Smoothing Taxable Income, Tax Avoidance, and the Information Content of Taxable Income

Abstract:     
Prior research examines whether firms smooth their financial statement earnings. However, recent research also suggests that firms have significant incentives to smooth their taxable income. This study investigates whether smoothing taxable income influences the outcomes of firms’ future tax avoidance activities as well as the information content of taxable income. We find that firms with smoother taxable income have more favorable outcomes in their future tax avoidance activities (i.e., exhibit higher levels of future tax avoidance), which is consistent with smoothing taxable income reducing the uncertainty associated with future tax benefits and allowing firms to develop more successful tax avoidance strategies. Contrary to research that finds that smoothing enhances the information content of financial statement income, we find that smoothing reduces the information content of taxable income. This finding is consistent with managers smoothing taxable income to achieve specific tax objectives, likely distorting the information contained in taxable income.

Number of Pages in PDF File: 43

Keywords: Income smoothing, taxable income, tax avoidance, information content

JEL Classification: G32, H25, H32, M41

working papers series