DOES THE IRS PAY ATTENTION TO CASH TAX AVOIDANCE?

Abstract

The extant literature documents an insignificant association between cash tax avoidance and IRS enforcement as proxied by the frequency of the IRS’s downloads of annual reports. This result is puzzling given the IRS’s interest in curbing tax avoidance and several stakeholders’ perception of cash tax avoidance garnering undesirable IRS scrutiny. To shed light on this puzzle, we posit that the IRS focuses its enforcement efforts on only the cash tax-avoiding firms that are likely to yield favorable enforcement outcomes to the IRS such as levied interests and penalties. Consistent with this view, we provide evidence of a significant positive association between cash tax avoidance and the IRS's acquisitions of the 10-Ks hosted on EDGAR when firms are profitable both in the current year and in the past. We further document a more pronounced effect for large firms and firms with foreign operations. In addition, using IRS budgets as an instrument for IRS attention, we find that the firms that are the subject of incremental IRS attention (i.e., consistently profitable and large) have greater future cash tax payments. Overall, our findings support substantial IRS scrutiny of the financial statements of cash tax-avoiding firms when the firms will likely pay back taxes, interest, and penalties to the IRS. Our evidence speaks to the seemingly lax IRS enforcement espoused by the media and civil society organizations and suggests a rather more efficient enforcement process underlies this perceived laxity.