Earnings Management of Firms Subject to the Alternative Minimum Tax.

This study examines the extent to which reported earnings were managed in response to the book income adjustment component of the alternative minimum tax (AMT). A sample of 151 non-financial firms subject to the AMT was identified using the NAARS database. These firms were partitioned by their relative incentive to respond to the book income adjustment. Earnings management was operationalized using accruals related to long-lived assets (depreciation, amortization, and depletion). The results indicate that certain firms managed accruals to minimize the cost of the AMT. These results are consistent across three alternate calculations of discretionary depreciation accruals. This finding corresponds with the view that firms altered their reporting behavior in response to the AMT and supports concerns expressed by policy-makers. Consistent with the evidence reported in Gramlich (1991) and Dhaliwal and Wang (1992), limited evidence is found of anticipatory earnings management in the year preceding the imposition of the AMT. After including variables to control for other possible factors that might motivate firms to manage earnings (leverage, firm size, and bonus scheme variables), the tax variable continues to be significant in its predicted direction.