Year after year, audit claims are the most severe among errors and omissions, or E&O, claims - but tax claims are the most likely to be brought, according to insurance experts.

"The majority of carriers report somewhere between 50 and 60 percent of claim activity against accountants arises out of tax engagements," said John Raspante, senior vice president and director of risk management for NAPLIA (North American Professional Liability Insurance Agency). "They're not the most significant claims, but they're the most frequent. It's like a baseball player who bats .333 but hits mainly singles, compared to a player who bats .200 but hits a lot of home runs."

Nevertheless, the majority of funds paid out in claims indemnity and in defense of claims arise out of tax services, according to Raspante. "That's because of the sheer multitude of claims in that area," he said.

Wes Marston, vice president of claims at CPA Mutual RRG, agreed. "Taxes are the mainstay of so many accounting practices, so the sheer numbers weigh into it," he said. "Tax returns are also subject to review not only by taxing authorities but also successor accountants and even financial advisors that might point out potential problem areas. They are documents that tend to be looked at in the future - they don't just go away."

One of the reasons for a tax claim is typically the result of an examination change, observed Raspante. "Everything is going fine, then there's an examination by the taxing authority, and then an assessment. The client thinks the results of the audit are the accountant's responsibility. For example, you list the taxpayer as a real estate professional on the return, and the IRS is successful in asserting that the taxpayer is not a real estate professional. When the allowable real estate losses become unallowable, the reaction is to go to the accountant and say, 'You advised me to do that, so you should be responsible for the penalties and interest.'"



Claims resulting from marital dissolution or separation are also common, Raspante noted. "There are so many exceptions in matrimonial taxation, and divorces are so common these days, so preparers need to be aware of the rules involving divorcing spouses."

One example is in the area of the ability to carry forward losses and deductions. "When the taxpayers get divorced, it's important who gets the carry-forward," he said. "Many times accountants don't quantify what these are. They need to be quantified and listed as a marital asset. Where the spouse is receiving an increase in marital assets, the other spouse can propose lower alimony payments. Matrimonial tax is complex because it creates exceptions to otherwise basic rules, and many accountants are not aware of these."

One of the problem areas is when the statute of limitations begins with state nexus claims, Raspante indicated. "If you are a New York corporation but Illinois feels that you have a connection, and you should have filed for 20 years, the statute of limitations doesn't begin running if you never registered there. It can result from business or sales and use tax filings that the taxpayer was never aware of."

"Each state's nexus rules are different, but the taxpayer hires us with the understanding that we are familiar with what those rules are," he said.

Payroll tax reporting often creates liability in the area of employees versus independent contractors. "Many times, accountants are not familiar with the rules, which are complex," said Raspante, "and they are subject to multiple review - the IRS, the [Department of Labor] or the state worker's compensation board can dispute the status of a worker. The IRS is very successful in these types of examinations."

Ethical standards such as those found in Circular 230 or the AICPA's Statements on Standards for Tax Services can create claims, Raspante noted. "If you have knowledge of an error on a previously filed tax return, you have to convey to your client what the rules are. For example, if you see the client took a deduction for a political contribution on a previous return, you have to inform them that it's not allowable as a charitable contribution. If you notice but don't inform the client and he or she is audited, he'll say that you could have mitigated the situation two years ago."



There are a number of things preparers can do to protect themselves. "Weeding out potentially bad clients is the best way," said CPA Mutual's Marston. "You can do your best work for some people and they'll still sue, while others won't sue when confronted by the worst work. Engagement letters, while they are not as widely used in tax engagements, can certainly help for the same reasons as in audits."

Also, it is important to stay within your area of expertise, especially when faced with issues such as estate tax issues or like-kind exchanges, he observed. "Someone who doesn't usually prepare estate tax returns might take on the estate of a long-term client. If you have no expertise in an area, turn it down or get outside help."

"Communicate in writing to clients when you don't have sufficient information to file a return well ahead of the due date, with the understanding that it won't be filed unless certain items are provided," advised Marston.

A contributing factor to the current number of tax issues is that there have been so many changes in the tax law, especially since 2008, observed Randy Werner, loss prevention executive at Camico. "Preparers have a hard time just keeping up with tax law changes and advising and warning their clients," she said. "There's been an uptick in the common areas such as late filing and late payment - it goes back to trying to determine the preparer's obligations to the taxpayer."

"Then there are the complex areas such as S corporation or C corporation elections," she said. "What happens is the clients think they have elected to be an S corporation but they don't follow through. The CPA files as if the entity is an S corporation but it's not because it never properly elected to be one."

"We see a lot of late filing and late payment in the estate tax area because there's no regular filing date," Werner said. An estate return might be due on June 26. "We recommend double-calendaring when you do estate and trust work. Someone else should be responsible on that calendar as well as yourself."

Another potential cause of professional liability of CPAs doing tax work is when they start dabbling in more complex areas in which they don't have expertise, she said: "Don't decide, 'Well, my client of 20 years died and I think I'll help out the family.' This can get you into a lot of trouble."

Foreign Bank and Financial Accounts, or FBAR, reporting issues have also become more prevalent, according to Anthony Cooper, tax analyst in Camico's Loss Prevention division. "The FBAR issue typically comes up because the accountant didn't ask the right question," he said. "Practitioners might learn about it through an organizer, or they might get a form that indicates interest from a foreign bank. Sometimes their clients receive an inheritance from someone abroad. There may be no income involved, so the clients don't think they have to tell practitioners." The penalties are stiff, so it behooves the practitioner to drill down to determine whether or not an FBAR is required.

The uncooperative client can be a potential area for liability, Werner observed. "For example, a CPA just told us they received an e-mail from a client that he was away and couldn't be back until after October 16. He's on extension, and is not responding to the CPA's e-mails that it will be too late."

"Section 7216 confidentiality issues and foreign bank accounts are the two things that accountants involved in tax practice call me about the most," said Ralph Picardi, a partner in Boston-based Lapping and Picardi, whose practice focuses entirely on serving as a consultant to accountants and their insurers.



"The regulations under Code Section 7216 were amended several years ago to be stricter, and as a result, tax professionals need to be more careful before they disclose information in their files to third parties," said Picardi. "It used to be that a client would call and say, 'I'm getting a loan' or 'I'm extending a line of credit, please send the bank a copy of my return.' Now you have to get their permission in writing and it must be in a specific form. Even if the accountant receives a subpoena, they must be careful to follow the rules. And the IRS hasn't come out with a lot of guidance to explain to accountants what they should do or not in light of the new regulations."

"Accountants and preparers need to be aware that these restrictions are out there, become familiar with them, and when asked to provide information to anyone other than the client, they should ask their insurance carrier, their own legal counsel, or the AICPA for guidance on whether they should give information, and if so, how," he advised. "The penalties are both civil and there are potential criminal penalties for violating the rules."

Foreign accounts can be a trap for the unwary accountant, Picardi observed: "A lot of them get into trouble with foreign bank accounts or foreign entities. Several forms have to be filed, with different due dates. It's a way for the government to track who has what internationally. A lot of preparers don't have a good working knowledge of the rules."

In many instances, clients don't disclose foreign accounts to their accountants, Picardi indicated. "Accountants need to be aware of the pitfalls and tailor their questionnaires to that and address the topic in engagement letters as to whether they are handling the foreign aspects of their clients' returns."


Rickard Jorgensen, president and chief underwriting officer at Jorgensen & Co., a professional liability and risk management consulting firm, offers these tips to minimize liability in tax practice:

  • The key issue is to secure an engagement letter or, at the least, some form of signed acknowledgement from the client regarding the scope of services. If there is no signed acknowledgement, CPAs leave themselves open to allegations from owners and third parties (like lenders) for risks beyond the scope of a relatively conventional tax assignment. Put it in writing so that the client fully understands the nature of the services you are providing.
  • Make sure that you are aware of all deadlines and adhere to them. Set up a diary to ensure appropriate acknowledgements and receipts. Do not assume anything -- keep following up until you are satisfied. Don't rely on client representations or verbal assurances that something has been completed and sent off.
  • Your fees for service should contain a detailed description of the services provided and timely. Do not batch invoices. Get them out immediately and create milestones for payment. Accumulation of an outstanding account is the quickest way to a dispute. Many claims against CPAs (and other professionals) arise from attempts to collect fees. Often a cash-strapped client will use a countersuit that alleges negligence to negotiate a lower fee. It is prudent to avoid permitting the outstanding fees to accumulate.
  • Stay within your comfort zone and only provide services where you have true expertise. Do not provide tax services to a public company if your primary business is 1040s. Only make promises that you can fulfill.
  • Keep an open and regular dialogue with clients and always return communications - phone calls, faxes or e-mails -- within a reasonably short time frame. If nothing else, observe good business courtesy and treat your client with the respect you expect from them.

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