Your first tool to secure business – and your first shield of protection if that business goes sour – depends on essential ingredients, according to preparers speaking about good engagement letters.

First in the recipe: others’ professional opinions. “Good engagement letters, like good tax returns, are not a do-it-yourself project,” said Enrolled Agent John Walker of Concord, N.H.-based J. Walker & Co. “It’s OK to draft the main points and get samples from various sources, but have yours reviewed by an experienced business-law attorney in your state. Doing so makes sure your letter provides the protection you want and helps that attorney see you as a responsible, competent fellow professional,” he said.

Specify, specify, specify

Roy Frick, an EA at Fairway Services Limited and Frick Accountants Ltd. in Ocean City, Md., said a good engagement letter specifies what services you’re providing this client; must contain terms for payment and an out clause if you can’t perform the services for whatever reason; and must be specific as to the term and when the engagement ends.

“What will I do for them and in what time? What will they do and in what time? The fee expectation and the disengagement language – how can either of us fire the other?” said EA Jeffrey Schneider, with Florida-based SFS Tax and Accounting Services.

“It’s important to let the client know that they have ultimate responsibility for what goes on their return,” said EA Cheryl Morse of Wellesley, Mass.-based Emerging Business Partners Inc. “Engagement for tax preparation, for example, does not include auditing of bookkeeping.”

Whittier, Calif.-based EA Mike Habib recommends that you always include:

* Timeframe: The engagement defined by specific time, such as a month or a year to complete. (Others recommend language to allow for an extension if the job becomes complicated.)

* Responsibilities: Firm duties and client responsibility clearly outlined. (Clear deadlines are important, Morse stressed. Her wording: “If we do not have all of your information by a date, usually two to three weeks before the due date, it is likely your return will be put on extension, and we expect to be paid at the time the tax return is presented for signature.”)

* Scope: A “very specific” outline of the engagement, be it tax prep, tax planning, audit representation or any other function.

* Payment: Clearly defined (flat fee or progress payment), as is billing (hourly, flat or by progress, for example).

Regarding specific language, Walker recommends:

  • “You (the taxpayer) have complied with all documentation requirements of income and deductions as required by law for all items of income and deductions” (which might include mileage logs, properly worded receipts for charitable deductions or verification of education expenses paid, among many others).
  • “You (the taxpayer) agree to provide us with any information that may affect your return even if we have not specifically asked for it.” Walker noted, “We’re not psychics. We’re not going to know your mother-in-law moved in and maybe can be claimed as a dependent if you don’t mention it, or you had a temporary job assignment away from your normal workplace and travel to that assignment may be deductible.”
  • “If your return is examined we are available to represent you at an additional fee.” Walker explained:“Without that, the taxpayer will expect unlimited representation for any conceivable notice or request for substantiation they receive. That’s when you discover the taxpayer has no records, or a boxful, and expects you to do a year’s bookkeeping for free to respond to the notice.” (Morse added, “We are about to add another section regarding representation, since many clients seem to be their own worst enemies and we tend to stress over these situations more than some of our clients. We will let them know that if appointments are missed and deadlines for producing requested documentation are not met, we will cease to represent them.”)
  • “Fees unpaid after 30 days are subject to interest (specify rate) and the taxpayer agrees to pay any costs of collection, including reasonable attorney fees.”

The language

Permissible interest, collection practices and attorney fees vary from state to state, Walker pointed out. “Make sure you find out what is allowed in your state,” he said. “Often, proper language is specified by state law.”

Twila Midwood, an EA at Advanced Tax Centre, Rockledge, Fla., likes to include within client responsibilities the details of documentation provided and record retention and the location of the engagement. “Should problems arise, the engagement letter needs to be specific regarding where the work will be performed,” she said. “Terms need to be addressed regarding litigation and the location where it will be conducted.”

Location is one point that EA John Sheeley, in Goshen, N.Y., founder of Tax Practice Pro Inc. and teacher of a continuing education class on engagement letters, recommends as an essential part of letters. Among others:

1.Exclusion clause: “Section 10.32 of Circ. 230 suggests that you must communicate ‘clearly with the client regarding the terms of the engagement.’ Be clear to indicate both what you are and what you are not planning to do for the client in this engagement,” Sheeley said. The clause from his current letter reads, “The engagement does not include any services not specifically stated in this letter. However, we would be pleased to consult with you regarding other income tax matters, such as proposed or completed transactions, income tax projections, and for research in connection with such matters. Tax advice cannot be provided without a request in writing. We will render additional invoices for such services at our standard billing rates.”

2. Location: “My practice services clients all over the world,” he said. “I bet (many practitioners) have clients from outside of town or state. Even if you don’t, what if a client moves out of state and then alleges an error on work you completed? What if you were sued in small claims court in another state? Your engagement letter needs to state where a lawsuit can occur. Absent this clause, you risk needing to defend yourself someplace out of town at an additional cost and probably with an attorney you have never worked with before.” His example of wording (using his location): “Any ensuing litigation shall be conducted within the County of Orange, State of New York, according to New York State law.” 

3.  End of the engagement: “When can you put the pencil down? When does your liability end? Absent an agreement, courts have held tax professionals liable long after the tax return was filed,” Sheeley said. The clause from his 2014 agreement: “Our engagement will be satisfied upon delivery of the completed returns to the company. Therefore, the company will be solely responsible for filing the returns with the appropriate taxing authorities.”

4. Nexus issues: The letter should limit the engagement to the preparation to the current-year federal tax return and the tax returns for the states where the taxpayer deemed themselves a resident during the year, according to Sheeley: “If nexus to a non-resident state needs to be determined, it will be under a separate engagement letter. The purpose here is to limit liability should the client refuse to file a non-resident return or not advise the preparer of income sourced outside the resident state. Think Schedule C and pass-through entity income.”

Other points

  • Your firm’s privacy policy regarding client information. See a template at FreePrivacyPolicy.com.
  • Permanent files’ checklists for individual and business clients.
  • Carryforward schedules.
  • According to a recent survey of accounting fees and income from the National Society of Accountants, nearly one in 10 practitioners also request a percentage of their fee with their engagement letters.

The Wyoming Association of Public Accountants, among many others, offers a sample engagement letter.

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