The Determinants and Consequences of Rounded Estimated Annual Effective Tax Rates

Abstract

I document a novel empirical observation: firms’ estimated annual effective tax rates (ETRs), which are used to record tax expense each quarter, occur unexpectedly often at rounded decimal values of .00% and .50%. I argue that these rounded values—which occur in 32% of firms—appear less consistent with the detailed tax estimation processes illustrated in accounting guidance. I assess the extent to which the tax information for these firms is less relevant or remains materially sufficient by examining whether rounded rates reflect management opportunism, the difficulty of the estimation process, and firm-specific resources and procedures. I do not find that these rounded rates are used opportunistically, but rather that they are used when tax calculations are relatively simpler and that they reflect a subgroup of firms that likely routinely rely on rounding heuristics or less detailed internal tax calculations. Consistent with this proposed simplicity, I also find that these firms’ estimated annual ETRs more accurately predict their year-end ETRs and that this predictability is reflected in analysts’ tax forecasts, which have lower dispersion and greater accuracy for these firms. While the frequency of rounded estimated annual ETRs is unexpected, I generally do not find that rounded rates are associated with adverse consequences, but rather reflect sufficient tax estimates for firms with relatively simpler tax situations