A War Story: Unclaimed Tax Credits and the Difficult Client

A War Story: Unclaimed Tax Credits and the Difficult Client

By Hunter Colby

Editor’s Note: “War Stories,” drawn from Camico claims files, illustrate some of the dangers and pitfalls in the accounting profession. All names have been changed.

In 1998, All Purpose Specialties, Inc. (APSI), a large manufacturing company in Chicago, approached Larry Lister, CPA, to prepare the company’s tax returns. The prior accountant, Jay Bates, CPA, had recently disengaged from APSI. Lister called Bates and spoke with him about his experience with the company. Bates had several good things to say about APSI and its dynamic CEO, who had built a thriving business with his knack for constantly generating new business.

When Lister asked about the company’s accounting and financial processes, Bates glossed over details, saying that the APSI’s phenomenal growth made such details a low priority with the CEO and the financial officers. Lister’s own firm was in need of bigger clients at the time, so he decided to take the company on, hoping that his work for it might attract other large clients.

As soon as he accepted the work, Lister found that the previous year’s tax returns for APSI were on extension by Bates. Part of the problem, according to the APSI controller, was that there were liabilities in excess of $750,000 that had not been recorded for the tax year (1997), making a correct return impossible. Lister advised APSI that a return could be filed with an attachment stating that the return would be amended when additional information was available.

Lister started to gather the information, only to find that the company’s records were extremely disorganized and the financial department staff just as disorganized and difficult to work with. At one point Lister advised APSI that there appeared to be substantial potential for tax credits due to the hiring of employees in state “enterprise zones” and federal “empowerment zones” (EZ credits). The CPA was having so much trouble getting basic information from the company, though, that trying to obtain eligibility information for employees living in the zones seemed nearly impossible.

He did a nominal analysis showing the amount of time it would take for him to obtain the information and calculate the EZ credits. The CPA then concluded that the time and fees required would cost APSI more money than the credit money it would receive. He told the APSI controller about his analysis and conclusion, and the controller agreed not to pursue the credits.

Lister then discovered that APSI was having a billing dispute with Bates, who refused to provide records that Lister needed to complete the returns. Lister managed to work around Bates, and finally completed the amended returns for 1997.

Lister prepared APSI’s tax returns for three more years (1998–2000), but he was highly frustrated by the company’s poor bookkeeping and slow payment of his invoices. He sent several written communications to APSI management over the years about the difficulties he had with the company’s finance department, especially in obtaining the information and documents necessary for tax return preparation. When no improvements were made, he finally disengaged. APSI then retained a third CPA, William Rogers, who contacted Lister for information. Lister informed Rogers about the difficulties he had with APSI.

Two years later, APSI sued Lister, alleging that he had missed $520,000 worth of EZ credits on the company’s tax returns for the four years he prepared them. The lawsuit also claimed negligence on the part of Lister for not informing the company that it could have received more tax benefits by hiring more employees living within enterprise zones.

Statute of Limitations Closed

Included in the suit was $50,000 worth of EZ credit for 1997, for which the statute of limitations was now closed. Also included in the suit were contingency fees of $156,000 charged by Rogers (30 percent of the total EZ credits produced) to do the work necessary to determine the amount of EZ credits available for each tax year. Total alleged damages came to $206,000.

Lister went back through his files and collected all of the written communications he provided to APSI management over the years about his difficulties in obtaining the information and documents necessary to prepare the tax returns. When his attorney provided APSI with the evidentiary support that the CPA had communicated frequently to the company about the problems, and the carrier refused to pay any settlement money, APSI agreed to dismiss its lawsuit in exchange for a written release agreement in which the CPA paid $0 in settlement.

Loss Prevention Tips

Document the advice you provide to clients as well as the decisions clients make. Also document difficulties with client personnel in obtaining information and documents necessary for the CPA’s work, including e-mail, letters, file notes and phone calls.

Institute thorough client-screening practices before preparing and signing an engagement letter. Much of the information a CPA needs can be asked at the client interview and verified later through other interviews. The more information you get, the better you can assess the risk of the engagement or the client.

An engagement letter should address your expectations of the client in providing timely information and documents. The letter can include billing and collections policies as well as stop-work or disengagement provisions, which can later be enforced if the client doesn’t cooperate or pay you in accordance with your policies.

Hunter Colby, J.D., is a claims specialist with Camico Mutual Insurance Co. and has over 17 years of experience in claims, with expertise in claims avoidance and mitigation procedures. He earned his bachelor’s degree from State University of New York at Stony Brook and his law degree from Peninsula University in Mountain View, Calif. He is a member of the California State Bar Association.