Identifying Tax-Induced Earnings Management Around TRA 86 as a Function of Prior Tax-Aggressive Behavior.

Abstract This study extends previous research examining how conflicts between tax and financial reporting are resolved. A variable reflecting a firm's propensity to engage in tax-minimizing behavior is developed to augment previous models used to explain shifts in discretionary current accruals resulting from the tax rate reductions contained in the Tax Reform Act of 1986 (IRA 86). The paper provides evidence consistent with the following predictions: (1) the probability of making a negative discretionary current accrual shift in the year prior to the tax rate change is directly related to tax-aggressiveness; (2) tax-aggressive firms will make greater negative discretionary current accrual shifts in the year prior to the tax rate reduction than other firms; and (3) the magnitude of the shift in negative discretionary current accruals is a function of the rate change faced by the firm.