Unrecognized tax benefit and its impact on firms’ financial activities: A longitudinal analysis

• Published date: 01 July 2021
• Author: Yi Ren,Chialing Hsieh
• Date: 01 July 2021
• DOI: http://doi.org/10.1002/jcaf.22506

Received:  May  Accepted:  May 

DOI: ./jcaf.

RESEARCH ARTICLE

Unrecognized tax benefit and its impact on firms’ financial

activities: A longitudinal analysis

Yi Ren1Chialing Hsieh2

Department of Accounting, College of

Business, Illinois State University,

Normal, Illinois, USA

Department of Accounting, Finance,

and Business Law,Soules College of

Business, The University of Texasat Tyler,

Tyler , Texas, US A

Correspondence

ChialingHsieh, PhD, Department of

Accounting,Finance, and Business Law,

SoulesCollege of Business, The University

ofTexas at Tyler,Tyler,TX , USA.

Email:chsieh@uttyler.edu

Abstract

Our study investigates the unrecognized tax benefit (UTB) across firms and its

impact on the firm’s financial activities using the generalized estimating equa-

tions (GEEs). We find the UTB variation across firms is largely related to the

firms’ operation characteristics and firms with higher UTB balances are more

likely to overstate their uncertain tax positions (UTPs). Also, we find that UTB

balances are positively associated with firms’ cash holding and employee stock

compensation expenses. Our results provide evidence that UTB has become an

important financial disclosure and have affected firms’ financial operations.

KEYWORDS

unrecognized tax benefit, uncertain tax position, panel data, longitudinal analysis, generalized

estimating equations

1 INTRODUCTION

In an attempt to increase relevance and comparability in

financial reporting of uncertain tax positions, the Finan-

cial Accounting Standards (FASB)issued an Interpretation

No.  (commonly known as FIN  and now incorpo-

rated in ASC -). Prior to FIN , firms used diverse

criteria to determine whether uncertain tax return bene-

fits should be recognized in their financial statement.FIN

 standardizes the method of accounting for recognition

and measurement of uncertain tax benefits (UTBs), and

requires companies disclose UTBs for uncertain tax posi-

tions (UTPs) claimed on tax returns that are not permit-

ted to be recognized in financial statements. Accordingly,

UTBs are the difference between the amount of tax benefits

resulting from tax positions and the amount recognized on

financial statement per the FIN  analysis. An UTB is clas-

sified as a liability which shall not be combined with other

deferred tax assets and deferred tax liabilities (see FIN 

Summary).

FASB Summary of Interpretation No. . https://www.fasb.org/

summary/finsum.shtml

Before the implementation of FIN , there was little

publicly-available information on tax reserve to address

UTPs a corporation claimed (Blouin et al., ; Blouin &

Robinson ). FIN  mandates UTB reporting related

to UTPs and thus increases disclosure of such tax reserve

information (Gleason et al., ). Figure shows the aver-

age UTB balance of S&P  companies for each fiscal year

between  and .The average UTB balance at the

end of fiscal year  is more than $ million, an aver-

age increase rate of more than % compared to year ,

while the average assets of S&P  companies have an

increase rate of % in the same period. The magnitude

and the increase rate indicate that UTBs have been playing

an increasingly vital role in the financial reporting recently.

Further,not all firms report UTBs and there is considerable

UTB variation across firms. Tech firms often claim R&D

tax credits and multinational companies frequently adopt

transfer pricing practices to cross-border transactions as

well as intellectual property such as research, patents, and

royalties that could increase UTPs. In this study we inves-

Companies in financial sector are excluded.

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