Empirical implications of incorrect special item tax rate assumptions

Review of Accounting Studies, forthcoming

Posted: 6 Dec 2021

See all articles by William M. Cready

William M. Cready

University of Texas at Dallas - Naveen Jindal School of Management

Thomas J. Lopez

University of Alabama - Culverhouse School of Accountancy

Craig A. Sisneros

Oklahoma State University

Shane Stinson

University of Alabama

Date Written: November 30, 2021

Abstract

The use of assumed tax rates to adjust special items (e.g., restructuring charges, asset writedowns, etc.) is common in empirical accounting research, as these items are reported pre-tax and are often used in research designs that include after-tax earnings. This study aims to explore the potential empirical consequences of assuming an incorrect tax rate in adjusting special items. We focus our investigation on special items, given both their prevalence in the literature as well as the wide variation in tax rate assumptions from these studies. Our investigation shows that the tax rate assumed can be critical to the interpretation of results. Importantly, our evidence suggests extreme tax rate assumptions, in particular the highest statutory rate, are especially problematic and yield dramatically biased estimates. Our review of the tax consequences of special items suggests that, in almost all circumstances, the marginal tax rate is the theoretically correct rate to apply to these items when adjusting for tax. Consistent with this view, our empirical evidence, with a limited exception, suggests that marginal tax rates represent the best estimate of the true tax rate. By providing empirical evidence on the potential empirical consequences of these varied tax rate assumptions, we offer a guide for future researchers on the importance of this critical design choice.

Keywords: Special items; nonrecurring items; assumed tax rates; marginal tax rates

JEL Classification: M40, M41, H25, H32

Suggested Citation

Cready, William M. and Lopez, Thomas J. and Sisneros, Craig A. and Stinson, Shane, Empirical implications of incorrect special item tax rate assumptions (November 30, 2021). Review of Accounting Studies, forthcoming, Available at SSRN: https://ssrn.com/abstract=3974943

William M. Cready

University of Texas at Dallas - Naveen Jindal School of Management ( email )

P.O. Box 830688
Richardson, TX 75083-0688
United States

Thomas J. Lopez (Contact Author)

University of Alabama - Culverhouse School of Accountancy ( email )

Culverhouse College of Business
Tuscaloosa, AL 35487-0223
United States
205-348-2907 (Phone)

Craig A. Sisneros

Oklahoma State University ( email )

Spears School of Business
397 Business Building
Stillwater, OK 74078-4011
United States
4057449718 (Phone)

HOME PAGE: http://https://business.okstate.edu/directory/sisneros-craig-833239.html

Shane Stinson

University of Alabama ( email )

101 Paul W. Bryant Dr.
Box 870382
Tuscaloosa, AL 35487
United States

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