Tax Season Advice: Documentation Can Minimize Liability

“In the realm of income taxation, the CPA’s job is to advise and warn individuals about alternatives and their possible benefits and risks,” Klein says. “Once the choice of alternatives is made, document why the choice was made and the individual’s involvement. The CPA may also get a second opinion from another tax specialist, much like a doctor getting a second opinion from another specialist.”

According to Klein, tax professionals must be sure of their competency and ability to render the best advice possible. In addition, CPAs can take a number of steps to mitigate the risks associated with tax work.

Best Practices

Klein offers the following loss control techniques:

• Screening. Careful screening will help avoid “engagement creep,” whereby the scope of an engagement may begin to extend beyond the competencies of the CPA firm. All clients and engagements should be reevaluated on a regular basis, at least annually, to ensure that the firm is capable of performing the services required by the engagement and is performing the services frequently enough to become proficient at them.
• Identifying high-risk engagements. Risky clients can be identified by:
  
  • Running credit checks;
  • Examining previous financial statements;
  • Examining the prior accountant’s management letters; and
  • Interviewing the client, key personnel, bankers, legal counsel, prior accountants, and auditors.
  • S corporation elections. S corporation elections are made primarily for tax benefits. When this choice is made, individuals make assumptions about the future that may or may not come true. When events make the S corporation choice less beneficial than originally thought, tax advisors are exposed to liability. CPAs can also face liability from not consulting with clients regarding S elections. For example, a consultation should occur when a closely held C corporation has substantially appreciated assets. In advising on decisions of corporate disposition, CPAs should do the following:
  • Provide a full consultation of all negative and positive tax ramifications.
  • Document the consultation in an “informed consent” letter, providing a brief summary of the issues discussed.
  • In the letter, provide places where the client can acknowledge that it has read and understood the summary letter and affirmatively indicate that it either does or does not want an S corporation election.
  • Informed consent is more important than ever because of its technical nature and the limited ability of a client to discern the pros and cons of the situation. Documentation ensures that an advisor is not held responsible for unexpected events or less than optimal results.
• Estate tax planning. Generally, there is a very long lead time between when estate planning decisions are made and when the decisions are known. Memories fade over time, making documentation of professional advice and individual decisions all the more important. The following risk-avoidance ideas for estate tax planning may be useful:
  • All planning advice should be included in an “informed consent” letter that outlines the positive and negative consequences of all options in terms the client will understand and obtain the client’s consent. Without this letter, it is easier for claimants to make it appear the CPA made certain decisions.
  • Tax professionals must be certain of their competency in this area and must be sure to document the reliance upon attorneys when drafting the estate plan, and indicate which professionals are responsible for each aspect of the plan.

“When an individual dies, the CPA advisor may be dealing with unhappy, potentially litigious beneficiaries,” according to Klein. “We know that there will be no deposition from the deceased client, so the documentation from the original planning and decision-making process becomes the CPA’s primary line of defense.”

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