Tax season is the busiest time of the year for CPAs, and with a vast number of clients and services to manage, you will likely be facing increased exposure to professional liability risk. Looming deadlines and an ever-evolving regulatory landscape make tax season an especially high-pressure time of year for accountants. Here, we’ll take a closer look at some of these risks, along with steps you can take to help mitigate them at tax time and throughout the year.
Top Reasons Certified Public Accountants Face Lawsuits Related to Tax Services
Tax season is a stressful time for both CPAs and their clients. Expectations are high, and so are the financial stakes. Accountants can be sued for many reasons, but claims related to tax services typically account for nearly three-quarters of malpractice claims against CPAs. Here are some of the reasons a CPA may be at higher risk of a lawsuit during tax time:
- Tight Deadlines: CPAs are nearly always working on a deadline, especially during tax season. Missing deadlines or failing to file for an extension is a common liability and can result in penalties and interest owed to the IRS, for which the client may blame the CPA.
- Miscalculations: Mistakes happen, but even a small error in tax calculations can lead to major headaches for clients, including audits and penalties. Those audits and penalties sometimes result in claims against accountants.
- Bad Advice: Providing consulting services and financial advice to clients is part of what you do, but if you make a mistake or provide off-hand verbal advice instead of giving formal guidance after research, it could lead to errors on tax returns and serious financial consequences for your clients and you.
- Poor Documentation: Even if you believe you’re not at fault for a tax error, missing records and inadequate documentation of client communications could leave you lacking necessary evidence to mount a successful defense of a malpractice claim.
- Insufficient Expertise: Taking on clients with complex tax needs in highly specialized industries and/or outside your experience could put you at risk, making you more susceptible to an error and subsequent legal action.
How CPAs and Accounting Firms Can Proactively Help Avoid Malpractice Lawsuits
Risk management should be the norm in your accounting firm throughout the year. Even during tax season, when there is elevated liability risk, you can take a number of preventative measures to help protect your practice. Here are some of the top risk control tips you should consider for this tax season:
1. Have a Signed CPA Engagement Letter with the Client
An engagement letter is a useful way to prevent professional liability risks when preparing tax services. A signed engagement letter shows that you and your client are both in agreement about the provision of services on your part. Even for a simple tax engagement, engagement letters should be updated and signed by the client annually. Advise your client that a signed engagement letter must be received before you commence your tax services. This helps ensure that both your and the client’s expectations regarding the services to be rendered continue to align.
2. Specify Your Services to the Client
If you have a solid idea of the services you provide, but your client doesn’t, this can result in an expectations gap with the client and a future claim because you did not meet their standards. To help prevent potential misunderstandings regarding the services you provide, make sure your engagement letter is specific about the scope of your services, including what is and is not within the scope.
Doing this allows your client to ask questions about the nature of the services and clarify any confusion before starting work. If additional services are required after the client’s review, draft a new engagement letter or amend the original to add these ancillary services.
3. Stick to Your Scope of Services
Perhaps you are only supposed to provide tax services, but your client is requesting a tax projection or more concrete solutions to their business management issues. Going beyond the scope of your initial services exposes you to potential mistakes down the road and invites future litigation with your client. Limit your services to those outlined in the documented agreement or make formal amendments in writing to help manage this risk.
4. Ensure Your Client Holds Up Their End
When it comes to performing quality services, both you and the client should be in sync regarding information gathering. This includes making sure the client provides relevant, accurate, and complete financial records to you on time. If clients fail to do this, you may make an error because of a time crunch or provide recommendations based on inaccurate or incomplete information. A deliverable that is wrong or an inaccurate recommendation because of bad information often results in a professional liability claim.
To help ensure your client holds up their end, outline their obligations in the engagement letter, and require that they acknowledge and sign the letter before you commence any services.
5. Identify High-Risk Clients Early
One way to reduce your professional risk is to proactively evaluate existing clients and vet new ones to identify those that might expose you to greater liability. Keep an eye out for some of these red flags:
- Evasiveness about their finances or income sources
- Reluctance to sign documentation or provide ID, records, or personal information
- Tendency to make high-pressure or unrealistic demands outside the scope of services
- History of frequent changes in accountants, consultants, or auditors
- Involvement in high-risk industries like entertainment, trusts/estates, financial services, and more
- Unusual cash flow with incoming payments that don’t always align with the client’s business structure
6. Disengage from Problem Clients Promptly
If you didn’t identify the red flags listed above before engaging with a client, you may face the uncomfortable reality of client termination down the road. This may become necessary if you notice a client has stopped paying for services, is unresponsive, is difficult to work with, or is engaging in unethical behavior. You may also choose to end a client relationship if you no longer wish to provide the required services, or if your firm changes its focus or risk profile and it no longer aligns with the client’s needs. Ending a client relationship comes with its own risks, but you can follow these steps to minimize the accountant’s liability as much as possible:
- Conduct an internal review and document everything that supports the need for disengagement.
- If a deadline is near, discuss the situation with your professional liability insurance carrier.
- Write a disengagement letter outlining the termination of your services. Follow the advice here, which includes a sample termination letter at the end.
- Send the disengagement letter via certified mail or through another method that ensures they receive it to maintain your documentation.
7. Secure Your Data
Cyberattacks are a real, growing, and ongoing concern for CPAs, so much so that the IRS requires all tax professionals to maintain a Written Information Security Plan (WISP). This is because the data and personal information you retain from your clients is highly sensitive. Losing that information could expose you to potentially devastating consequences, including technological disruptions, reputational damage, monetary damage, and regulatory action.
As a result, maintaining cybersecurity is vital during tax season. You can help protect your data by making sure your anti-virus software is updated, using multi-factor authentication to access your network, sending encrypted email communications, and limiting access to client information to only those firm members with a clear need to access the data.
8. Secure a Professional Liability Insurance Policy
Sometimes, you can follow all the necessary preventative measures, and it may still not be enough. Errors often occur during the hectic tax busy season and demonstrably increase the possibility of a client filing a claim or lawsuit against you.
To help reduce the damages that a legal claim can cause to your finances and your reputation, make sure you have a professional liability insurance policy in place. This type of insurance helps protect you in situations of negligence (failing to adhere to specific accounting standards or tax regulations), inaccurate advice, misrepresentation, and errors and omissions.
Help Manage Professional Liability Risk with AICPA Member Insurance Programs
Even with growing risks for CPAs, there are ways you can help prevent potential mishaps. Make sure that you and your clients are on the same page by obtaining a signed engagement letter, sticking to your scope of service or formal scope expansion, and documenting everything. To help further reduce professional liability risk, consider acquiring a professional liability insurance policy to help cushion the financial impact of mistakes arising from your professional services.
Vet prospective insurance companies to make sure they understand CPA firms, specifically insuring CPAs and accountants. Thoroughly research policy limits for your insurance coverage before agreeing to the policy terms. Policyholders can trust AICPA Member Insurance Programs. Our experts understand the unique needs of CPAs and can help keep you protected while reducing some of the damage that professional liability lawsuits can heap on your company.
Explore solutions for professional liability protection tailored to CPA firms.