Interim Tax Reporting Accuracy: Determinants and Consequences

Abstract

This study examines the determinants and consequences of tax reporting accuracy. Firms are required to report tax expense each quarter based on their estimated annual effective tax rate (ETR). However, because of both bias and estimation error, these estimates do not always accurately represent annual ETR, creating variation in ETRs and earnings. This study documents several factors that are negatively associated with interim tax reporting accuracy but have no association with bias, suggesting that these factors significantly contribute to estimation error within the tax accounts. Consistent with a monitoring role over financial reporting, analyst following, institutional ownership, and auditor tenure are positively associated with interim tax reporting accuracy through reduced estimation error. In addition, estimated taxable income is more informative to investors for firms that have been more accurate in prior years, and investors respond more positively to beating analysts’ forecasts using a decrease in the tax rate when the firm has a record of accurate tax reporting.

Keywords: accounting for income taxes, market pricing, audit quality, analyst coverage, institutional investors, earnings management

JEL Classification: G10, G14, M40, M41, M42, H20