Tax Season is Here

Tax season is heating up. It is typically the busiest time of the year for accountants who perform tax preparation services for individuals. Tax preparation services can be the biggest source of income and percentage of business for accountants. However, despite the large volume of tax preparatory work, a majority of accountants do not use engagement agreements with their clients for tax services. Ironically, many of these accountants routinely use engagement agreements for any work other than for tax-related services. 

Professional Liability Claims and Tax Services

The failure to utilize an engagement agreement can become an issue in the event a professional liability claim is made against an accountant. Unfortunately, a great majority of claims made against accountants stem from tax-related services. From 2013 to 2015, the Hanover Insurance Group reported that 70 percent of their accountants’ professional liability claims involved tax-related services. 

These claims often involved disputes between the accountant and the client or purported client over what services the accountant was to provide the client or even if there was a retention at all. It is common for potential clients to fail to deliver the requisite records to the accountant in enough time to properly prepare and file a return. There also may be confusion over whether the accountant is providing any tax planning advice beyond just the preparation of a return and who is responsible to file a completed return. Even with long-term clients, where an accountant prepares individual and business tax returns for a client every year, disputes can occur without an annually executed engagement agreement where there is an additional tax issue in a particular year. 

For example, a long-term client requests advice from the accountant on the sale of the client’s business that year and any possible tax consequences. Following the sale of the business, the client incurs significant unanticipated tax charges and penalties. While the accountant claims he was retained each year only for the preparation of tax returns, the client claims that the accountant failed to provide proper tax advice concerning the sale of the business. The sale of the business agreement in that year went beyond the scope of the usual tax preparation work that the accountant typically completed each year. However, without an engagement agreement, it is unclear whether the additional work had been agreed to by the accountant.

Well-Drafted Engagement Agreements

To help accountants manage the risk of a professional liability claim, the following are some of the elements that should be addressed and included in a well-drafted engagement agreement hopefully to avoid the client confusion and misunderstandings that can lead to claims.

Identify Client, Fees, and Timing of Services. The engagement agreement should identify all clients to the agreement, whether individual or corporate. The fees and payment of such should be explained. In addition, it is important to state when supporting tax documents need to be provided, who is responsible for filing the return, and when signatures are required for both the engagement agreement and the return.

Scope of Work. In the agreement’s scope of work section, it is critical to spell out exactly what work the accountant has agreed to perform for a client by identifying the year and the type of tax returns to be prepared. The agreement also should indicate any limitations of the services, such as not providing any tax planning advice or defense if a return is challenged by a government agency. It also is helpful to address that, if additional services are needed, the accountant and client will need to agree in writing to the work and any additional fees. 

Identify Client Responsibilities. The agreement should identify the client’s responsibilities, such as the required documentation for the return and when those documents must be provided. The client must agree to the accuracy and completeness of the records provided. The agreement should note that the client is responsible for identifying if they hold any interests or assets in foreign countries and disclose any additional filing requirements in those other jurisdictions.

Use of Third-Party Service Providers, Electronic Data Communications, and Storage. The agreement should specify how communications will be made with the client and how electronic data will be stored and for how long, and it should allow for the use of third-party vendors for storage and preparation of documents.

Engagement Agreements Should Be Limited. Engagement agreements should be limited in time and renew each year. It is not recommended that an accountant use an evergreen engagement agreement, which is an agreement without a clear end of services. An engagement agreement typically should have a beginning and an end of the services performed by the accountant. This forces the accountant and the client to review the scope of work at least annually. 

The client should have time to review the engagement agreement before executing it, and the accountant should require the client to sign the engagement agreement before any services are performed. The accountant should retain the original executed engagement agreement and provide the client a copy.

Accountants can minimize their risks by communicating regularly with clients. Regular communication can help solidify the accountant-client relationship and help the accountant learn if the tax needs of the client have changed from the previous year. By utilizing well-drafted engagement agreements, accountants can manage risk and avoid misunderstandings and confusion that can lead to costly professional liability claims.

Note: The recommendation(s), advice, and contents of this material are provided for informational purposes only and do not purport to address every possible legal obligation, hazard, code violation, loss potential, or exception to good practice.