John Capp, CPA, was preparing an estate tax return for one of his clients, Michael Kelly. Kelly had recently inherited the estate of his father, and a large part of the estate was a majority partnership in a successful high-tech venture. However, the values of the partnership interests were being disputed by newer minority partners, who felt that their interests were under-valued and that the older Kelly interests were over-valued. The dispute was headed into litigation. Capp delegated the monitoring of the litigation to his assistant, so that the deadline for the estate tax return—nine months after Michael Kelly Sr.’s date of death—would not elapse without the CPA taking action on the return. However, the assistant failed to log the estate tax return due date on the calendar. Capp and the assistant became buried in income tax return work while the estate tax return deadline, which happened to be April 4, quietly slipped by.
Ten months after that, Kelly informed Capp that the litigation over the partnership had been resolved in his favor, causing Capp to realize that the estate tax return due date had been missed. He calculated the tax on the estate, which came to about $500,000, and he also realized that Kelly was going to be faced with a hefty late-filing penalty assessment.
He assured Kelly that they could request a penalty abatement, which Capp believed was sure to be granted, due to the “reasonable cause” Kelly had for missing the deadline. Capp did not report the penalty situation to his professional liability insurance carrier because he was certain he could manage the penalty abatement on his own. He drafted a letter detailing the facts and circumstances involved in the failure to file on time, and he mailed it to the IRS.
Several weeks later, Capp received a letter from the IRS, denying the penalty abatement request on the basis that Kelly had “not exercised ordinary business care and prudence” when he failed to provide sufficient information on the estate assets to Capp. The late payment penalties, which run 5 percent per month, came to about $200,000, which took Kelly’s tax liability from about $500,000 to $700,000. When Kelly saw the increased penalty amount, he was extremely disappointed and demanded that Capp pay the $200,000.
Making matters worse, because Capp had believed he would succeed in obtaining a penalty abatement, he had not reported the potential claim within the policy period, causing him to miss the deductible reduction for early reporting, offered by CAMICO.
• Capp had coverage with the CAMICO Mutual Insurance Company Accountants Professional Liability insurance. While he was aware of the potential claim situation in 2015, he did not report the potential claim to CAMICO in 2015.
• In 2016, the potential claim became an actual Claim.
• Because Capp was consecutively renewed with CAMICO and had the policy form with “Continuity of Coverage for Potential Claims,” he has full coverage for damages resulting from his error or omission.
• However, had he reported the potential claim situation in 2015, he would have also benefited from the 50% deductible reduction up to $50,000.
Loss Prevention Tips
• Had Capp promptly reported the potential claim to CAMICO, he not only would have protected his full policy limits, but he would have benefited from CAMICO’s tax penalty abatement services, which provide legal expertise for abatement requests ranging from the simple to the complex.
• Some policyholders worry about their premiums going up as a result of reporting a claim or potential claim, but CAMICO does not impose surcharges because a matter was reported before becoming a claim, or even because of claim reporting.
• In fact, CAMICO encourages early reporting by reducing the deductible by 50 percent, up to $50,000, for any potential claim that is reported before a claim is made. Further, if CAMICO determines that it is appropriate to retain legal counsel to assist with a pre-claim situation, the legal expenses will be absorbed by CAMICO.
“War Stories,” drawn from CAMICO claims files, illustrate some of the dangers and pitfalls in the accounting profession. All names have been changed.