Distilling the Reserve for Uncertain Tax Positions: The Revealing Case of Black Liquor

Abstract

We examine the extent to which management judgment affects the reserve for unrecognized tax benefits. We analyze the financial statement disclosures of 19 paper companies that received a total of $6.4 billion in refundable excise taxes during 2009. All of these companies included the refunds in financial income, but 14 excluded all or part of the refunds from taxable income. Despite the magnitude and unprecedented nature of the exclusion, only five of the excluding firms accrued a full reserve for this uncertain position. Six of the excluding firms did not accrue any reserve. This variation suggests managers enjoy wide latitude in applying the more likely than not standard for determining additions to the reserve. Our findings suggest that financial statement users should exercise caution when comparing tax reserves across companies. In addition, we find some evidence that income-increasing decisions are related to characteristics generally associated with weak corporate governance. .

Keywords: Effective Tax Rate, Uncertain Tax Positions, Tax Avoidance

JEL Classification: M41, H25