Mind the Gap: Determinants and Implications of the Difference between Tax Expense and Tax Paid

• In Event: Taxes and Financial Reporting

Abstract

Prior research consistently documents that GAAP effective tax rates (ETRs) are four to eight percent higher than cash ETRs, suggesting that corporate income tax expense materially exceeds income tax paid each year (i.e., a positive tax accrual). We explore the underlying processes that generate the tax accrual, and consider how these processes impact the tax accrual’s ability to predict future tax cash flows. We identify four processes that affect the tax accrual: near-term tax payments, economic transactions accounted for differentially for financial reporting and tax reporting, loss status, and managerial incentives to use discretion in the tax account. We decompose the tax accrual into components based on these four processes, and examine the persistence of each component and its relation with future tax payments. Tax accruals related to managerial incentives to use discretion and economic transactions accounted for differently for financial and tax reporting are highly persistent, but are poor predictors of future tax payments. Our findings contribute to a better understanding of accrual determinants and implications at the account level.

Authors

• Xi Chen, University of Houston-Houston

• Allison Koester, Georgetown University

• Terry J Shevlin, University of California-Irvine