Early Evidence on the Determinants of Unrecognized Tax Benefits

Abstract

This study examines the association between disclosures of unrecognized tax benefits made under FASB Interpretation No. 48 and existing measures of tax avoidance. Prior research suggests managers use discretion in accounting for income tax contingencies to meet key earnings targets. It is not clear however, whether such opportunism mitigates the signal about tax avoidance activity provided by these contingencies or whether the opportunistic use of these reserves continued following the adoption of FIN 48. We find that both the level of unrecognized tax benefits at fiscal year-end and changes in the liability linked to current year tax positions are related to firm characteristics that prior research has found to be associated with tax avoidance activity. Further, we document a significant and negative association between firms’ cash effective tax rates and the ending balance of unrecognized tax benefits. We believe this analysis will be useful to researchers and financials statement users that rely on financial statement-based measures of tax avoidance to evaluate corporate tax planning.