Given the fact that most accountants prepare taxes, it's not surprising that the most frequently asserted claims against accountants are in the tax arena.

While not the most significant claims in terms of severity, the sheer number of claims generates the majority of funds paid in claims and in defense of claims, according to John Raspante, a CPA and senior vice president and director of risk management for NAPLIA (North American Professional Liability Insurance Agency).

"There are basically three categories of tax claims against accountants," he said. "The first type is the outright error: The CPA missed it. We get those all the time -- last month we had a claim where the CPA simply forgot to file a sale and use tax return. It can be chalked up to human error. This is why you have E&O [professional liability] insurance."

But it can result in heavy liability, Raspante indicated. "For example, we had a claim where for years the individual client filed a federal return, and also a New York State and City personal income tax return, and a New York City unincorporated business tax return. Somehow, the preparer and the reviewer made the same error. The preparer forgot to file the unincorporated business return, and the reviewer didn't catch it. Six months later, they received a letter from the state. The client wasn't upset that he had to pay the tax, but he was upset with the $36,000 late filing and late payment fees."

"Preparers rely too heavily on their software, but somehow the checks and balances don't happen the way they should," he said. "These are simple, basic errors. It's why people have insurance."

The second category of tax claims results from a technical misapplication of the rules, according to Raspante. "CPAs can't know everything," he said. "They might be practicing in an area in which they're not familiar. For example, the targeted Jobs Credit is an area in which we frequently see errors. The employer gets a credit for hiring from various 'targeted groups.' These include veterans and convicted felons. A lot of the targeted groups eligible for the credit happen to be in the construction industry. The taxpayer learns about it through membership in an association, and if they don't take the credit the CPA gets the blame. This is one credit that is frequently missed by tax preparers."

The third area involves a violation of ethics or rules of conduct claims, Raspante noted. "These claims are generated by violations or allegations of negligence that come about by straying from a code of conduct. For example, there would be an issue as to whether the accountant can accept a commission or a referral fee when they send their client to another professional, such as an attorney, a financial planner or a stockbroker. Or can the accountant represent both sides in a transaction by preparing returns for a trust and a beneficiary? These can result in claims that aren't the result of human error or the technical misapplication of the tax rules, but they can be very troubling to the practitioner. New York says if there is a cause of action resulting in a monetary award of more than $25,000, it has to be reported to the New York State Board of Accountancy."

 

STUMBLING BLOCKS

An area of concern for many accountants is the misclassification of workers, according to Raspante, since misclassification of workers can mean not only that the client is liable for back payroll taxes, it can also generate professional liability claims against the accountant.

"Many times, accountants are not familiar with the independent contractor/employee distinctions, and the IRS, the [Department of Labor], or the Workers Compensation Board comes in and says they're employees, not independent contractors," he said. "The rules are complex, and they are subject to multiple review - the IRS, the DOL or the state workers compensation board can dispute the status of a worker. The IRS is very successful in these types of examinations. It's very common for them to reclassify independent contractors to employees, and the claim that arises can be very material."

Moreover, the distinction is crucial in the application of the Affordable Care Act rules, since a non-employee may be excluded, according to Knoxville, Tenn.-based CPA Edgar Gee. "For several years, the DOL and the [Internal Revenue Service] and 40-plus states have had an information-sharing agreement," he noted. "When one of them audits a business on this issue, they share the results with the other two. It's a triple whammy - when you settle with one of them, you might think it's the end of the matter. In reality, that's just the beginning -- you still have two other wars to fight."

"You can't do much about claims resulting from human error," Raspante said. "Remember, you should know the rules. Read all the instructions, and don't leave it up to the software. Check and review returns at least once, and for high-net-worth clients, there should be a second review."

To lessen the chance of claims resulting from technical misapplication of the rules, Raspante recommends that accountants stay within their skill zones. "They should practice in areas where they have comfort levels," he said. They should consider affiliating with someone else, because they can't tackle everything on their own. For example, we get calls all the time informing us that they just picked up a new client in an area they know nothing about, and they want to know if they will be covered. We'll cover them, but the bigger issue is, 'Do you really want to do this work?'"

To diminish the chances of becoming involved in ethical claims, Raspante recommends that the accountant become intimately acquainted with Circular 230 and state rules of ethics: "These claims generate a lot of publicity, and they don't go away fast," he said. "They can lead to revocation of the accountant's license, and they're all a matter of public record."

 

SCARY TRENDS

A current trend in tax liability claims is the competency issue, according to Randy Werner, CPA, Esq., a loss prevention executive at Camico.

"The tax rules have become significantly more complicated," she observed. "The areas have broadened and the demands have grown so much that it's very difficult to be on top of every single issue. It's easy for accountants to miss tax breaks, such as credits, that a client can take advantage of, or to miss something that the client should have put on the return."

There are a number of things that an accountant can do to avoid being in this position. "Stay on top of CPE," she said. "Do good client screening. Ask yourself if this client has something unusual on their tax return, something they need to look into a little further to determine whether they are comfortable in taking on this client with their particular needs."

"Tax practitioners feel that tax practice is a lower-risk practice and many of them do not get engagement letters, or they try to shorten their engagement letters to please the client. A robust engagement letter defines the client's responsibility and delineates what the firm will and will not do for the client," Werner explained. "It's an administrative burden for the firm, but ultimately it's one of the best lines of defense for a claim when the client's expectations do not match what the CPA firm agreed to do. If there's no engagement letter, it will be a 'he said, she said' situation, and juries will give the client the benefit of the doubt."

An ongoing issue for accounting firms involves suits for the collection of fees, where the client counterclaims with a malpractice claim against the accountant. "It can be a big risk to tax practitioners," Werner said.

For new clients, and for slow-paying or delinquent clients that want services, she recommends charging an up-front "back-end" retainer, and then billing the client for the remainder. "If the client stops paying, use the stop-work clause in the engagement letter, and enforce it by stopping your work," she said. "This helps prevent getting into the position where you might consider suing. CPAs are not banks, and shouldn't be carrying clients unless they are good credit risks."

 

WATCH WHAT YOU KEEP

The fact that CPAs typically collect and store information about their clients may open them up to liability if any of the information is compromised, observed Rickard Jorgensen, president of Jorgensen & Co. "The information is generally of a personal nature, and it includes things like Social Security numbers and credit card details, because when an accountant compiles information for a tax return they have to make inquiry about the personal financial status of their clients," he said. "And if they hold this information in an Internet-connected system or on a portable device, they are exposed to either theft of that data or cyberattacks involving extortion."

Things a firm can do to protect itself include common-sense measures, Jorgensen observed: "Change and protect your password, update your software, make sure you have a decent firewall, and don't allow people into your server rooms," he said. "Employees' remote access to your servers exposes your business to a security breach. Make sure you control the access."

The insurance industry is just starting to develop adequate products that address these risks, Jorgensen indicated. "So you have to be quite careful in finding the right protection. We're just learning as we go along - you will find policies that are full of holes and some overlapping with other professional liability policies."

"Conventionally, what's been happening is that accountants will add a rider to their professional liability insurance," Jorgensen explained. "The problem with that is that it could erode the insurance for normal CPA activities of audit, attest and tax, so it's wise to look at the possibility of buying independent insurance that will respond and not remove coverage with the main firm activities' endorsement. If there's a $2 million claim against you and you have to practice for the next year, you have no insurance."

Jorgensen recommends separate coverage. "It's additional protection, and it's not a very expensive proposition," he said. "Although I like the idea that it can be part of the main policy, in truth, as a practice, it should be separate coverage."

 

PROTECTIVE LANGUAGE

With the elimination of the requirement for Circular 230 warnings at the end of every tax-related e-mail, many practitioners are questioning the need for a replacement, noted Ruddy Ramelli, a tax partner at Jones Walker LLP.

"The warnings served to notify the recipient that they couldn't rely on this advice to get out of penalties imposed by the IRS. In June, the IRS revised the way they approach covered opinions, and part of this was to get rid of the disclaimer," he explained. "However, a lot of practitioners took comfort in the disclaimer. They said it means, 'This is preliminary advice and you can't sue me on it.' They thought it gave a measure of protection. Whether it did or not, I'm not sure, but it clearly wasn't the service looking to protect practitioners from liability claims."

"That's one area that we'll see fleshed out. A lot of practitioners correspond with their clients via e-mails, and these are a lot shorter than a long memorandum to the client that discusses the facts and reasoning and cases and statutes and regulations. They're a quick and concise way to respond to a client's request. So practitioners are worrying whether they should include a disclaimer," he explained. "We've eliminated the Circular 230 notice from our e-mails, but we haven't yet made the decision as to whether or not we want to add something in its place."

State and local taxes present the practitioner with unique liability risks, according to Bill Backstrom, head of the Tax & Estates Practice Group at Jones Walker.

"At the federal level, there's one code and one set of regulations and administrative guidelines," he observed. "With state and local taxes, there are different codes in every state. In some states like Louisiana, there are local tax codes as well. Some of the provisions are similar, but many have different provisions, and a multitude of interpretations. And there just aren't the administrative guidelines you have at the federal level. This makes it an inherent risk for practitioners to give advice to their clients."

"Moreover, all over the country, legislatures are reluctant to enact laws that impose new taxes or expand existing taxes," Backstrom said.

"State and local government face budget issues, some of them generated by federal mandates. So the only way budgets can be met is to enforce the existing laws more rigorously. They find new ways to interpret existing laws to collect new revenues."

What this means is that practitioners cannot rely on traditional interpretations of the law, Backstrom suggested. "They may take positions in audits that aren't addressed either in statutes or administrative guidelines," he said. "You have situations where the taxpayers made every attempt they could to file the correct return, but the tax administration takes a new position in the audit. This leads to uncertainty, and raises the risks for practitioners in trying to reach accurate conclusions to advise their clients."

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