JATA - Spring 1985

Volume 6, No. 2

Salience of Tax Evasion Penalties Versus Detection Risk

Betty R. Jackson and Sally M. Jones


The sanction structure of the income tax system of the United States involves two primary elements: risk of detection and magnitude of penalty. Either element may be varied to alter the expected cost of tax evasion. The government has changed both elements with little explicit recognition of the behavioral implications of such changes. This paper develops a hypothesis based on Kahneman and Tversky's prospect theory with respect to the sensitivity of individuals toward risk of detection versus magnitude of penalty. The results of a laboratory experiment designed to test the hypothesis are reported. The experiment provides evidence that the magnitude of a penalty should be more closely examined as a component in the tax evasion sanction structure. The implications of these findings on the structure of future research also are discussed.

Incorporating Probability Analysis In Taxpayer Appeal Decisions

Judy L. Porcano and Thomas M. Porcano


The decision to appeal an IRS determination in the courts is well-suited for formal quantitative analysis techniques. Specifically, conditional probability analysis and net present value models can be combined to provide the taxpayer with a framework to analyze the appeals decision and compare expected results with other alternative uses of the funds necessary to appeal the issue. In addition, the framework can be quite useful in performing sensitivity analysis to determine the magnitude of changes in expected final settlements due to changes in certain variables. This article presents the development of decision models based upon this analysis and a specific application of the models to display their usefulness in helping to reduce the uncertainty associated with the appeal decision. Overall, the application of this framework to the taxpayer appeal decision appears to be very fruitful and enhances the taxpayer's decision-making ability.

The Security Market Reaction to Tax Legislation as Reflected in Bond Price Adjustments

Allen W. Bathke, Jr., Richard L. Rogers, and Jerrold J. Stern


This study analyzes the impact of four tax acts on flower bond prices using a capital markets methodology. While the four tax law changes were not intended specifically to affect the desirability of flower bonds, the estate planning value of the bonds was affected. Moreover, financial institutions investing in these bonds experienced shifts in wealth as a result of the tax law changes. This research focuses on the timing and the extent to which the complex tax law information was impounded into the prices of these specialized securities. The results indicate that security prices did react to the tax law changes as hypothesized, but that the period of the price adjustment process was lengthy. The results are mixed with respect to whether the market reaction commenced on a timely basis.

Alternate Indexing Schemes for Nonbusiness Income Taxation: Distributional and Revenue Effects

Barbara A. Ostrowski


Nineteen eight-five will mark the advent of an indexed tax system in the United States. This indexation will affect only bracket (including the zero bracket) and exemption amounts. Tax policy analysts have suggested indexing other inflation-affected items such as capital asset transactions. In this research study, various indexation models are developed and their distributional and revenue effects are compared for four groups of taxpayers. The least revenue was derived for the ERTA Model (named for the corresponding legislation), the simplest of the indexation models.

Obtaining and Preserving Tax-Exempt Status under Section 501(c)(3): Judicially Developed Factors for Detecting the Presence of Substantial Nonexempt Activities

Paul J. Steer


In order to obtain and maintain tax-exempt status under Code Section 501(c)(3), an organization must not engage in any nonexempt activity in a substantial way. Since no definitive legislative or administrative guidelines have been delineated to determine if this constraint has been violated, the courts have been forced to arbitrate on this matter. The objective of this research is to extract and evaluate the criteria used by the courts to gauge the presence of substantial nonexempt activities. An analytical review of the leading cases in this area was conducted. A total of nine separate factors were found to have been applied consistently by the judiciary. These factors may be utilized as a device to forewarn an exempt entity of the presence of substantial nonexempt activities. Additionally, the model can serve as a tool in identifying and evaluating the issues that the courts will examine if litigation becomes necessary.

Profile of Tax Dissertations in Accounting: 1967-1984

Gerald D. Brighton and Robert H. Michaelsen


The purpose of this paper is to provide classification information on tax dissertations in accounting. In order to accomplish this purpose, the abstracts of 224 tax dissertations in accounting that were completed during the 18 years form 1967-1984 were analyzed. These dissertations were classified in terms of subject matter and data collection methodologies. The subject of 148 (66 percent) of the dissertations was tax policy, leaving 76 (34 percent) in other areas. The historical approach was the dominant data collection methodology used (i.e., data retrieval from library materials, tax records, data banks, etc.). This approach accounted for 135 (60 percent) of the dissertations. Data creation by experimental methods accounted for 46 dissertations (21 percent). Of these, 40 were by simulation, all in the last 13 years. The remaining 43 (19 percent) used a field approach, of which 28 were questionnaires. Most tax accounting dissertations are inter-disciplinary, drawing on accounting, law, economics, psychology, and political science for subject matter or methodologies.