Future Taxable Income Research Articles

The predictive ability of tax contingencies for future income tax cash outflows

AbstractPrior research shows that contingent liabilities do not accurately predict future cash payments due to the managerial discretion afforded by accounting standards. We examine the extent to which current accounting guidance for a material contingent liability—the reserve for unrecognized tax benefits (UTBs) under Financial Interpretation No. 48 (FIN 48)—generates accruals that are predictive of future income tax cash outflows. We document that UTBs fully unwind as cash tax payments over the subsequent 5 years, suggesting that managers, on average, accurately incorporate their expectations of future tax liabilities. This result persists for firms that are (1) most affected by the implementation of FIN 48, (2) unable to impound detection risk into their reserves, (3) engaged in relatively more ex ante tax avoidance, (4) suspected to have engaged in earnings management through the tax accounts, and (5) subject to plausibly exogenous shocks to tax reporting. Overall, our results suggest that current accounting guidance under FIN 48 for contingent tax liabilities enables managers to accurately report, and financial statement users to reliably predict, future cash obligations.

Incorporating Financial Statement Information to Improve Forecasts of Corporate Taxable Income

ABSTRACTWe examine whether public financial statement information is incrementally useful in forecasting confidential taxable income. More precise firm-level taxable income forecasts can improve policymakers' modeling of the tax system and the analysis of proposed changes in corporate tax law, while more accurate macro-level forecasts of corporate taxable income can improve estimates of corporate tax revenues, a significant component of the federal budget. We find the addition of financial statement information improves firm- and industry-level estimates of future taxable income by primarily providing more timely information, but also through accruals. Our results suggest that macroeconomic forecasts of taxable income may be further improved by the aggregation of firm-level forecasts that are generated using financial statement information. Importantly, our results are driven primarily by tax information in financial statements. We also contribute to the research on the information content of financial statement information for forecasting economic activity.JEL Classifications: M41; M48; H25.

Odloženi porez na dobitak u multinacionalnim bankama - slučaj Hrvatske, Srbije i Slovenije

Deferred income tax is an important position in financial statements of banks. It is primarily a result of temporary differences between book and tax values of assets and liabilities. Subsidiaries of multinational banking groups that operate in Croatia, Serbia and Slovenia have to report on deferred tax in accordance with International Accounting Standard 12 - Income Taxes. This paper examined the practices related to deferred income tax in such banks. In this regard, there four banking groups were sampled (two Austrian and two Italian) that operate in three observed countries. Research results showed that net deferred tax assets/liabilities do not usually have materially significant share in total assets of banks, though there is statistically significant difference in the materiality between countries. In general, banks recognize deferred tax assets less after the Covid-19 pandemic, due to the growing uncertainty over achieving the future taxable income, though such reduction is not statistically significant. In addition, the sources of deferred income tax significantly vary between countries, though the valuation of financial assets is, in general, the most common source of deferred tax.

Estimating and Imputing Missing Tax Loss Carryforward Data to Reduce Measurement Error

The ability to reduce current and future taxable income with prior years' taxable losses is highly relevant for explaining firms' effective tax rates. Compustat data on the tax loss carryforward (TLCF) are, however, often missing. We propose a method to estimate values for the missing TLCF data instead of the common practice in the literature of imputing zero values. In order to assess the accuracy of our method, we compare our estimated TLCFs with both a random selection of 10-K data and Compustat data for firm-years where Compustat data is available. The results show that our estimated values align very closely with the reported data. We re-analyze two existing studies using these estimated values. With the first, we show that imputing our estimated values instead of zeros leads to a large decrease in measurement error. This reduces the risk that firms with missing data and low effective tax rates are incorrectly classified as tax aggressive. The second re-analysis shows that using our estimated TLCFs leads to economically and statistically different conclusions compared to imputing zeros. Using our estimated values thus increases the probability of correct inferences in studies that use Compustat TLCF data. The estimated values are available from https://doi.org/10.34894/N9J1WE.

Incorporating Financial Statement Information to Improve Forecasts of Corporate Taxable Income

We contribute to the research on the information content of earnings as it applies to the forecasting of economic activity across reporting models. We examine whether publicly available financial statement information is incrementally useful in forecasting confidentially reported taxable income. More precise firm-level taxable income forecasts can improve policymakers’ modeling of the tax system and their ability to analyze the effect of proposed changes in corporate tax law. When aggregated, improved micro-forecasts can also yield more accurate macro-forecasts of corporate taxable income, a significant component of the federal budget. We find that financial statement information improves firm-level estimates of future taxable income by providing more timely information. We also document the usefulness of the deferred tax valuation allowance in improving taxable income estimates for loss firms. Our evidence suggests public financial statement information complements proprietary data to improve estimates of future taxable income for budgetary and policy use.

The Income Tax in an Uncertain World: Pillar, Symbol, and Instrument

One of the few certainties about Canada's future is that tax policy will change over time, especially, perhaps, with respect to income taxes. Exactly what changes are made will depend not only on changes in economic conditions and the concerns of the party in power but also on how we ("the people") think of taxes as symbols of what we are and want to be--the nature of our democracy, the extent to which we want to redistribute, and to whom, and how and to what extent we want to alter market outcomes. The author sketches this broader setting in which tax policy needs to be considered and suggests a few possible implications for future income tax reform.

The Income Tax in an Uncertain World: Pillar, Symbol, and Instrument

One of the few certainties about Canada's future is that tax policy will change over time, especially, perhaps, with respect to income taxes. Exactly what changes are made will depend not only on changes in economic conditions and the concerns of the party in power but also on how we (the people) think of taxes as symbols of what we are and want to be -- the nature of our democracy, the extent to which we want to redistribute, and to whom, and how and to what extent we want to alter market outcomes. The author sketches this broader setting in which tax policy needs to be considered and suggests a few possible implications for future income tax reform.

Mental accounting of income tax and value added tax among self-employed business owners

Mental accounting describes a series of cognitive operations that help organize financial activities and facilitate money management. Self-employed taxpayers who make use of a separate mental account for future income tax payments or collected value added tax (VAT) might find it easier to declare their taxes correctly than taxpayers who do not. This study used a questionnaire to investigate whether self-employed taxpayers (N = 350) use mental accounting to manage their income tax and VAT obligations, whether mental accounting relates to tax knowledge, business and personality characteristics, and to what extent mental accounting is related to intended tax behavior. Our results reveal that some taxpayers mentally segregate taxes from turnover (segregators) while others do not (integrators). We found small differences in mental accounting between income taxes and VAT. Moreover, confirmatory factor analyses suggested that tax knowledge and mental accounting are distinct constructs. Segregation of taxes was related to lower impulsivity and more positive attitudes toward taxation. Individuals who stated they segregate taxes due from turnover more often claimed to run financially prosperous businesses. Mental accounting was not related to intentions of evading taxes, but individuals with higher mental accounting scores reported more pronounced levels of tax planning. While our research design does not allow drawing causal inferences, these findings could suggest that increasing self-employed taxpayers’ ability to organize their financial activities might be a promising strategy to strengthen the competitiveness of their businesses.

An Estimation Method for Missing Tax Loss Carryforward Data to Reduce Measurement Error

The ability to reduce current and future taxable income with prior years’ taxable losses is highly relevant for explaining firms’ effective tax rates. Compustat data on the tax loss carryforward (TLCF) are, however, often missing. We propose a method to estimate values for the missing TLCF data instead of the common practice in the literature of imputing zero values. In order to assess the accuracy of our method, we compare our estimated TLCFs with (i) a random selection of 10-K data and (ii) Compustat data for firm-years where Compustat data is available. The results show that our estimated values align very closely with the reported data. Re-analyzing Frank et al. (2009) shows that imputing our estimated values instead of zeros leads to a large decrease in measurement error. This reduces the risk that firms with missing data and low effective tax rates are incorrectly classified as tax aggressive. Consistent with this, a re-analysis of Dyreng et al. (2017) shows that using our estimated TLCFs leads to economically and statistically different conclusions compared to imputing zeros. Using our estimated values thus increases the probability of correct inferences in studies that use Compustat TLCF data. The estimated values are available from https://doi.org/10.34894/N9J1WE.

NEWS ABOUT TAXES AND EXPECTATIONS-DRIVEN BUSINESS CYCLES

This paper analyzes the possibility of expectations-driven business cycles to emerge in a one-sector real business cycle model if the unique driving force is news about future income tax rates. We find that good news about labor income tax rates cannot generate expectations-driven business cycles, whereas good news about capital income tax rates can. We show that a one-sector real business cycle model enriched with (i) variable capital utilization and (ii) investment adjustment costs and driven solely by news shocks about capital income tax rates is able to generate qualitatively and quantitatively realistic business cycle fluctuations. In contrast to numerous studies in the news-driven business cycle literature, our model maintains separable preferences.

The Deferred Tax Asset Valuation Allowance and Firm Creditworthiness

ABSTRACTIn this study, I provide evidence that the valuation allowance for deferred tax assets helps predict the future creditworthiness of a firm. Under the provisions of SFAS No. 109, a firm records a deferred tax asset provided it expects to generate sufficient taxable income to realize the asset in the form of tax savings in the future. If a firm does not expect to generate sufficient taxable income to realize the asset, then a valuation allowance is created to reduce the balance. As a result, the valuation allowance indicates management's expectation of future taxable income, which could be informative in predicting the ability of the firm to make future interest and principal payments on debt. Alternatively, the valuation allowance may not be informative regarding creditworthiness if it is a result of overly conservative accounting practices or if it is used as an earnings management tool. I document a negative association between material increases in the valuation allowance and contemporaneous and future changes in credit ratings, evidence that is consistent with the valuation allowance providing a summary measure of a decline in firms' creditworthiness.JEL Classifications: G29; H25; M41.Data Availability: Data are available from sources identified in the paper.

The Deferred Tax Asset Valuation Allowance and Firm Creditworthiness

In this study, I provide evidence that the valuation allowance for deferred tax assets helps predict the future creditworthiness of a firm. Under the provisions of SFAS No. 109, a firm records a deferred tax asset provided it expects to generate sufficient taxable income to realize the asset in the form of tax savings in the future. If a firm does not expect to generate sufficient taxable income to realize the asset, a valuation allowance is created to reduce the balance. As a result, the valuation allowance indicates management’s expectation of future taxable income, which could be informative in predicting the ability of the firm to make future interest and principal payments on debt. Alternatively, the valuation allowance may not be informative regarding creditworthiness if it is a result of overly conservative accounting practices or if it is used as an earnings management tool. I document a negative association between material increases in the valuation allowance and contemporaneous and future changes in credit ratings, evidence that is consistent with the valuation allowance providing a summary measure of a decline in firms’ creditworthiness.

Do Investors Use Prior Tax Avoidance when Pricing Tax Loss Carryforwards?

ABSTRACTThe Internal Revenue Code allows firms to carry excess tax losses forward to offset future taxable income and reduce taxes. Consistent with tax loss carryforwards (TLCFs) creating a significant asset, prior research finds that investors positively value TLCFs. However, investors face significant uncertainty about whether firms will have sufficient future taxable income to benefit from TLCFs. We hypothesize that investors' valuation of new TLCFs will vary with firms' prior tax avoidance behavior because it signals firms' abilities to generate taxable income to offset TLCFs through tax planning. We confirm that investors assign a positive value to new TLCFs and find that investors' valuation varies with firms' prior tax avoidance behavior. Investors positively value TLCFs when firms exhibit high variability in prior tax avoidance and high levels of prior tax avoidance. Our results are incremental to the effect of changes in the valuation allowance on investors' valuation of new TLCFs.JEL Classifications: M40; M41; M49.Data Availability: Data used in this study are available from public sources identified in the paper.

The Information Content of the Deferred Tax Valuation Allowance: Evidence from Venture Capital Backed IPO Firms

Author(s): Allen, Eric James | Advisor(s): Dechow, Patricia; Sloan, RIchard G. | Abstract: In this dissertation I examine the deferred tax disclosures of a unique sample of venture capital backed firms that conducted their initial public offering (IPO) between 1996 and 2008, and generated a net operating loss (NOL) carry-forward. I find that 83% of the sample firms record an allowance fully valuing-out the carry-forward's associated deferred tax asset. This full allowance is, on average, 72% of total assets - a fact which provides strong evidence (at least in terms of this accrual) that these firms are not upwardly managing their earnings prior to IPO. I show that the size of a firm's NOL, and proxies for its expectation of future taxable income have significant predictive power for the magnitude of the valuation allowance. I also show that the allowance sends a strong negative signal about a firm's future book income. Both of these results support the contention that, though conservative, the valuation allowance does provide information about an IPO firm's economic fundamentals. Finally, I introduce a new explanation for the presence of the allowance: the ownership change limitation. This limitation can cause a firm to record an allowance independent of its expectations about future earnings. I provide evidence that firms take this limitation into account when recording the valuation allowance, and that controlling for it can enhance the allowance's signal regarding future income.

A Note on Recent Income Tax Developments Impacting Charitable Organisations in South Africa

The regulatory and fiscal environment in which South African charitable organisations operate have changed significantly over the past decade. This paper examines recent income tax developments which affect public benefit organisations (PBOs). A literature review was performed, with reference to statutory law, published articles and textbooks. The regulatory framework governing non-profit organisations (NPOs) is first considered. Thereafter, the income tax requirements relating to PBOs are addressed. Lastly, the paper reviews the rollover treatment for excess deductible donations, the deductible donations of appreciated immovable property and the interpretation of the expression 'substantially the whole'. The current and future income tax treatment of these aspects are examined. It was found that the section 18A deduction was enhanced by allowing the excess amount (above the allowable threshold) to be carried over to future years of assessment. The incentive for deductible donations on 99-year endorsements for land conservation was improved. Greater clarity is now provided with regard to the requirement of 'substantially the whole'. It is submitted that these changes will assist in supporting charities in the vital role they play towards greater fiscal and social reform. DOI: 10.5901/mjss.2014.v5n20p676

Predictable Uncertainty: The Relation between Unrecognized Tax Benefits and Future Income Tax Cash Outflows

This study examines competing arguments about whether Financial Interpretation No. 48 (FIN 48, now ASC 740-10-25) provides information to financial statements users regarding the realizability of future income tax cash outflows related to reserves for unrecognized tax benefits (UTBs). Critics believe FIN 48 provides substantial discretion in accruing UTBs, while proponents argue the Interpretation improves the reliability and comparability of UTBs. Our results show that, on average, UTBs are predictive of income tax cash outflows up to three years in the future. This link is economically significant as UTBs explain 8.2 percent as much of the variation in future income tax cash outflows as do contemporaneous income tax cash outflows. Using data provided by the IRS, these results hold in validation tests linking UTBs to future IRS audit settlements. In cross-sectional analyses, we find that UTBs are more informative for future income tax cash outflows in firms that (1) purchase tax services from their auditor; (2) engage in relatively less tax avoidance; and (3) are subject to greater IRS audit scrutiny. Our results should interest financial statement users, standard setters, and tax authorities as these parties estimate the future economic consequences of uncertain tax positions.

Have the tax benefits of debt been overestimated?

We re-examine the claim that many corporations are underleveraged in that they fail to take full advantage of debt tax shields. We show prior results suggesting underleverage stems from biased estimates of tax benefits from interest deductions. We develop improved estimates of marginal tax rates using a non-parametric procedure that produces more accurate estimates of the distribution of future taxable income. We show that additional debt would provide firms with much smaller tax benefits than previously thought, and when expected distress costs and difficult-to-measure non-debt tax shields are also considered, it appears plausible that most firms have tax-efficient capital structures.

Have the Tax Benefits of Debt Been Overestimated?

We re-examine the claim that many corporations are underleveraged in that they fail to take full advantage of debt tax shields. We show prior results suggesting underleverage stems from biased estimates of tax benefits from interest deductions. We develop improved estimates of marginal tax rates using a non-parametric procedure that produces more accurate estimates of the distribution of future taxable income. We show that additional debt would provide firms with much smaller tax benefits than previously thought, and when expected distress costs and difficult-to-measure non-debt tax shields are also considered, it appears plausible that most firms have tax-efficient capital structures.

Honoring Expectations About Taxes: Are Roth IRAs Different?

Beginning in January 2010, taxpayers may convert balances in traditional IRAs into tax prepaid Roth IRAs. Those who decide to do so will be relying on current law that allows the payment of a tax now to replace any future income tax on the earnings within the Roth IRA and on withdrawals therefrom. In this paper, I explore whether these taxpayers should be afforded any exception from the generally accepted idea that changes in tax laws that affect pre-existing investments raise no special concerns. I conclude that although the Roth IRA holder, especially of the Roth IRA holder who has converted a traditional IRA into a Roth IRA through the prepayment of income taxes on the account, is qualitatively different from most investors facing tax changes, this difference gives rise only to political, and not constitutional, concerns. I further conclude that the current Congress would be wise to remove the ability of current IRA holders to convert their accounts into Roth IRAs, and thus to minimize the political challenge future Congresses will face given the expectations of the holders of such accounts.

Creating a Bigger Bath Using the Deferred Tax Valuation Allowance

Abstract: The provisions of SFAS No. 109 allow US companies to make an earnings big bath even bigger through the establishment of a deferred tax valuation allowance. At the time a firm recognizes a non‐cash charge, it also recognizes a deferred tax asset to represent the future tax benefits of the charge. Recognition of the deferred tax asset partially mitigates the negative earnings impact of the special charge. However, if the firm does not expect to have sufficient future taxable income to utilize the future tax benefits of the charge, SFAS No. 109 requires the firm to establish a deferred tax valuation allowance, effectively eliminating the recognized deferred tax asset. Thus, the establishment of the valuation allowance amplifies the negative earnings impact of the non‐cash charge. We use a valuation allowance prediction model to identify firms that create a larger‐than‐expected valuation allowance; these firms may be creating a large valuation allowance as a reserve to be used to manage earnings in a subsequent period. We find that the vast majority of these larger‐than‐expected valuation allowances apparently reflect informed management pessimism about the future in that these firms actually do have poorer operating performance in subsequent periods. We do not find any evidence that subsequent reversals of valuation allowances are used to turn a loss into a profit. However, we do find a very small number of firms that appear to have used a valuation allowance reversal to meet or beat the mean analyst forecast.