The tax return filing season, when accountants demonstrate their value to clients, is also the time when they are most open to charges of negligence, incompetence or malpractice.
"The pressure increases dramatically during busy season when everyone is working at 100 miles an hour to meet deadlines and complete returns," observed Jock Wols, chief executive officer of insurance broker RiskDesk. "And that's when they are the most likely to be open to professional liability claims."
The upcoming filing season presents a number of issues that could become liabilities if they are not addressed correctly. Foremost among them is the involvement of third parties in the return process, according to Deb Rood, risk control consulting director for CNA, the underwriter for the AICPA Professional Liability Insurance program.
"Some third parties that calculate tax credits appear to be taking overly aggressive positions when calculating the credit," she indicated. "When the client asks the CPA firm to prepare amended tax returns, it puts the CPA firm in a difficult spot. Utilizing a third party to calculate credits has been around a long time — R&D studies and cost segregation studies are examples. But it's more prevalent now with the Employee Retention Credit and energy efficient tax credits. There are many consulting firms convincing CPA firm clients to take extremely aggressive positions, oftentimes without the client realizing how aggressive the position is.
"Every non-CPA firm is out there taking extremely aggressive positions," Rood observed. "The client may get a report or study from a third party and hand it to the CPA with a request that they amend their return to comport with the study."
The IRS just warned of such third-party promotions of improper Employee Retention Credit claims in
Rood recommends that practitioners add a provision in their engagement letter providing:
- The CPA will have to evaluate the third party's work;
- The client understands that the position may be challenged by the tax authorities; and,
- The CPA firm is not responsible if the position is disallowed by the tax authority.
Rood recommends that when a client presents the CPA with a third party's report, they consider the following: The AICPA Code of Professional Conduct and Treasury Department Circular 230 allow CPAs to rely upon a client's representations without further work unless it appears to be incorrect, incomplete or inconsistent with other information known by the CPA.
"In other words, the CPA can't blindly accept a third party's work and incorporate it into a tax return," she said. "Look at the report, and see if it makes sense. The CPA may not be an expert, but they can tell when something smells fishy. For example, if it's a syndicated conservation easement, does it make sense that a client would invest $100,000 and get a tax deduction of $200,000?"
"If it makes sense, you can incorporate it into the return with some additional disclosure to the client," she said. "But every once in a while, it's too far off. That's when things get tough. You have to tell the client you can't incorporate the third party's report into the tax return. The client will either need to get a new report, file the return without the report for the time being and amend it when an acceptable report is received, or go somewhere else."
The Inflation Reduction Act contains a ton of new provisions that CPAs need to familiarize themselves with, according to Rood: "I'm especially concerned about the green incentives. Clients may expect their CPAs to tell them about all of these opportunities. The engagement letter should specify that the CPA is not obligated to tell the client about every possible tax incentive."
The engagement letter should also guard against claims arising from oral advice from the CPA.
"CPAs are regularly asked off-the-cuff questions and they answer these questions without realizing that the client may rely upon their answer," Rood said. "To protect themselves, the engagement letter should state that the client should not rely upon oral advice as it is preliminary and based on general business concepts, not necessarily the client's specific situation. Sometimes it's difficult to not respond to a client, so if oral advice is provided, follow it up with an email stating the same," she said.
Update your letters now
The insurance industry anticipates liability claims in connection with Employee Retention Credit fraud, agreed Stan Sterna, vice president for Aon, the broker and national administrator for the AICPA Member Insurance Program.
"And before filing season begins, it's a good time to update engagement letters," he suggested. "The percentage of accountants that use engagement letters for tax services is historically low. Some preparers have hundreds or even thousands of returns, and they have decided that it's too difficult to get engagement letters. But we see a lot of claims in tax due to either evergreen engagement letters or no engagement letters. The engagement letter is the first line of defense, especially if the claim involves 'engagement creep.'"
For example, a client may allege that they hired the accountant to do their return, but the accountant agreed to provide advice on internal controls or finances.
"The accountant should tell the client they need to update the engagement letter," Sterna said. "It should consist of a 'meeting of the minds' as to the scope of the engagement. This is critical to the defense of any liability claim."
This time is also a chance for accountants to look at their client list and "cull" those that are constantly complaining or that have to be chased for information or payment, or need explanation as to why a strategy is risky.
"These are clients that can create a problem down the road," Sterna observed. "Most CPAs are in a comfortable position, post-pandemic. They have the luxury of being able to look at their client list and decide which clients they wish to continue serving."
Season-specific concerns
Two issues at the forefront of risk for the upcoming season have to do with the burden of reporting for passthrough entities (IRS Forms K-2 and K-3) and state and local taxes for business clients with employees working remotely, according to Camico tax analyst Anthony Cooper.
"In regard to the state and local tax issue, it is crucial to have an engagement letter that clearly defines the scope of the services," he said. "The engagement letter could limit services to the preparation of federal and specified state income tax returns. If the client desires a state and local tax analysis to determine whether they have an income, payroll or sales tax filing requirement in one or more states, it should be specified in the engagement letter."
"Unfortunately, the passthrough entity issue is an unavoidable administrative burden for practitioners with passthrough entity clients," Cooper said. "The CPA firm should make sure they possess the necessary competence to properly complete the forms and to assist clients in determining whether additional forms are required."
Wols of RiskDesk, which is underwritten by Nationwide and specializes in startup and part-time accountants, noted that risk doesn't pay attention to firm size.
"Managing the rush of tax season is vitally important for the small as well as the larger practitioner," he said. "There are deadlines that have to be met, extensions that have to be applied for — it's nothing new, but it continues to affect filing season risk."
Maintaining cyber security awareness is especially key during filing season, he indicated. "The cyber criminals are aware that preparers are under heavy pressure. From their perspective, the small practitioner may not be as lucrative as a Fortune 500 company, but they present a much easier target. Everyone has to understand that they are at risk."
