There are several steps that firms can take to minimize areas of risk in tax-related services provided to clients; to help illustrate that point, we’ve outlined three key strategies here. When considering these or additional actions, however, keep in mind that certain professional liability concepts affect the way CPAs and their services are perceived by clients and others. For example:

• CPAs are not judged by professional standards in the liability world. The way they are judged depends upon the perceptions of jurors—average, hard-working individuals who, for the most part, understand little if anything about what CPAs do in their profession. CPAs may also be judged by other professionals, such as judges or arbitrators, who are hampered by the same ignorance or lack of experience.

• The length of the CPA’s relationship with the client, multiplied by the breadth of services, equals the amount of risk exposure to the CPA. This formula, also known as the “geometry of duty,” means that the CPA at a certain point becomes viewed as a trusted financial advisor with fiduciary responsibilities to monitor the client’s financial resources.

• Clients expect CPAs to advise them of opportunities and warn them of risks. If a claim involves any type of fraud, clients generally believe that the CPA should have known that it was occurring, and jurors generally believe that a CPA’s job is to catch fraud, or at least to warn the client of the risks.

Jurors rarely care about CPA professional standards, rules or disclaimers. What they care about is CPAs “getting it right.” When you are preparing tax returns, you are not required to verify certain types of information. But if something looks irregular, it may very well be irregular. Investigate the issue, document it, and communicate it.

Claims involving tax credits
Professional liability claims involving unclaimed or improperly calculated business tax credits sometimes result from the client discovering the errors or omissions with the assistance of another CPA firm. The client may then initiate a claim against the CPA who prepared the original return, with damages depending on whether the refund statute of limitations for the tax year(s) involved is still open, or the credit had to be claimed in a specific year.

If the refund statute of limitations is open, the amount of damages may include the return preparation fee for the amended return. If the statute of limitations is closed, the damages may include the amount of the unclaimed credits, which can be significant.

To prevent a client from targeting your firm with this type of claim, do the following:

1) that your firm’s members familiarize themselves with (a) the various federal and state credits available and (b) how to properly calculate each available credit;

2) that as part of its return preparation process (using a tax return organizer or other written communications), your firm obtain client representations regarding the client’s eligibility for the various available federal and state income tax credits and the client’s desire to take advantage of specific credits; and

3) that your firm consider identifying and carefully reviewing prior returns that have a strong probability of containing unclaimed or improperly calculated credits, and inform the client of any such credits.
Documentation

Always document important information, events, advice, and your client’s decisions. Documentation also serves as an effective reminder of why certain decisions were made. For instance, a client may have a good business reason for not taking certain tax credits, but as memories may begin to fade over a period of time, documentation will prevent the client from later asserting that the CPA was responsible for not taking certain credits on the client’s tax return.

Another good use of documentation is to obtain written confirmation of the amounts used to calculate tax filing extension payments. Written confirmation gives the client an opportunity to review the information and to change any information that appears incorrect, or to provide any missing information or estimates, prior to the deadline. The confirmation also serves as a record of the client’s representations so that the client cannot initiate an action against the CPA if the client incurs a penalty.

Documentation is needed from the beginning to the end of the engagement. It begins with the engagement letter, which states what the firm is going to do, what it’s not going to do, the limitations of the engagement and what the client’s responsibilities are.

The engagement letter is an excellent way to manage client expectations for the engagement, including billing and payment terms, which should also be discussed with the client. A proven way to avoid fee collection problems is to always include a stop-work clause in the letter and enforce the clause to prevent unpaid fees from building up to the point where you believe you can no longer walk away from them.
When the unpaid fees become so large that the firm wants to sue for them, the client has little to lose by suing the CPA for malpractice, escalating the situation from a simple fee dispute to a lawsuit. The legal fees incurred as a result of the lawsuits, and the billable time lost by the firm, often exceed the amount of fees owed to the firm. It’s also important to check with your professional liability carrier before taking any legal action, as your insurance policy might not cover a counter suit to your suit for fees.

Conflicts of interest
Tax return preparation engagements are also prone to conflicts of interest when the CPA is representing a married couple that is getting a divorce, or representing business partners who are dissolving their business entity. The CPA will sometimes agree to represent both the husband and the wife in a divorce when they are still friendly and cooperative. Many times, though, the relationship in a divorce will deteriorate rapidly, and the CPA is then caught in the middle. The same is true for dissolutions or disputes among business partners. Disputes between partners or owners often result in the CPA’s advice becoming perceived by one of them as favoring the other partner, resulting in a professional liability claim.
When in doubt about the best course of action, call your attorney or professional liability risk adviser for guidance.

Randy R. Werner is a loss prevention executive with Camico. She responds to Camico loss prevention hotline inquiries and speaks to CPA groups on various topics.