CONTENTS LIST OF CONTRIBUTORS vii EDITORIAL BOARD ix AD HOC REVIEWERS xi AIT STATEMENT OF PURPOSE xiii MAIN ARTICLES PROFESSIONAL LIABILITY SUITS AGAINST TAX ACCOUNTANTS: SOME EMPIRICAL EVIDENCE REGARDING CASE MERIT Donna D. Bobek, Richard C. Hatfield and Sandra S. Kramer 3 AN EMPIRICAL ASSESSMENT OF SHIFTING THE PAYROLL TAX BURDEN IN SMALL BUSINESSES Ted D. Englebrecht and Timothy O. Bisping 25 AN EMPIRICAL EXAMINATION OF INVESTOR OR DEALER STATUS IN REAL ESTATE SALES Ted D. Englebrecht and Tracy L. Bundy 55 CHARITABLE GIVING AND THE SUPERDEDUCTION: AN INVESTIGATION OF TAXPAYER PHILANTHROPIC BEHAVIOR FOLLOWING THE MOVE FROM A TAX DEDUCTION TO A TAX CREDIT SYSTEM Alexander M. G. Gelardi 73 v vi HOW ENGAGEMENT LETTERS AFFECT CLIENT LOSS AND REIMBURSEMENT RISKS IN TAX PRACTICE Lynn Comer Jones, Ernest R. Larkins and Ping Zhou 95 THE ALTERNATIVE MINIMUM TAX: EMPIRICAL EVIDENCE OF TAX POLICY INEQUITIES AND A RAPIDLY INCREASING MARRIAGE PENALTY John J. Masselli, Tracy J. Noga and Robert C. Ricketts 123 AN EMPIRICAL INVESTIGATION OF FACTORS INFLUENCING TAX-MOTIVATED INCOME SHIFTING Toby Stock 147 RESEARCH NOTES ACADEMIC TAX ARTICLES: PRODUCTIVITY AND PARTICIPATION ANALYSES 1980–2000 Paul D. Hutchison and Craig G. White 181 EDUCATORS’ FORUM EXPORT INCENTIVES AFTER REPEAL OF THE EXTRATERRITORIAL INCOME EXCLUSION Ernest R. Larkins 201 LIST OF CONTRIBUTORS Timothy O. Bisping Department of Economics and Finance, Louisiana Tech University, USA Donna D. Bobek School of Accounting, University of Central Florida, USA Tracy L. Bundy School of Professional Accountancy, Louisiana Tech University, USA Ted D. Englebrecht School of Professional Accountancy, Louisiana Tech University, USA Alexander M. G. Gelardi College of Business, University of St. Thomas, St. Paul, MN, USA Richard C. Hatfield Department of Accounting, University of Texas at San Antonio, USA Paul D. Hutchison Department of Accounting, University of North Texas, USA Lynn Comer Jones Department of Accounting and Finance, University of North Florida, USA Sandra S. Kramer Fisher School of Accounting, University of Florida, USA Ernest R. Larkins School of Accountancy, Georgia State University, USA John J. Masselli Area of Accounting, Texas Tech University, USA Tracy J. Noga Department of Accounting, Suffolk University, USA Robert C. Ricketts Area of Accounting, Texas Tech University, USA Toby Stock School of Accountancy, Ohio University, USA vii viii Craig G. White Area of Accounting, University of New Mexico, USA Ping Zhou Stan Ross Department of Accountancy, City University of New York – Baruch College, USA EDITORIAL BOARD EDITOR Thomas M. Porcano Miami University Kenneth Anderson University of Tennessee, USA Caroline K. Craig Illinois State University, USA Anthony P. Curatola Drexel University, USA Ted D. Englebrecht Louisiana Tech University, USA Philip J. Harmelink University of New Orleans, USA D. John Hasseldine University of Nottingham, England Peggy A. Hite Indiana University-Bloomington, USA Beth B. Kern Indiana University-South Bend, USA Suzanne M. Luttman Santa Clara University, USA Gary A. McGill University of Florida, USA Janet A. Meade University of Houston, USA Charles E. Price Auburn University, USA William A. Raabe Columbus, USA Michael L. Roberts University of Alabama, USA David Ryan Temple University, USA Dan L. Schliser East Carolina University, USA Toby Stock Ohio University, USA ix AD HOC REVIEWERS James R. Hasselback Florida State University, USA Ernest R. Larkins Georgia State University, USA Cherie J. O’Neil Colorado State University, USA Robert C. Ricketts Texas Tech University, USA Janet W. Tillinger Texas A&M – Corpus Christi, USA Patrick J. Wilkie George Mason University, USA xi ADVANCES IN TAXATION EDITORIAL POLICY AND CALL FOR PAPERS Advances in Taxation (AIT) is a refereed academic tax journal published annually. Academic articles on any aspect of federal, state, local, or international taxation will be considered. These include, but are not limited to, compliance, computer usage, education, law, planning, and policy. Interdisciplinary research involving, economics, finance, or other areas also is encouraged. Acceptable research methods include any analytical, behavioral, descriptive, legal, quantita- tive, survey, or theoretical approach appropriate for the project. Manuscripts should be readable, relevant,andreliable.To be readable, manuscripts must be understandable and concise. To be relevant, manuscripts must be directly related to problems inherent in the system of taxation. To be reliable, conclusions must follow logically from the evidence and arguments presented. Sound research design and execution are critical for empirical studies. Reasonable assumptions and logical development are essential for theoretical manuscripts. AIT welcomes comments from readers. Editorial correspondence pertaining to manuscripts should be forwarded to: Professor Thomas M. Porcano Department of Accountancy Richard T. Farmer School of Business Administration Miami University Oxford, Ohio 45056 Phone: 513 529 6221 Fax: 513 529 4740 E-mail: porcantm@muohio.edu Professor Thomas M. Porcano Series Editor xiii PROFESSIONAL LIABILITY SUITS AGAINST TAX ACCOUNTANTS: SOME EMPIRICAL EVIDENCE REGARDING CASE MERIT Donna D. Bobek, Richard C. Hatfield and Sandra S. Kramer ABSTRACT As with most professional service occupations, liability claims are a major concern for accounting professionals. Most of the academic research on accountants’ professional liability has focused on audit services. This study extends research onaccountants’ professional liability by examining liability claims arising from the provision of tax services. In addition to a descriptive analysis, the current study explores the role of merit in tax malpractice litigation. Hypotheses are developed based on the legal construct of claim merit, which requires the presence of accountant error and damages as a result of that error for a claim to be considered meritorious. The hypotheses are tested using logistic and OLS regression of 89 actual claims filed with an insurer of tax professionals. The results suggest that the components of merit are significant in determining both the presence of compensatory payments to the client and the dollar amount of those payments, although the hypothesized interaction effect is only significant for the dollar amount of compensatory payments. Advances in Taxation Advances in Taxation, Volume 16, 3–23 Copyright © 2004 by Elsevier Ltd. All rights of reproduction in any form reserved ISSN: 1058-7497/doi:10.1016/S1058-7497(04)16001-8 3 4 DONNA D. BOBEK ET AL. INTRODUCTION This study examines the relationship between merit and outcome in tax malprac- tice claims. Although this relationship seems intuitive, prior research focusing on accountant liability in an audit setting has been unable to find a significant link. The role of merit is of importance to accounting firms who have a vested interest in legal reform. For example, the large accounting firms have stated that unwarranted litigation (i.e. lacking merit) and coerced settlements are the “principal cause” of the profession’s liability problems (Arthur Andersen & Co. et al., 1992). Using detailed claim files from an accountant insurance company, we explore this issue in the tax accounting profession. Palmrose (1997) undertook a review of the audit malpractice literature in an effort to answer the question, “do the merits of a case matter with regards to bring- ing and resolving claims against auditors?” Kinney (1993)asserts thatmeritorious claims against independent auditors require three elements: substandard financial statements, substandard audits, and compliance with relevant legal standards (e.g. detrimental reliance on the financial statements). However, Palmrose (1997) suggests that the low probability of bringing a claim to court actually severs the theoretical tie between merits and outcome. The empirical data drawn from several studies (e.g. Dunbar et al., 1995; Palmrose, 1994) suggest that the role of merit is inconclusive (particularly with regard to outcome). This result is due in part to the fact that prior research generally does not undertake the question of merit directly, and has been unable to find an adequate proxy for claim merit. Palmrose (1997) concluded her study with a call for research that examines the role of merit in accountant malpractice claims. Although most research examining the issue of malpractice liability in the accounting profession deals with auditor liability, the issue of tax professional liability is also of concern. Several different sources have quantified the fact that tax accounting engagements result in more claims brought by clients than any other area of accounting practice (although audit claims are higher in total costs). In fact, the AICPA reports that 60% of all accountant malpractice claims in the AICPA Professional Liability Insurance program arise from tax engagements (Anderson & Wolfe, 2001). This is up from 43% ten years ago. Donnelly et al. (1999) note that the frequent enactment of tax law changes and the relatively recent inclination of the IRS and the Tax Court to hold practitioners responsible for client information has put additional pressure on small and midsize accounting firms. This pressure, they add, has led to “more frequent and more severe mal- practice claims arising from tax planning and preparation” (p. 59). Although the occurrence of taxmalpracticeclaims is quite high,the research regarding this issue has been limited. Professional Liability Suits Against Tax Accountants 5 This study extends prior research in both auditing and tax litigation. Tax research in this area is fairly new and has yet to address the important relationship between claim merit and claim outcome. And, although some audit research has directly addressed the issue of merit (e.g. Carcello & Palmrose, 1994; Dunbar et al., 1995), audit researchers typically have a difficult time finding an adequate proxy for claim merit. We begin by developing a definition of claim merit based on caselaw (Anderson, 1991; Rockler vs. Glickman, 1978). Specifically, we define a meritorious case as one that contains both tax professional error and damages occurring as a result of that error. We also hypothesize that meritorious claims should be more likely to result in compensation being paid to the client, as well as larger payment amounts. We examine these hypotheses with data from the files of an insurance company (the files contain good proxies for these two components of merit). As prior audit research has suggested, it appears that a claim does not have to meet the strict legal criteria of a meritorious claim in order to result in a compen- satory payment to the client. Our results suggest that the existence of either error on the part of the tax professional or damages incurred by the client is enough to result in compensatory payments. However, there is a fairly large and significant difference in the magnitude of payments for claims with both error and damages compared to all other claims, after controlling for the overall size of the claim. In fact, claims with both components of merit resulted in average compensatory payments that were more than four times larger than other claims in our sample ($62,921 vs. $15,284). 1 Thus, we conclude that the effect of the components of claim merit, as suggestedbycaselaw,areasignificant determinant of both thelike- lihood of compensatory payments being made, and the amount of those payments. The remainder of this article is organized as follows. In the next section, prior research regarding professional liability of accountants is discussed; followed by a definition of claim merit and development of the hypotheses. This is followed by a description of the variables and descriptive data regarding the sample. In the next section, results are reported and discussed. Finally, conclusions and opportunities for future research are discussed. PRIOR RESEARCH There are two streams of research on which this study draws. First, there is some prior research that deals directly with tax accountant liability, although this research does not address the issue of claim merit. Second, there is a larger body of research regarding audit litigation. The audit environment shares some key characteristics with the tax environment. For example, both originate from [...]... error by the accountant In a number of cases, the accused accountant readily admitted to the insurance company investigator that he had made a mistake in completing the return In other cases, the insurance company’s investigator determined that the accountant had made a mistake If either the accountant or the insurance company investigator determined that a mistake was made in preparing the tax return,... from 1440 small business owners in the Hampton Roads area of Virginia to ascertain whether the payroll tax is shifted by passing it on to the consumer by way of increased prices, passing it on to the employee by way of reduced wages, or absorbed by the business in the form of reduced profits The resulting sample of 182 small business owners in EHI revealed that, in general, small businesses are not likely... meritorious claims should result in compensatory payments to the client However, prior audit research, as well as anecdotal observation, shows that there are other reasons, including the cost involved in defending a claim, the low likelihood of the case ending up in court, and the uncertainty involved in proving that a claim is not meritorious, that may lead accountants (and their insurance company) to make... employees in the ArkLaMiss, as opposed to the burden being borne by firms and customers Also, stronger anti-tax sentiment was noted in the ArkLaMiss as compared to prior literature Little support was found for the proposition that firm size impacts the incidence of taxation On the other hand, statistical analysis indicates that the industry within which a firm operates was in uential in the incidence of taxation. .. examine the incidence of payroll taxes broken down according to industry and firm size in order to ascertain the impact of these market conditions Second, a direct comparison to the EHI study provides insight into the degree to which we can generalize from our results, or the degree to which incidence of payroll taxes 32 TED D ENGLEBRECHT AND TIMOTHY O BISPING Table 1 Classification by Industry Industry... Learning from past disasters The CPA Journal, 66(2), 12–17 AN EMPIRICAL ASSESSMENT OF SHIFTING THE PAYROLL TAX BURDEN IN SMALL BUSINESSES Ted D Englebrecht and Timothy O Bisping ABSTRACT Prior studies on the social security tax have focused on it being regressive; a system that is detrimental to savings in the United States; a system that will bankrupt itself; and a host of economic inquiries examining... ask nothing specifically about elasticities in our survey, our results implicitly reveal the firm’s beliefs regarding labor market and product market elasticities RESEARCH METHOD Data Base In order to compile the data necessary to analyze payroll tax incidence in the case of small businesses, a survey was mailed to randomly-selected small businesses in Arkansas, Louisiana and Mississippi in the Spring of... question is extremely valuable in that firms are asked to provide specific dollar amounts, thereby making the incidence of the tax quantifiable Part Four of the questionnaire is designed to gather demographic and other general information regarding firms This information allows one to examine, for instance, whether firms bear more of the burden of a tax in one industry relative to other industries, or if perhaps... collected in the context of economic theory regarding tax incidence The primary purpose here is twofold First, while much of the theoretical work in the literature would suggest that the incidence of a tax varies with market conditions, little has been done to examine this using survey techniques Two important aspects of these conditions available in our dataset include the industry within which a... effects of changes in the payroll tax structure on small businesses Notwithstanding its numerous deficiencies, it is considered a seminal study in the analysis of payroll taxes and over time has provided invaluable guidance in evaluating the social security system Ricketts’ Study Ricketts (1990) investigated the vertical and horizontal equity effects of the combined impact of payroll and income taxes for . reasons, including the cost involved in defending a claim, the low likelihood of the case ending up in court, and the uncertainty involved in proving that. matter with regards to bring- ing and resolving claims against auditors?” Kinney (1993)asserts thatmeritorious claims against independent auditors require