Taxpayers' tax and financial reporting decisions in a game theoretical model

In a game theoretical model, this paper analyzes taxpayers' decisions on reporting financial income and taxable income to the tax authority, and the tax authority's strategic auditing. It extends the previous research by incorporating taxpayers' financial reporting decision into the model. It leads to three conclusions: (a) the tax authority is more likely to audit taxpayers reporting high accounting income but low taxable income than those reporting no accounting-tax differences; (b) the tax authority is more likely to audit taxpayers reporting low taxable income and low accounting income if they have low financial reporting costs than if they have high such costs; and (c) the degree of connection between the true taxable income and the true accounting income affects taxpayers' reporting strategies.