Mitigating risk related to tax reform

By Deborah K. Rood, CPA

For many tax professionals, 2018 got a lot busier when President Donald Trump signed P.L. 115-97, known as the Tax Cuts and Jobs Act (TCJA), on Dec. 22, 2017. As a result, CPAs were inundated with questions such as "Should I prepay my real estate taxes?" How CPAs choose to answer this question and others related to tax reform will vary, and the choices the CPA makes may give rise to professional liability risk. In fact, one CPA in the AICPA Professional Liability Insurance Program (the Program) has already experienced a claim whereby the client asserted the CPA failed to advise her to prepay 2017 real estate taxes, causing a permanent loss of a tax deduction.

While tax planning opportunities associated with the TCJA may be a windfall to a CPA firm's bottom line, vulnerability to professional liability claims exists. When the last significant overhaul of the Internal Revenue Code was enacted in 1986, claims against tax practitioners in the Program increased. Anticipating claims related to the TCJA and identifying how CPAs may mitigate their risk is the focus of this column.

WHAT CLAIMS MAY ARISE

The two primary risks anticipated are:

  • Allegations of failure to advise a client about potential tax savings opportunities presented by the TCJA; and
  • Providing incorrect advice regarding the application of the TCJA to a client's tax situation.

To illustrate these risks, consider the following hypothetical scenario:

A client reports partnership earnings from USF. The CPA includes the income on the client's individual tax return and takes the qualified business income deduction (QBID). She did not ask what type of business USF was.

After the client was audited, the CPA realized that USF was not eligible for the QBID because some or all of its activities were from disqualified specified service business activities. When a significant tax liability was owed, the client asserted that the CPA was responsible for the penalties and interest because she improperly prepared the individual tax returns.

Creating and implementing protocols now is a proactive way to mitigate risk from claims that may arise related to changes in the TCJA.

WAYS TO MITIGATE THE RISK OF A PROFESSIONAL LIABILITY CLAIM

Employ tax compliance engagement letters

Engagement letters for tax preparation services should be limited to compliance services only and identify exactly which tax returns will be prepared. Engagement letters for tax planning services represent a separate engagement, and a separate engagement letter should be obtained. It is not recommended that "limited tax planning" services be included in a compliance engagement letter, as scope of services is not defined. AICPA Tax Section members have access to sample individual and business income tax return engagement letters in the Annual Tax Compliance Kit.

Know the tax reform law

Failure to understand the nuances of the law and its interpretations is at the root of many professional liability claims. Taking the following measures can help reduce this risk:

  • Complete continuing professional education related to the aspects of the TCJA that most affect your client base. The AICPA has consolidated the bulk of its educational efforts within the Tax Reform Resource Center. Additional learning opportunities are available via the AICPA Store.
  • Keep up-to-date with additional guidance as it is released. The Tax Reform Resource Center will have updates to its resources as well as links to official guidance as it is issued.

Inform clients about tax reform

CPAs should, ideally, discuss TCJA implications with every client, but this may be impractical.

Consider sending your clients a newsletter or email with a high-level overview of changes related to the TCJA. Include a note that clients should contact you to discuss the TCJA's impact.

Many CPAs will use the TCJA as a new business development opportunity and may host a seminar, giving clients and prospects an overview of the legislation's key components. Leverage the AICPA sample presentations "Tax Cuts & Jobs Act — Individuals" and "Tax Cuts & Jobs Act — Business Provisions." Again, impose the responsibility on the attendees to contact you to explore TCJA planning opportunities specific to their situation.

Retain newsletter distribution and seminar attendance lists to help in defending a potential future claim of failure to advise about the TCJA.

NEW BUSINESS OPPORTUNITIES

The TCJA will generate new business opportunities for CPA firms. When new services are requested, CPA firms should:

Obtain an engagement letter

When a professional liability claim arises, having an engagement letter that clearly defines the scope of services and deliverables is essential. Unfortunately, approximately 43% of tax claims from the CNA Accountants Professional Liability Claim Database in 2017 involved situations in which practitioners failed to use an engagement letter. Many of these claims were related to tax consulting. Much of what is done related to the TCJA should include a new engagement letter.

A sound tax consulting engagement letter will:

  • Specifically define the scope of services — for example, "research whether certain activities of XYZ Corp. could be segregated to maximize the specified services business deduction."
  • Describe the deliverables. Identify whether a spreadsheet, memo, or oral advice will be provided. Consider including a sample template as an appendix to the engagement letter.
  • Say that the advice will be based upon the Code, regulations, and other applicable guidance as of the date of the advice and that the firm may be reengaged to update the advice.
  • State that the client is responsible for decisions and implementation of any planning strategies. If the client engages the CPA firm to help with implementation, a separate engagement letter should be secured.

A sample tax consulting engagement letter is available from many professional liability insurers, and AICPA Tax Section members have access to it with the Annual Tax Compliance Kit.

Identify the client's options and consequences

The law is not comprehensive, and IRS guidance continues to be released. As a result, there may not be clear answers to many TCJA planning opportunities, and clients may have options available to them. If this is the case:

  • Describe available options;
  • Identify potential consequences of each option;
  • Let the client make an informed decision; and
  • Document the options, consequences, and the client's decision, including the thought process, if known, even for oral advice.

While a client may expect a recommendation, the final decision rests with the client.

THE RISK OF INFORMAL ADVICE

Much of the advice requested may occur through a quick phone call or other informal discussion.

Providing informal advice may be riskier than giving formal advice because thorough research may not be conducted, client-specific facts may not be reviewed, and conversations may not be documented. When a client makes a costly decision based upon incomplete, informal advice, CPAs often become the target of a claim.

To mitigate this risk, after an informal conversation, send an email summarizing the discussion. Ask the client to contact you if recommendations are sought for more formal advice upon which he or she can rely. If you are engaged, document these additional services in a new engagement letter.

Deborah K. Rood, CPA, is a risk control consulting director at CNA. For more information about this article, contact specialtyriskcontrol@cna.com.


Continental Casualty Co., one of the CNA insurance companies, is the underwriter of the AICPA Professional Liability Insurance Program. Aon Insurance Services, the National Program Administrator for the AICPA Professional Liability Program, is available at 800-221-3023 or visit cpai.com.

This article provides information, rather than advice or opinion. It is accurate to the best of the author's knowledge as of the article date. This article should not be viewed as a substitute for recommendations of a retained professional. Such consultation is recommended in applying this material in any particular factual situations.

Examples are for illustrative purposes only and not intended to establish any standards of care, serve as legal advice, or acknowledge any given factual situation is covered under any CNA insurance policy. The relevant insurance policy provides actual terms, coverages, amounts, conditions, and exclusions for an insured. All products and services may not be available in all states and may be subject to change without notice.

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