Financial Statement Incentives and Benefits of Voluntary Real-Time Tax Audits

Abstract:     
This study examines the relation between tax risks disclosed in financial statements pursuant to Financial Interpretation No. 48 (FIN 48) and voluntary corporate taxpayer participation in the Internal Revenue Service’s (IRS) new real-time Compliance Assurance Process (CAP) audit program. Specifically, we examine whether financial statement considerations influence participation in CAP audits; and whether CAP audits generate non-tax benefits through a lower FIN 48 tax reserve due to resolution of uncertain tax positions. By coupling confidential IRS data on CAP participation with a large sample of FIN 48 disclosures, we find that the decision to participate in CAP is positively related to the size of initial tax reserves. However, CAP participation likelihood decreases as the aggressiveness underlying the uncertain positions increases. After controlling for non-random selection into CAP, we also find that CAP audits provide financial statement benefits through a significant and persistent reduction in participants’ FIN 48 tax reserves. Our results contribute to the tax avoidance literature by analyzing a unique setting in which corporate decisions pertaining to voluntary tax compliance are linked to significant non-tax incentives and benefits.

Number of Pages in PDF File: 50

Keywords: Compliance Assurance Process, CAP audit, FIN 48, ASC 740-10-25, tax reserve

JEL Classification: M41, M42, M48, H25

working papers series