Practice Makes Perfect

Tax practitioners have enough concerns without having to fear the specter of a professional liability claim resulting from a preventable mistake or oversight. Many of these slip-ups can be prevented by simply jotting a contemporaneous note recording the rationale for an election or flagging a filing deadline on the calendar. Early, thorough and well-documented communication with the client—including a well-crafted engagement letter—is key, as are close attention to filing deadlines and thorough double-checking of all return information. Here are some common trouble spots that tend to trigger a substantial number of claims.

ESTATE TAX RETURN LATE PENALTIES
The deadline for filing an estate tax return is based on the decedent’s date of death. Because it’s not a regular date (like the April 15 deadline for individual returns), it is sometimes overlooked, resulting in late filings. To make matters worse, because of the large tax amounts reported on estate tax returns, the late filing penalties often exceed $100,000. CPAs ensnared by such claims usually didn’t pay enough attention to their calendaring system for due dates or didn’t have a system at all.

CPAs also incur late payment penalties for estate tax returns by not realizing that:

A payment extension request requires completion of a separate section of IRS form 4768.

The payment extension is not automatic (like the filing extension for individuals); it requires a showing of “reasonable cause.”

The IRS has discretion whether to grant the payment extension because of the “reasonable cause” requirement. Therefore, the extension should be requested well in advance of the estate tax return due date to account for the contingency of an IRS denial.

ENTITY SELECTION ISSUES
Claims arise because the CPA rather than the client chose the “best” legal entity for the client’s new business and did not document the advice provided to the client. Each entity type has advantages and disadvantages. If unforeseen events occur after the business has launched, a selected entity’s disadvantages can be triggered. If they are, a client may complain that a different entity type would have better addressed the situation. The CPA must provide clients full information regarding available entity types and the advantages and disadvantages of each. After receiving that information, clients—not the CPA—must select the entity they feel is the best fit for their new businesses.

PENALTIES FOR FEDERAL FORMS 5471 AND 5472
A $10,000 penalty applies to failure to file a form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, or form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. The penalty most often is triggered when the CPA is not aware of the forms’ filing requirements, which are extremely complex. Your firm should ask the following questions to determine whether a client might be required to file the applicable form. If the answer to either question is “yes,” you should consult the relevant form’s instructions to determine if, in fact, your client must file the form:

Form 5471. Is an individual client an officer or director of a foreign corporation? Or does a client own 10% or more of a foreign corporation’s stock?

Form 5472. Is any corporation client a foreign corporation or owned 25% or more (directly or indirectly, by vote or value) by a foreign individual or entity?

SECTION 754 ELECTIONS
When a partnership has made an IRC section 754 election, an individual partner can obtain an asset basis step-up for his or her share of the partnership assets upon the death of another partner, a sale of the partner’s interest or certain other events. Claims in this area usually arise because the CPA missed a section 754 election opportunity or failed to properly document why the election was or was not made. To avoid missing section 754 elections, each year before preparing a partnership return, the CPA firm should request information on any partner’s death or partnership interest disposition. The information can be requested in the data organizer. Once the CPA has that information, it is easier to identify section 754 election opportunities. The CPA should then provide the client full information regarding a section 754 election and its potential benefits and detriments. The client should then decide whether or not to make the section 754 election.

While a section 754 election is beneficial in most circumstances, it is impossible to predict whether future events might render it detrimental. Therefore, the CPA should send a written confirmation of the client’s decision regarding the election. That confirmation will prevent the client from holding the CPA responsible if future events render the section 754 election detrimental.

By Keith R. Lee , CPA, J.D., staff taxation counsel for CAMICO, a CPA-owned mutual insurance company.