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Tax Practice and Engagement Letters

Business Insurance

By now, most tax practitioners are well aware of the recommendation by professional malpractice defense attorneys and insurers to issue annual engagement letters that define the scope and limitations of engagements, the responsibilities of the accountant and the client, the engagement work product, fee and payment requirements, and other agreed-upon engagement terms. Although the use of engagement letters is a well-known and recommended practice, some CPAs still choose not to use them. In approximately 50% of all tax malpractice claims reported between 2001 and 2010 in the AICPA Professional Liability Insurance Program, the practitioner did not issue an engagement letter. During the same period, in approximately 10% of all tax malpractice claims, there were disputes regarding the terms of the engagement. As tax season approaches, it a good time to revisit your firm policy on the use and content of engagement letters.

Many firms prepare business tax returns as part of a larger client engagement that includes bookkeeping, financial statement preparation, or consulting services. Business clients should consistently be required to sign an annual engagement letter as a condition of continuing to render services. With respect to tax work, a separate engagement letter is the preferred method to avoid scope disputes, and should be customized for each engagement. 

In a tax compliance engagement letter, numerous elements should be included such as the client tax year-end, the specific tax returns to be prepared, and any change in tax status that has occurred since the filing of the prior year returns. The engagement letter should define the scope of agreed-upon services. The letter should specifically disclaim responsibility for providing tax planning advice or additional services such as determining the client’s state or local tax filing obligations. Engagement letters issued for the prior year should be reviewed for accuracy prior to being issued for the current year. 

A CPA may become aware that the client initiated actions during the year affecting its tax filing obligations such as selling or shipping goods out-of-state or opening a branch overseas.  The CPA should initiate a conversation with the client regarding these matters, and follow up with an e-mail to the client documenting the conversation, any recommendations, and potential risks and consequences such as penalties and interest for non-filing. If the client declines a recommendation to prepare and file tax returns, document this as well via e-mail, and consider whether or not to continue the association with the client. 

CPA firms increasingly have access to client tax and accounting records maintained on firm computers or third-party servers. Absent an engagement letter defining the scope of services being rendered, confusion can arise regarding firm responsibility for client’s other filing obligations such as payroll, sales, use, and local tax returns, or adjustments to client accounting records needed to prepare income tax returns. CPA firms with such access should communicate with the client orally and in an engagement letter regarding the client’s responsibility for the:

  • Accuracy and completeness of the returns.
  • Review and approval of information used to prepare tax returns.
  • Retention of supporting records required by the tax authorities
  • Timely preparation and filing of any tax returns including those that the firm has not been engaged to prepare.
  • Prompt payment of taxes.

Clients experiencing financial difficulties tend to put tax payments at the end of the line behind the payment of payrolls and vendor invoices. In doing so, they may accuse their CPA of failing to advise them of their duties and applicable deadlines when taxing authorities start proceedings to collect unpaid taxes.

Preparing tax returns for individuals is high volume work. For many firms, a substantial part of their income is generated during tax season, and saving time becomes paramount. However, the cost of defending and settling even one malpractice claim, in both dollars and lost time, far exceeds the costs associated with issuing annual engagement letters. 

Engagement letters should be sent to individual tax clients along with tax organizers at the beginning of tax season. While obtaining a signed engagement letter prior to rendering services is the preferred risk management method, this may not be practical or cost-effective for all clients. Nevertheless, criteria can be developed to identify those individual tax clients presenting elevated risk, and obtaining signed engagement letters is appropriate for these clients. Examples of clients presenting elevated risk are self-employed clients, high net worth clients, clients with overseas income or income earned in multiple states, and couples that are separated and/or in the process of divorce. A firm may consider using unilateral engagement letters for simple individual tax return clients. These letters do not require a client signature, but rather indicate that clients must contact the firm if they disagree with any of the information or terms in the engagement letter. The client acknowledges acceptance of the engagement by providing tax information or returning the organizer to the firm. The risk in using a unilateral letter is that it may not constitute adequate proof that the firm and the client have a mutual agreement and thus may fail to be an effective defense tool in the event of a claim.

Engagement letters are important risk control tools for every CPA practice. Using annual engagement letters for tax work can help prevent scope and billing disputes as well as malprac tice claims.



November 2011

By Accountants Professional Liability Risk Control, CNA, 333 South Wabash Avenue, 39S Chicago, IL 60604.


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The purpose of this article is to provide information, rather than advice or opinion. It is accurate to the best of the author’s 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.

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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, including the sample letter, 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.

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