Short Term Incentive Effects of a Reduction in the NOL Carryback Period

The Journal of the American Taxation Association, Vol. 33, Issue 2, pp. 67-87, Fall 2011

Posted: 28 Mar 2011 Last revised: 29 Jan 2012

See all articles by Susan Albring

Susan Albring

Syracuse University - Joseph I. Lubin School of Accounting

Dan S. Dhaliwal

University of Arizona - Department of Accounting (deceased)

Inder K. Khurana

University of Missouri at Columbia - Robert J. Trulaske, Sr. College of Business

Raynolde Pereira

University of Missouri at Columbia - School of Accountancy

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Date Written: March 21, 2011

Abstract

The Taxpayer Relief Act of 1997 (TRA 1997) reduced the net operating loss (NOL) carryback period from three to two years, thereby creating a short term incentive effect due to the increased opportunity cost of not recognizing a NOL in the transitional fiscal year of 1997. Specifically, failure to recognize a NOL in 1997 results in the loss of recovery of taxes paid in two prior tax years as opposed to the usual forgone recovery of taxes paid for a single tax year. In light of this higher opportunity cost, we examine whether these firms undertook income shifting to accelerate loss recognition in the tax year 1997. Our findings support this prediction. Compared to a control sample of loss firms, we find the NOL firms in the treatment year of 1997 display higher (lower) levels of income decreasing (increasing) earnings management. To further identify the incentive effect, we focus strictly on the NOL firms in the transition year. We find firms with higher incremental opportunity costs undertook greater income shifting to accelerate loss recognition. Among the treatment firms, we also identify firms for which income shifting to accelerate loss recognition is feasible (i.e., firms for which analysts expect future losses). We find a higher level of earnings management among these firms. Overall, our study highlights the influence of tax incentives on firm reporting behavior. While much of prior research focuses on tax effects arising from tax rate changes, we study how changes in tax law provisions can also create incentive effects which may not be readily apparent.

Keywords: Taxpayer Relief Act of 1997, Net Operating Loss, NOL, NOL Carryback Period, Short Term Incentive, Income Shifting, Earnings Management, Tax Incentives, Loss Recognition

JEL Classification: M41, H25

Suggested Citation

Albring, Susan M. and Dhaliwal, Dan S. and Khurana, Inder and Pereira, Raynolde, Short Term Incentive Effects of a Reduction in the NOL Carryback Period (March 21, 2011). The Journal of the American Taxation Association, Vol. 33, Issue 2, pp. 67-87, Fall 2011, Available at SSRN: https://ssrn.com/abstract=1792889

Susan M. Albring (Contact Author)

Syracuse University - Joseph I. Lubin School of Accounting ( email )

900 S. Crouse Avenue
Syracuse, NY 13244-2130
United States

Dan S. Dhaliwal

University of Arizona - Department of Accounting (deceased)

Inder Khurana

University of Missouri at Columbia - Robert J. Trulaske, Sr. College of Business ( email )

331 Cornell Hall
Columbia, MO 65211
United States
573-882-3474 (Phone)
573-882-2437 (Fax)

Raynolde Pereira

University of Missouri at Columbia - School of Accountancy ( email )

337 Cornell Hall
Columbia, MO 65211
United States
573-882-6253 (Phone)

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