Changes at the firm? What to do with working papers

It wasn’t until after he retired that Richie Retiree, CPA, received an ominous call. A former client had undergone an IRS audit, and the auditor disagreed with positions taken on the return, assessing additional tax, penalties, and interest. The former client was livid and blamed Richie for the alleged errors on the return. Knowing that a professional liability claim was likely imminent, Richie contacted the firm that purchased his practice to obtain his records, which were transferred to the purchaser to help provide continuity of service to Richie’s clients. However, the purchaser no longer had the records for the client in question, as that particular client had opted to retain a different CPA after Richie retired. As Richie suspected, the former client sued Richie for negligence. Without supporting working papers, Richie had a difficult time defending the claim and ultimately settled.

CPA firm ownership changes can be a whirlwind of decisions and emotions. As the practice changes hands, don’t neglect a very important but easy-to-overlook piece: the working papers that form the foundation for the practice. In the event of a malpractice claim or a regulatory inquiry, you may need to produce working papers to support your defense. If you don’t have them, you could end up in the same unfortunate situation as Richie Retiree.

TRANSITIONING CLIENTS — AND THE WORKING PAPERS, TOO?

When a CPA firm sells or transitions all or part of its client list, the question of what happens to the existing working paper files is often raised. It is also raised, for example, when:

• One or more firm owners leave the firm to join another firm or start a new firm and they wish to take clients they served with them; or
• A firm sells its practice to another firm and the sellers work at or with the acquiring firm to assist with the transition but do not obtain any ownership interest in the acquiring firm.

Before addressing what happens to the original working papers when the seller (hereafter, the “predecessor”) closes shop or transfers some or all of the practice to another firm (hereafter, the “successor”), two points from the AICPA Code of Professional Conduct (the Code) should be kept in mind:

• The working papers are the member firm’s property, albeit subject to state or federal laws or regulations or contractual agreement; and
• The predecessor is responsible for maintaining the confidentiality of client information in its working papers.

RISK MANAGEMENT RECOMMENDATIONS

The recommended risk management practice is for the predecessor firm to retain possession of the original working papers in accordance with its record retention policy.

If clients will be transferred or transitioned to a new firm, copies of the working papers may be provided to the successor firm upon receipt of written consent from the client in the appropriate format, as well as a signed acknowledgment letter from the successor firm contractually restricting its use of the predecessor’s working papers. While this may sound simple enough, there are many considerations.

Obtaining client consent

For many clients, consent to transfer a firm’s working papers from the predecessor to the successor may follow the guidance outlined in ET Section 1.400.205, Transfer of Files and Return of Client Records in Sale, Transfer, Discontinuance or Acquisition of a Practice, of the Code. Paragraph .01 of this section requires the CPA to request consent to transfer the client file from each client that is subject to sale or transfer and to notify the client that consent may be presumed after 90 days if the client doesn’t respond, unless prohibited by law or the rules and regulations of the applicable state boards of accountancy. From a risk management perspective, obtaining a client’s explicit, written consent is preferred.

If tax return information will be transferred, the client’s consent must conform to Internal Revenue Code Sec. 7216 and related regulations. For Form 1040 tax clients, the consent must also comply with Rev. Procs. 2013-14 and 2013-19. CPAs may consider using AICPA sample letters for this purpose. Federal law requires that tax preparers obtain written consent from each taxpayer before any disclosure or use of federal income tax return information, including copies of the tax returns, with limited exceptions. Under Sec. 7216, there is no presumption of consent after 90 days for tax clients. Persons who knowingly or recklessly violate Sec. 7216 may be found guilty of a criminal misdemeanor, which carries penalties of a fine up to $1,000, imprisonment up to one year, or both.

Depending on the nature of the information, other federal and state laws, such as the Health Insurance Portability and Accountability Act of 1996 (HIPAA), may also need to be considered. Consultation with legal counsel is recommended.

Successor acknowledgement and agreement

In the event all or part of the predecessor’s practice or client list is being transitioned or sold, the separation or sale agreement should include any file transfer and/or retention arrangements and address responsibility for obtaining client consent, effectuating the transfer, and paying related costs. Copying of any working papers should always be done under the control and supervision of the predecessor firm.

After obtaining client consent or the lapse of 90 days for nontax clients, copies of working papers may be provided to the successor. Before doing so, it is recommended that the predecessor require the successor to acknowledge the limited purpose for which copies are being provided. For an example, see Exhibit C of AU-C Section 510, Opening Balances, of the AICPA Clarified Statements on Auditing Standards. While this example pertains to audit engagements, it can be modified for other services.

While not recommended, in the rare circumstance that the successor firm takes possession of any of the predecessor’s original working papers, the predecessor firm should address the following in the separation or sale agreement after consulting with an attorney:

• The predecessor remains the owner of working papers generated by the predecessor;
• The successor will maintain custody of the working papers solely for the purpose of providing continuing service to the client;
• The successor will maintain the working papers in accordance with applicable confidentiality requirements;
• The successor will maintain the working paper files in the state and format as provided by the predecessor;
• Any documentation prepared by the successor will be maintained separately from the predecessor’s working papers;
• The successor firm will maintain and dispose of the working papers in accordance with the predecessor’s record retention policy;
• The successor firm will notify the predecessor firm if access to the predecessor’s working papers is requested, whether by subpoena or otherwise;
• The successor will give the predecessor firm unrestricted access to the working papers and return original files upon request;
• If any portion of the predecessor firm’s working papers is compromised, whether by loss, damage, or breach of privacy, the successor firm will promptly notify the predecessor; and
• Next steps if the successor ceases to practice, merges, or sells its practice should also be addressed.

It is also recommended that the predecessor maintain copies of all communications from the successor firm regarding the working papers, including a detailed list of the working papers released to the successor.

OTHER CONSIDERATIONS

The considerations in this article do not apply only to sale agreements, but also any time a client transitions from one firm to another. Regardless of why the client is served by a successor firm, addressing questions on a timely basis regarding working papers is an important risk management activity for the predecessor firm.

Planning for the day when access to original working papers is necessary for a predecessor firm in the event of a professional or regulatory inquiry or a malpractice claim could create a smoother process for all parties involved.

10: Increase (in percentage points) in M&A optimism, according to Boston Consulting Group’s M&A Sentiment Index, from 81 in August 2024 to 91 in January 2025.

Source: M&A Outlook 2025: Expectations Are High, Boston Consulting Group, Jan. 15, 2025.

Kevin Hayes, CPA, is a risk control consultant 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.