American Taxation Association

JATA abstracts - Spring 2006

JATA - Spring 2006

Volume 28, No. 1

A Model of Dynamic Tax Planning with an Application to Estate Freezes
Kenneth J. Klassen and Richard C. Sansing

The Effects of the Cost of Foreign Internal Funds on the Probability That a Firm Issues Domestic Debt
Susan M. Albring

Do Managers Use the Valuation Allowance Account to Manage Earnings around Certain Earnings Targets?
Mary Margaret Frank and Sonja Olhoft Rego


A Model of Dynamic Tax Planning with an Application to Estate Freezes

Kenneth J. Klassen and Richard C. Sansing

Abstract

This paper develops a model of dynamic tax planning in which the implementation of a tax plan involves exercising an option to execute an irreversible investment or financing structure transaction. The model considers four aspects of such transactions and shows that transactions are deferred if the tax savings from the transaction are lower or if the time horizon over which the transaction can be executed is longer. Deferral is also increasing in cost of a future unfavorable event to which the irreversibility of the transaction limits one's ability to respond, but may increase or decrease with a change in the probability that an unfavorable event occurs. We apply the model to a common estate freeze tax plan in Canada. Undertaking an estate freeze requires a private company's owner-manager to choose how one's business assets are to be distributed at death. In contrast to the conventional wisdom regarding the timing of this strategy, we find that waiting to implement the strategy is often optimal. We test the model using data on family-owned businesses in Canada and find strong support for the model's predictions.  Top


The Effects of the Cost of Foreign Internal Funds on the Probability That a Firm Issues Domestic Debt

Susan M. Albring

Abstract

This paper investigates whether U.S. multinational firms' use of domestic debt to fund investments depends upon their cost of foreign internal funds. The pecking order theory predicts that firms should generally prefer internal funds as a financing source over debt. Holding total internal funds constant, I investigate an exception to this general relation by examining whether firms are more likely to issue domestic debt as the tax cost of their foreign internal funds increases. Using a sample of 268 firmyears, I find that the probability of firms with non-binding foreign tax credit limitations using domestic debt relates positively to their permanently reinvested earnings. This finding contributes to the literature by suggesting that tax and financial reporting costs associated with foreign repatriations influence firms to forgo internal funds as a fi- nancing choice in favor of debt.  Top


Do Managers Use the Valuation Allowance Account to Manage Earnings around Certain Earnings Targets?

Mary Margaret Frank and Sonja Olhoft Rego

Abstract

This paper provides additional evidence on earnings management via the deferred tax asset valuation allowance account (VAA). Earlier publications that do not find evidence of earnings management via the VAA examine contractual incentives using broad samples. A more recent publication finds evidence consistent with earnings management via the VAA but examines capital-market-based incentives using a homogeneous sample. To bridge the gap between these studies, we exploit a heterogeneous sample over an extended time period but examine capital-market-based incentives to manage earnings. The results provide substantial evidence that firms use the VAA to smooth earnings toward the mean analyst forecast. However, the results do not provide evidence that firms use the VAA to smooth earnings toward positive or prior year's reported earnings targets or engage in "big bath" behavior for any of the earnings targets.  Top

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