Making the Connection Between Tax and Strategic Business Decision-Making

Editor: Annette Nellen, J.D., CPA

Tax is usually taught as a discrete part of an accounting student’s curriculum, even though tax practitioners are aware that every financial transaction has tax implications. Therefore, accounting students and job applicants are often unable to apply tax considerations to other areas of accounting decision-making. The academic community needs to better prepare future tax professionals to think in those terms. This column suggests that cross-discipline approaches, including exercises such as the assignment described here, can be used to expand students’ ability to apply knowledge learned in one area of accounting to other areas.

One area that receives a lot of press is the various tax incentives that are offered to both individuals and corporations. These incentives can affect (and are in fact intended to affect) business decisions, usually in an effort to stimulate a targeted area of the economy. A decision-maker is not able to optimize business outcomes unless he or she considers all facets of the alternatives, and the decision-maker must be aware that they exist and their potential benefit to the decision at hand. Therefore, any activity or exercise that enables a decision-maker to consider more alternatives is beneficial not only to the decision-maker, but also to the organization as a whole.

Background on Tax Incentives

While the primary function of the tax law is to collect tax dollars to support government functions, special provisions and incentives are often implemented in an attempt to influence individual and corporate behavior and positively affect the economy as a whole. These incentives have been designed to benefit taxpayers directly through tax credits, exclusions, and deductions, and indirectly through incentives to businesses to encourage growth. However, standard economic assumptions about individual behavior tend to be inaccurate in that people do not act rationally, are not perfectly self-interested, and hold inconsistent preferences. It is also unclear whether the targeted taxpayers are aware of many of the incentive provisions contained in recent tax legislation and, thus, whether those taxpayers took advantage of those provisions.

Myriad influences affect whether current benefits are extended or allowed to expire and whether new incentives should be added in an ailing economy. In today’s climate, because lower tax receipts from incentives compound the federal deficit, there are more questions whether the incentives are achieving their stated fiscal goals. Nonetheless, the government is expected to take an active hand in economic recovery, and incentives are designed to do this. Politics further compound the dilemma since members of Congress are reluctant to vote in a way that costs their constituents more money, resulting in the continuation of existing tax incentives.

Tax incentives take many forms. For example, incentives have been offered in different ways (tax rebates, credits, and deductions) and for different durations (one-time only, for a limited time, and permanently). The creation of various tax incentives intended to stimulate the economy provides the opportunity to create an assignment that focuses on relevant tax and nontax factors to consider when making capital-budgeting decisions. This exercise is appropriate at the end of an introductory tax class, at either the undergraduate or graduate level, and fits well within the objectives of the AICPA Model Tax Curriculum (MTC).

According to the AICPA’s description of the MTC, the “primary objective of the MTC is that students understand the role taxation plays in business decision making and financial reporting by building a foundation for future learning in tax.” Thus, an assignment that incorporates a discussion of various tax incentives that could be considered in a capital-budgeting decision is an ideal exercise for helping students understand the role of taxation in business decision-making and how they should consider both tax and nontax factors when advising clients on the best course of action.

Motivation and Assignment Details

As noted in the MTC, “faculty should use a variety of teaching methods to achieve the learning outcomes of the Model Tax Curriculum, tailored to the differing needs of students at schools with differing missions and accounting curricula.” One such teaching method is the use of in-class discussions. “Compared with the traditional lecture method, discussions elicit higher levels of reflective thinking and creative problem solving, including synthesis, application and evaluation. There is also evidence that information learned through active discussion is generally retained better than material through lecture” (Doyle, Learner Centered Teaching: Putting the Research on Learning Into Practice (Stylus 2011)).

Educational Objectives

The assignment described below provides an exercise that teachers can use at the end of an introductory course to give students a better understanding of the role that taxes play in the decision-making process. As noted in the MTC, students should be able to apply “analytical reasoning tools to assess how taxes affect economic decisions for all taxpaying entities (including individuals, partnerships, Subchapters C and S corporations)” (emphasis in original). The assignment accomplishes this objective by requiring students to consider both tax and other business factors that taxpayers might consider as they decide whether to make a capital investment. The assignment achieves the broad business objective of developing strategic- and critical-thinking skills through the use of a well-designed in-class discussion for small and large groups. Prior research finds that quality in-class discussions lead to greater critical thinking (Tsui, “Fostering Critical Thinking Through Effective Pedagogy: Evidence From Four Institutional Case Studies,” 73 The Journal of Higher Education 740 (November/December 2002)).

The assignment also helps to satisfy other learning objectives such as considering uncertainty when evaluating proposed alternatives and encouraging students to weigh relative values of alternative decisions. Finally, the assignment can expose students to current events (i.e., tax incentives currently in effect and those being proposed, implemented, or phased out).

Implementation Guidance

The assignment should facilitate a one-day class discussion. Students separate into small groups of three or four to engage in discussion and complete the assignment. All groups should then discuss their group recommendations with the entire class. Two versions (A and B) of this assignment are included with this column. Half of the groups should get assignment A, in which the students act as a tax adviser evaluating the merits of a capital-budgeting decision involving physical capital and the related tax incentives. The other half of the groups should get assignment B, in which the students act as a tax adviser evaluating the merits of investing in human capital and those related tax incentives.

Exhibit 1 contains the general introductory information and basic financial information to be used for both versions of the assignment sheet. Exhibit 2 contains the details for both versions.

This assignment is used to generate discussion in class. Thus, teachers should evaluate students based on their participation. The purpose of this assignment is to expand students’ horizons and provide the opportunity for a class discussion at a small group level and at a larger level. Once these students begin practicing, they will find that a lot of work in practice is accomplished in teams or groups, and learning how to “collaborate in small and large discussion groups is great practice” for the real world (Doyle, Learner Centered Teaching: Putting the Research on Learning Into Practice (Stylus 2011)).

The assignment provided in Exhibit 2 is adaptable, and instructors can incorporate the assignment into the classroom in a variety of ways. Exhibit 3 contains other factors that can be used in the group discussion or in the classroom discussion at the instructor’s discretion. In addition, with a few modifications, the assignment can also be used in a managerial accounting class (either undergraduate or graduate) by changing the perspective from a tax adviser to a manufacturing client to a senior production manager for a manufacturing company.

Relevance to Practitioners

The implications of cross-discipline exercises such as the assignment described here go beyond the classroom and into the workplace. Using exercises to raise awareness about peripheral effects of a decision could be an appropriate part of employee training. Also, tax practitioners have a unique ability to enhance students’ academic experience by bringing real-life perspectives into the classroom. Thus, an exercise like this would be a good vehicle to prepare students for a guest speaker who could discuss how tax incentives affect client tax planning.

Conclusion

This assignment should help students understand some special tax incentives and encourage applying tax considerations to other areas of accounting and business. Students are encouraged to go beyond basic financial analysis to consider tax implications. The assignment should promote an understanding of tax incentives in an interdisciplinary manner, considering both tax and other business factors when making production-related decisions, while stimulating discussion in small groups and in the class as a whole. Students who are able to articulate ideas and thoughts clearly will be more successful in their careers. In addition, students need to understand that “one of the most important aspects of college learning is hearing the different views of their peers,” which is “a major way they develop and refine their thinking” (Doyle, Learner Centered Teaching: Putting the Research on Learning Into Practice (Stylus 2011)).

Printable PDF versions of the class materials are available here:

• Exhibit 1, General Information
• Exhibit 2, Assignment Sheet
• Exhibit 3, Additional Questions/Options