The season when tax preparers put their knowledge into practice and earn the most money is also the time when they are the most vulnerable to charges of negligence, incompetence or malpractice. The pressures and deadlines of busy season are unrelenting, confronting them with the necessity of working late hours, making hasty decisions and not having enough time to address all the issues they’re faced with. And as the year wound to a close, there was a real possibility of a complete tax overhaul, either before or soon after the end of the year.
Some issues from the CARES Act will spill over into next year’s filing season and create risks. One of these is the Child Tax Credit, according to John Raspante, a CPA and director of risk management for McGowanPro.
“This is an area that will create some risk, perhaps not large in terms of dollar amount but it could result in a CPA being discharged or in client alienation,” he said. “The Child Tax Credit has increased from $2,000 to $3,000. It’s a substantial credit, especially if the taxpayer has three or four kids. In order to get money into people’s pockets as part of the stimulus, the IRS began giving the credit in July 2021, as advance payments ahead of filing season. But there could be issues that might cause trouble. For example, a dispute might arise between a husband and former wife over who can claim. The one who claimed will have a lower refund because they got the money ahead of time. If the preparer puts the wrong number in, the taxpayer might go from a refund situation to owing the government. Any discrepancy could cause delays in processing, which might give rise to claims against the preparer.”
Another area that requires close attention by the preparer is digital currency, Raspante indicated. “People are using Bitcoin to buy and sell services, and it’s being bought and sold on exchanges,” he said. “The IRS believes it could be an opportunity for some to underreport income, so the preparer has to do a really good job of confirming if the taxpayer had any transactions. Reporting by third parties is not that accurate or consistent, so the IRS is keeping a close watch. It will create risk exposure, especially if the IRS has a record of a transaction and it’s not getting reported. Some accountants are not even asking their clients whether they had any transactions in digital, or virtual, currency. They’re simply assuming there were none.”
Anne Termine, an expert in crypto and former chief trial attorney for the Commodity Futures Trading Commission, agreed.
“The IRS is using ‘John Doe’ summons to compel, with court approval, information from a third party, such as a crypto exchange, to get information on taxpayers not named in a summons,” she explained. “This year, federal courts authorized the IRS to issue two John Doe summons to popular cryptocurrency exchanges Circle Internet Financial and Payward Ventures, a.k.a. Kraken. These inquiries centered on platform users with at least $20,000 in crypto transactions.”
Termine believes that investigation and enforcement by the IRS will increase. “Cryptocurrency industry participants — [and their preparers] — should anticipate that the IRS might begin to scrutinize customers and business processes,” she said.
Fallout from the pandemic
Corporate returns and Schedule Cs are another area of risk, given the economic hardships generated by COVID, according to Raspante.
“We will see an increase in failed businesses or in ones that will ultimately fail or have significant losses in 2021,” he said. “If that occurs, tax professionals will need to watch [net operating losses]. They vanished for a while, but were brought back under the CARES Act.”
Financial hardship often creates tax issues, he observed. “There are provisions in the code for cancellation of debt. Typically, if a debt is canceled for less than the amount owed, it creates cancellation-of-debt income. But there are exceptions and exclusions that the preparer should know.”
For example, an amount canceled as a gift or bequest is an exception to the cancellation of debt rule, while debt canceled in a Title 11 bankruptcy or to the extent a taxpayer is insolvent is an exclusion from gross income. Failure to apply the proper treatment to these issues is a potential risk trigger, Raspante indicated.
Meanwhile, more states are auditing taxpayers that leave a large metropolitan area and move to a different state. “It’s not as simple as moving out of New York on July 21 and treating all your income from that date forward as income earned in Florida,” he said. “You have to analyze the taxpayer’s situation in terms of residency and domiciliary rules, and be on the lookout for an increase in audits as a result of the nation becoming more mobile.”
The increased mobility on the part of taxpayers can affect both individuals and their employers, noted Mike Semes, of counsel with Baker Hostelter. “It has liability risks because it affects withholding,” he said. “If the employer doesn’t get unemployment withholding right, they’re liable for penalties and the preparers suffer damage to their reputation, as well as exposure to professional liability risks.”
One of the reasons for risks in this area is the uncertainty, he suggested. “The uncertainty arises because not every state utilizes the same nexus rules when the employer is subject to withholding obligations,” he said. “In some states, it’s the location of the office even if the employee is working at home in another state. In other states, it’s the opposite. There may be dual obligations. States have not put out a lot of guidance, and that compounds the uncertainty — and the liability risk for tax preparers.”
”The whole cyber issue remains a challenge,” remarked Raspante. “It grows when economies are sluggish and more criminals are phishing or attempting to open emails. “We’re seeing professional liability claims due to cyber issues increase at an unprecedented rate.”
Seasonal preparations
Deb Rood, risk control consulting director at CNA, the underwriter of the AICPA professional liability program, summed up the steps accountants and tax professionals must address to ameliorate the risks they face in the approaching tax season.
She recommends that they focus broadly on data security, firm staff and client preparation, updates to engagement letters, and client acceptance and continuance procedures.
“Data security is becoming more of an issue,” she said. “From the preparer’s standpoint, look at all the valuable information they have. Anecdotally, we’ve seen an uptick in cybersecurity claims.”
The Internal Revenue Service recognizes this, and requires preparers to attest to their data security plans when they update their PTINs. “Staff should be trained to recognize phishing attempts and be made aware of ransomware,” she explained. “The firm should make sure that it has cyber insurance, and understand what coverage they have.”
“I recently spoke to a CPA who received an email from a client who asked him to change his bank account number,” she said. “When an accountant receives an email like that, the first thing they should do is pick up the phone and call a known number to verify the request from the client. Unfortunately, the CPA acted in haste, and went ahead and changed the account number. The email was not from his client, but from a ‘bad actor.’ Our claims people hear about instances like this every day.”
Rood recommends that accountants provide a “laundry list” of recent tax legislation to clients: “They’ve seen the headlines, but don’t know the tax implications, so inform them in a newsletter or a webinar about generally high-level items. And now is the time to contact the regular procrastinators. Figure out how to work together to prevent last-minute fire drills.”
On the staff side, Rood recommends placing emphasis on staff training and on making sure research resources are up to date to eliminate errors. “And review policies and procedures from last year to see if they need to be changed,” she added.
“Remind staff of the importance of engagement letters, including engagement letters for additional services — anything other than just tax compliance,” she added. “Casual questions on the phone regarding topics such as taxation on the sale of their business or exercise of stock options are outside the scope of tax compliance and should be addressed.”
Finally, Rood believes that many accountants fall short when it comes to client continuance. “If you’re working with the right client, they respect you, and they get information to you and pay their bills in a timely fashion,” she said. “Make sure to look at the situation every year to make sure they’re still the ‘right client.’ You don’t want to be the CPA that says ‘I knew that client was trouble.’ It’s hard — a lot of CPAs feel it’s easier to keep a bad client than get a new one.”
