Reducing Your Risk: Documentation and Engagement Letters

By Randy R. Werner, J.D., LL.M./Tax, CPA

CPA liability exposures during tax season are always a concern, regardless of economic or professional conditions. CAMICO’s claims experience shows that many high-exposure tax claims have certain characteristics in common, primarily as follows:

  • The services for which the client had engaged the CPA were unclear.
  • The CPA had not clarified his or her role or the client’s expectations, usually because an understanding between the CPA and the client had not been reached or adequately documented.
  • A lack of clarity and documentation made the CPA’s services difficult to effectively complete. Inadequate documentation also made it difficult to defend the CPA in a subsequent malpractice action.

Documentation is critical in any claims situation, and the engagement letter is the first step in addressing that issue. The engagement letter will clarify the services that you will render, describe the scope and limitations of the engagement, and allocate, in limiting language, your responsibilities, and the responsibilities of the client.

By documenting the understanding between you and the client, you minimize your chances of facing litigation, because the engagement letter will leave little or no room for misunderstanding — a common reason for lawsuits. If you do find yourself in the middle of a lawsuit, then the engagement letter will serve as documented evidence of the duties your firm was to perform.

Always try to receive a signature on the engagement letter. Failure to do so may be interpreted by the courts as the client not agreeing to the terms of the engagement. Proceeding with the requested work without a signature could also suggest that you completed the engagement under terms different from those contained in the unsigned engagement letter.

Defensive Documentation

Always follow up significant client meetings with documentation. A written description of the subject discussed at the meeting is an important tool you can use to communicate with your client and to ensure that both you and the client are proceeding with the same expectations and assumptions.

Draft additional engagement letters when necessary. New engagement letters are sometimes needed. For example:

  • if any additional services in the existing engagement’s subject matter will exceed a pre-determined fee threshold (e.g., the original meeting discussed the tax ramifications of a sale, but the client now wants an analysis of a business merger); or
  • if the services will cross into a different area (e.g., the original meeting discussed the tax ramifications of a sale, but the client also wants business valuation services).

Where a CPA has carefully defined an expanding engagement with a series of engagement letters, the client will have much more difficulty trying to hold the CPA responsible for matters not encompassed by the engagement letters.

Informed Consent Letters

In certain situations, such as S corporation elections or estate tax planning, it is good practice to use an “informed consent letter.” Once the client has been provided with a full consultation of all negative and positive ramifications involved, document the consultation and all tax planning advice in a letter, providing a brief summary of the issues discussed. Also, provide an area at the bottom of the letter that:

  1. allows the client to indicate that they have read and understood the summary letter; and
  2. provides the client an opportunity to affirmatively indicate that they either do or do not consent.

The informed consent letter clarifies that the CPA advises and informs, and the client decides. Without this letter, it is easier for claimants to make it appear that the CPA made the decisions on behalf of the client. Documentation will prevent the client from later asserting that your firm is responsible for unexpected events and for less than optimal results.

Avoiding Collection Problems

The best way to avoid having a collection problem is to communicate your billing and collection policies in your engagement letter. Consider including a fee estimate, noting that unforeseen circumstances or changes in the engagement could make a revision necessary.

Retainers/Deposits: Since tax engagements are generally fast-moving, retainers or deposits may be the best option for clients that are slow-paying, financially stressed, or new to the firm (until they have established some credit with you). Remind clients that retainers are not an estimate of the total cost of the engagement, do not earn interest, and must be paid before work begins.

Stop-Work/Disengagement Clauses: The letter can include stop-work or disengagement provisions, or both, that should be enforced if a client doesn’t pay you in accordance with the engagement letter. A stop-work clause in the fees section of your engagement letter enables your firm to stop work on a tax return in the event the client fails to pay in a timely manner. The enforcement of this clause will help prevent your firm from completing too much work without receiving payment from the client. Stop-work clauses must be enforced in order to be effective.

Bill on a timely basis, and do not allow fees to build up. When unpaid fees become too large, they provide an incentive for the client to sue for malpractice, especially when the CPA sues for fees.

Alternative Dispute Resolution: Simple fee disputes are better resolved through mediation and arbitration than through litigation. CAMICO recommends mediation for all disputes as a first step and binding arbitration for fee disputes only as a second step.

CPA firms should first consult with a risk advisor or attorney to weigh the risks and consequences of suing for fees. Lawsuits and counter-suits almost always result in the CPA spending far more in attorney fees and in lost billable time than is warranted for the fees owed to the CPA.

Include a mediation clause for all disputes and a binding arbitration clause for fee disputes only in your engagement letter, and have the letter signed by the client. CAMICO does not recommend binding arbitration for disputes other than simple fee disputes. The only exception might be simple individual income tax return preparation engagements (1040 forms), but not complex returns. Note that some states do not permit arbitration clauses.

We advise CPAs to not use a general arbitration clause in an engagement letter. Most engagements, when in dispute, tend to produce complex, high-risk, high-dollar disputes that are better managed through litigation than arbitration. An effective legal defense can be restricted and impaired by arbitration.

Randy Werner is a loss prevention executive with CAMICO (www.camico.com). She responds to CAMICO loss prevention hotline inquiries and speaks to CPA groups on various topics. Werner has Big Four public accounting experience in federal and state tax as well as regional accounting firm experience. She has practiced as a sole practitioner in estate planning since 1984.


Download Essential Tax Resources for the 2017 Tax Season

With the increasing complexities in tax law and regulations facing CPAs today, it is even more prudent to stay current on risk management and loss prevention practices. CAMICO has put together a collection of 20 tax-related articles, war stories and updated sample tax letters – available to you for download and use.

Click here to download the tax resources

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