Estimates of the Magnitude of Financial and Tax Reporting Conflicts

Abstract

This study examines the tax reporting consequences of financial reporting discretion. Using a matched sample of financial statements with tax returns, I provide estimates of the accuracy of tax return information inferred from financial statements. To examine the tradeoffs between financial and tax reporting, I model the relation discretionary financial accounting accruals have to discretionary federal tax accruals. The methodology takes advantage of the contemporaneous nature of reporting to mitigate econometric problems identified in previous research. I find the extent tax reporting reflects discretionary financial reporting varies dramatically by industry, profitability, and the sign of discretionary accruals. I also find managers are able to undertake tax reducing activities with less of an effect on financial reporting than tax increasing accruals, consistent with recent evidence on the differential growth of book and tax income, and with tax avoidance activities.