Changes at the firm? What to do with working papers

It wasn’t until after he retired that Richie Retiree, CPA, received an ominous call. A former client had undergone an IRS audit, and the auditor disagreed with positions taken on the return, assessing additional tax, penalties, and interest. The former client was livid and blamed Richie for the alleged errors on the return. Knowing that a professional liability claim was likely imminent, Richie contacted the firm that purchased his practice to obtain his records, which were transferred to the purchaser to help provide continuity of service to Richie’s clients. However, the purchaser no longer had the records for the client in question, as that particular client had opted to retain a different CPA after Richie retired. As Richie suspected, the former client sued Richie for negligence. Without supporting working papers, Richie had a difficult time defending the claim and ultimately settled.

CPA firm ownership changes can be a whirlwind of decisions and emotions. As the practice changes hands, don’t neglect a very important but easy-to-overlook piece: the working papers that form the foundation for the practice. In the event of a malpractice claim or a regulatory inquiry, you may need to produce working papers to support your defense. If you don’t have them, you could end up in the same unfortunate situation as Richie Retiree.

Transitioning clients — and the working papers, too?

When a CPA firm sells or transitions all or part of its client list, the question of what happens to the existing working paper files is often raised. It is also raised, for example, when:

• One or more firm owners leave the firm to join another firm or start a new firm and they wish to take clients they served with them; or
• A firm sells its practice to another firm and the sellers work at or with the acquiring firm to assist with the transition but do not obtain any ownership interest in the acquiring firm.

Before addressing what happens to the original working papers when the seller (hereafter, the “predecessor”) closes shop or transfers some or all of the practice to another firm (hereafter, the “successor”), two points from the AICPA Code of Professional Conduct (the Code) should be kept in mind:

• The working papers are the member firm’s property, albeit subject to state or federal laws or regulations or contractual agreement; and
• The predecessor is responsible for maintaining the confidentiality of client information in its working papers.

Risk management recommendations

The recommended risk management practice is for the predecessor firm to retain possession of the original working papers in accordance with its record retention policy.

If clients will be transferred or transitioned to a new firm, copies of the working papers may be provided to the successor firm upon receipt of written consent from the client in the appropriate format, as well as a signed acknowledgment letter from the successor firm contractually restricting its use of the predecessor’s working papers. While this may sound simple enough, there are many considerations.

Obtaining client consent

For many clients, consent to transfer a firm’s working papers from the predecessor to the successor may follow the guidance outlined in ET Section 1.400.205, Transfer of Files and Return of Client Records in Sale, Transfer, Discontinuance or Acquisition of a Practice, of the Code. Paragraph .01 of this section requires the CPA to request consent to transfer the client file from each client that is subject to sale or transfer and to notify the client that consent may be presumed after 90 days if the client doesn’t respond, unless prohibited by law or the rules and regulations of the applicable state boards of accountancy. From a risk management perspective, obtaining a client’s explicit, written consent is preferred. See Appendix A for a Sample Client Authorization for Working Paper Access/Copies that is intended for use with all clients other than individual income tax clients.

If tax return information will be transferred, the client’s consent must conform to Internal Revenue Code Sec. 7216 and related regulations. For Form 1040 tax clients, the consent must also comply with Rev. Procs. 2013-14 and 2013-19. CPAs may consider using AICPA sample letters for this purpose. Federal law requires that tax preparers obtain written consent from each taxpayer before any disclosure or use of federal income tax return information, including copies of the tax returns, with limited exceptions. Under Sec. 7216, there is no presumption of consent after 90 days for tax clients. Persons who knowingly or recklessly violate Sec. 7216 may be found guilty of a criminal misdemeanor, which carries penalties of a fine up to $1,000, imprisonment up to one year, or both. See Appendix B for a Sample Client Notification and Request for Consent for Working Paper Access/Copies that is intended for use with individual income tax clients.

Depending on the nature of the information, other federal and state laws, such as the Health Insurance Portability and Accountability Act of 1996 (HIPAA), may also need to be considered. Consultation with legal counsel is recommended.

Successor acknowledgement and agreement

In the event all or part of the predecessor’s practice or client list is being transitioned or sold, the separation or sale agreement should include any file transfer and/or retention arrangements and address responsibility for obtaining client consent, effectuating the transfer, and paying related costs. Copying of any working papers should always be done under the control and supervision of the predecessor firm.

After obtaining client consent or the lapse of 90 days for nontax clients, copies of working papers may be provided to the successor. Before doing so, it is recommended that the predecessor require the successor to acknowledge the limited purpose for which copies are being provided. For an example, see Exhibit C of AU-C Section 510, Opening Balances, of the AICPA Clarified Statements on Auditing Standards. While this example pertains to audit engagements, it can be modified for other services.

While not recommended, in the rare circumstance that the successor firm takes possession of any of the predecessor’s original working papers, the predecessor firm should address the following in the separation or sale agreement after consulting with an attorney:

• The predecessor remains the owner of working papers generated by the predecessor;
• The successor will maintain custody of the working papers solely for the purpose of providing continuing service to the client;
• The successor will maintain the working papers in accordance with applicable confidentiality requirements;
• The successor will maintain the working paper files in the state and format as provided by the predecessor;
• Any documentation prepared by the successor will be maintained separately from the predecessor’s working papers;
• The successor firm will maintain and dispose of the working papers in accordance with the predecessor’s record retention policy;
• The successor firm will notify the predecessor firm if access to the predecessor’s working papers is requested, whether by subpoena or otherwise;
• The successor will give the predecessor firm unrestricted access to the working papers and return original files upon request;
• If any portion of the predecessor firm’s working papers is compromised, whether by loss, damage, or breach of privacy, the successor firm will promptly notify the predecessor; and
• Next steps if the successor ceases to practice, merges, or sells its practice should also be addressed.

It is also recommended that the predecessor maintain copies of all communications from the successor firm regarding the working papers, including a detailed list of the working papers released to the successor.

Other considerations

The considerations in this article do not apply only to sale agreements, but also any time a client transitions from one firm to another. Regardless of why the client is served by a successor firm, addressing questions on a timely basis regarding working papers is an important risk management activity for the predecessor firm.

Planning for the day when access to original working papers is necessary for a predecessor firm in the event of a professional or regulatory inquiry or a malpractice claim could create a smoother process for all parties involved.

Appendix A:  Sample Client Authorization for Working Paper Access/Copies (not for use with individual income tax return preparation clients)
 
(Predecessor Firm Letterhead)
 
Date
[Authorized Client Representative Name and Title]
[Client Name]
[Client Address]
 
 
Dear [Authorized Client Representative Name]:
 
It has been a privilege to provide professional services to [Client Name] (“you” or “your”). Thank you for the opportunity to work with you.
 
Effective [Date], [Successor CPA Firm] has purchased certain assets of [Predecessor CPA Firm] (“firm,” “we,” “us,” or “our”), which includes the right to provide professional services to you. In connection with this transaction, our firm will no longer be able to provide services to you.
 
(if client is a non-1040 tax return preparation client, add the following paragraph)
You, the taxpayer, authorize that any and all information furnished to us for or in connection with the preparation of tax returns under this engagement letter may, for a period of up to [insert number of years] years from the date of this engagement letter, be disclosed to [Successor CPA Firm], engaged directly or indirectly in providing tax planning or preparation of tax returns. Disclosures under this paragraph may consist of all information contained in tax returns. If the taxpayer wishes to request a limited disclosure of tax return information, the taxpayer must inform us.
 
As certified public accountants, we have a duty to maintain client confidentiality. To the extent you wish to grant permission to our firm to provide copies to [Successor CPA Firm] of our working papers relating to your engagements and containing your confidential information, please sign the authorization below and return it to us by [Date]. Please note that, in accordance with the AICPA Code of Professional Conduct, if a response is not received from you within 90 days, your consent is presumed, and we will transfer your information to [Successor CPA Firm].¹
 
 
Sincerely,
 
__________________________________________
[Predecessor CPA Firm]
 
 
To: [Predecessor CPA Firm]:
 
We will engage [Successor CPA Firm] to provide services to us in the future. Please provide them with copies of your relevant working papers relating to our engagement with you to facilitate the transition.
 
 
__________________________________________
Client Name
 
__________________________________________
Signature
 
 
 
Appendix B:  Sample Client Notification and Request for Consent for Working Paper Access/Copies (for use with Form 1040 income tax return preparation clients)
 
(Predecessor Firm Letterhead)
 
[Date]
[Client and Spouse Names]
[Client Address]
 
 
Dear [Client and Spouse Names]:
 
It has been a privilege to provide professional services to [Client and Spouse Names] (“you” or “your”). Thank you for the opportunity to work with you.
 
Effective [Date], [Successor CPA Firm] has purchased certain assets of [Predecessor CPA Firm] (“firm,” “we,” “us,” or “our”), which include the right to provide professional services to you. In connection with this transaction, our firm will no longer be able to provide services to you.
 
As certified public accountants, we have a duty to maintain client confidentiality. To the extent you wish to grant permission to our firm to provide copies to [Successor CPA Firm] of our working papers relating to your tax returns and containing your confidential information, please sign the attached Section 7216 consent form² and return it to us by [Date].
 
Under federal law, we cannot disclose your tax information to third parties, including [Successor CPA Firm] on your behalf without the appropriate written consent.
 
Sincerely,
 
__________________________________________
[Predecessor CPA Firm]

Kevin Hayes, CPA, is a risk control consultant at CNA. For more information about this article, contact [email protected].
 
This article originally appeared in the Journal of Accountancy.