Limits of Tax Regulation: Evidence from Strategic R&D Classification and the R&D Tax Credit

Posted: 27 Dec 2018

See all articles by Stacie Kelley Laplante

Stacie Kelley Laplante

University of Wisconsin - Madison

Hollis Ashbaugh Skaife

Graduate School of Management, UC-Davis

Laura Swenson

University of Wisconsin - Milwaukee

Daniel Wangerin

Wisconsin School of Business

Date Written: December 10, 2018

Abstract

We investigate a tax avoidance strategy where firms use the ambiguity inherent in tax reporting to classify indirect costs as research and development (R&D) expenditures to take advantage of the R&D tax credit. We label this tax practice “strategic R&D classification”. We find a one standard deviation increase in strategic R&D classification leads, on average, to a 1.7% (1.5%) reduction in GAAP (cash) effective tax rates, suggesting this practice provides significant tax savings. However, we also find strategic R&D classification is related to both the level and changes in uncertain tax benefit liabilities required to be recognized under FIN 48, suggesting this practice comes with financial reporting costs. Our study contributes to the literature by documenting some of the costs and benefits associated with a previously unexplored tax strategy, and highlights the limitations faced by tax authorities in monitoring firms’ R&D tax credit.

Keywords: R&D Tax Credit, R&D, Tax Planning, Tax Avoidance, Tax Strategy

JEL Classification: G30, G32, M41

Suggested Citation

Laplante, Stacie Kelley and Skaife, Hollis Ashbaugh and Swenson, Laura and Wangerin, Daniel D., Limits of Tax Regulation: Evidence from Strategic R&D Classification and the R&D Tax Credit (December 10, 2018). Journal of Accounting and Public Policy, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3298889

Stacie Kelley Laplante

University of Wisconsin - Madison ( email )

975 University Avenue
Madison, WI 53706
United States
608-265-3494 (Phone)
608-265-3494 (Fax)

Hollis Ashbaugh Skaife (Contact Author)

Graduate School of Management, UC-Davis ( email )

Graduate School of Management
1 Shields Ave
Davis, CA 95616
United States

Laura Swenson

University of Wisconsin - Milwaukee ( email )

Bolton Hall 802
3210 N. Maryland Ave.
Milwaukee, WI 53211
United States

Daniel D. Wangerin

Wisconsin School of Business ( email )

975 University Avenue
4104 Grainger Hall
Madison, WI 53706
United States

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