Two Tax Areas Prone to Claims

1. Income tax issues can become technical to the point where most of the burden for decision-making falls on the CPA. There is often a limit to how much the CPA can ask the client to decide in technical tax issues. “It’s much like a patient seeing a doctor about a serious, complex medical condition,” said Ron Klein, JD, CFE, CAMICO risk management counsel. “The problem and treatment are so critical that the patient will ultimately go with the treatment the doctor recommends. The tax professional must be sure of his or her competency and ability to render the best advice possible for the client.”

Loss Prevention Tips: Careful screening of the firm’s clients and engagements will help avoid “engagement creep,” whereby the scope of an engagement may begin to extend beyond the CPA firm’s core competencies. All clients and engagements should be re-evaluated at least annually to confirm that the firm is: 1) capable of performing the services required by the engagement; and 2) is performing the services often enough to be proficient.

There are also high-risk clients and engagements. Both can be identified with careful client screening. Much of the information needed to screen a new client can be obtained by:

• running credit checks,
• examining previous financial statements,
• reading the prior CPA’s management letters, and
• interviewing the client, the client’s key personnel, banker, legal counsel, prior accountants and auditors

“The CPA’s job is to advise and warn the client about alternatives and their possible benefits and risks,” Klein said. “Once the choices are made, document the reasons and the client’s involvement. The CPA may also get a second opinion from another tax specialist, much like a doctor getting a second opinion from another specialist.”

2. Entity selection issues generally involve decisions about Sub-S or C Corporation selection or conversion. Clients make choices about S corporation elections because they believe the benefits of their choices outweigh the detriments. But sometimes events occurring after the choice make it less beneficial than originally planned, exposing the CPA to liability. Often CPA liability results from inadequate consultations with clients before these decisions are made. For example, a consultation should occur (which may not result in an S election) when a closely held C corporation holds substantially appreciated assets.

Loss Prevention Tips: Provide the client with a full consultation describing all negative and positive tax ramifications involved, and document the consultation in an “informed consent” letter, providing a brief summary of the issues discussed. Also, provide an area at the bottom of the letter which: 1) allows the client to indicate they have read and understand the summary letter; and 2) provides the client an opportunity to affirmatively indicate whether they want an S election. “Informed consent” is always important but more so in these situations because of the technical nature and the limited ability of the client to discern the pros and cons. Documentation will prevent the client from later asserting that your firm is responsible for unexpected events or less-than-optimal results.

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