Predictable Uncertainty: The Relation between Unrecognized Tax Benefits and Future Income Tax Cash Outflows
54 Pages Posted: 5 Feb 2014 Last revised: 1 Oct 2016
Date Written: September 30, 2016
We estimate the extent to which the reserve for unrecognized tax benefits (UTBs) accrued under Financial Interpretation No. 48 (FIN 48) provides information about the realizability of future income tax cash outflows. Proponents argue that FIN 48 facilitates the ability of UTBs to predict future income tax cash outflows, while critics believe FIN 48 allows for too much discretion in accruing UTBs. We find that UTBs are predictive of future income tax cash outflows and that this empirical relation converges to one over a five-year horizon. This finding is inconsistent with claims of systematic over- or under-reserving of the UTB. We also find no change in the informativeness of income tax reserves under FIN 48 compared to prior guidance under Statement on Financial Accounting Standards No. 5. However, supporting arguments made by FIN 48 critics, we find that the relation between UTBs and future income tax cash flows is stronger for firms that (1) retain a tax and audit specialist accounting firm or (2) engage in less tax avoidance.
Keywords: unrecognized tax benefit; specialist; tax avoidance; FIN 48; ASC 740
JEL Classification: M41, M48, H26
Suggested Citation: Suggested Citation