Trade-Offs between Tax and Financial Reporting Benefits: Evidence from Taxable Acquisitions

Abstract

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.