Write-Off: The Tax Blog

Financial Accounting Income Should Not Be Included as Part of the Tax Base: Statement for the record, U.S. Senate Committee of Finance

Monday March 29, 2021 • Jeff Hoopes, UNC

Last week the Senate Finance Committee held a hearing on How U.S. International Tax Policy Impacts American Workers, Jobs, and Investment. There was some discussion of taxing book income, at about 1:42:00. The eminent Fabio Gaertner and I decided to write an official statement for the record about including financial accounting income income in the tax base, and, submitted it as part of the official record associated with the hearing. Following is our full statement:

Financial Accounting Income Should Not Be Included as Part of the Tax Base

Statement for the record regarding “How U.S. International Tax Policy Impacts American Workers, Jobs, and Investment” U.S. Senate Committee of Finance, March 25, 2021

Fabio B. Gaertner, University of Wisconsin-Madison

Jeffrey L. Hoopes, University of North Carolina

Recently proposed tax policies have financial accounting income (GAAP income, or book income) serve as part of the tax base. These proposals range from a flat tax on book income for corporations above a certain size,[1] to using book income as part of a minimum tax for corporations above a certain size.[2]

We oppose including financial accounting income in the tax base. Our opposition stems from (a) the academic literature in accounting, which identifies clear negative effects associated with taxing financial accounting income; and (b) additional negative effects, though not yet empirically tested, which seem highly plausible given what we do know about incentives faced by corporations.

In short, including financial accounting income in the tax base will result in worse financial information for investors and less efficient tax collection, economically disadvantage companies based in the United States, politicize accounting standards, and require highly complex implementation, which may undermine the intention of current proposals. These arguments can be further understood below.

  1. Reduced information to investors and less efficient tax collection.


  • Financial accounting income and taxable income serve distinct audiences, and as such, different purposes. The goal of financial accounting rules is to communicate useful financial information to investors. The objective of tax rules is to raise revenue and establish economic incentives deemed desirable by the political process (Hanlon and Shevlin 2005; McGill and Outslay 2002; McClelland and Mills 2007).
  • Combining audiences decreases the effectiveness of both financial reporting and tax collection. That is because rules that improve the usefulness of financial reporting are often at odds with the collection of revenue, and vice versa. For example, fair value accounting is designed to give investors the most up-to-date picture of a company’s assets. It does so by re-valuing certain assets according to their market value. When market value increases, this re-valuation results in an increase to financial accounting income. This income increase, however, is an unrealized gain. Taxing unrealized gains results in poor tax collection practices since such gains do not produce cash, and companies may be liable to pay taxes without the liquid assets necessary to do so.
  • Financial reporting would suffer as well. Financial accounting requires firms to make numerous assumptions about the future (e.g., what is the useful life of an asset, what portion of receivables will be uncollectable). Because the future is uncertain, there is often a range of reasonable assumptions that could be made in the financial reporting process. Taxing financial accounting income introduces a downward bias in reporting, as accountants would be incentivized to use whatever estimates in the range that result in the lowest income, rather than using the estimates they think are best. This would result in less information, or lower quality information, being available to investors.
  • Further, when book income was previously used in forming the tax base, companies made accounting choices that altered the communication of financial information and deteriorated the financial information available to investors (Gramlich 1991; Dhaliwal and Wang 1992; Boynton et al. 1992; Manzon 1992).
  • Some have argued that conforming book and tax would improve the quality of accounting earnings. However, the empirical evidence so far shows that accounting choices that do not represent economic realty (i.e., earnings management) are more likely to happen in high-conformity regimes (Blaylock et al. 2015; Guenther et al. 1997). Earnings management makes it more difficult for investors to understand which corporations to invest in, including investors at pension funds, retirement accounts, and nonprofit endowments. That is, conforming financial accounting and tax rules result in financial accounting earnings that convey less information to financial markets (Hanlon et al. 2005). This loss of information weakens equity capital markets in the U.S. (Blaylock et al. 2017).
  • Conforming financial accounting and tax rules incentivizes firms to use more non-GAAP earnings (also called pro-forma or street earnings). These alternative disclosures will likely circumvent the original motivation for including financial accounting earnings in the tax base, as companies can manage financial income downwards while inflating non-GAAP earnings. Companies would be able to use non-GAAP earnings as a substitute for the higher, taxed earnings, because financial markets value non-GAAP earnings (Bradshaw and Sloan 2002). A proliferation of non-GAAP earnings would decrease the role of the FASB in guiding financial reporting, making the financial accounting system less useful and investors less safe.
  1. Economic disadvantages for U.S.-based companies.


  • One major reason tax payments are much lower than one would expect given financial accounting income is the tax treatment of net operating losses (Christensen et al. 2021). These provisions, which allow companies to offset prior losses against future income, are a major fiscal tool used in helping companies weather economic downturns (which is why, for example, they played a role in the bipartisan CARES Act). Net operating losses are generally universally allowed in other countries, and limiting their effectiveness by taxing financial accounting income would put U.S. firms at a competitive disadvantage.
  • Not all firms that operate in the U.S. are U.S.-domiciled, and not all subsidiaries of U.S. parent firms operate in the U.S. If only U.S. parents are subject to this tax, then U.S. firms will have an added incentive to expatriate.
  1. Politicizing of accounting standards.


  • Including financial accounting income in the tax base would increase the incentives for Congress to interfere with the FASB as an independent accounting standards setter. While government does oversee the FASB through the SEC, the SEC has mostly allowed the FASB to work independently (with a few notable exceptions (Zeff 2005)), shielding financial reporting from political considerations. A politicized FASB would almost certainly produce lower-quality financial accounting standards, damaging the integrity of accounting information and U.S. capital markets.
  1. Complex implementation, which stands to threaten the original intent of the change.
  • One purported advantage of including financial accounting income in the tax base would be its imagined simplicity. However, implementing such a tax would not be straightforward. Addressing the complications would likely create unintended consequences.
  • One specific reason firms report low taxable income combined with high accounting income is the availability of target economic incentives set forth by Congress (e.g., the R&D Tax Credit). Taxing financial accounting income would reduce the effectiveness of these economic incentives, including potential future incentives being considered to help fight climate change or bolster domestic manufacturing, etc. Once Congress starts adjusting the financial accounting values that would be taxed for items such as the R&D Tax Credit or NOLs, they will fall subject to exactly the type of political incentives that some believe have challenged the Internal Revenue Code, adjusting based on the preferences of political interests and not based on the best way to collect revenue.
  • The consolidated corporation that files a Form 10-K with the SEC and the consolidated corporation that files a Form 1120 with the IRS are not the same legal entity. Tax and financial accounting consolidation rules are different, and determining what entity to tax is not trivial. Proposals that tax financial accounting income would require rules for addressing these differences and have potential unintended consequences on business organization.
  • Not all corporations, or even all large corporations, prepare GAAP-audited financial statements (Lisowsky and Minnis 2020). Determining what value to tax for non-GAAP users is a complex endeavor. If only public firms are subject to a financial accounting income tax, this will disincentive firms from going public in the U.S., locking out retail investors and workers with retirement savings from investing in companies that will opt to not go public because doing so would impose a large, new tax on them.


The vast majority of large corporations are already required to reconcile their financial and taxable incomes for the IRS (see Form M-3). Only a very small portion of these differences are thought to come from nefarious activity (Gaertner et al. 2016). Rather, these differences stem from differences in tax law, as purposefully written by Congress and financial accounting standards, as purposefully promulgated by the FASB. If Congress deems the tax law to be deficient in any case, Congress should revise the tax code to resolve the perceived problem directly.

Given the significant potential for unintended disturbances in financial reporting and financial markets, we oppose including financial accounting income in the tax base.


Fabio B. Gaertner, University of Wisconsin-Madison

Jeffrey L. Hoopes, University of North Carolina at Chapel Hill










Blaylock, B., F. B. Gaertner, and T. Shevlin. 2017. Book-tax conformity and capital structure. Review of Accounting Studies 22 (2): 903–932.

Blaylock, B., F. Gaertner, and T. Shevlin. 2015. The association between book-tax conformity and earnings management. Review of Accounting Studies 20 (1): 141–172.

Boynton, C., P. Dobbins, and G. Plesko. 1992. Earnings Management and the Corporate Alternative Minimum Tax. Journal of Accounting Research 30: 131–153.

Bradshaw, M. T., and R. G. Sloan. 2002. GAAP versus The Street: An Empirical Assessment of Two Alternative Definitions of Earnings. Journal of Accounting Research 40 (1): 41–66.

Christensen, D. M., D. G. Kenchington, and R. Laux. 2021. How Do Most Low ETR Firms Avoid Paying Taxes? Review of Accounting Studies Forthcoming.

Dhaliwal, D., and S. Wang. 1992. The effect of book income adjustment in the 1986 alternative minimum tax on corporate financial reporting. Journal of Accounting and Economics 15 (1): 7–26.

Gaertner, F. B., S. K. Laplante, and D. Lynch. 2016. Trends in the Sources of Permanent and Temporary Book-Tax Differences During the Schedule M-3 Era. National Tax Journal 69 (4): 785–808.

Gramlich, J. D. 1991. The Effect of the Alternative Minimum Tax Book Income Adjustment on Accrual Decisions. Journal of the American Taxation Association 13 (1): 36.

Guenther, D. A., E. L. Maydew, and S. E. Nutter. 1997. Financial reporting, tax costs, and book-tax conformity. Journal of Accounting and Economics 23 (3): 225–248.

Hanlon, M., Laplante Stacie Kelley, and T. Shevlin. 2005. Evidence for the Possible Information Loss of Conforming Book Income and Taxable Income. Journal of Law and Economics 48 (2): 407–442.

Hanlon, M., and T. Shevlin. 2005. Book-tax conformity for corporate income: An introduction to the issues. In Tax Policy and the Economy, Volume 19, 101–134. MIT Press.

Lisowsky, P., and M. Minnis. 2020. The Silent Majority: Private U.S. Firms and Financial Reporting Choices. Journal of Accounting Research 58 (3): 547–588.

Manzon, G. B. 1992. Earnings Management of Firms Subject to the Alternative Minimum Tax. The Journal of the American Taxation Association 14 (2): 88.

McClelland, J., and L. F. Mills. 2007. Weighing Benefits and Risks of Taxing Book Income. Tax Notes 115 (7).

McGill, G. A., and E. Outslay. 2002. Did Enron Pay Taxes?: Using Accounting Information to Decipher Tax Status. Tax Notes 96 (8).

Zeff, S. A. 2005. The Evolution of U.S. GAAP: The Political Forces Behind Professional Standards. The CPA Journal 75 (2): 18–29.



[1] See https://elizabethwarren.com/plans/real-corporate-profits.

[2] See https://joebiden.com/two-tax-policies.

Posts and comments are solely the opinion of the author and not that of the UNC Tax Center or any other person or entity.