Managing Risk in Tax Season and Beyond

Although the current tax year has shown signs of returning to more normalcy after the pandemic-induced chaos of recent years, CPA firms continue to face unique challenges and risks they shouldn’t ignore. In addition to trying to keep up with the increasing complexities of evolving tax laws and regulations (e.g., state pass-through entity taxes, K-2s/K-3s, etc.) and easing but ongoing challenges of working with the IRS and other taxing authorities, many firms are experiencing significant capacity challenges as they struggle to find and retain qualified talent to support and meet their clients’ service needs.

To mitigate these risks, firms need to prioritize performing the “right services” for the “right clients.” Here are three client-related questions to consider that may help you identify potential risks to your firm and position it for long-term success.

1. IS THE CLIENT STILL A GOOD FIT?

From a timing perspective, there’s no better time than now to review your client list to decide whether clients remain a good fit for your firm—and do so before and after every tax season. Disengaging from clients that don’t meet your firm’s needs will better position you going forward. Consider these red flags with clients:

• Difficult or uncooperative behavior (e.g., withholding critical information, argumentative, or disrespectful to firm members).
• Changes in a client’s business.
• Deteriorating relations (e.g., not taking your advice, unresponsive, or acting in a way that suggests compromised integrity).
• Potential conflicts of interest.
• Constantly questioning your fees or requesting a discount before services commence.
• Late, slow, or partial payments.

Pay particular attention to difficult or manipulative clients who are slow in accommodating your requests, don’t return your calls, or are unresponsive. When a client seems unwilling to provide you with the information needed to complete an engagement, assess the underlying cause: Is the problem merely sloppy recordkeeping or is the client deliberately delaying or withholding information? Be cautious in situations where it appears that documents are deliberately withheld or you’re urged by a client to proceed without appropriate or sufficient documentation.

Abrupt changes in a client’s behavior may be indicative of a failing business, financial problems, substance abuse, or other personal problems. Trying to uncover the source of the problem could be beneficial, but whatever you do, don’t ignore the warning signs of a deteriorating relationship. And always be on the lookout for potential conflicts of interest. It’s extremely important to examine potential or actual conflicts of interest from each party’s point of view.

Conflicts of interest have long been a major factor in professional liability claims against CPAs. Part of the problem is that if CPAs aren’t proactive and sensitive to their existence, potential conflicts of interest aren’t perceived before the incidents that trigger these claims. If potential conflicts are identified, you must assess whether you can objectively represent the parties involved, and if you determine you can, assess whether there are reasonable safeguards to eliminate or reduce the threat to an acceptable level.

2. IS THE ENGAGEMENT A GOOD FIT?

Firms who dabble in practice areas outside of their expertise have a much higher risk of having a claim. Learning the art of saying “no” to clients is an important, but often overlooked, risk mitigation tool.

If clients seek your help with transactions or activities outside your comfort zone or skill set, you’ll be better served suggesting they seek the advice and counsel of professionals with expertise in those areas.

It’s important to recognize, embrace, and maintain your competencies. Frankly, this rule is fundamental to the profession, as the AICPA’s Code of Professional Conduct requires CPAs to only undertake professional services they can reasonably expect to complete with professional competence.

3. ARE YOU MANAGING CLIENT EXPECTATIONS?

Effective communication is a key factor in any CPA-client relationship, and when you work to stay informed and in control of managing client expectations, you help to safeguard your firm. To that end, good documentation is critical to successfully managing client expectations. Jurors (members of the public) generally consider CPAs to be experts in documentation, and falling short of that expectation may be viewed as negligent and perceived as performing below the standard of care. Consider these documentation tips:

• Utilize engagement letters. While these letters won’t immunize you from lawsuits, they can be your first line of defense if a client makes a claim against you. You likely already have executed engagement letters with your tax clients. However, to prevent engagement creep, memorialize the additional services by updating your letter or obtaining a signed addendum, clarifying the revised scope and limits.

• Always document significant meetings and communications. Follow up with written communications in circumstances including but not limited to:

- Change in engagement scope (may require a new engagement letter).

- Negative information (e.g., tax return is already late, client’s failure to timely provide information, or client is facing an audit).

- Judgment calls (e.g., aggressive tax positions taken by your predecessor).

- Client agreement to take significant action.

- Conversations regarding transactions, extensions, or estimated tax payments.

• Advise clients of opportunities and risks. Consider obtaining a tax representation letter or stand-alone certification letter to mitigate high-risk scenarios, such as:

- If your firm is preparing amended income tax returns to reflect employee retention credit (ERC) adjustments as required by the taxing authorities, and the firm isn’t responsible for assessing or opining on the client’s eligibility for the ERC, it’s recommended to have the client sign a tax representation letter in addition to having a signed engagement letter for such services. This added defensive documentation will help protect the firm if clients later allege that the firm should’ve opined regarding ERC eligibility, and/or if clients later allege the firm didn’t appropriately advise them of the potential risk given the extended statute of limitations afforded by the IRS for assessments without a corresponding extension for taxpayers to pursue refunds on the income tax returns.

- For clients with known extensive digital asset transactions, it may be prudent to have them sign a tax representation letter or a stand-alone certification letter at the conclusion of the engagement addressing crypto asset implications. This additional defense provides evidence of the client’s understanding and acceptance of their responsibilities regarding digital asset transactions and the limitations of the services your firm provided.

- In addition to the above examples, there’s a new area of potential risk associated with the Corporate Transparency Act (CTA), which introduces a new and expansive reporting regime for entities deemed to be reporting companies. Therefore, CPA firms are strongly recommended to inform and advise their clients of the beneficial ownership reporting requirements under the CTA.

• Ensure written documentation is factual, professional, and without personal commentary or unsubstantiated opinions. Unprofessional or inappropriate comments can damage documentation integrity. Ask yourself whether your documentation would be helpful or harmful if presented at trial.

• Mind fees, billings, and collections. The challenging economy has brought fee issues to the forefront as some clients struggle to meet their financial commitments, including bills owed to their CPAs. Good communication with non-paying clients is important and may spur payment. At the very least, contemporaneously memorialized communications create a defensive documentation trail demonstrating that the client, by not responding to your communications, didn’t have a valid basis to claim your fees weren’t owed. When dissatisfied with work, clients normally respond to such communications by detailing their dissatisfaction.

• Strategically and respectfully disengage. Skillfully handled transitions can be mutually beneficial to firms and clients. However, care is needed when disengaging from engagements after they’ve begun. Disengaging too late and without sufficient cause may increase the likelihood a firm could face allegations of damages if the successor is unable to meet the deadline.

Whether you decide to disengage with a specific client, type of business, or area of practice, it’s extremely important to terminate relationships professionally, formally, and in writing. At a minimum, your disengagement letter should always contain clear statements, a description of your work, and a list of any due dates or filings. When done effectively, disengagements are a good risk management tool for your firm, and knowing how to execute them skillfully and professionally will help you grow your practice and avoid potential liability exposure.

• Report potential claim situations early. Promptly report potential claims, including potential errors or omissions. Doing so protects your firm’s full policy limits.

Above all, it’s important to tread carefully when working with any client. Be sure to arm yourself with knowledge, know your limitations, and be willing and able to say “no” to some clients—your firm’s reputation and success depends on it.

Suzanne M. Holl, CPA, is senior vice president of Loss Prevention Services with CAMICO. With more than 30 years of experience in accounting, she draws on her Big Four public accounting and private industry background to provide CAMICO’s policyholders with information on a wide variety of loss prevention and accounting issues.

Related Content:

• 8 Critical Elements of an Effective Engagement Letter: An engagement letter is critical to the success of any CPA. To help protect yourself and your firm, make sure your letter has these eight elements.
• 5 Risk Management Tips for CPA Firms Contemplating Outsourcing: Due diligence is critical for CPA firms who are considering outsourcing their work to a third party. Before signing any contracts or agreements, consider these five risk management tips.