Assessing Tax Risk : Practitioner Perspectives

This study uses insights from tax practitioners and tax authorities to define and develop an ex-ante estimate of tax risk that is independent of common tax outcomes studied in the literature. Validation tests confirm that our tax risk measure (1) captures the predictable and unpredictable uncertainty inherent in the three sources of tax risk (i.e., economic risk, tax law uncertainty, and inaccurate information processing) and (2) represents a construct different from current academic tax avoidance, tax uncertainty, and general business risk measures. We then use the tax risk measure to answer two research questions. First, we find a significant, negative association between tax risk and future long-run cash effective tax rates. Second, we demonstrate that our tax risk measure explains a substantial portion of unrecognized tax benefits, incremental and relative to measures of information risk, conditional conservatism, unconditional conservatism, and tax avoidance. Our study offers a measure of tax risk that, consistent with Scholes-Wolfson, reflects the tax risk inherent in all business activities, not just tax avoidance activities, has unique industry effects, and contributes to our understanding of the factors that affect tax planning decisions and result in variation in firms' effective tax rates. We enhance future tax research by improving the internal, external, and construct validity of tax risk