January 2001

Tax Engagements Continue to Lead Claims Losses

Despite earlier industry predictions that CPAs would be entering into fewer tax engagements due to consumer tax preparation software programs and online services, tax engagements have continued to grow in number and dollar-size among small to mid-sized CPA firms.

However, along with this growth comes a higher incidence of liability claims. Camico’s most recent claims experience shows that tax-related claims are continuing to grow in both frequency and severity.

Tax claims for the year 2000 are averaging about $105,000, up substantially from our 14-year average of $70,000. (See chart) Tax-related claims lead all other types of engagements in both frequency and severity.

We believe this trend is due to a number of factors, some of which are as follows:

The 10-year bull market has inflated asset values, turning what used to be smaller mistakes into bigger mistakes.

The bull market has attracted larger numbers of investors, and more of them are turning to CPAs for tax preparation work. Fewer taxpayers trust themselves or a software program to do tax returns that have become more complex because of investments.

The economic boom has drawn CPAs away from tax preparation work and into other industries where they have become controllers and CFOs. This trend has created a shortage of qualified staff. The combination of more high-end tax returns and fewer qualified staff members to handle those returns has led to firms becoming over-extended and more prone to larger mistakes.

Tax preparation work tends to be advisory in nature, as basic tax compliance services often expand into tax planning, estate planning, business succession planning, investment advice, and other areas with tax implications. Consequently, tax professionals deal with a variety of complex, technical issues, many of which have long-term impacts.

A significant number of tax claims against CPAs are due to providing tax clients with oral advice. Camico recommends that CPAs put all tax advice in writing, which protects the firm from the “off the cuff” advice that firm members might render clients.

Written advice also:

protects the firm from advice that might be provided by a less experienced staff member or a staff member who is not as familiar with the client’s circumstances as he or she should be;

enables the firm to carefully reflect on the underlying issues and properly research those issues before rendering its opinion; and

helps the firm collect fees for its services (clients are often more willing to pay professional fees if they have something in writing).

Engagement letters are recommended for all separate tax engagements. A firm should consider adding the following language to specifically limit risk exposure due to providing oral tax advice:

Although we are available to provide you with tax planning advice, we are not obligated to do so unless you specifically request it. It is our policy to put all tax planning advice in writing. You should not rely on any advice that has not been fully reviewed and put in writing by our firm.

To avoid misunderstandings with the client, and because tax laws change so often, the authors recommend that the firm consider using the following wording in tax advice letters:

It is important to realize that the tax advice discussed in this letter is based on our understanding of the facts as you have presented them to us, and on the tax law as it currently exists. Unless you specifically ask us to do so, we can accept no responsibility for updating this advice to reflect future changes in the tax law or to allow for changes in your individual circumstances.

Finally, engagement letter language should also reflect the limits of the firm’s scope, especially when it helps distinguish between tax advice and investment advice. Sample wording could be:

In our relationship, we are often advisors, not advocates, with regard to investment advice. We will advise you on the implications, if any, of specific matters you bring to our attention. We are not . We can only advise you on the implications of this investment in light of today’s tax laws and economy.

As always, assistance with engagement letter language and other issues pertaining to CPA professional services is available from Camico’s loss prevention and advisory hotline at (800) 652-1772.