Smooth 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 innate and discretionary components of smooth taxable income and whether those characteristics influence 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 smoothness reducing the uncertainty associated with future tax benefits and allowing firms to develop more successful tax avoidance strategies. Contrary to research that finds that smoothness enhances the information content of financial statement income, we find that smoothness reduces the information content of taxable income. This finding is consistent with the smoothness of taxable income either eliminating or reducing the information contained in the unique economic shocks experienced by taxable income.

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

JEL Classification: G32, H25, H32, M41