ABSTRACT

Our study examines how the uniform rules of FIN 48, which governs accounting for income tax uncertainty, affect the relevance of income tax accounting. By requiring all firms to follow the same recognition and measurement process, the FASB intended FIN 48 to improve the relevance of income tax accounting. However, practitioners argue that reserves reported under FIN 48 lack relevance because they represent liabilities that will never be paid to tax authorities. Consistent with these concerns, we estimate that over a three-year period, only 24 cents of every dollar of reserves unwind via settlements. Moreover, contrary to the FASB's intention, we find no evidence that FIN 48 increased the ability of tax expense to predict future tax cash flows. Rather, we find that the predictive ability of tax expense for future tax cash flows decreases among firms for which FIN 48 is most restrictive. Finally, we find no evidence that investors identify firms for which reserves overstate future tax cash outflows and incorporate this into their valuations. Our results provide evidence that the uniform accounting rules of FIN 48 negatively affect the relevance of income tax accounting.

JEL Classifications: H25; M41; M48.

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