When a client’s needs exceed the CPA’s expertise, an expert may be used. However, this does not eliminate risk for the CPA firm.
By Deborah K. Rood, CPA, MST
This article originally appeared in the November 2022 issue of the Journal of Accountancy.
CPAs understand when a client’s technical needs exceed their experience and a third-party expert may need to be engaged to assist. However, working with these third parties does not eliminate risk for the CPA firm. Consider this claim scenario:
A client manufactured precision conveyor systems for the pharmaceutical industry. Each system was custom-designed for the product, location, environment, and other factors, requiring extensive computer programming.
The CPA firm advised the client that substantial research and development (R&D) credits may be available and referred the client to an expert. The client engaged the expert to conduct an R&D study, which the CPA firm then used to amend tax returns, resulting in substantial refunds. The amended tax returns triggered an IRS audit, and a large portion of the R&D credits was disallowed due to lack of documentation.
The client initiated a claim against the CPA firm for the lost credits, indicating that because the CPA prepared the amended returns that included the expert’s calculations, the client believed that the CPA firm had “signed off ” on the calculations and supporting documentation.
Just because an expert is involved doesn’t mean a CPA firm is entirely off the hook. When a third party’s work is incorporated into a CPA’s deliverable or a CPA relies on the work of others in arriving at its conclusions, the CPA may be held liable for deficiencies in the expert’s work.
When and How Third Party Experts Are Used
Third parties may be engaged for their experience in complex areas of tax that require specialized knowledge or may be used to provide valuation, actuarial, or other expertise needed to test complex audit areas. For example:
- A CPA firm engages a larger firm to review its tax filings related to the international operations of its largest client.
- A CPA firm refers a client that recently purchased a new manufacturing facility to a cost-segregation firm and incorporates the resulting study into the client’s corporate tax return.
- A client asks a CPA firm to amend payroll tax returns to reflect employee retention credits calculated by a third party independently engaged by the client.
- A CPA firm performing an audit of a defined benefit plan engages an actuarial specialist to assist with the audit of the plan’s employee benefit obligations and disclosures.
Regardless of the situation, when third parties are involved, a CPA firm should take additional steps to help mitigate risk, many of which are required by the professional standards.
Step 1: Assess the third party’s competence and qualifications
The “Use of a Third-Party Service Provider” interpretation (ET §1.300.040) of the AICPA Code of Professional Conduct requires a CPA firm to “ensure that the third-party service provider has the required professional qualifications, technical skills, and other resources.” In addition, paragraph .09 of AU-C Section 620, Using the Work of an Auditor’s Specialist, indicates that an auditor should “evaluate whether the auditor’s specialist has the necessary competence, capabilities, and objectivity.” In other words, the firm should conduct due diligence to determine whether the third party has the appropriate expertise in the area that will be leveraged or relied upon by the firm.
Even if the client selected and engaged the third party, the CPA firm should independently vet the expert if its work will be used by the firm.
Step 2: Clarify understanding with the third party
If the CPA firm is engaging an expert directly, the parties should enter into a written agreement delineating the expert’s scope of services, each party’s responsibilities, timing, and other important terms and conditions. An agreement is required when an auditor’s specialist is engaged in accordance with AU-C Section 620.
CPA firms should also consider including a provision in the agreement that requires the expert to protect confidential information received. While the “Disclosing Information to a Third-Party Service Provider” interpretation (ET §1.700.040) indicates that entering into a contractual agreement regarding the protection of confidential information is, along with other conditions specified in paragraph .02 of ET §1.700.040, an option in lieu of client consent, given sensitivity regarding data privacy and protection, this provision is recommended.
Fee arrangements should be addressed in the engagement letter with the third party. Although referral fees or commissions are, in certain circumstances, permissible under the “Commissions and Referral Fees Rule” (ET §1.520.001), consider the impact of this fee structure on the firm’s objectivity, including how such a fee would be viewed in hindsight.
Finally, consider including a provision that requires the expert to maintain professional liability, cyber, and/or other applicable insurance coverages.
Step 3: Notify the client and obtain consent
The “Use of a Third-Party Service Provider” interpretation (ET §1.150.040) requires the CPA firm to inform the client, preferably in writing, that a third party may be used on the engagement. This disclosure is required before confidential information is provided to the third party and may be accomplished via a provision in the client engagement letter.
However, if tax return information will be provided to the third party, the client’s consent, including specific required language, may be required under Internal Revenue Code Sec. 7216. Sample disclosures that comply with the requirements of Sec. 7216 are available to AICPA members.
In addition to obtaining client consent to disclose confidential information to a third party, the firm should manage the client’s expectations regarding any limitations of the firm’s responsibility related to the expert’s work. For example, if an expert is engaged to calculate tax credits or accelerate deductions, consider obtaining the client’s written acknowledgment that it understands that a taxing authority could disagree with the expert’s calculations or position taken on a subsequent return, and that, if this occurs, additional tax, penalties, and interest may be assessed for which the client will be responsible. In addition, the client should acknowledge it wishes to proceed based on this understanding.
Step 4: Review the expert’s work
Clients, and CPAs, may believe that where an “expert” is engaged, a CPA firm may incorporate its work without question. However, a CPA firm should not accept the expert’s work at face value. Some level of supervision and/or review should be conducted, as noted in various professional standards. For instance:
- The “Use of a Third-Party Service Provider” interpretation (ET §1.300.040) requires the firm to plan and supervise the third party’s work.
- Section 10.22(b), Reliance on Others, of Treasury Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10), requires tax practitioners to exercise due diligence when relying upon the work product of another person.
- Paragraph .12 of AU-C Section 620 states that the auditor should evaluate the adequacy of the work of the specialist for the auditor’s purposes.
- Although AICPA Statement on Standards for Tax Services (SSTS) No. 3, Certain Procedural Aspects of Preparing Returns, generally permits tax practitioners to “rely, without verification, on information furnished by … third parties,” it also states that they cannot “ignore the implications of information furnished and should make reasonable inquiries if the information furnished appears to be incorrect, incomplete, or inconsistent either on its face or on the basis of other facts known to the member.” SSTS No. 3 also requires tax practitioners to make appropriate inquiries to determine if the taxpayer has other information required by the taxing authority, such as sufficient documentation.
The depth of the CPA’s review depends upon many factors, including, but not limited to, the complexity and significance of the expert’s work, the expert’s experience, and the CPA’s prior experience with the expert. Remember to document the review performed, including discussions with the client and expert.
Additional Thoughts
Referring clients to experts, even if their work is not incorporated into the CPA firm’s deliverable, may result in a professional liability claim. Before doing so, follow the advice outlined in the article “Unintended Consequences of Professional Referrals.”