One Size Does Not Fit All: How the Uniform Rules of FIN 48 Affect the Relevance of Income Tax Accounting

Abstract

Our study examines how the uniform rules of FIN 48, which governs accounting for income tax uncertainty, affect the relevance of income tax accounting. By requiring all firms to follow the same recognition and measurement process, the FASB intended FIN 48 to improve the relevance of income tax accounting. However, practitioners argue that reserves reported under FIN 48 lack relevance because they represent liabilities that will never be paid to tax authorities. Consistent with these concerns, we estimate that over a three-year period, only 24 cents of every dollar of reserves unwind via settlements. Moreover, contrary to the FASB's intention, we find no evidence that FIN 48 increased the ability of tax expense to predict future tax cash flows. Rather, we find that the predictive ability of tax expense for future tax cash flows decreases among firms for which FIN 48 is most restrictive. Finally, we find no evidence that investors identify firms for which reserves overstate future tax cash outflows and incorporate this into their valuations. Our results provide evidence that the uniform accounting rules of FIN 48 negatively affect the relevance of income tax accounting. JEL Classifications: H25; M41; M48.

Does FIN 48 Improve Firms' Estimates of Tax Reserves?

“…We find no statistical difference in the overall adequacy or accuracy of reserves pre-and post-FIN 48. This finding is broadly consistent with evidence in Robinson, Stomberg, and Towery (2016) and Ciconte, Donohoe, Lisowsky, and Mayberry (2016), who find no improvement in the relation between tax reserves and cash taxes paid post-FIN 48.…”

“…Overall, we find little evidence to reject the null hypothesis of Hypothesis 1 of no overall change in financial reporting quality, measured using either the adequacy or accuracy of tax reserves, after FIN 48. This evidence, not considering ATS, can be viewed as largely consistent with concurrent research (Ciconte et al 2016;Robinson et al 2016).…”

“…Prior research has indirectly examined the effect of FIN 48 on the financial reporting quality of tax reserves by examining earnings management through tax reserves (Cazier, Rego, Tian, and Wilson 2015;Gupta, Laux, and Lynch 2016), changes in effective tax rates in the year of an IRS settlement (Robinson, Stomberg, and Towery 2016), and the mapping of tax reserves into future cash taxes paid (Ciconte et al 2016) before and after FIN 48. In contrast to Robinson et al (2016) and consistent with Ciconte et al (2016) we find no evidence our sample firms are systematically over-reserved for uncertain tax positions post-FIN 48. However, we caution that our inferences are based on a sample of firms with material audit assessments or settlements and may not generalize to firms with low probabilities of audits from tax authorities.…”

“…We net the additions (TXTUBPOSPINC) with reductions (TXTUBPOSPDEC). We do not include settlements, which reflect actual cash payments (PricewaterhouseCoopers 2013; Robinson et al 2016), in the dependent variable. Including settlements in the dependent variable would create a mechanical relation with AppealsSettle because AppealsSettle is a subset of what is included in the settlements line of the rollforward.…”

Income Statement Reporting Discretion Allowed by FIN 48: Interest and Penalty Expense Classification

“…We provide evidence that the income statement classification discretion permitted by FIN 48 allows for differences among firms in reporting penalties and interest that affects the usefulness of this information by financial statement users. Our results contribute to the debate regarding the decision usefulness resulting from the FASB's income tax reporting guidance (Robinson, Stomberg, and Towery 2016).…”