Discussion of Earnings Management and the Corporate Alternative Minimum Tax

Abstract

This paper presents an empirical study of possible earnings management in response to a tax on reported income (book income) introduced in the Tax Reform Act of 1986. Starting in 1987, book income became part of the corporate alternative minimum tax (AMT) base which applied to corporations that did not pay a minimum level of regular tax. The authors' objectives are to identify firms exposed and not exposed to the AMT, and to determine whether firms exposed to the AMT managed their accruals to reduce the cost of the AMT. Boynton, Dobbins, and Plesko adapt the Jones [1991] approach to estimate a discretionary accrual proxy (DAP) for 649 Compustat manufacturing and transportation firms, applying firm-specific data to a model based on pooled-industry data for the years 1981-85. They then access a proprietary IRS tax return file and remove the DAP estimate from the book income amount reported on the tax return. The AMT is recalculated for each firm based on the resulting book income amount to estimate the pre-AMT position, i.e., the position before discretionary accruals. A final sample of 414 firms is partitioned according to whether the firms face the AMT based on the pre-AMT book income and based on the reported book income. The 414 firms are further partitioned on the presence or absence of AMT-mitigating characteristics, such as net operating loss carryforwards and foreign tax credits. The paper reports results consistent with the first hypothesis that firms used discretionary accruals to reduce income in 1987, the first year