1040 forms
Bloomberg News

No one likes to be sued, but if you prepare taxes you’re more likely to be sued than in any other area of accounting practice.

“Measured by the amount of dollar losses, tax claims against accountants represent about one-third of damages paid out. However, when measured by frequency, this jumps to two-thirds of all claims against accountants,” said Rickard Jorgensen, president of Jorgensen & Co., an insurance broker and managing general underwriter of accountants professional liability insurance.

“This can be broken down further in that about one-third of claims are made by individuals and half arise from corporate or partnership returns,” he said. “This means that although there continues to be a preponderance of claims from tax services, most of these claims settle for smaller amounts of money.”

“During the past tax season, cybersecurity incidents continued to dominate as the primary pitfalls in the tax preparation landscape,” said Randy Werner, CPA, Esq., loss prevention executive at Camico. “In the first week of April 2017 alone, Camico had eight reported matters from policyholder firms that experienced data breaches resulting in the filing of fraudulent federal and state returns.”

Jorgensen agreed. “In the past two years there has been an increase in the number of claims arising from the filing of fraudulent tax returns by criminals,” he said. “The fact pattern for this is that the computer network or server of an unsuspecting tax preparer is accessed and copies of past years’ client returns are stolen. These returns are used to fabricate bogus returns for the current year and are submitted in advance of the legitimate returns. The IRS pays funds to a temporary address or bank account and it is only when the preparer later attempts to file returns that the fraud is revealed.”


New this year!

Some specific issues arose during the 2017 filing season that are likely to generate future claims, according to John Raspante, CPA, director of risk management for CPA Protector Plan, a division of insurance intermediary Brown & Brown. “One of the first issues that flooded our hotline was the requirement by many states for the numbers and dates of drivers’ licenses. The purpose was to combat identity theft. These requirements came out after the majority of preparers had sent out organizers. It was mandated late in the game and added an additional step to preparation. Returns couldn’t get processed as quickly, refunds were delayed because the state couldn’t verify the taxpayer’s identity. When clients’ refunds are delayed they blame the accountant.”

“This was a recurring issue during tax season,” he said. “We haven’t received any claims yet, but it could happen: a client leaves their current accountant, and the new one says, ‘Your preparer made this mistake.’”

Another potential liability issue that arose was the reversal of due dates for corporations and partnerships, Raspante indicated. “CPAs had to get their partnership returns done a month earlier than they normally would,” he said. “This was known to the tax preparation community earlier in the year, but many didn’t anticipate what would occur. In many cases, the necessary information was not available in March, so the partnership was put on extension, and K-1s were late. As a result, individual returns were placed on extension. When that happens, there can be a mistake in the amount of money sent in with the extension. There are penalties, and in some instances the extension might be invalid. With the larger volume on extension there are more opportunities for mistakes, and liability issues.”

Another issue was the requirement to manually file returns where the client was the victim of identity theft and a fraudster had already filed a return in the client’s name. “The preparer had to attach a form as to why they were not filing electronically,” he explained. “It goes back to another administrative requirement that preparers had to deal with. This past tax season was most difficult, and the majority of preparers identified those three areas.”

“Although CPAs remain a favored target for hackers seeking to obtain personal information to file fraudulent returns, we’ve also seen a number of claims arising out of transitions from one preparer to another where inaccurate information is transferred,” said Matthew Tornincasa, a partner at CPA liability litigator Shendell & Pollock. “In one case, the CPA believed the client had paid a certain amount of tax in 2015. The information was incorrect, which caused the CPA to make errors in certain forward calculations of tax. We’ve already received a demand letter, [a threat of litigation], and presumably the prior accountant will also get some kind of demand letter. Our position is that our client accurately reflected the information provided by his predecessor.”

“The takeaway is that you can place too much trust in your predecessor’s work,” said Tornincasa.

“After each tax season concludes, there will always be garden-variety claims where clients incurred penalties and say it must be the fault of the CPA,” he said. “This is particularly so when the CPA receives incomplete information. From a risk management standpoint, it’s important for CPAs to document what information they received and, if possible, when they received it.”


Preventive measures

Both Jorgensen and Werner recommend frequent back-ups of all important files, data and information. “We had a CPA who backed up daily during the work week but did not back-up over the weekend,” Werner said. “He was hit with ransomware on Monday morning during tax season, but his staff had worked all day on Saturday, and some staff worked on Sunday. He was able to recover the firm’s files through Friday, but it took an additional three days to eradicate the malware and recover the firm’s system. He did not have an incident response plan and team in place, which would have allowed him to recover more efficiently. He also did not have any cyber-insurance to assist with the costs.”

All liability specialists recommend a signed engagement letter as a means to protect the accountant and limit the scope of the engagement, but few accountants actually use them for tax preparation purposes. “They should use them, but tax preparation is the least likely area for an engagement letter to be utilized,” said Raspante. “Most accountants feel they don’t need them because there’s less risk of a lawsuit, but actually the opposite is true — they’re more likely to be sued.”

“If you give bad advice or miss a due date, that’s negligence, and it provides justification for the client to seek damages,” he added. “A well-structured engagement letter, with all the right caveats, is worth its weight in gold. It’s an administrative nightmare for a firm to get engagement letters from 4,000 clients — my old firm had one person whose job throughout the year was to monitor engagement letters from tax return clients, and make sure the letters all went out and came back with signatures.”

In the absence of a signed engagement letter, Jorgensen recommends an affirmative conduct letter. “It’s a statement of understanding that can be attached to a tax organizer,” he said. “It does not require a signature, but it creates a clear contract with the client including all the important terms of the engagement. It’s almost as strong as an engagement letter — if you send it to a client and they provide the information required for their tax return, you are taking it as they agree to all the terms and conditions in the letter.”

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Roger Russell

Roger Russell

Roger Russell is senior editor for tax with Accounting Today, and a tax attorney and a legal and accounting journalist.