When the IRS Speaks: Investor Valuation of Private Letter Rulings and Tax Opinions in Corporate Spin-offs

• In Event: Pen Pals with the IRS

Abstract

This study examines investor valuation of the reduction in tax uncertainty provided by private letter rulings (PLRs) relative to obtaining a tax opinion from a law firm or accounting firm. Using a sample of tax-free corporate spin-offs from 1996 to 2019, we find that the market reacts more favorably to corporate spin-off filings that disclose the receipt of a favorable PLR relative to filings without such disclosure. Our findings indicate that the magnitude of abnormal returns is influenced by the relative size of the spun-off entity and the tax sensitivity of the investor base. In addition, returns are influenced by the IRS’s breadth of PLR scope, with time periods of broader rulings yielding greater investor confidence. This study contributes to the understanding of investor valuation of tax uncertainty in spin-off transactions and informs the IRS as it continues to assess and improve its PLR program.

Authors

• Shannon Chen, University of Arizona

• Stephen Lusch, University of Kentucky

• Frank Murphy

• Junwei Xia, Texas A&M University