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Risk Management for Tax Engagements

According to the AICPA, in 1990 tax engagement were responsible for 42 per cent of all malpractice claims filed against CPA. Fast-forward to today and that apportionment of losses hasn’t change much. In fact, according to the same source, tax claims against CPAs can be quantified as follows:

  • 55% of total number of claims against CPAs (by service)
  • 17% of total dollar amount claimed against CPAs (by service)

Which illustrates that there are lots of small tax claims made against CPAs.

Tax claims may also be sub-divided by types of clients:

Tax pie chart

The most common sources of tax claims are as follows:

  • Failure to advise
  • Filing errors
  • Election errors
  • Estate Tax errors

Some risk considerations:

  • Engagements involving estate tax returns, Subchapter-S elections and corporate mergers present a much higher level of risk and should be approached with a degree of caution.
  • If the tax engagement is complicated enough to require the involvement of attorneys or other third parties, you need to spell out their specific duties and obligations.
  • Prospective clients must understand that they are accountable for the accuracy of the accounting data and supporting documentation. You may also wish to explain that there will be no guarantee the taxing authority will approve a position taken on the return. At this point you may also wish to discuss what, if any, services you will provide if a return is questioned by the taxing authority.
  • Review prior year’s tax return for an idea of the complexity involved. Determine if carryovers or other factors should be considered. More importantly, it is prudent to assess the adequacy of your client’s record-keeping system.
  • At the beginning of the tax season, many of you will be employing per diems, experts in tax law, temporary and support staff. It is imperative that this staff is well aware of current tax laws as well your firm’s internal policies.
  • Federal and State tax laws are constantly changing, not keeping abreast of these changes is a frequent source of malpractice claims. You should:
    • Regularly attend tax refresher courses.
    • Conduct in-house seminars and training sessions to support staff.
    • Subscribe to tax update services and professional tax publications.
    • Periodically review the SRTPs and Treasury Department Circulars.


It is imperative that you provide a tax organizer from each claim that includes a written questionnaire requesting details such as:

  • Marital Status
  • Independents
  • Annual Personal Income
  • Income Producing Property
  • Tax Deductible Expenses
  • Missing Returns

Have your client sign the statement attesting to the fact that, to the best of their knowledge, the information provided is accurate. You’re not required to verify this information but you must make reasonable inquiries if the information appears to be incorrect or incomplete.

Because personal tax services do not usually require an engagement letter, it is prudent to include an affirmative conduct statement in the cover letter included with the tax organizer.

According to Ralph Picardi, Esq, every state recognizes that contracts can be formed by something other than a signed engagement letter. Oral contracts and those formed by affirmative action are examples. In the absence of a state law requiring a signed writing (which should be verified with local counsel), the reasonableness of the communication will likely impact whether a contract is enforceable.

An engagement letter should be included in the Tax Organizer; however, in an attempt to ensure that the agreement is binding, regardless of the client’s signature, the following wording should be used in the engagement letter:

If you agree to authorize us to prepare your 201_ personal income tax returns pursuant to the terms set forth above, please execute this letter on the line below designated for your signature, and return the original of this executed letter to us along with a completed copy of the enclosed tax organizer and the supporting documentation requested therein. You should keep a copy of this fully executed letter for your records. If this firm does not receive from you the original of this letter, in fully executed form, but receives from you a completed copy of the enclosed tax organizer and/or supporting documentation requested therein, then such receipt by this office shall be deemed to evidence your acceptance of all of the terms set forth above. If, however, this office receives from you no response to this letter, then this office will not proceed to provide you with any professional services, and will not prepare your 201_ income tax returns.


The AICPA states that a CPA should not recommend to a client that a position be taken with respect to the tax treatment of any item on a return unless the CPA has a good faith belief that the position has a realistic possibility of being sustained administratively or judicially on its merits if challenged.

To determine whether a realistic possibility exists:

  1. Establish relevant background facts.
  2. Distill the appropriate questions from those facts.
  3. Search for authoritative answers to such questions.
  4. Resolve questions by weighing the authorities uncovered by a search. This research must be properly documented in the work papers.
  5. Arrive at a conclusion supported by the authorities.

It is crucial to stay within the foregoing guidelines to avoid a potential malpractice claim.


Up to the point when you’re ready to file a tax return, your clients’ file should contain:

  • Correspondence
  • Forms
  • Checklists
  • Research
  • Logs
  • Documentation of phone conversations

Have your work reviewed by an experienced accountant. If you’re a sole practitioner you might want to reach an agreement with another practitioner to perform cross reviews.

Is It Really Over?

A Look at Tax Planning

During the year, a client may look to you for validation of a questionable tax plan developed by them or an attorney. If you don’t think this is a red flag or suspicious, think again. It’s one thing if you formulated the tax plan, but validating a questionable tax plan is cause for concern. If the aggressive tax plan fails, your client may deny any participation and will look to you for any recovery of any additional tax or penalties imposed by the taxing authority.

A tax plan may be structured in an infinite number of ways. It all depends on what the plan is meant to accomplish. In most engagements, the objective is to limit the amount of taxes paid, but it’s not unusual for a firm to design a plan to limit a client’s personal liability or to assist with retirement planning. Meeting these objectives will require an exhaustive inquiry into business and non-business issues before rendering any advice.

Your Role in Tax Planning

At minimum, a concerted effort between you and the client is required. The roles and responsibilities should be outlined in an engagement letter that should include the following provisions:

  • State that there is no guarantee (expressed or implied) that the taxing authority will approve the plan.
  • Indicate that the tax plan will be based on specific factual representations and existing tax laws, both of which are subject to change.
  • Point out that the advice is for initial planning only and that compliance with other conditions must be evaluated before and during the implementation of the tax plan.

Once you undertake the engagement:

  • Ensure that the client provides sufficient factual data and supporting documentation.
  • Keep abreast of any changes in your client’s tax status and financial activities.
  • Research current law and alternative positions.
  • Look for potential legislative changes that could be enacted before the plan is implemented.

Documentation will play a key role, therefore following up on any oral advice with a written communication will help eliminate any misunderstandings between you and the client.

Final Word

When you’re ready to present your tax plan, you should make it clear to your client that the advice is subject to future changes in tax laws or their overall tax position. You should:

  • Discuss the extent to which your client will be advised of any future changes in the law.
  • Be aware that the client has an obligation to keep you advised of changes in tax status and/or financial activities that might affect the tax plan. You’re partly responsible for keeping the lines of communication open.


Jorgensen & Company are not attorneys and do not offer any form of legal advice. Consult with appropriately qualified local counsel for more assistance. Rickard Jorgensen is President & Chief Underwriting Officer for the CPAGold™ program and may be contacted at (201) 345 2440 or





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