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Identify “Problem” Tax Clients

Professional Liability, Tax Services, Articles

Approximately two-thirds of all professional liability claims in the AICPA Professional Liability Insurance Program arise from tax practice.  While technical errors by the tax preparer generate the majority of these claims, many claims arise from engagements for clients that in hindsight can be identified as “problem” clients.  Let’s take a look at a few of these client types: 

But I Thought You Were Preparing the (Payroll, Sales, Use, Local) Tax Returns:

This small business client runs its cash-based business on a shoestring, and most of the employees are family members.  Most of its time is spent on selling and servicing customers, relying on a family member with limited accounting experience to do the day to day bookkeeping work. Inquiries about tax matters generate responses such as “talk to Mary” (the bookkeeper) or “Mary’s doing that.” Often, these other tax returns are not filed or are not filed timely, sometimes due to ignorance or neglect, and sometimes, to avoid paying the tax.  Faced with a substantial tax bill, as well as penalties and interest, this client tends to blame the CPA for failing to advise of tax obligations, especially if the tax liability is for a tax the client has not previously collected or paid.

Meet with the principal client contact at least annually to discuss the client’s obligation to collect, withhold and remit various applicable taxes timely, and to file the related tax reports and returns.  Document this discussion in a follow-up email to the client, and obtain signed engagement letters on an annual basis identifying the specific tax returns to be prepared. When a client is informed of an obligation to collect and remit a newly applicable tax, send a follow up email to the client summarizing the discussion.

Don’t Worry About It, We Won’t Get Audited:

In the course of preparing current income tax returns, the CPA identifies an error made on a prior tax return self-prepared by the client. The error involves unreported income, improper deductions, or other problems that would result in additional taxes, if corrected. The client ignores the CPA’s recommendation to file amended tax returns to correct the error. Nothing happens until an audit is initiated more than a year later. Then, the client blames the CPA for failing to prepare amended returns for filing.  By this time, the accrued interest on the unpaid tax and penalties far exceeds the tax liability.

While Statements on Standards for Tax Services (SSTS) No. 6 and Treasury Department Circular 230, Section 10.21 do not obligate a CPA to inform a client in writing of an error on a prior return, consider sending an email to the client documenting the need to file an amended return.  If the client takes no action to correct the prior error, SSTS No. 6 provides that:

“…the member should consider whether to withdraw from preparing the return and whether to continue a professional or employment relationship with the taxpayer. If the member does prepare such current year’s return, the member should take reasonable steps to ensure that the error is not repeated.”

I Need to Clean up Some Back Taxes: 

Unsolicited, a prospective client shows up asking for help, indicating a failure to file tax returns for a while, seeking assistance in filing the returns and reaching a negotiated settlement with the taxing authorities. The client may be recently divorced or a business owner. The CPA reaches a proposed negotiated settlement with the taxing authority. The client balks at accepting the settlement because it requires the liquidation of business or personal assets, perhaps including securities that requires realization of capital gains upon their sale, and decides to do nothing. The taxing authority ultimately takes action to collect the back taxes and seizes property. The client then sues the CPA, alleging the CPA is responsible for the loss of their home and/or business.  Additionally, the CPA doesn’t get paid for the work performed. 

In these types of circumstances, a proper business practice would be to carefully screen unsolicited new tax clients requesting assistance.  In addition, the CPA should investigate the client’s filing status for the last several years to determine if their tax problems extend to third parties such as former partners or spouses.  The CPA should also obtain a cash retainer and signed engagement letter clearly defining the scope of the engagement before beginning any work. An inquiry should be conducted to determine how the client intends to pay its taxes, and confirming the client is able and willing to liquidate assets, if necessary, in order to pay the tax.  If the client fails to respond to phone calls or emails, send a termination letter to the client at both their email and street address, retaining proof of delivery in the form an email confirmation and/or mail courier tracking number. 

I’ll Get It to You in a Couple of Weeks: 

Every CPA has clients that have poorly maintained records and procrastinate in providing data needed to file returns. Some clients are so negligent in this regard that their shortcoming may result in the potential for a claim ultimately asserted against the CPA. For example, clients who own a business but keep their records in a shoebox, or use accounting software but do not maintain updated records are unable to produce sufficient data for the CPA to determine their estimated tax payment.  When the client is later assessed late payment and underpayment penalties, the CPA may be blamed for failing to advise of the obligation to make an estimated tax payment. Even if penalties are not assessed on estimated tax payments, when the shoebox arrives at the CPA’s immediately prior to a deadline, the CPA is more likely to make errors due to the severe time constraints imposed.


Most CPAs have a few clients that are delinquent in these or similar areas. Consider whether or not the fees generated by the client are worth assuming the additional risks associated with the work.  If the answer is yes, a signed engagement letter with a specified deadline to provide data needed to calculate estimated taxes and file an extension should be obtained. The letter should also explain that penalties and interest accrue on taxes that are not paid timely.  If possible, establish the deadline at least 30 to 60 days prior to the initial filing deadline. The engagement letter also may include a provision nothing that the CPA may withdraw from the engagement if the client does not produce the requested data prior to the deadline. If resignation is required, consider doing so via a client termination letter, while retaining proof of delivery. 

It’s Your Fault I Owe Late Payment and Underpayment Penalties 

Many CPA firms continue to prepare tax returns for clients that they have not met face to face for several years, with personal contact limited to a few phone calls or emails. Tax organizers are typically sent to clients for completion with a unilateral engagement letter describing the scope of the engagement and the client’s responsibilities.  When the CPA does not receive the completed organizer and is unable to contact the client by telephone or email, as a courtesy the CPA files for an automatic extension of time on behalf of the client.  The CPA never receives a reply from the client, and assumes the client hired someone else to prepare their returns.  Many months later, the former client presents a claim against the CPA for the penalties and interest owed upon the late filing of the returns. 

The CPA should issue annual engagement letters clearly indicating the client’s responsibility to complete and timely remit the tax organizer and supporting information. The letter should also explain the obligation to timely file either the returns or an extension of time to pay actual or estimated taxes prior to the deadline. It also should note the accrual of late payment and underpayment penalties and interest. The CPA may also indicate that if the client does not provide the requested data by the specified deadline, the firm will not provide tax services.  

While some CPAs automatically file extensions for clients, there can be significant risks involved. Consider the CPA who filed an extension of time to file for an unresponsive client.  The client subsequently missed the extended filing deadline and was assessed significant penalties and interest. The successor CPA attempted to claim that the client did not have the mental capacity to understand the application of filing deadlines. Unfortunately, the “automatic” extension filed by the predecessor CPA contradicted this position, penalties were assessed, and a professional liability claim was made against the CPA for the penalties. Assuming this responsibility on behalf of a $500 tax client you have not met in two years generally does not make sense. 

Professional Liability Insurance Matters 

Any of the aforementioned circumstances can conceivably result in the imposition of penalties and interest against clients and thus may lead to professional liability claims. Additionally, in some situations, clients could allege they would have collected applicable sales and use taxes had they been timely informed of their obligations. 

If a client has been informed of a tax filing or reporting obligation or an error on a prior tax return and takes no action in response, several measures should be implemented. The client should be notified in writing of the filing or reporting obligations and the potential consequences emanating from the failure to act accordingly. In addition to considering withdrawal from the engagement, the CPA should report the matter to the firm’s professional liability insurer and consider consulting with an attorney. 

The insurer’s claim professional will discuss the matter with the practitioner when it is initially reported. Depending on the circumstances, the claim professional may also refer the CPA to an attorney for assistance. Actions may be recommended to help the practitioner mitigate the risk of experiencing a claim from the “problem” client. 

While many CPAs routinely encounter clients exhibiting some of the traits noted in this article, most are fortunate not to experience claims as a result.  However, appropriate precautions taken prior to and during tax season can help prevent avoidable claims.  Now is a good time to review client lists and determine the actions to take before tax organizers are sent out for the year.

January 2014

CNA, Accountants Professional Liability Risk Control, 333 South Wabash Avenue, 36th Floor, Chicago, IL 60604. 

This information is produced and presented by CNA, which is solely responsible for its content.

The purpose of this article is to provide information, rather than advice or opinion. It is accurate to the best of the authors’ knowledge as of the date of the article. Accordingly, this article should not be viewed as a substitute for the guidance and recommendations of a retained professional. In addition, CNA does not endorse any coverages, systems, processes or protocols addressed herein unless they are produced or created by CNA. CNA recommends consultation with competent legal counsel and/or other professional advisors before applying this material in any particular factual situations.

Any references to non-CNA websites are provided solely for convenience, and CNA disclaims any responsibility with respect to such websites.

To the extent this article contains any examples, please note that they are for illustrative purposes only and any similarity to actual individuals, entities, places or situations is unintentional and purely coincidental. In addition, any examples are not intended to establish any standards of care, to serve as legal advice appropriate for any particular factual situations, or to provide an acknowledgement that any given factual situation is covered under any CNA insurance policy. Please remember that only the relevant insurance policy can provide the actual terms, coverages, amounts, conditions and exclusions for an insured. All CNA products and services may not be available in all states and may be subject to change without notice.

IRS Circular 230 Notice: The discussion of U.S. federal tax law and references to any resources in this material are not intended to: (a) be used or relied upon by any taxpayer for the purpose of avoiding any federal tax penalties; (b) promote, market or recommend any products and/or services except to the extent expressly stated otherwise; or (c) be considered except in consultation with a qualified independent tax advisor who can address a taxpayer’s particular circumstances.

Continental Casualty Company, one of the CNA insurance companies, is the underwriter of the AICPA Professional Liability Insurance Program.