December 2000

Loss Prevention for Personal Tax Practitioners

Loss prevention becomes most critical during income tax season, when the annual time constraints, an overabundance of work, and stress tend to lead the personal tax practitioner away from basic loss prevention measures. A short supply of experienced staff and an oversupply of returns can cause CPAs to become overextended, leading to mistakes and lawsuits.

Loss prevention experts, in conjunction with practicing tax accountants, have helped Camico identify the following ideas and approaches, which have been effective in enhancing tax practice management as well as risk management and should help to reduce losses and produce a successful 2000 tax season.

Tax Season Triage

The basic idea is to get a handle on your clients and their returns. Clients can be rated A, B, and C, with A clients being the most cooperative and knowledgeable, C the most difficult to work with, and B falling somewhere in between (perhaps as B+ or B-).

Such a client rating system can be combined with an easy system for rating returns as Complex, Medium, and Simple. Under such a scheme, C clients with complex returns pose the highest risk to the firm and A clients with simple returns, the lowest risk. A clients with complex returns represent higher than average profitability and risk.

Complex returns, of course, should go to experienced staff that will prevent as many big errors as possible and pay close attention to the important considerations. Too often items such as exercised stock options are missed, or staff simply stop paying attention to the size of the amounts.

Regardless of the return’s complexity, C clients tend to cause more losses. Many want nothing to do with their returns, know very little about the process, and want their CPA to take care of everything. C clients pose a higher risk than those who want a team approach, so it is important to pay close attention to documenting and communicating properly with them.

Clear and firm written communications on deadlines can be used in engagement letters as well as in tax organizers, perhaps with wording such as, “We will need worksheets completed in full by March 15 in order to have returns prepared April 15. Otherwise, extensions for the returns can be filed.”

In addition to being diligent about documenting and communicating properly, the CPA might want to avoid “rescuing” clients over and over. Once the deadlines, the CPA’s expectations of the client, and the CPA’s responsibility to the client have been communicated, the client’s procrastination should not become the CPA’s problem. Approaches vary, of course, depending on the extenuating circumstances and the CPA-client relationship.

Rating returns according to difficulty can help identify returns requiring more time, or even extensions. Difficult returns can be addressed earlier in the season. Some CPAs ask clients to submit gift tax and partnership information during the first week of January.

The main idea is to implement a system that works best for the firm and to deal with clients in a consistent manner that best suits the needs of the practice.

Extensions

Extensions can be used as a means of regulating workflow so that it does not all hit between Jan. 1 and April 15. Many clients are receptive to not having their returns completed by April 15 if it means their CPA has more time to study their returns and the related transactions and deductions. The CPA should communicate his or her high standards and the fact that he or she does not want to rush the work.

Any interest and penalty costs associated with payments made with extensions are generally lower than the cost of errors made by rushing to meet a deadline. The client should pay what the CPA thinks is owed, overestimating or underestimating the payment is usually better than rushing and making errors on the return.

The payments made with extension requests are typically calculated to include 1) the amount necessary to reduce the payment due with the current year’s tax return to zero, 2) the subsequent tax year’s April 15 estimated tax payment, and 3) the subsequent tax year’s June 15 estimated tax payment (if necessary).

The completed return then allocates any overpayment (i.e., the total tax payments less reported tax) reported on the current year’s tax return to the subsequent tax year’s April 15 and possibly June 15 estimated tax payments. However, the subsequent tax year’s April 15 and June 15 estimated tax payments can also be used to “cover” the current year income tax due if that amount was inadvertently estimated too low at the time the extension payment was calculated.

Firms are also finding, due to staff shortages and the competitive hiring market, that they can’t always push personnel as hard as they used to in order to meet a deadline. Unless the firm wants to provide major incentives to staff around April 15, it might pay to come up with a plan for putting at least a percentage of its returns on extension.

Fees

Higher fees may be in order this year, especially if staff is in such short supply. If overhead costs are increasing, it seems reasonable that fees should increase accordingly.

The fee issue is, of course, highly sensitive. Each firm must evaluate its own fee structure to determine whether increases are in order. High-end returns generally warrant attention from experienced staff, who in turn warrant higher fees. And clients that create time-consuming problems for tax preparers may warrant higher fees as well.

If an accounting firm raises its fees in December, it may be able to pay larger bonuses on April 15, when staff are tired of their work and in the mood to give notice (or on June 15 or August 15, to help keep staff from taking their bonuses with them to the next employer).

Staffing

Staffing can be a challenge. Recruiting college graduates has become harder for smaller firms, as larger firms offer larger salaries.

If job offers are not made quickly, candidates are likely to go elsewhere..

Furthermore, staff often leave firms after a few years to become controllers or CFOs with nonaccounting companies. New staff look to firm partners for examples of working lifestyles and, if the partners are overworked, staff may conclude that they could be better off in another career, all of which underscores the need for partners to apply some systems that will help get their practices and workflows under control.

Some firms are finding relief by hiring paraprofessionals (temporary or part-time) to help with the basic process: preparing tax organizers and engagement letters, logging dates that documents and worksheets are received, copying client data, filing, and assembling completed returns at the back end of the process.

Paraprofessionals become even more valuable as they gain experience and familiarity with the firm’s operations. Part-time staff can sometimes help the firm over the tax hump for three or four months and then work elsewhere for the remainder of the year. If they can be enticed back for another tax season, so much the better.

Scope of Practice and Specialization

Some CPAs make an annual habit of redefining and understanding the scope of their own practice, going as far as to write out a clear statement of what they can and cannot do. If they have clients who do not fit into that scope, they disengage and refer the clients elsewhere, especially if the tax season workload is too great. CPAs increase their exposure to loss by accepting specialized tax engagements they do not fully understand. Continuing professional education and specialization help set high standards, and high standards mean not doing returns that are not fully understood, not dabbling, and not giving off-the-cuff advice.

Engagement letter language should reflect the limits of a firm’s scope, especially in reference to distinguishing between tax 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 (choose appropriate title: investment counselors, brokers, stock agents). We can only advise you on the implications of this investment in light of today’s tax laws and economy.”

Some accounting firms review each other’s returns on an informal, collegial basis. Others bring in specialized accounting expertise on a per diem basis. As tax accounting becomes increasingly complex and technical, specialization and cross-referring among CPAs will probably become more prevalent.

The current problems in tax preparation may become even more difficult without CPAs re-thinking the way business is conducted. By planning ahead and implementing a few good strategies, tax practitioners can reduce the stress and pain of tax season, minimize their exposure to litigation, and increase the likelihood of a successful tax season.

Assistance with engagement letter language is available from Camico’s loss prevention and advisory services at (800) 652-1772.