Does Private Tax Disclosure Reduce Audit Risk?

• In Event: Pen Pals with the IRS

Abstract

This paper provides the first large-sample empirical evidence on how voluntary, private disclosures to tax authorities—in the form of Private Letter Rulings (PLRs)—affect the likelihood of IRS audits. PLRs offer binding guidance on the tax treatment of specific transactions, allowing firms to reduce legal uncertainty in advance of filing. However, obtaining a PLR requires voluntarily disclosing sensitive transaction details to the IRS, potentially increasing scrutiny. Whether PLRs reduce or increase audit risk remains an open empirical question.
Using a novel, AI-assisted dataset of 1,456 firm-year observations in which U.S. public firms disclose obtaining PLRs in SEC filings, we find that receiving a first PLR significantly reduces future audit probability. Specifically, our stacked difference-in-differences design, using entropy-balanced control firms, reveals a 4.6 percentage point decline in the likelihood of IRS audit in the five years following a firm’s first PLR. To further validate our interpretation, we contrast PLRs with tax opinion letters disclosed in financial statements and find no effect of opinion letters on audit incidence, suggesting the reduction is unique to direct engagement with the IRS.
We explore mechanisms by analyzing changes in firms’ financial statement disclosures following a PLR. We find that the tax footnote becomes longer, contains more numerical detail, and exhibits reduced uncertainty language—consistent with reduced tax risk. Importantly, the uncertainty language in the MD&A does not change, suggesting that the observed shift is specific to tax-related disclosures rather than a general change in tone or risk environment.
Cross-sectional analyses reinforce our interpretation. The audit reduction is concentrated in smaller firms, which are less likely to be audited ex ante and thus may gain more from signaling transparency. Similarly, the audit reduction is driven by firms with higher baseline effective tax rates, indicating that PLRs are more effective in reducing audit risk among firms that are not already engaged in aggressive tax planning. Moreover, we show that our results are not driven by PLRs related to reorganizations—which represent over half the sample—as the results persist in a subsample excluding reorganization-related rulings.
Our study makes three key contributions. First, we contribute to the literature on tax uncertainty and enforcement by introducing a new lens: voluntary, private interaction with the IRS that occurs outside of audit settings. Second, we expand the disclosure literature by showing that firms’ voluntary disclosures to regulators—not just capital market participants—can influence regulatory outcomes. Third, we provide practical implications for both corporate tax planners and policymakers. For managers, our findings suggest that obtaining a PLR may serve as a form of audit insurance. For tax authorities, the findings imply that expanding PLR access may encourage proactive compliance while reducing enforcement burdens.
Together, our results suggest that private tax disclosure, far from merely informing the IRS, can alter enforcement dynamics in meaningful ways. PLRs appear to substitute for audits—not because they reduce tax avoidance per se, but because they provide credible signals of transparency and risk aversion. In an era of resource-constrained enforcement, such mechanisms may offer a path to more efficient tax administration.

Authors

• Andrew Belnap, University of Texas at Austin

• Jeff Hoopes, University of North Carolina at Chapel Hill