Income Shifting by NOL Firms When Loss Carry-Forward Period is Extended

Changes in tax laws are known to create an environment for firms to shift income from one period to another for tax purposes. In this paper, we investigate whether firms with net operating losses (NOL firms) inter-temporally shifted incomes when the loss carry-forward period was extended from five to ten years as a result of the 2008 tax law change in Korea. Our analysis shows that the extension of the carry-forward period affects NOL firms’ marginal tax rates, and that the income-shifting behavior of NOL firms varies, depending on the expectations of when the NOL incurred in 2008 would be exhausted through deductions from future taxable incomes. We then hypothesize that only NOL firms which anticipate to exhaust their 2008 NOL in a fiscal year within the extended loss carry-forward period will shift losses from 2008 to 2009 (or equivalently, shift income from 2009 to 2008) so as to increase their 2009 NOL. Consistent with our prediction, we find that only NOL firms that expect to entirely deduct 2008 NOL in the extended loss carry-forward period shift income in the direction of increasing 2009 NOL. Our study contributes to the extant literature on the subject of tax-motivated income-shifting behaviors by documenting relatively rare empirical evidence that certain NOL firms may shift income in response to an extended loss carry-forward period.