Both practitioners and academics are increasingly focusing their attention on the riskiness of firms’ tax planning activities. In this study, we examine how external auditors respond to tax risk, measured using the volatility of firms’ annual cash and GAAP (Generally Accepted Accounting Principles) effective tax rates. Consistent with the notion that tax risk represents a source of engagement risk that is priced by external auditors, we first document a positive association between audit fees and tax risk incremental to fee premiums arising from tax aggressiveness. We also find that knowledge spillover benefits related to the provision of tax nonaudit services moderate this positive association. In supplemental tests, we provide evidence on additional auditor responses to tax risk. In particular, we document that tax risk is positively associated with both audit report lag and the likelihood of the auditor reporting a tax-related material weakness in the client’s internal controls. Our findings add to the growing literature at the intersection of corporate taxation and auditing, and to the literature distinguishing between the level and riskiness of firms’ tax avoidance strategies.

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This study investigates the effect of KPMG's Deferred Prosecution Agreement (DPA) on the accounting firm's ability to sell auditor-provided tax services (APTS) and its clients' tax avoidance. We document that following the DPA, clients were more likely to discontinue or reduce purchasing APTS from KPMG relative to the other Big 4 accounting firms. However, we do not find any evidence of a change in tax avoidance among KPMG clients continuing to purchase APTS following the DPA relative to other Big 4 clients. Broadly, our findings highlight how elevated reporting standards and external monitoring impose significant negative economic consequences on the service providers subject to these sanctions. At the same time, it appears clients do not suffer any observable tax costs by continuing to engage a sanctioned tax service provider.

We examine the influence of the Alternative Simplified Credit (ASC) on firms' research and development (R&D) spending. The ASC remedies a perceived flaw with the previous R&D tax credit regime that excluded firms with high R&D intensities during their fixed-base periods and/or high sales in the previous four years from claiming a credit. We document a large increase in R&D tax credit eligibility following the enactment of the ASC, and find that its effect on R&D spending was positive relative to firms not utilizing this new credit-calculation option. Specifically, we estimate that the ASC induced an additional $2.26 of R&D spending for every dollar of forgone tax revenue. These results provide evidence that the ASC has spurred R&D investment in a setting where firms have a choice between two credit-calculation methods. JEL Classifications: H25, H32, O31