Audit Representation

By Ric Rosario, CPA

Bob, a doctor and the president of Medical Management Associates (MMA), and Frank, a CPA, have been golfing buddies for years. One day, Bob asks Frank to consider doing some general accounting and tax services for him. Frank knows Bob has a reputation for being litigious and aggressive about avoiding taxes, but Frank overlooks the reputation and accepts the offer. They conclude their verbal agreement with a handshake and never define the specifics in writing.

Four years later, Frank is still doing monthly financial statements, 1099s, tax returns, and payroll returns for Bob when problems arise. The Employment Development Department and the State Board of Equalization want to audit Bob and MMA. Bob asks Frank to represent his company as its current CPA.

Frank hesitates to accept the job because he was not responsible for Bob and MMA's financial affairs during the time in question. Bob reassures Frank, however, that he has documentation to refute any claims the auditors could possibly make, and Frank agrees to represent Bob and his company.

Unfortunately, Frank is unable to provide Bob with much assistance during the EDD audit. EDD asserts that Bob paid himself a salary, which he falsely claimed was a loan repayment. Since Bob cannot find any documentation for the loan, and Frank knows nothing about it, the EDD finds Bob personally liable for $80,000 in payroll tax liabilities, penalties, and fines.

Concurrent with the end of the EDD audit, the state board auditors levy a $100,000 assessment against Bob and MMA for failing to pay sales tax on the purchase of a Jaguar, an airplane, and extensive amounts of medical equipment. Bob counters that these "purchases" are actually tax exempt leases to other companies, but he is unable to provide the auditor with any records.

In an effort to bail out his clients, Frank hunts through several old files and locates documentation that reduces the assessment to $40,000, which includes a fraud penalty. Bob, unhappy about the large sums of money he owes, sues Frank. Bob alleges substandard care by Frank in his handling of the audits and sues for the amount owed in both audits. Bob's claims are threefold in regard to the EDD audit. He charges that Frank

1) misled him, because Frank said the potential liability would be minimal (and it was $80,000);
2) did not tell him he could be found personally liable; and
3) failed to properly present evidence of Bob’s large loan to MMA.

In regard to the state board audit, Bob claims Frank was not looking out for his best interests, because when the proceedings concluded, Bob still owed $40,000. Bob believes he owes nothing.

The judge recognizes that Bob’s claims against Frank are without merit and throws the case out. However, this is not before Frank runs up $50,000 in defense fees and loses many billable hours.

Loss Prevention Tips

Although Frank did not have to pay any damages, there are a number of things he could have done to avoid or at least minimize the defense costs and loss of billable hours, and there are lessons here for all CPAs.