Risk Management Tips for Tax Season

With the increasing complexities in tax law and regulations facing CPAs today, it is even more difficult to stay current on risk management and loss prevention practices. IMPACT presents the following overview of key liability areas, pitfalls and tips as a guide for tax practitioners heading into busy season.

Client Assessment/Evaluation

If the firm needs to disengage from a tax client, it’s better to do so in February than in April. Firms should evaluate all potential new clients and re-evaluate all current clients on a regular basis, at least annually.
Client evaluation enables the firm to better monitor engagements, consider any changes that might affect the professional relationship, and avoid situations that could escalate into crises. Three main considerations in the process are:

1) Is the engagement a good fit for the firm’s expertise?

The firm should be: 1) capable of performing the services required by the accepted engagements, and 2) performing the services often enough to be proficient at them. CAMICO claims experience shows that firms “dabbling” in services outside of their areas of expertise are not practicing them often enough to become proficient. Services that represent less than 15% of a firm’s service concentration produce disproportionately high loss ratios. (See chart, “Risk is High for Beginners and Dabblers.”)

2) Is the client the type of client the firm would like to represent?
CPAs should communicate with predecessor accountants and third parties to obtain as much information as possible about the client. Are the client’s expectations of CPAs reasonable? Does the client appropriately value CPAs’ services and advice?
Background investigations are recommended for all significant engagements. Consider potential or actual conflicts of interest, as well as whether the CPAs’ independence and/or objectivity are impaired in fact or appearance, especially when considering services for attest clients.
3) Is the client financially viable?
The answer to this question is critical, especially in avoiding fee collection problems and disputes. Much of the information you need can be obtained by:
   • Interviewing the client and the client’s key personnel, banker, attorney, predecessor accountants and auditors
   • Running a credit check
   • Examining the past three years of financial statements
   • Examining the past three years of tax returns
   • Examining prior CPA’s management letters

Red flags and Warning Signs

Some of the warning signs that it may be time to disengage from certain clients include:
   • Late or slow payments
   • Difficult or uncooperative behavior
   • Withheld information
   • Changes in client’s business
   • Deteriorating client relationship
   • Changes in the firm
   • Potential conflicts of interest
   • Requesting a discount before services commence
Conflicts of interest

Troublesome or emotionally charged scenarios often lead to conflict of interest allegations. Examples include entity dissolutions, acquisitions, trusts, bankruptcies, mergers, divorces, representing an entity and all or some of its owners, or any situation that involves or has the potential to result in opposing or unhappy factions.

When a client dissolves a partnership or files for divorce, you may feel compelled to disengage from one or both parties to avoid potential or actual conflict of interest. Continuing to prepare tax returns for a divorcing couple, for example, may be problematic, as each spouse could accuse you of preparing the return in a manner more favorable to the other spouse. Continuing to work with two former partners after dissolution presents a similar challenge, especially if the partners are not on amicable terms.

How to Disengage

Disengaging is good practice management, and knowing how to do it skillfully and professionally will help you grow your practice and avoid liability. When you decide to disengage, you should terminate the relationship professionally and formally, in writing.

At a minimum, the disengagement letter should always contain clear statements, a description of the completed and remaining work, and a list of any due dates or filings. The client need not feel antagonized in any way. When done effectively, a disengagement can leave the client feeling like you have acted in the best interests of both parties.

CAMICO can review disengagement letters and help you sort through issues pertaining to client situations. Is the client still your client? If not, then a formal disengagement may be in order. Also consider withdrawing Power of Attorney authorizations to limit your professional liability.

Sample disengagement letters, client screening checklists for individual and corporate clients, information on background checks, and other tools and resources are available on the CAMICO Members-only Site under Knowledge Tree (Reference Library), under folders titled “Client Screening” and “Disengagement Letters.”

Fee Issues

Fee collection issues can be managed proactively so that they are no longer a major problem for the firm. Here are some key steps to take:
   • Communicate your expectations for prompt client payments and take action when payments are not prompt.
   • Communicate your firm’s policies regarding billing and payments in the engagement letter, including stop-work and disengagement provisions to be enforced if payments are not received in accordance with the policies.
   • Bill on a timely basis, and do not allow fees to build up to the point where you believe you can no longer walk away from them. When unpaid fees become too large, they provide an incentive for the client to sue for malpractice, especially when the CPA has sued to collect fees.
   • Simple fee disputes are better resolved through mediation and arbitration than through litigation. That’s why CAMICO recommends mediation for all disputes as a first step and binding arbitration for fee disputes only as a second step. CAMICO also provides a premium credit to policyholders who agree to an alternative endorsement to their policy to exclude coverage for claims arising subsequent to suits for fees.

Suing for fees creates a high probability of a counter-suit by the CPA’s client, usually alleging malpractice during the engagement in question. This escalates the situation from a simple fee dispute to a malpractice lawsuit. Lawsuits and countersuits 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.

The engagement letter becomes the CPA’s first line of defense in fee and other disputes. It is in many respects a written contract between you and your client. It should clarify the understanding with the client, the services to be rendered, the scope and limitations of the engagement, the responsibilities of the client, and those of the CPA, in limiting language. Always obtain the client’s signature on the letter.

Engagement creep: If an engagement expands beyond the terms of the engagement letter, draft a new engagement letter.

Guidance, tools and sample engagement and other letters can be found in the Engagement Letter Resource Center on the CAMICO Members-only Site.

While the first document in any engagement should always be the engagement letter, good documentation of other aspects of the engagement is also invaluable for risk management purposes. The legal defense of a firm is usually much more successful and effective when based on what the firm has documented, rather than on recollections of the firm’s personnel.

Documentation can also improve client communications, clarify the scope and areas of responsibility in certain engagements, address expectation gaps, provide value-added service to clients, and create potential new services. Inadequate or improper documentation, on the other hand, can be a costly mistake.

Jurors generally consider CPAs to be experts in documentation, and falling short of that expectation when faced with a liability suit may be viewed by the public as negligent and below the standard of care for the services rendered. Since the public generally places the burden to document on the CPA, even an informal email exchange documenting a brief telephone conversation can help.

The following are some documentation tips for tax season:

• Always document significant meetings, communications and follow up. Follow up with written communication in the following circumstances such as:
    o     Change in the scope of an engagement (may require a new engagement letter)
    o     Negative information (e.g., tax return is already late, client’s failure to timely provide information, client is facing an             audit)
    o     Judgment calls (e.g., the former CPA took an aggressive position that client is aware of and has consented to)
    o     Client to take material action on discussion
    o     Conversations regarding transactions or amounts used for extension payments.
    o     Do you due diligence in tax services

Obtain written confirmation of the amounts used for calculations. For example, a confirmation can be sent to the client with the tax extension payment form, giving the client an opportunity to review the information and to change any information that appears incorrect, prior to April 15. The confirmation then serves as a record of the client’s representations in case the client incurs a late payment penalty.

If you need information at the last minute to complete a return, have the client send the data via e-mail or fax. The e-mail or fax becomes part of your records, support and documentation. Remind the client if they fail to cooperate with the request.

Use informed consent letters in engagements such as Sub-S Corporation selections or conversions, estate tax planning, and aggressive or gray tax strategies, clarifying that CPA advises and informs, while the client decides. With this letter, it is difficult for claimants to make it appear that the CPA made the decisions and is responsible for the results.

Aggressive or gray tax positions may call for the client to provide you with an opinion from tax counsel confirming that the position has a realistic possibility of being sustained on its merits if challenged. If you’re advising a client on a complex transaction or exchange, you may want to have your legal counsel review the documentation before passing it on to your client.

Fraud: CPAs are not required to verify certain types of information, but if something looks irregular, a prudent course of action is to investigate, document, communicate, and get it right. Client and public expectations of CPAs have increased in recent years to the point where CPAs are expected to: 1) always detect fraud, and 2) advise and warn clients about their exposures to fraud. The public expectation to always detect fraud can be extremely difficult to meet, but the expectation to advise and warn is much less difficult. By advising and warning clients of their defalcation exposures, CPAs are able to minimize liability stemming from the expectation to detect fraud.

Internal control advisory letters: Advise and warn clients about their exposures to defalcation. The letter: 1) warns about general risks, 2) suggests steps clients can take to reduce risks, 3) indicates the Association for Certified Fraud Examiners has found that only three percent of frauds in their most recent survey were initially detected by their external auditors, and 4) offers annual CPA services to address fraud risks. Examples can be found in the Fraud Resource Center on the CAMICO Members-only Site under “Risk Management Tools and Engagement Letters.”

Documentation should be factual, professional, and without personal comments, which may be inappropriate and damaging to the integrity of the documentation. Ask yourself whether you or your client would be harmed if the documentation was presented to the “ladies and gentlemen of the jury.”

Do your due diligence in tax services, as required in the Statements on Standards for Tax Services, under Circular 230 and other regulations.

Note changes in return due dates. The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 changed the due dates for partnership and corporate income tax returns as well as for FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR), among other items. For more information, see “Return Due Dates Change” on the CAMICO Members-Only Site under Knowledge Tree, Risk Management, CAMICO Publications, IMPACT, 2015, IMPACT 104.

Early Reporting

Promptly report potential claims, including potential errors and omissions, to CAMICO. This will not only protect your full policy limits, but you may benefit 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, and they will not impact the policy limits or be charged to the deductible.

Subpoena and consultation services are included in these pre-claims benefits. Early reporting helps our claims specialists achieve early, efficient and effective resolutions, thereby mitigating the impact of an error or omission.

As always, policyholders can call the Loss Prevention department at 1.800.652.1772, or email lp@camico.com.

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