• Determine whether the client has given you sufficient relevant information to answer the question. If the subject is a complicated tax issue, explain that you will need additional information from the client and time to analyze the facts and possibly research the applicable regulation. Do not provide advice if you have any doubt about your answer.
  
  
• Document your conversations with the client in your files. Consider including the following:
  
  
  • Dates
    
    
  • Client/contact name
    
    
  • Client questions and the information provided to you
    
    
  • Your response and applicable authority
    
    
  • Issues to follow up with client at a later date
    
    

  Any important filing requirements or due dates should be covered in your conversations and documented as a memo to the client, along with alternatives and applicable risks.

• Consider the guidance on providing tax advice included in the AICPA Statements on Standards for Tax Services and Treasury Department Circular No. 230.
  
  

If you think a client may be faced with potential tax issues based on a casual conversation with them (e.g., a client mentions that the company has consigned inventory out-of-state or has hired an out-of-state sales person), inquire further, alert the client to your concerns, and document the conversation.

Exercising due care contemplates that a practitioner has sufficient knowledge about the technical requirements of an engagement. If a practitioner is not up-to-date on the applicable tax rules and regulations, consideration should be given to attending appropriate continuing education programs or studying available IRS publications and instructions before embarking on the work. Tax returns should be subjected to a final overall review before delivery to the client for filing.

Many of the tax claims which allege failure to advise or use of an improper tax treatment result from the practitioner's failure to clearly delineate engagement scope in oral and written communications with clients. Income tax return clients often seek to lay blame on CPAs when faced with a tax liability that could have been mitigated or avoided through appropriate tax planning. Additionally, business income tax return preparation clients faced with unplanned sales tax, use tax, or occupancy tax liabilities may claim that preparing these returns was the responsibility of the CPA.

Engagement scope dispute problems can best be addressed by issuing engagement letters, clearly delineating the scope of the engagement, and highlighting the fact that additional services are available at an additional fee. To reduce your risk, avoid using automatically renewable engagement letters, even if the engagement remains unchanged from year to year to avoid inadvertently extending the legal statute of limitations. Consider the fact that in litigating this type of dispute, jurors are forced to rely on the credibility of the parties' testimony in the absence of relevant and timely documentation that shows the scope and timing of the engagement.

Filing Errors

In 2006, 17% of all tax claims reported in the AICPA Professional Liability Insurance Program result from improper or untimely filing or failure to file tax returns or extension forms. You can reduce your risk of late filing claims by:

• Double-checking the required original filing and extension due dates for tax returns and refund claims and ensuring that these dates are built into the preparation process;
  
  
• Including a transmittal letter with the completed tax returns that includes detailed instructions indicating that it is the client's responsibility to sign and file the return, when the returns are due, and how and where they should be filed;
  
  
• Retaining confirmation receipts as proof that client electronic tax returns/extension forms have been received by the tax authorities;
  
  
• Sending paper tax returns using certified mail or IRS/state-designated private delivery services with tracking systems;
  
  
• Instructing clients to notify you immediately if they receive any IRS/state notices, including notice of late filing; and
  
  
• Using a diary system or time management software to track task and filing deadlines.

Adhere to strict internal deadlines for receiving client information necessary to complete your work and for processing returns. Your engagement letters and any follow-up letters to clients should note both your internal deadlines and IRS/state filing deadlines. If an extension of time must be requested, send the application to your client with a dated cover letter explaining the need to file for an extension. The letter should indicate the IRS/state due dates to apply for extensions and explain that underpayment and late payment penalties and interest may apply. The letter should clearly state that the client is responsible for signing and mailing the application for extension to the IRS on a timely basis.

Calculation Errors

Approximately 12% of all tax claims presented against AICPA Professional Liability Insurance Program policyholders allege calculation or filing errors. Some basic but important practices can help practitioners avoid such claims.

• Double-check all computations and spreadsheet formulas prior to inputting data. Though simple and obvious, this step is often overlooked in an effort to save time. Do not rely on your client's arithmetic, even if a tax organizer has been used.
  
  
• Compare current year's income, deductions and other important information to the prior year's return. A cursory review should reveal significant year-to-year changes. If the documentation provided by the client (e.g., W-2s, receipts, property tax bills, etc.) for the current year does not explain the changes noted, ask the client about them to determine if further investigation is required.
  
  
• Utilize built-in quality controls in tax preparation software. Do not override edit and data linking functions designed to check for errors. Also, be wary of program "bugs" in software programs, which can result in:
  
  
  • Data import errors,
    
    
  • Data calculation/transfer errors arising from incorrect formulas or links, and
    
    
  • Out-of-date calculations if the software hasn't been updated to reflect tax law changes
    
    
• Utilize professional staff or practitioners from another firm to spot-check your work. If you use a practitioner outside of your firm, consider the need to protect confidential client information.
  
  
• Don't assume that your client's filing status remains unchanged unless you have clearly assigned the responsibility for determining status to the client in an engagement letter. If recommending filing status is part of your engagement, document and date all discussions with your client about this in your work paper file. Note any change in the status in the engagement letter and/or the transmittal letter that accompanies the completed returns.
  
  

Election Errors

While claims arising from election errors have declined substantially in recent years due to changes in the tax codes, such claims still arise and are generally preventable. These claims primarily arise in connection with the preparation of corporate tax returns for closely held businesses. The most common election error allegations involve S corporation status and NOL carryback/carryover.

Owners of small corporations usually have a limited understanding of the tax impact of these elections. Often, they have heard about the ability to make such an election from a business associate and are interested in obtaining the tax savings they heard about. Providing off-the-cuff advice in this area, or in any area that requires consideration of the client's specific situation, is a recipe for trouble. A practitioner should carefully examine the client's circumstances, research the tax rules and regulations, and explain to the client - preferably in writing - the respective benefits and drawbacks of these elections.

If the client is preparing to incorporate its business or a subsidiary, you should also advise management to consider the tax implications of incorporation prior to doing so. Lack of communication between the client, their attorney, and the CPA regarding the consequences of a business transaction is a common problem leading to claims. Remind your clients that business transactions have legal, tax, accounting, and other implications, and that their interests are best served by discussing these issues with both their attorney and you prior to making a decision.

Discussions with clients should be followed by a letter confirming that these issues were discussed, noting requirements to qualify for an election, establishing deadlines for making or terminating an election, and most importantly, stating that the decision to make the election is the client's responsibility - not yours.

In Summary

As a tax practitioner, you can practice effective risk management while providing tax-related services by:

• Maintaining a system of quality controls that include appropriate training and supervision.
  
  
• Adhering to firm processing and quality control procedures, regardless of time constraints.
  
  
• Ensuring that you and your client have a mutual understanding of the timing and scope of your engagement, the tax issues discussed, and the individual responsibilities of both parties.
  
  
• Issuing engagement letters.
  
  
• Documenting all discussions with the client both in your work paper file and in a letter to the client.

In addition to incorporating the recommendations listed above, it's also important to use common sense and maintain professional skepticism. If the information received from a client appears to be inconsistent or incorrect, chances are it probably is.

January, 2007

By: Joseph Wolfe, Assistant Vice President, Loss Control, CNA, Accountants Professional Liability, 333 South Wabash Ave., Chicago, IL 60604.

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 publication. Accordingly, this article should not be viewed as a substitute for the guidance and recommendations of a retained professional.

Nothing contained herein should be construed as acknowledgement by Continental Casualty Company that a given situation would be covered under a particular insurance policy. To determine whether a specific situation may be covered, please refer to your policy. Only the insurance policy can give actual terms, coverage, amounts, conditions and exclusions. Any references to non-CNA websites are provided solely for convenience, and CNA disclaims any responsibility with respect to such websites.

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

CNA is a service mark registered with the U.S. Patent and Trademark Office.

Copyright © 2007, Continental Casualty Company. All rights reserved.