Do Firms Incur Costs to Avoid Reducing Pre-Tax Earnings? Evidence from the Accounting for Low-Income Housing Tax Credits
The Accounting Review, Forthcoming
49 Pages Posted: 28 Aug 2007 Last revised: 4 Sep 2009
Date Written: August 21, 2009
Examining corporate investment in low-income housing tax credits reveals that firms are willing to incur costs in order to manage the income statement classification of an expense. Accounting rules allow investors who purchase a tax benefit guarantee to amortize their equity in a real estate partnership as a tax expense, rather than as an operating expense, thus avoiding a reduction in pre-tax earnings. Using confidential data from tax credit syndicators, I model the market price of a tax credit as a function of the existence of the guarantee, controlling for foreclosure risk on the underlying real estate. The results are consistent with the hypothesis that an economically significant amount of the guarantee fee is paid by corporate investors for the right to use an accounting method that avoids reductions in pre-tax earnings.
Keywords: expense classification, pre-tax earnings, tax credit, earnings management
JEL Classification: M41, M43, H25
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