The Internal Revenue Service plays an important role in improving corporate transparency and encouraging corporations to act in the best interests of their shareholders and other stakeholders. The agency makes increasingly consequential decisions about audit selection and strategy, and receives substantial private financial disclosures from firms.

However, its enforcement activities and other interactions with firms remain private until they are disclosed by the firm in financial statements. Thus investors are not immediately aware of IRS-related information about the firms they invest in, which potentially creates profitable trading opportunities for tax officials. Our research investigates whether the stock trades of high-ranking IRS officials are associated with tax-related information.

Nuts and Bolts

IRS officials likely possess relevant information about firms from at least three sources. First, they are privy to information on enforcement decisions concerning corporate taxpayers before it is disclosed to the public. Second, they have access to corporate tax returns, which are not publicly disclosed but contain valuable information about firms’ operations and organizational structures. Third, they have advance notice of IRS policy adjustments and initiatives that may lead to changes in scrutiny for certain firms and industries. This information — not available to other market participants — may cause the personal financial transactions of IRS officials to be associated with positive abnormal returns and future tax enforcement outcomes.

We created a dataset of more than 5,000 private stock transactions conducted by IRS officials between 2016 and 2020, using financial disclosure forms recently released to the public. We began by analyzing the extent to which the stock transactions of these officials generated positive abnormal returns. Our findings reveal that IRS officials’ trades, predominantly their purchases, generated abnormal returns of 0.7 percent to 3.5 percent 60 to 120 days after the trade. These findings suggest that IRS officials had relevant information that the market had yet to fully incorporate into stock prices.

Next, we considered the extent to which the trades of IRS officials were associated with subsequent tax enforcement outcomes. While market participants may observe broad changes in a firm’s profitability or operations, IRS officials are more likely to be aware of future tax enforcement, or they may even influence these decisions through audit selection and investigation. Firms following generally accepted accounting principles must create a financial reserve for tax benefits they claim but expect the IRS to deny if audited. Moreover, firms must publicly disclose this unrecognized tax benefit (UTB) reserve. If a firm’s UTB reserve decreases, it suggests that the firm learned favorable information about pending or expected tax enforcement, but if a firm’s UTB reserve increases, it suggests the opposite. Thus, we examined changes in UTB reserves to determine whether IRS officials’ stock transactions were associated with tax enforcement outcomes.

Our research finds that IRS officials’ stock purchases were associated with subsequent decreases in firms’ UTB reserves. Specifically, firms were 24 percent more likely to reduce their UTB reserves in the year following an IRS official’s purchase. Likewise, firms were 14 percent more likely to benefit from a lapse in a statute of limitations after an IRS official’s purchase. Additionally, firms were 47 percent more likely to suffer large, unfavorable tax settlements in the year following an IRS official’s sale of their stock. These findings suggest that IRS officials’ purchases of a stock predict more favorable tax enforcement outcomes against that firm, while sales predict less favorable tax enforcement outcomes. Furthermore, the association between the trades of IRS officials and tax enforcement was strongest among trades that generated positive abnormal returns, providing further evidence that the trades were related to future tax enforcement outcomes.

Hands in Cookie Jars

IRS officials likely gain an advantage by reviewing information about firms obtained through audits. We evaluated this claim by examining the likelihood that each firm would be audited, which we measured by tracking the number of times each firm mentioned the IRS in their annual 10‑K public financial statements. Our findings reveal that the association between IRS officials’ stock transactions and enforcement outcomes was strongest among firms that had a higher likelihood of being audited. Additional evidence suggests that IRS officials’ stock purchases were more strongly associated with future lapses in statutes of limitations among firms with a lower likelihood of being audited. These findings support the claim that IRS officials gain private information about firms’ finances through audits — or decisions not to audit.

The information advantage that IRS officials have is likely greater when the market is more uncertain of a firm’s tax burden. We evaluated this claim by investigating firms with larger discrepancies in analysts’ predictions of their tax burden. Our research finds that the association between IRS officials’ stock purchases and subsequent reductions in UTB reserves was greater for firms with more disagreement among tax forecast analysts. The same was true for the association between IRS officials’ stock sales and tax settlements unfavorable to firms. These findings support the claim that the information advantage of IRS officials is strongest when other market participants are less certain of a firm’s tax burden.

Say It Isn’t So

We conducted three analyses to explore alternative explanations for our findings. First, insignificant changes in UTB reserves may have driven our findings, but our findings remained the same when focusing exclusively on large changes in UTB reserves. Second, it is possible that a few large transactions by a small number of officials drove our findings. Yet when we conducted our analyses with only transactions below $15,000 in value—93.6 percent of the transactions in our dataset — we found the same results. Finally, other senior officials in the federal government may have predicted tax enforcement outcomes against firms, suggesting that IRS officials did not have a unique information advantage relative to other government officials. However, our findings show no association between tax enforcement outcomes and the trades of officials in the Department of the Treasury who did not work for the IRS.