Part 2 of 3
As featured in the CPA Insider
Malpractice and Tax Practice
With accounting malpractice lawsuits increasingly in the public eye, you put your practice on the line each and every day. There are numerous liability risks that can arise in the practice of accountancy, and identifying them is half the battle. This three-part series about accounting malpractice looks at common causes of claims and sheds some light on reducing professional liability risk. In this article, we'll take a closer look at the risks associated with tax practice.
Tax practice generates approximately 50 % of all claims in the United States. In fact, for most CPA firms, claims are more likely to arise from tax practice than from all other practice areas.
In approximately 60% of business tax claims, the client alleges that the CPA provided inappropriate tax advice or failed to provide advice that would have assisted the client in either reducing tax liability, avoiding tax compliance problems, or both. Typically, these claims involve miscommunication with clients on tax issues or allegations that the CPA had a duty to provide tax-planning advice that in fact was not part of the engagement.
Inadequate documentation is a problem seen in most accounting malpractice claims. While the use of tax return preparation software has improved documentation of the work performed, the use of engagement letters to document the understanding is still too infrequent. Engagement letters, which define the scope of services and delineate client and firm responsibilities, are a key defensive tool in preventing and defending accounting malpractice claims. In 54% of the business tax claims in the AICPA Professional Liability Insurance Program, engagement letters were not issued. The same is true in 78% of all individual tax claims. And in claims arising from estate-related tax services, a comparatively riskier area of tax practice, 63% of the engagements were performed without an engagement letter.
Estate-related tax services, which include estate planning and the preparation of estate and gift tax returns, generate higher severity relativity than either business or individual tax services. Estate-related services present higher risk to CPA firms for three reasons:
- Specialty service needs — Estate planning is a niche practice that requires extensive training and experience. Often, claims involve CPAs who have performed few or no engagements in this area, but agree to prepare a gift tax or estate tax return because of their long-time relationship with the client or family member.
- Outdated plan problems — Inadequate or out-of-date estate plans can result in post-death disputes among estate beneficiaries. Conflicts of interest can arise as well, as many CPAs provide tax-planning advice to multiple family members who become adversaries in an estate-related dispute.
- Miscommunication — The failure to communicate is a typical problem associated with claims arising from estate-related services. Missed filing deadlines, failure to advise a client to disclaim an interest in an asset of an estate, and failure to communicate the need for post-death estate planning by estate beneficiaries are all problems leading to claims in this practice area.
Additionally, more than 20% of all AICPA Professional Liability Insurance Program claims arise from tax services to individuals. The most common claims involve allegations that the CPA failed to prepare tax returns in a timely manner or to advise the client of the need to file out-of-state tax returns. While errors or negligence on the part of the CPA are factors in these claims, documentation of communications with clients regarding deadlines and filing obligations is often lacking. Organized working papers that detail client discussions and include copies of follow-up letters confirming engagement scope and client responsibilities help guard against disparities between client and CPA expectations, and support a solid defense in the event of a claim.
In Part 3 of this series, we will examine the risky business of audit engagements and uncover ways to reduce liability.
Accounting malpractice is a very complex subject that cannot be fully addressed in this article. For more detailed information on professional liability and risk management, please contact Aon Insurance Services at (800) 221-3023, or visit the AICPA Insurance Programs website at www.cpai.com. Always consult with competent counsel on all matters relating to legal liability.
June, 2005
By Joseph Wolfe, Assistant Vice President, Risk Control, CNA, Accountants Professional Liability, CNA Center, Chicago, IL 60685.
This article is not, nor should it be construed as legal advice or opinion. As legal advice must be tailored to the specific circumstance of each case, the general information provided herein is not intended to substitute for the advice of professional counsel. The statements, analysis and opinions set forth in this article are solely those of the author and do not reflect the statements, opinions or analysis of any third party, including CNA or any of its subsidiary or affiliated companies. CNA does not make any representations, endorsements, or assurances about information contained on the websites referred to herein or the accuracy of any information contained on such sites. The views, statements and materials contained on these websites are solely those of the owners of the sites.
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 2005, Continental Casualty Company. All rights reserved.
For further reference, see:
Risk Management: A CPA's Toolkit for a Changing Environment by Anthony Davis, Marcia Gordon and Robert Spencer, AICPA product #056503. Link to http://www.cpa2biz.com/.
The Risk Management Resource Area, a Web page containing multiple articles on risk management in public accounting. Link to http://www.cpai.com.
Avoiding Tax Malpractice, by Robert Feinschreiber and Margaret Kent, CCH product # 04950101. Link to http://www.onlinestore.cch.com/.
Accounting, Auditing and Financial Malpractice, by George Spellmire, Jr., Wayne Baliga and Debra Winiarski, Harcourt Brace Professional Publishing, 1998.
Accounting Irregularities and Financial Fraud: A Corporate Governance Guide, by Michael Young, Aspen Publishers, 2001.
