JATA - Spring 1993

Volume 15, No. 1

An Empirical Investigation of the Effects of Advocacy on Preparers' Evaluations of Judicial Evidence

Linda M. Johnson


This study reports the results of a laboratory experiment in which 109 tax professionals evaluated evidence related to an ambiguous area of the tax law. Prior researchers using archival data found that preparers act as advocates in ambiguous areas of the tax law. This study examines whether tax preparers weight supportive evidence more heavily than opposing evidence when evaluating evidence and the degree to which advocacy contributes to this phenomenon. The results support the contention that the advocacy role contributes to tax preparers' use of confirmatory processes in their evaluations of judicial evidence. The results also suggest that the degree of advocacy preparers display may affect the strength of their recommendations to clients.

Corporate Characteristics Associated with Master Limited Partnership Formation

William D. Terando and Thomas C. Omer


In this study we investigate the extent to which several corporate characteristics, such as debt level, tax costs, and cash flow, are associated with corporate formation of Master Limited Partnerships. Congress and the popular press suggest that tax savings was the sole motivation for using the MLP form. As a result, Congress's concerns about the demise of the corporate tax base led to new rules that changed MLP taxation from partnership to corporate for most publicly traded MLPs. The results of this study suggest that before 1986, both debt level and tax benefits appear to have influenced MLP formation. In 1987, debt level and cash flow are important predictors of MLP formation. The strongest result for all periods appears to be the difference in debt levels between firms that formed MLPs and those that did not. The lower tax costs of MLPs alone will not induce a wholesale defection from the corporate form.

Measuring Explicit Tax (Dis)Advantage for Corporate Taxpayers: An Alternative to Average Effective Tax Rates

Patrick J. Wilkie and Stephen T. Limberg


Studies using the average effective tax rate (ETR) to measure corporate tax (dis)advantage have played a critical role in tax legislation. Recent research, however, has questioned the effectiveness of the ETR for this purpose. In this study we extend that line of research in two ways. First, we assess the availability and reliability of the ETR as a measure of tax (dis)advantage. Second, we develop an alternative statistic to the ETR. We empirically test the alternative statistic against the ETR in a replication of the U.S. General Accounting Office study of the effect of the 1986 Tax Reform Act on corporate tax (dis)advantage.

Our empirical results indicate that the ETR is often unavailable, and when it is available, it is not reliable as an indicator of cross-firm and through-time differences in tax (dis)advantage. Further, we show that a more direct measure of tax (dis)advantage, the tax subsidy on equity statistic (TSE), can be computed for almost all firm-years and is better able to identify firms that are more or less tax-advantaged. These findings should allow policymakers to enact more effective legislation and enable researchers to construct experiments that have greater power and more internal validity.

New Evidence on "Secondary Evasion"

Charles W. Christian and Sanjay Gupta


In this study we provide new evidence on "secondary evasion," the phenomenon associated with the clustering of tax returns at the top of the $50 tax table brackets. Based on data from 1979-86 we find that this phenomenon persists over time, under different table structures, and over a larger range of income than previously studied. We also examine the association of this phenomenon with several tax policy variables and certain taxpayer characteristics. Based on regression models estimated with longitudinal data, we find a positive effect for marginal tax rates and opportunity, and a negative association with income and age.

Optimal Funding of Qualified Pension Plans

Brian Greenstein and Roland Lipka


Over-funding of qualified pension plans may cause the marginal tax rates applied to the distributions from such plans to exceed the rates applied to the earnings from which the pension contributions were made. This is due to the graduated tax structure, the 15 percent excess distribution tax, and the possible exposure of social security benefits to taxation. When this occurs, continued use of qualified retirement savings can be suboptimal. We report results for 162 different tax scenarios by varying interest rates, number of years to retirement, the amount saved, marginal tax rates during employment and the initial balance in the pension plan. We find that planning opportunities do exist (in over one-third of our scenarios) and that the planning problem, rather than being isolated to a narrow set of predictable fact patterns, is pervasive.

The Use of Nonparametric Methods in Tax Research

Jean D. Gibbons


Nonparametric statistical methods should be used in tax research whenever the assumptions of classical statistics cannot be verified or the data are based on a ranking (an ordinal scale), as with Likert scale measurements. This paper discusses the advantages of using the nonparametric counterparts in place of many popular classical tests. The appropriate uses of three nonparametric procedures--the rank correlation coefficient, Kendall's coefficient of concordance, and the Wilcoxon signed rank test--are explained in detail and are illustrated using data reported by Porcano (1987) concerning the effectiveness of government tax incentives to encourage investment in fixed assets. The results verify and extend Porcano's conclusions.

The Accuracy and Adequacy of Tax Data in COMPUSTAT

Michael R. Kinney and Edward P. Swanson


The accuracy of the amounts reported by Standard & Poor's Compustat Services, Inc. (COMPUSTAT) in 19 tax fields is examined. The error rate varies widely, although it is generally higher for items reported in the footnotes than for items reported on the income statement or balance sheet. The error rates are higher for utilities and when special items are reported on the income statement below income from continuing operations. These special items include the use of an NOL carryforward, discontinued operations, cumulative adjustments, and extraordinary items. In addition to errors, researchers should be aware of COMPUSTAT's coding policies. Under some circumstances (as discussed in the paper), a field may indicate an amount is missing when an amount is reported in the financial statements. This is particularly true for the breakdown of current and deferred taxes into federal, state, and foreign components. The usefulness of the NOL carryforward field is also limited by COMPUSTAT's coding policies and errors.

Optimal Use of the Marital Deduction in Estate Tax Planning

Richard P. Weber


Married couples can save up to $1,052,000 in estate taxes through optimal combination of the transfer tax rate schedule, the unified credit, and the marital deduction. In the special case in which both deaths occur relatively close together (zero to ten years apart), larger tax savings can be achieved by also taking advantage of the credit for prior transfers. For example, over two million dollars in savings can be achieved on a total estate of $20 million, if both spouses die within two years of each other. Arranging one's financial affairs to achieve these savings makes sense in some situations and is not worthwhile in others. In this paper the methods for achieving these savings and the optimal level of savings in various situations are illustrated. Flexible methods for achieving the optimal levels of savings depending on the actual pattern of the couple's deaths are also discussed.