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Documentation, Engagement Letters Key to Tax Risk Management

Documentation - engagement letters are the key to tax risk management
By Suzanne M. Holl, CPA and Duncan B. Will, CPA/ABV/CFF, CFE CPA liability exposures during tax season are always a concern, regardless of economic or professional conditions. However, in the wake of the pandemic, liability exposures during this tax season are even more exacerbated given the added complexities associated with the magnitude and state of flux with many of the new or expanded economic and tax-specific relief measures (credits, deferrals, etc.). Defensive documentation is essential to successfully manage risk exposures; practitioners need to be proactive, not reactive, with their written documentation in today’s litigious environment. CAMICO’s claims experience shows that many high-exposure tax claims have certain characteristics in common, primarily as follows:
  • The services for which clients engaged the CPA were unclear.
  • The CPA did not clarify his or her role or the client’s expectations, usually because an understanding between the CPA and the client was never reached or adequately documented.
  • A lack of clarity and documentation made the CPA’s services difficult to satisfactorily complete.
  • Inadequate documentation makes it difficult to defend the CPA in future malpractice actions.
Documentation, or the lack thereof, is always a critical factor in any claim, and the engagement letter is the first line of defense. A well-defined engagement letter clarifies the services that you will render, describes the scope and limit of the engagement, and delineates in limiting language, not only the scope of the engagement, but yours and your client’s responsibilities. Documenting the understanding between you and the client minimizes the likelihood of litigation, because a well-constructed engagement letter leaves little or no room for misunderstandings, which could result in “expectation gaps” — the root cause of many lawsuits. If you do find yourself in the middle of a lawsuit, then the engagement letter will evidence the duties that your firm was expected 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. In limited situations, like lower risk tax engagements, the use of a well-crafted unilateral clause may be appropriate as it establishes actions that if taken, acknowledge the client’s acceptance of the engagement letter’s terms and conditions. Although this type of clause is not quite as compelling as having a client signature, it provides some protection. 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 on significant client meetings and discussions with defensive documentation. Provide attendees with a synopsis that includes the date, the participants’ names, the matters discussed, the action items and who is responsible for each. Following up significant meetings or discussions with documentation will ensure that you and the other parties are proceeding with the same expectations and assumptions and will provide excellent defensive documentation should someone later allege something else was discussed, they weren’t present, or you were responsible for taking actions you had not agreed to. Client notifications are a helpful risk management tool to document your communications regarding updates of significance. Jury research shows that the public, including clients, perceive that the CPA’s fundamental job is to “advise and warn” — to advise clients of opportunities and to warn them of risks. The burden on tax practitioners to “advise and warn” is especially important today. The fast pace of change adds complexity and challenges to tax compliance. It is important to have written documentation with clients to avoid expectation gaps. For example, critical changes to the application of economic and tax relief measures, and the new rules associated with sales and local tax workaround initiatives are important issues to communicate in writing to clients to mitigate the possibility of client expectation gaps. Draft additional engagement letters when necessary. New engagement letters are sometimes needed to avoid engagement creep or client-expectation gaps when the additional services require management to acknowledge and accept certain terms and conditions not stipulated previously. When CPAs carefully memorialize an expanding engagement, it is significantly more difficult for clients to hold CPAs responsible for matters outside the scope of the engagement letters.

Informed Consent Letters

In certain situations where there may be different tax alternatives available to the client (for example, estate tax planning) CAMICO encourages the use of “informed consent letters.” The informed consent letter clarifies what the CPA advises and informs, and the client ultimately decides which action they wish to take. Without such a letter, claimants can allege that the CPA made the decisions on behalf of the client. This type of defensive documentation minimizes potential liability exposures were the client to later assert that your firm is responsible for unexpected events or less than optimal results.

Avoiding Collection Problems

The best way to avoid having a collection problem is to detail your fees, billing, and collection policies in your engagement letter. Consider including a fee estimate, noting that unforeseen circumstances or changes in the engagement could necessitate revisions. Retainers/Deposits: Most ongoing engagements lend themselves to the use of retainers or deposits. These options may be best for clients that are slow paying, financially stressed, or have yet to establish a payment history with you. The engagement letter clause should clearly state that retainers are not an estimate of the total cost of the engagement, do not earn interest, must be paid before work begins, and if depleted, must be replenished before work continues. Stop-Work/Disengagement Clauses: CAMICO encourages the use of a stop-work/disengagement provision which can be enforced if a client doesn’t pay in accordance with the terms of the engagement letter. The clause stipulates that if the client does not pay the firm, the firm can stop services without incurring any liability to the client for doing so. The enforcement of this clause significantly reduces the risk that your firm feels compelled to continue incur ever growing fees when the client has yet to pay for prior services. The closer to a deadline this clause is triggered, the greater the exposure to the firm. Don’t wait until right before deadlines or due dates to stop work. Work stoppages close to a deadline increases the likelihood the client will claim that you (not they) breached the contract. Alternative Dispute Resolution: When used appropriately, mediation and arbitration can significantly reduce the cost and the emotional roller-coaster ride of disputes. CAMICO recommends adding clauses to engagement letters calling for mediation to resolve all disputes, and then binding arbitration for fee disputes not resolved during the mediation. When there is a fee dispute, the firm should inform the client in writing that unless paid within a specified number of days, the firm will initiate mediation to settle the matter. Using the mediation and arbitration process to settle fee disputes is more effective than litigation, though there is no guarantee that the whole amount owed will be collected. The process itself may prompt some clients to pay some or all the outstanding fees. Filing suit to collect outstanding fees often triggers a countersuit. CAMICO’s claims history indicates binding arbitration to resolve fee disputes is the safer and more effective alternative. We advise CPAs not to 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. 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”). As always, CAMICO policyholders can call 1.800.652.1772 or email the Loss Prevention department at for more information or assistance.

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