Documentation, Engagement Letters Key to Tax Risk Management

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.

Step-by-step guidance through the engagement letter writing process, sample engagement letters, an engagement letter checklist and other tools can be found in the Engagement Letter Resource Center, located on the CAMICO Members-Only Site (Policyholder Login is at

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. CAMICO also provides as much as five percent premium credit to policyholders who agree to an endorsement to their policy to exclude coverage for claims arising subsequent to suing for fees.

CAMICO policyholders who have not elected to have the endorsement have the option of suing to collect fees, but the firm must first consult with CAMICO. The consultation enables a specialist to assist the policyholder in weighing 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. CAMICO will cover claims arising subsequent to suits for fees if the firm has that option under their policy, but the premium credit is not available.

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. Suggested engagement letter language can be found on the CAMICO Members-Only site in the Engagement Letters Resource Center under the “Getting Started” tab (“Summary of Engagement Letter Components”).

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.

As always, CAMICO policyholders can call 800.652.1772 / 650.378.6800 or email the Loss Prevention department at for more information or assistance.

Share this post

Leave a comment

Filtered HTML

  • Web page addresses and e-mail addresses turn into links automatically.
  • Allowed HTML tags: <a> <em> <strong> <cite> <blockquote> <code> <ul> <ol> <li> <dl> <dt> <dd>
  • Lines and paragraphs break automatically.

Plain text

  • No HTML tags allowed.
  • Web page addresses and e-mail addresses turn into links automatically.
  • Lines and paragraphs break automatically.

Latest Articles

  • 12 Jul

    Malpractice Risks Increase During Difficult Economic Times

    In CAMICO's 35 years of experience, economic conditions have had a significant impact on CPA professional liability claims. In light of the current economic challenges, now more than ever, CPAs will need to be prepared and vigilant to minimize the potential of additional liability exposure... read more

  • 09 Jul

    Creditworthiness Verifications and PPP Loans

    CPA firms receiving requests from lenders for creditworthiness verifications for clients who had requested Paycheck Protection Program (PPP) loans were often unsure of how to respond. The advice CAMICO gave CPAs assisting their clients with PPP loan applications is valid for similar circum... read more

  • 07 Jul

    War Story 119

    Subject: Business Management Services; Wire Transfer Fraud

    John Duval, CPA, had been engaged for several years by a high-net-worth client, Ed Robertson, who developed commercial and residential real estate. Duval provided business management and bill-paying services, which inclu... read more

  • 07 Jul

    Recognizing the Signs of Elder Abuse

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

    The elderly population in the U.S. (those 65 and older) is projected to grow to 80 million by the year 2050, and the incidence of elder abuse, including the hard-to-detect financial and material exploitation perpetrated against ... read more