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Responsibilities to Clients When a CPA Firm Is Merging or Acquired

Puzzle pieces

Arthur J. (Kip) Dellinger, Jr., CPA

It is not news to CPAs and their firms that the profession began undergoing an enormous consolidation a few years ago, which is expected to accelerate over the next several years. This is a result of many factors — retirement planning, monetizing of client values, staggering advances in technology, market share and services expansion, among many other reasons.

The consolidation typically takes the form of mergers and acquisitions and sometimes a combination of both. And it involves not only very large firms merging — or bringing in firms of significant size in a local or regional market — but also includes local firms and even sole practitioners combining or acquiring practices of retiring practitioners.

When a proposed merger or acquisition transaction is undertaken, questions arise about the professional obligations and responsibilities of the target firm, including any required communication pertaining to its clients’ confidential information and the transfer of client files to the successor entity.

Professional Standards — American Institute of Certified Public Accountants (AICPA)

Two provisions of the AICPA’s Code of Professional Conduct address merger and acquisition issues.

The first and most significant provision is ET § 1.400.205 – Transfer of Files and Return of Client Records in Sale, Transfer, Discontinuance or Acquisition of a Practice1 — and additionally interpreted in Frequently Asked Questions: General Ethics (updated March 18, 2022).

ET § 1.400.205 provides that when a CPA’s practice is sold or transferred to another firm and the seller/transferor will no longer retain an ownership in the successor practice, each client must receive a written request for consent to transfer its files to the successor firm. The notification may state if a negative response is not provided within 90 days, permission will be assumed by the successor to transfer the files. Moreover, the files should not be transferred until client permission is obtained or the 90 days period expires. Additionally, the acquiring firm is equally responsible for compliance with these requirements. However, there are conflicting requirements discussed below when tax information will be transferred in a sale of a practice.

Equity vs. Non-Equity Transferors

The Frequently Asked Questions addressing “Transfer of client files in a merger” clarify that if a target CPA firm’s owner(s) become equity partners, the client notice requirements do not apply — regardless of the percentage of ownership.

Alternatively, if the target CPA firm’s owner(s) are admitted as non-equity partner(s), the client written notice requirements discussed earlier will apply.

There may also be hybrid situations — for example, when the target CPA firm’s partner, equity or non-equity, “own” clients. In that event, each client situation must be evaluated and treated in a manner consistent with these rules pertaining to equity and non-equity owners in successor entity.

Conflict of Interest Considerations (ET § 1.700.010)

In some circumstances, the parties must consider possible conflicts of interest. For example, when two CPA firms are combining and each represent industry competitors, or when a practice being acquired includes a competitor of a client of the acquiring firm (where one or both clients would prefer not to share the same CPA firm) can create a conflict-of-interest issue. How such matters are handled should be specified in the agreement to the contemplated merger or acquisition.

Accountancy Laws

CPAs and CPA firms are regulated by Boards of Accountancy in the states and other geographical locations where they practice. When one or both firms are pursuing an acquisition or merger, the parties should ascertain which Boards have jurisdiction and determine the applicable jurisdictional rules that apply to the contemplated transaction. Fortunately, the overwhelming number of jurisdictions adopt (specifically or impliedly) the ethics rules of the AICPA (for example, Rule 58 of the California Board of Accountancy).

The California Board of Accountancy recently proposed a specific rule regarding CPA firms’ duties when there was a sale or transfer of a licensee’s practice (Proposed Rule Sec. 54.2) but withdrew the proposal in February 2022. This presumably means California continues to default to the AICPA provisions.

CPAs Must Comply with Onerous Treasury Regulation Requirements

Internal Revenue Code Section § 7216 (“the Code” or “7216”) is a criminal statute regulating tax preparers with regards to their “uses” and “disclosure” of a taxpayer’s return information. The Code is very general and provides that Treasury issue regulations governing the application of Code Section § 6713, which provides civil monetary penalties for similar violations. Its application is governed by 7216 regulations and the provision is more likely to be asserted by the Internal Revenue Service (“the IRS” or “Treasury”) because proving a criminal violation has a much higher bar than meeting a civil violation.

Treasury has issued three regulations under Sec. § 7216 – Reg. Sec. 1.301.7216-1, 2 and 3. These regulations should be reviewed annually by firm leadership to ensure continued compliance with their requirements, IRS Section 7216. Regulation 1.301.7216-1 addresses, definitions and the respective penalties associated with violations of the Code. The significant portion states that “taxpayer information” is any information pertaining to the taxpayer. For example, the use or disclosure of the taxpayer’s name can result in a violation and the regulation is not limited to financial information or identification numbers.

The second regulation, 1.302.7216-2, is key to a firm’s practice because it sets forth those “uses and disclosures” that a tax preparer may make or engage in without prior written approval of the taxpayer, whose information is to be used or disclosed. One of the uses may be to compile a list for solicitation of tax return preparation business (1.302.7216-2(n)). While the CPA firm, as a compiler of the list, is not generally permitted to transfer it, an exception is made when there is a transfer in combination with the sale or disposition of the firm. The typical due diligence conducted prior to the proposed sale of the CPA’s tax preparation business will not represent a transfer of the list if: the CPA selling the firm has a written confidentiality agreement with the acquiring firm that expressly prohibits any use or disclosure of information permitted to be on the list for any purpose other than the purchase of the firm’s business.

If the use or disclosure is not contained in the second regulation, then strict adherence must be made with the third regulation, which sets forth specific, detailed requirements for obtaining the taxpayer’s prior written approval.

Regulation Section § 301.7216-2(d)(1) permits, without taxpayer approval, the use and disclosure of taxpayer information among preparers and processors of a firm regarding tax return preparation and related-tax advice. Therefore, when a merger takes place between two firms and there is continuity of personnel from the target firm in the successor firm, the IRS can be expected to apply the same principles as the AICPA to the transaction. When the target firm’s owners do not retain an equity interest in the successor firm, an abundance of caution would be to comply with the stricter request for permission requirements set forth in Reg. Sec. 301.7216-3. Unfortunately, the request for consent does not specify the number of days within which the client must respond, which can be problematic for the successor firm, instead requiring affirmative consent must be given by the taxpayer before a transfer takes place.

The regulations do not provide for an acquiror’s quality review of tax returns in connection with a sale or merger of a CPA firm’s practice. This is different than the AICPA rules and consequently, the CPA firm whose clients’ returns will be the subject of a review, must obtain client permission for the use and disclosure of their return information when contemplating a sale or merger.

This may present challenges to the two firms, as the acquiror will be limited in identifying particular returns and therefore may request to review it (because they cannot have access to any return information in the selection process). Or, the target firm would have to seek permission from every tax return client to enable the acquiring firm to make its selection. The parties must find a satisfactory solution to the quandary — perhaps a random selection from a list identified (only by numbers) that correspond to an alphabetized master retained by the target firm.

It is critically important to remember in merger and acquisition transactions that the requirements under tax laws must be complied with in addition to complying with the CPA profession’s ethical standards.

Arthur J. (Kip) Dellinger, Jr., CPA, provides services as an expert in the areas of CPA tax practice regulatory discipline and malpractice matters.




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