.

Trade-Offs between Tax and Financial Reporting Benefits: Evidence from Purchase Price Allocations in Taxable Acquisitions

U.S. GAAP requires assets acquired in business combinations to be recognized at fair value. The tax basis of assets acquired in taxable asset acquisitions must also be adjusted to reflect fair values. Managers can increase the net present value of cash tax savings by allocating a greater portion of the purchase price to shorter-lived assets. However, this conforming tax planning strategy results in lower book income immediately following the acquisition. Taxable acquisitions are therefore a powerful setting to investigate tradeoffs between tax and financial reporting benefits. We predict and find that managers with stronger tax incentives relative to financial reporting incentives shift a greater amount of the purchase price from intangible to depreciable assets. We also find that managers facing both strong financial reporting and tax incentives allocate more to intangibles relative to managers with only strong tax incentives. These results suggest managers trade off cash savings to report higher net income.

The Determinants of Segment-Level Tax Expense Disclosure

This study examines the determinants of the disclosure of segment-level tax expense. Segment reporting rules require firms to report segment-level profit using a definition of earnings that is consistent with profit measures used for internal reporting. Thus, we expect firms using after-tax performance measures for internal reporting to define segment-level profit on an after-tax basis. However, given the ambiguous nature of segment reporting rules, firms with higher proprietary costs of disclosure may choose to report segment-level profit on a pre-tax basis, thus avoiding segment-level tax reporting. We find that only 13.8% of all multi-segment firms report after-tax profits at the segment-level. Using the presence of after-tax CEO incentives as a proxy for the internal use of after-tax segment performance (Phillips 2003), we find a positive association between after-tax incentive use and segment-level tax reporting in our full sample. We also find a negative association between effective tax rates and segment-tax reporting; suggesting firms engaging in tax avoidance are less likely to disclose segment-level taxes. We then split our sample of firms into those defining segments along geographic rather than non-geographic lines and find that the use of after-tax incentives increases the likelihood of reporting only for non-geographic-based operating segments, while proprietary costs of disclosure (i.e., ETRs) only decrease the likelihood of reporting for geographic-based operating segments. Overall, our results suggest discretion in ASC 280 is used to reduce disclosure quality of segment-level taxes for firms with geographic-based segments.