IRS Attention

• Date: 01 March 2017
• Author: JACOB R. THORNOCK,BRADEN M. WILLIAMS,ZAHN BOZANIC,JEFFREY L. HOOPES
• DOI: http://doi.org/10.1111/1475-679X.12154
• Published date: 01 March 2017

DOI: 10.1111/1475-679X.12154

Journal of Accounting Research

Vol. 55 No. 1 March 2017

Printed in U.S.A.

IRS Attention

ZAHN BOZANIC,

∗JEFFREY L. HOOPES,

†

JACOB R. THORNOCK,

‡AND BRADEN M. WILLIAMS

§

Received 19 February 2015; accepted 11 September 2016

ABSTRACT

We study how public and private disclosure requirements interact to influ-

ence both tax regulator enforcement and firm disclosure. To capture IRS

enforcement activities, we introduce a novel data set of IRS acquisition of

firms’ public financial disclosures, which we label IRS attention. We examine

the implementation of two new disclosure requirements that potentially al-

ter IRS attention: FIN 48, which increased public tax disclosure requirements,

∗The Ohio State University; †University of North Carolina at Chapel Hill; ‡Brigham Young

University; §University of Texas at Austin.

Accepted by Douglas Skinner. Weare grateful for the insightful suggestions received from

an anonymous reviewer. Wealso appreciate comments from Sam Anderson, Darren Bernard,

Terrence Blackburne, Amoray Cragun, Mike Drake, Scott Dyreng, Alex Edwards (ATA dis-

cussant), Merle Erickson, Paul Fischer, Pete Frischmann, Kevin Holland (Oxford discussant),

Mike Iselin, Colin Koutney,Ed Maydew, Rick Mergenthaler, Lillian Mills, Michelle Nessa (Mid-

west Conference Discussant), Phil Quinn, Darren Roulstone, Jeri Seidman, Terry Shevlin, Lo-

rien Stice-Lawrence, Erin Towery (FARS discussant), and Jaron Wilde; workshop participants

at the University of Chicago, the University of North Carolina, the University of Minnesota,

and the University of Texas at Austin; and participants at the 2014 BYU Accounting Sympo-

sium, the 2015 AAA FARS Midyear Meeting, the 2015 ATAMidyear Meeting, the 2015 Midwest

Summer Research Conference, and the 2016 Oxford Academic Symposium. We are grateful

for data assistance from SECLive.com and, in particular, from Slavi Marinov. Thornock is af-

filiated with SECLive.com as an academic advisor. We gratefully acknowledge financial sup-

port from the Fisher College of Business, the Foster School of Business, the Kenan-Flagler

Business School, the Marriott School of Management, and the McCombs School of Busi-

ness. Neither the IRS nor the SEC have provided any of the authors with privileged data for

this paper or have reviewed the paper. This work is solely the responsibility of the authors.

An online appendix to this paper can be downloaded at http://research.chicagobooth.edu/

arc/journal-of-accounting-research/online-supplements. The IRS attention data are available

at http://www.jeffreyhoopes.com/data/irsattentiondata.html.

79

Copyright C, University of Chicago on behalf of the Accounting Research Center,2016

80 Z.BOZANIC,J.L.HOOPES,J.R.THORNOCK,AND B.M.WILLIAMS

and Schedule UTP, which increased private tax disclosure. We find that IRS

attention increased following FIN 48 but subsequently decreased following

Schedule UTP, consistent with public and private disclosure interacting to

influence tax enforcement. We next examine how private tax disclosure re-

quirements under Schedule UTP affected firms’ public disclosure responses.

We find that, following Schedule UTP, firms significantly increased the quan-

tity and altered the content of their tax-related disclosures, consistent with

lower tax-related proprietary costs of disclosure. Our results suggest that

changes in SEC disclosure requirements altered the IRS’s behavior with re-

gard to public information acquisition, and, relatedly, changes in IRS private

disclosure requirements appear to change firms’ public disclosure behavior.

JEL codes: G38; H25; H26; M40; M41; M48

Keywords: IRS; corporate disclosure; tax enforcement; FIN 48; UTP; XBRL

1. Introduction

We study how public and private disclosure requirements influence regula-

tory enforcement and firm disclosure. Firms are required to provide vari-

ous regulators with an array of financial disclosures, both publicly and pri-

vately. Many firms provide public mandated disclosures as required by the

Securities and Exchange Commission (SEC) and private tax returns to the

Internal Revenue Service (IRS). The combination of requirements to pub-

licly disclose some information and privately disclose other information to

regulators, which we label “regulatory interaction,” has two implications.1

First, the public information can provide additional data for regulators to

use in the enforcement process and to supplement regulators’ private in-

formation. Second, because firms are aware that their public information

can be accessed and used by regulators, they can alter their disclosures so

as to make them less valuable in the enforcement process. We develop and

test predictions based on these two implications.

To examine the impact of public and private reporting requirements, we

use a setting in which there are two changes in disclosure requirements: a

change to the public disclosure requirements that could be useful to the reg-

ulator’s enforcement activities, which is then followed by a change to the

private disclosure requirements mandated by the regulator who previously

relied on the public disclosure. The information is similar across these two

changes in disclosure requirements; thus the setting allows us to effectively

hold constant the information, but vary whether its dissemination is pub-

lic or private.2We then focus on how these changes to public and private

1In this study we focus on a tax regulator, but the notion of regulatory interaction is not

limited to a tax setting and could also be relevant to other government or industry regulators

that require public or private information from firms.

2We acknowledge that there are some important differences in the information required

by FIN 48 versus Schedule UTP (Uncertain Tax Positions), which we discuss in detail in

section 2.

IRS ATTENTION 81

disclosure affect the regulator’s enforcement activities and the firm’s dis-

closure activities.

The two disclosure changes we consider are FIN 48 and Schedule UTP

(Uncertain Tax Positions). FIN 48 was introduced in 2006 by the Financial

Accounting Standards Board (FASB) to require firms to publicly disclose

their contingent tax liability, which relates to the firm’s strategic tax po-

sitions that could, if audited by the IRS, lead to additional tax payments.

This change increased the tax-based disclosure available to investors, but

because the disclosure is public, the IRS may also use this information.

Schedule UTP was introduced in 2010 by the IRS to require firms to pri-

vately disclose the risky tax positions that underlie their contingent tax li-

ability. Thus, Schedule UTP required the private disclosure to the IRS of

information similar to what was publicly disclosed under FIN 48.

We introduce a novel data set that captures a portion of the IRS’s ac-

quisition of publicly available financial accounting reports over the period

2004–2014.3This data set captures IRS downloads of firms’ annual finan-

cial reports from EDGAR and allows us to observe the timing and frequency

with which the IRS accesses financial information. Unlike previous studies

that examine IRS enforcement activity using micro- or macro-data provided

by the IRS, we examine IRS activity using data derived independently of the

IRS.4Similar to the nomenclature in prior research using the EDGAR data

(deHaan, Shevlin, and Thornock [2015], Drake et al. [2016]), we label IRS

acquisition of financial reports as “IRS attention” from this point forward.

We first present cross-sectional, associative evidence on IRS attention.

Firm characteristics explain a large portion of the variation in IRS attention.

We find that firm size, profitability, and foreign exposure are positively as-

sociated with IRS attention, and leverage and cash holdings are negatively

associated with IRS attention. In terms of tax-related firm characteristics,

IRS attention is consistently positively related to unrecognized tax benefits

(UTBs), somewhat negatively related to GAAP effective tax rates (ETRs),

and positively related to deferred tax assets (DTAs).

We develop and test predictions on how public and private disclosure

requirements interact to influence IRS attention, using FIN 48 and Sched-

ule UTP as changes to public and private disclosure requirements, respec-

tively. Prior theoretical research posits that tax authorities choose to au-

dit/examine companies based on the costs and benefits of doing so (e.g.,

3These public data have been provided by the SEC and similar data have been employed

in other studies (e.g., Drake, Roulstone, and Thornock [2015], Lee, Ma, and Wang [2015]).

4Nearly all such papers in the literature obtained data directly from the IRS, or from sources

that obtain their data from the IRS (e.g., Mills [1998], Gleason and Mills [2002], Guedhami

and Pittman [2008], El Ghoul et al. [2012], Hoopes, Mescall, and Pittman [2012], Ayers,

Seidman, and Towery [2014], Hanlon, Hoopes, and Shroff [2014], Towery[2015]). Since we

only observe the IRS downloading 10-Ks, we do not know the extent or fashion in which they

are actually used. An underlying assumption in this paper is that information acquisition is tied

to information usage, based on the intuition that it is unlikely that the IRS would download

10-Ks without them playing some role in the enforcement process.