Non-GAAP Tax Rate: Do Managers Use It to Achieve Earnings Targets?

In this study, we examine tax reporting in a non-GAAP setting. We focus on non-GAAP tax rates, which we define as the tax rates applied to non-GAAP exclusions (hereafter, exclusions). Using detailed hand-collected data, we find that non-GAAP tax rates are systematically lower (higher) when exclusions are income-increasing (income-decreasing), leading to higher after-tax non-GAAP earnings. In addition, using GAAP effective tax rate (hereafter, GAAP ETR) and the statutory tax rate as proxies for the non-discretionary portion of the non-GAAP tax rate, we find robust evidence that managers opportunistically use non-GAAP tax rates to achieve after-tax non-GAAP earnings targets. Finally, we document that firm-reported after-tax non-GAAP earnings are less persistent for future GAAP earnings, compared to non-GAAP earnings calculated using GAAP ETR or the statutory tax rate. The lower persistence of firm-reported non-GAAP earnings implies that non-GAAP tax rates are sometimes too high or too low, thus contaminating the after-tax non-GAAP earnings with mostly transitory exclusion items