Blocking and tackling: Engagement letters for tax compliance services

An engagement letter memorializes conversations between a client and CPA firm regarding the services to be provided by the firm and each party’s responsibilities in writing. Simple enough, right? However, in 2024, more than half of the tax claims asserted against CPA firms in the AICPA Professional Liability Insurance Program lacked an engagement letter related to the service underlying the claim.

One may hypothesize that, perhaps, firms obtain engagement letters for tax compliance services but fail to do so when the service is not as routine, such as responding to a notice, assisting a client with a tax audit, or performing year-end tax planning or research. If only that were true. Year after year, tax compliance claims are asserted and, more often than not, there is no applicable engagement letter.

Why the frustratingly dismal results when the benefits of engagement letters are well understood? Consider these recent experiences of CPAs in the AICPA Professional Liability Insurance Program who faced client disputes:

• The CPA indicated they obtained an engagement letter for every tax return … but for this particular dispute, it was nowhere to be found.
• The CPA used the “engagement letter” produced by their tax software … but it was not helpful, as it did not specifically define a scope of service, detail the CPA’s and client’s responsibilities, identify deliverables, include any risk allocation provisions, or even mention fees.
• The CPA produced an engagement letter from the initial year of providing services 15 years prior … but the scope of service, and even the client’s legal name, had changed since that time.

BENEFITS OF ENGAGEMENT LETTERS BEYOND CLAIM DEFENSE

Engagement letters can do more than just help defend a claim or resolve a dispute. They can provide business benefits to the firm, such as helping to:

• Limit the scope of services to enable greater opportunity to identify, and bill for, additional services.
• Clearly communicate client responsibilities, especially those around deadlines and provision of client information to help keep clients on track.
• Explain billing and payment terms, including the consequences of late payment, to facilitate accounts receivable management.
• Lay the foundation for efficient resolution of client disputes to help prevent disputes from turning into a professional liability claim.

RECOMMENDATIONS FOR INCREASING ENGAGEMENT LETTER USE FOR COMPLIANCE SERVICES

Obtaining engagement letters for tax compliance services should be relatively straightforward. It is a routine service, and, generally speaking, the deadlines and deliverables are consistent from client to client and year to year. Start with this low-hanging fruit and consider these practical suggestions to help consistently implement annual engagement letters for compliance services at your firm.

Leverage sample templates

No need to start from scratch. Use samples provided by the AICPA, professional liability insurers, and others. Consider all available resources and create engagement letter templates for each specific service that fit your firm’s risk tolerance and clientele. If you have a large 1040 practice with lower-risk clients, consider unilateral engagement letters that require only the signature of the CPA firm. Be sure to have an attorney familiar with professional liability matters in your jurisdiction review your templates.

Employ technology to help reduce administrative time

A big concern of many CPAs is the time it takes to administer the engagement letter process, but enabling the process with technology can create real efficiencies in the following areas:

• Engagement letter deployment — Once templates are developed, many practice management software tools and stand–alone packages can automate the creation, delivery, and tracking of engagement letters. Need a recommendation? Talk to your peers about what tech they employ.
• Electronic signature — Firms can speed up the process of obtaining signed engagement letters when they use an electronic signature tool to obtain the client’s signature.
• Automated reminders — Many tech tools automatically remind clients to sign the engagement letter, reducing follow–up time for both professional and administrative staff.
• Dashboard monitoring — Once again, tech may provide a dashboard of which clients have, and more importantly, which have not signed their engagement letter. As deadlines approach, this can help prioritize which client receives a phone call and from whom.

Require engagement letters for all compliance services

Without firm leadership requiring engagement letters, “exceptions” will still be made. Consider these strategies to help support the implementation of a mandatory engagement letter use policy:

• Client portals — Consider using a portal that requires the client to submit a signed engagement letter before they are allowed to access tax documents.
• Empower the assembly team — If a tax return cannot be assembled/finalized for filing until an engagement letter is received, an engagement letter should be obtained for every tax return. Good news — if technology is properly implemented, this may be unnecessary!
• Monitor compliance — As with any policy, monitoring mechanisms should be employed to assess whether firm members are adhering to the engagement letter policy. Depending on your firm’s size, consider random spot checks or a more formalized review.

Educate clients

Some CPAs may not use engagement letters because they are afraid clients may view them as a “CYA,” meant solely to benefit the CPA firm. Educate clients about how engagement letters help them understand what to expect from you and, thus, keep you accountable for the promised services. Including a sentence or two on the benefits in your client on-boarding process may efficiently accomplish this.

Training

Firm members may balk at using engagement letters if they do not understand their importance. Consider training for all employees, adjusting the message for the audience, explaining what specific provisions mean and how they benefit the firm. When partners and employees understand the firm’s engagement letters, they can confidently discuss a client’s questions about them.

Identify where engagement letters are not used

Sometimes, the CPA firm has at least one partner who “does their own thing” with their clients. Try the carrot-and-stick approach. In addition to monitoring for compliance with policy, consider incentivizing engagement letter use by linking compensation to a usage metric.

LEARN FROM OTHERS’ MISTAKES

Not convinced that engagement letters are useful even if you were to implement them on tax compliance engagements? Consider this:

A longtime client’s tax return was being finalized near the extended deadline as the client had numerous complex tax positions that required additional research and time. Due to the looming deadline and the firm’s comfort level with the longtime client, it bypassed its policy requiring a signed engagement letter before assembly of the final return. The firm was just happy to get it filed.

The return was later selected for audit, and the IRS examiner questioned several positions on the tax return, signaling that the audit was not going to be resolved quickly. Coincidentally, the client was in the process of being purchased. The IRS examination and delay gave the potential buyer cold feet and, in the client’s mind, caused the buyer to walk away from the deal.

While the audit ultimately resulted in no change, the client sued the CPA firm for the lost proceeds of the sale, asserting that the deal fell through because the positions taken on the return by the CPA raised audit flags. Without a signed engagement letter for the tax year in question, the firm could not lean on contractual provisions regarding arguable tax positions and client responsibilities to explain why the firm was not responsible for the IRS audit selection. Additionally, the firm could not leverage the limitation of damages clause to help defend against damages that were not directly related to the asserted error made by the firm. Extensive litigation with the now-former client ensued.

LOOK BEYOND COMPLIANCE

While engagement letter usage for tax compliance services has significant room for improvement, engagement letter usage for other tax services has even more! Do not stop with tax compliance. After improving engagement letter use in this area, look at the other tax services and strategize how to keep the engagement letter train going.

56%

The percentage of tax claims asserted in 2024 against CPA firms in the AICPA Professional Liability Insurance Program that lacked an engagement letter related to the underlying service.

Source: CNA Accountants Professional Liability Claim Database, underwritten by Continental Casualty Co. Copyright © 2025. All rights reserved.

Deborah K. Rood, CPA, MST, 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.