Unintended Consequences of Regulated Fee Structure

• In Event: Behavioral Tax

Abstract

ABSTRACT: This study examines the effect of contract structure (fixed versus contingent) and a contextual factor (positive versus negative benefit surprise) on tax professionals’ behavior. Regulatory restrictions on contract structure are based on the belief that contingent fee contracts “encourage tax return preparers to take unsupported positions on the taxpayers’ returns” (Murphy 1989, p. 2). Experienced tax professionals participated in an experiment investigating the effect of contract structure and benefit surprise on their judgments and decisions. Contrary to regulators’ beliefs about the effect of contingent fee structures, I do not find a main effect of contract structure. Rather, results show that tax professionals who contract under a fixed fee and encounter a negative benefit surprise are more likely to take uncertain tax positions than professionals who contract under a contingent fee and encounter a negative benefit surprise. In contrast, participants who contract under a fixed fee and encounter a positive benefit surprise are less likely to take tax positions that are more-likely-than-not to be accepted by the IRS. Supplemental analysis shows that the form of this interaction changes with the aggressiveness of the position. Results also show that tax professionals contracting under a contingent fee are more likely to inform their client that positions included on the tax return may not be supported if audited. The overall tenure of the results suggests that restricting the ability of tax professionals and their clients to allocate risk through the use of contingent fee contracts has the unintended consequence of increasing tax professionals’ aggressiveness and decreasing the information provided to taxpayers. These results are particularly important when considering the significant influence tax professionals can have on the positions taken on their clients’ tax returns.

Author

• Bryan W Stewart, Brigham Young University