Deficiencies in Tax-Related Internal Controls Detected Under Sarbanes-Oxley Section 404

Abstract

We examine detection, remediation and severity classification of deficiencies in tax-related internal controls identified under Sarbanes-Oxley Section 404. Our data comprise internal control deficiencies (ICDs) identified by company personnel and auditors, provided by several large auditing firms. We find that relative to ICDs in other accounts, tax ICDs are less likely to be remediated prior to yearend, are more likely to be severe, and are more likely to have failed to prevent a misstatement. Results show that companies under financial stress are more likely to have tax ICDs, and less likely to remediate those problems, implying that financial stress inhibits attention to internal controls over taxes. We find more severe tax ICDs among smaller, riskier companies lacking a high quality internal audit function. Investigating specific types of tax IDs, we find that severity classifications are higher for flaws in controls relating to the tax provision, deferred taxes, and compliance.