Every trial attorney will tell you that the first and most important tool in the defense of a malpractice claim against a CPA is a strong and carefully crafted engagement letter.
This was brought home last week with one of our long-standing CPAGold™ clients.
For years the CPA had provided corporate tax filing services to a small business – no audit, review, compilation or other attestation services. During an IRS audit the CPA’s client discovered that their controller had stolen more than $100,000 over the course of several years. Because this was exclusively a tax and bank reconciliation engagement, the CPA never secured an engagement letter. Although the matter is on-going, the lack of an engagement letter may impact the defensibility of this claim against the CPA.
A strong engagement letter would make the attorney’s job a lot easier.
The following lists some of the components of a good engagement letter. It is not all inclusive as the litigation landscape is ever-changing, but it does provide a starting place.
Alternative dispute resolution (ADR).
The most current version of this clause is available at: http://cpagold.com/2016/02/example-mandatory-mediation-provision-for-engagement-letters/. Your professional liability policy also contains certain provisions which reduce the policy deductible if you use an ADR clause. Premium discounts are also available.
Deadline for submitting return information.
Fixing the date when a client must provide you will all the information require to perform your engagement is fundamental and must be prominent in the engagement letter. Failure to meet the deadline should be reinforced with a statement that that you may have to withdraw from the engagement.
Cyber liability limitation
This is a new and evolving exposure for CPAs. A clause outlining your best efforts to mitigate exposure, subject to all legal requirements, may be appropriate. This is especially important in regard to tax engagements.
Indemnity and hold-harmless clauses.
Many malpractice claims arise from third party suits (lenders, investors, creditors) and these plaintiffs are not bound by the terms of an engagement letter. Including a clause that seeks to reimburse the CPA for losses arising from third party suits -including responding to subpoenas and giving testimony – can often prove crucial when defending a claim.
IRS or State examination.
Always secure a separate engagement letter for this type of assignment. It is more complex and may have to be deferred to another CPA (that did not prepare the return).
Limitation of liability clauses, consequential damage disclaimers, and limiting of the term to file a lawsuit.
These are often subject to local law but should not be overlooked. You should confer with counsel about what your state permits.
Limitation of scope clause.
Tax engagements can be broad and wording that delineates what services are NOT being provided is essential. The recent claim underlines this.
Stating the services you are not providing and having the client sign-off on this is the best defense. Period.
Limitation on use of the returns.
Certain unsophisticated clients may use tax returns in lieu of audited financial statements. A clause in an engagement letter limiting the use and distribution of returns is crucial.
Maintenance of Records.
You should reinforce the client’s responsibility to maintained accurate records to support any deductions claimed and establish an appropriate time to retain these records.
Outcome or results.
An engagement letter is a contract. You should never warranty results or the outcome of your services.
Review of prior-year returns.
Your services should be limited to this years’ engagement and you are not responsibility for an previous years work performed by another CPA or tax preparer.
Usually employed for fee disputes, you should consider expanding this clause to apply to conflicts, late delivery of information, ethics problems or failure to follow crucial advice.
Successor and assignment in interest.
In the event a CPA is merged or acquired, a provision that transfer the rights and protections of the engagement letter should be included.
It is crucial to include language stating that any tax position taken by a client must satisfy professional standards.
This list is not all encompassing and different engagements might require additional clauses. CPAGold™ and Ralph Picardi retain examples of engagement letters. If you require specific assistance please contact your agent or Ralph.