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Mergers and Acquisitions: What Do You Owe Your Clients?

When a merger or acquisition takes place, CPA firms have both a legal and ethical responsibility to their clients. By Arthur J. (Kip) Dellinger, Jr., CPA | Digital Exclusive - 2022

Retirement planning, monetizing of client values, staggering advances in technology, market share expansion, among other reasons, are causing an enormous consolidation period in the accounting profession—one that’ll likely continue to accelerate over the next several years. This consolidation typically takes the form of mergers and acquisitions (M&As)—sometimes a combination of both—involving large firms, local firms, and even sole practitioners combining or acquiring practices of retiring practitioners.

During these transactions, CPA firms have professional obligations and responsibilities to their existing clients—both legally and ethically. If you’re in the process of merging or acquiring, here’s what you need to know.

AICPA’s Professional Standards

Two provisions of the AICPA Code of Professional Conduct address M&A issues.

The first and most significant provision is under ET Section 1.400.205: Transfer of Files and Return of Client Records in Sale, Transfer, Discontinuance or Acquisition of a Practice. ET Section 1.400.205 provides that when a CPA’s practice is sold or transferred to another firm and the seller/transferor will no longer retain an ownership in the successor practice, each client must receive a written request for consent to transfer its files to the successor firm. The notification may state if a negative response isn’t provided within 90 days, permission will be assumed by the successor to transfer the files. Moreover, the files shouldn’t be transferred until client permission is obtained or the 90-day period expires. Additionally, the acquiring firm is equally responsible to comply with these requirements. There are, however, conflicting requirements when tax information will be transferred in a sale of a practice, as detailed below.

Equity vs. Non-Equity Transferors: AICPA clarifies that—regardless of the percentage of ownership—if a target CPA firm’s owner(s) become equity partners, the client notice requirements don’t apply (see “Transfer of client files in a merger” in AICPA’s Frequently Asked Questions: General Ethics). Alternatively, the client written notice requirements will apply if the target CPA firm’s owner(s) are admitted as non-equity partner(s).

There may also be hybrid situations. For example, if a target CPA firm’s partner (equity or non-equity) “owns” clients, each client situation must be evaluated and treated in a manner consistent with the rules pertaining to equity and non-equity owners in a successor entity.

Conflicts of Interest Considerations: In some circumstances, the parties must consider possible conflicts of interest. Examples of potential conflicts of interest could be when two CPA firms are combining and each represents industry competitors. Another example could be if a practice is being acquired and includes a competitor of a client of the acquiring firm (where one or both clients would prefer not to share the same CPA firm). These types of matters should be specified in the agreement to the contemplated merger or acquisition (see ET Section 1.700.010).

Applicable Boards of Accountancy Rules

CPAs and CPA firms are regulated by boards of accountancy in the states and other geographical locations where they practice. When one or both firms are pursuing an acquisition or merger, the parties should ascertain which boards have jurisdiction and determine the applicable jurisdictional rules that apply to the contemplated transaction. Fortunately, the overwhelming number of jurisdictions specifically or impliedly adopt the ethics rules of the AICPA (e.g., Rule 58 of the California Board of Accountancy).

Onerous Treasury Regulation

Internal Revenue Code (IRC) Section 7216 is a criminal statute regulating tax preparers with regards to their “uses” and “disclosure” of a taxpayer’s return information. The code is very general and provides that the Treasury issue regulations governing the application of IRC Section 6713, which provides civil monetary penalties for similar violations. Its application is governed by Section 7216, and the provision is more likely to be asserted by the IRS, as proving a criminal violation has a much higher bar than meeting a civil violation.

Three Treasury regulations have been issued under Section 7216 that should be reviewed annually by firm leadership to ensure continued compliance.

  1. Section 301.7216-1: Addresses definitions and the respective penalties associated with violations of the code. A significant portion of this section states that “taxpayer information” is any information pertaining to the taxpayer. For example, the use or disclosure of the taxpayer’s name can result in a violation, and the regulation isn’t limited to financial information or identification numbers.
  2. Section 301.7216-2: Is key to a firm’s practice because it sets forth “uses and disclosures” that a tax preparer may make or engage in without prior written approval of the taxpayer. One of the uses may be to compile a list for solicitation of tax return preparation business. While the CPA firm, as a compiler of the list, isn’t generally permitted to transfer it, an exception is made when there’s a transfer in combination with the sale or disposition of the firm. The typical due diligence conducted prior to the proposed sale of the CPA’s tax preparation business won’t represent a transfer of the list if the CPA selling the firm has a written confidentiality agreement with the acquiring firm that expressly prohibits any use or disclosure of information permitted to be on the list for any purpose other than the purchase of the firm’s business.
  3. Section 301.7216-3: Sets forth specific, detailed requirements for obtaining the taxpayer’s prior written approval. If the use or disclosure isn’t contained in the second regulation, then strict adherence must be made with this third regulation.

Section 301.7216-2(d)(1) permits, without taxpayer approval, the use and disclosure of taxpayer information among preparers and processors of a firm regarding tax return preparation and related tax advice. Therefore, when a merger takes place between two firms and there’s continuity of personnel from the target firm in the successor firm, the IRS can be expected to apply the same principles as the AICPA to the transaction.

When the target firm’s owners don’t retain an equity interest in the successor firm, it would be recommended to use an abundance of caution by complying with the stricter request for permission requirements set forth in Section 301.7216-3. Unfortunately, the request for consent doesn’t specify the number of days in which the client must respond, which can be problematic for the successor firm. Instead, it requires affirmative consent must be given by the taxpayer before a transfer takes place.

The regulations don’t provide for an acquirer’s quality review of tax returns in connection with a sale or merger of a CPA firm’s practice. This is different than AICPA’s rules and, consequently, the CPA firm whose clients’ returns will be the subject of a review must obtain client permission for the use and disclosure of their return information when contemplating a sale or merger.

This may present challenges to the two firms. Either the acquirer will be limited in identifying particular returns, or the target firm would have to seek permission from every tax return client to enable the acquiring firm to make its selection. The parties must find a satisfactory solution to the quandary—perhaps a random selection from a list identified (only by numbers) that correspond to an alphabetized master retained by the target firm.

As you can see, M&A transactions bring up a number of important laws for all parties to consider. While it’s critical to comply with these laws, it’s equally important to comply with the CPA profession’s ethical standards.

Arthur J. (Kip) Dellinger, Jr., CPA, provides services as an expert in the areas of CPA tax practice regulatory discipline and malpractice matters.


Related Content:

  • The 2022 M&A Outlook: After a record-breaking volume of global deals in 2021, what’s the forecast for mergers and acquisitions this year? Our expert says it’s likely to stay brisk.
  • Selling a CPA Firm or Small Business: These 10 essential steps will prove a handy guide to any M&A transaction, whether you’re a founder looking for an exit strategy or a CPA advising on another deal.

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