Corporate Tax Compliance:
The Role of Internal and External Preparers
Kenneth Klassen, Univ. of Waterloo
Petro Lisowsky, Univ. of Illinois
Devan Mescall, Univ. of Saskatchewan
2012 IRS Research Conference
June 21, 2012
Disclaimer
Confidential tax return data are obtained from the IRS via the
Large Business & International Division. These data are not
publicly available.
Because tax return data are confidential and protected by data
non-disclosure agreements under the Internal Revenue Code,
all statistics are presented in the aggregate; no statistics with
three or fewer observations are disclosed.
Any opinions are those of the authors and do not necessarily
reflect the views of the Internal Revenue Service.
Overview
• How do companies incorporate tax incentives into
their decisions?
• What is the process that leads some companies to
use aggressive tax strategies?
• Does the tax advisor matter?
– If the company internally prepares, will it report
differently for tax purposes?
– Is there a difference between external advisors depending
on if they are also the auditors?
Research questions
• Specific questions addressed
① Do internally-prepared tax returns differ from those
with an external advisor?
② Do auditor firm preparers differ from other preparers
in the aggressiveness of the resulting tax positions?
③ Can we infer tax compliance work from public tax fee
data?
Why are these questions important?
• The role of tax advisors is important to the
working of the tax system
– Renewed focus by IRS on role of preparers
• Tax advisory role is significant
– $816 M in Tax Fees paid to Auditors in our sample
– Role of preparers in individual and non-profit
settings; little known in corporate setting
• Tax fees are used extensively in research
– What do they suggest about tax compliance work, if
anything? Can we use them? If so, how?
Survey
• Tax Executives Institute Survey
– October - December 2010
– 8.1% response rate
– Our respondents: slightly larger than TEI population
– Tool to “look inside” the corporate tax department
Theory
• Why choose one preparer over another and how
does this affect tax reporting outcomes?
• Phillips and Sansing (1998)
• Taxpayers have an aversion to audit adjustments
– Affects whether taxpayers file favorable position if
uncertain; more averse taxpayers will not file favorably.
Theory
• Low Aversion  Internally Prepare
– Fees paid to hire advisor are greater than the benefit of
certainty from advisor’s research
– Internally prepared returns signal favorable positions
• Medium/High Aversion  Hire External Advisor
– Research causes favorable or unfavorable filing
• H1: Tax returns filed w/o external preparer will be
more aggressive than those filed w/external preparer
Theory
• Cripe and McAllister (2009) survey:
– “Low Cost” was #1 reason to use auditor as preparer
– 31% pay higher fees by foregoing auditor as preparer
– To be rational, benefits from external non-preparer must
exceed incremental cost: “preparer quality” was #2 reason
to not purchase tax services from auditor.
• If external non-auditors are higher quality, marginal
taxpayers can report more favorably when uncertain.
• H2: Tax returns filed with a non-auditor external
preparer will be more aggressive than those filed with
an auditor preparer.
Research Design
Log(UTB EB) =
f(INTERNAL PREP, OTHER PREP, Controls)
• OLS, Tobit, Multinomial Treatment Effects
• Tax Return, Compustat, FIN 48 disclosures,
Audit Analytics
Who Signs the Tax Return?
External Tax Preparer:
is the Auditor
312 (20%)
is not the Auditor 378 (25%) 81% disclose tax fees
paid to the auditor
Total External
690
Internal Tax Dept.
843 (55%)
Main Results
OLS
Tobit
Selection
Internal Prep
Other Prep
0.29 **
0.35 ***
0.22 *
0.27 *
0.67 ***
0.55 **
Log Assets
Tax reserve is
Pretax ROA
29-67% higher
Foreign
Income Prep
for Internal
NOL
0.92 ***
0.96 ***
0.90 ***
-0.46
-0.54
-0.41
Tax **
reserve is
3.27
22-55%
0.28
*** higher
for Other Prep
2.60 **
3.48 ***
3.48 **
0.28 ***
0.30 ***
R&D
2.50 **
2.54 *
Leverage
0.08
0.11
0.05
1,533
1,533
1,533
n
R2
60% ***
21% ***
Selection Model
Internal Prep
Log Assets
Pretax ROA
Foreign Income
NOL
R&D
Leverage
Non-tax fee ratio
n
0.66 ***
Other Prep
-0.13
-0.34
5.15 *
-0.26
-5.06 *
0.80
-1.64 *
-0.88
-0.18
0.08
2.51
-0.08
-2.07 *
843
378
Analysis with Tax Fee Data
• Because only tax fees paid to auditors are publicly
disclosed, many have used them
– As a proxy for tax planning level, use of the auditor for
compliance, or other features
• We attempt to replicate our results using tax fees
– Are tax fees a reasonable proxy to infer compliance?
• We cannot replicate the positive coefficient using
tax fee data to infer tax preparer
Benchmark: Using Tax Returns
Non Auditor Prep
All Controls
Adj./Pseudo R2
n
OLS
Tobit
0.26 **
0.32 **
YES
60% ***
1,533
YES
20% ***
1,533
Non Auditor Prep = 1
if
Internal Prep=1 or Other Prep = 1
Iterations: Using Tax Fees
Non Auditor Prep=1 if
OLS
Tax Fees=0
Tax Fees/Total Fees < 1%
-0.01
-0.03
-0.06
-0.06
Tax Fees/Total Fees < 5%
Tax Fees/Total Fees < 10%
-0.14 *
-0.13
-0.14
-0.13
Tax Fees/Total Fees < 25%
Tax Fees/Total Fees < 50%
-0.30 **
0.86
-0.35 ***
1.17
Tobit
Classification Accuracy
10-K suggests
non-auditor
prepares, but
auditor prepares
10-K suggests
auditor prepares,
but a non-auditor
prepares
Conclusion
• Companies choose a variety of preparers, but most do
compliance and planning work internally
• Relative to companies with external auditor preparers
– Companies with internally prepared returns are more tax
aggressive
– Companies with external non-auditor prepared tax returns
are also more tax aggressive
• Tax-fees are not sufficient to infer tax compliance work
– 20-62% inaccuracy rate
Thank You!
lisowsky@illinois.edu