Client breakups can create malpractice risk

Consider this:

A CPA prepared joint income tax returns for a married couple. After informing the CPA of the couple’s pending divorce, Spouse A engaged the CPA to perform tax consulting services related to a privately held business interest. Spouse A used the CPA’s advice to make certain binding tax elections regarding the business that negatively affected the value of the interest. Spouse B sued the CPA, alleging that the CPA conspired with Spouse A to minimize the business’s value, thus minimizing Spouse B’s divorce settlement. Litigation was protracted and expensive as Spouse B was unwilling to compromise, taking their anger and animosity out on the CPA.

As this claim scenario illustrates, it’s easy to get caught in the middle of feuding parties. Once notified of an impending breakup, whether a personal divorce or a business split, a CPA should act quickly to mitigate professional liability risk.

WHAT ARE THE RISKS?

Conflicts of interest are often asserted in divorce claims. One side typically asserts that the CPA made a decision or took an action to benefit the other side. While an actual or potential conflict of interest, in and of itself, does not result in a professional liability claim, the appearance of a threat to the CPA’s objectivity can weaken their defense against such claims.

When dealing with disputing parties, CPAs may also be accused of violating Internal Revenue Code Sec. 7216 or the “Confidential Client Information Rule” (ET §1.700.001) of the AICPA Code of Professional Conduct.

Finally, getting stuck in the middle of someone else’s dispute (and drama) can result in increased costs, time, headache, and stress — none of which are welcomed by the CPA.

PROACTIVE RISK MANAGEMENT STEPS

CPAs typically assume that a client’s basic facts remain the same year after year, unless informed otherwise. However, facts can change, leaving a CPA to scramble to address a client’s changing dynamics.

Therefore, consider including an engagement letter provision that puts the onus on the client to inform the CPA of any changes in facts, including marital status and business ownership, on a timely basis. Similarly, include a provision stating that if informed of a pending dispute, the parties acknowledge that the CPA may have a conflict of interest and may be unable to provide some or all of the agreed-upon services.

WHAT TO DO AFTER A DISPUTE IS ANNOUNCED

Breaking up can be hard to do, especially when the parties are emotional and feel they have been wronged. No matter how amicably a breakup starts, divorcing parties are inherently at odds, and the CPA can end up in the fray. Understanding how to manage risk can help lead to a successful outcome.

Communicate the new rules of engagement

A key first step when working with disputing clients is to articulate the engagement’s ground rules, which may differ from those previously followed. The ground rules should address:

Your limited role as tax preparer only:

Explain that you will not be able to provide tax advice to either side until the divorce is finalized or the dispute is resolved. Doing so would be a conflict of interest because advice may benefit one spouse to the detriment of the other, either at present or in the future. Recommend the parties each obtain individual representation to advise them. Your role is no longer that of an adviser but a neutral tax preparer. Be Switzerland.

The clients’ responsibility for making decisions:

Explain that while you may provide options for the clients’ consideration, they must mutually agree to and make all decisions regarding their tax returns. Explain that you will require all sides to provide written confirmation of their decisions, including, but not limited to, filing status, which you will then follow when preparing the tax return. Preferably, instructions will come from the clients’ attorneys. Retain documentation of client communications and decisions made in the workpapers.

Joint communications:

Explain that all communications will now be directed to all parties, which may differ from the past if you dealt largely with one spouse or owner.

Confidentiality and document requests:

In a married filing joint return, neither spouse should have an expectation of privacy regarding tax information used to prepare the return for current or previously filed joint years. For example, each spouse has the right to see the other party’s Form W-2, Wage and Tax Statement, or Forms 1099. However, if a spouse has a business interest, the other spouse would have the right to see the Schedule K-1 but not the underlying business return. Additionally, either spouse may request copies of prior joint tax returns and supporting information. If faced with this request, send copies to both spouses to avoid the appearance of favoritism. Avoid sending information to third parties, including counsel, and provide information directly to the taxpayers, who may then forward it to their counsel. If you receive a subpoena, consult your professional liability carrier, who may have resources to help you respond.

Obtain a new engagement letter

After you explain the rules of engagement, the parties should confirm that they will be able to abide by these protocols. Assuming they do, obtain a new engagement letter signed by all sides before performing services. A retainer is also beneficial.

Obtain a conflict-of-interest waiver

Treasury Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10), Section 10.29(b)(3), requires that the CPA obtain a conflict-of-interest waiver within 30 days of informed consent, confirmed in writing, and maintain it for at least 36 months. In a conflict-of-interest waiver, the parties acknowledge that there is a significant risk that representation of one spouse may be materially limited by the representation of the other and that all parties waive the right to independent representation.

Carefully monitor and manage deadlines and fees

Preparing a tax return for disputing clients will likely take more time than usual. Anticipate this by setting deadlines with a sufficient amount of cushion for clients to provide documentation and make decisions. Plan for follow-up questions and additional time. Help your clients understand that this additional time and effort will also result in increased fees. Inform clients that if you do not receive necessary information and instruction from all parties with sufficient time to prepare returns prior to the filing deadline, an extension may be necessary, or if no extension is available, the client will be responsible for any late-filing and latepayment penalties.

FEELING STUCK IN THE MIDDLE?

When faced with a divorcing client who doesn’t want to play by the rules and consistently puts you in a difficult and awkward position, it may be best to step away from all parties until things settle down and their breakup is finalized. If you determine this is the best option, inform both parties of your decision and send a written termination letter.

CPAs are subject to myriad professional obligations. The most basic is “being the adult in the room.” Remaining neutral and acting professionally is key to your success and a healthy relationship with all parties.

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

Continental Casualty Company, 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.

Seasonal spikes

March and August

The months when divorce filings consistently peak.

Source: “Is Divorce Seasonal? UW Study Shows Biannual Spike in Divorce Filings,” UW News, Aug. 21, 2016.