Professional liability risks related to Form 1065, CPA firm acquisitions

Sponsored by TaxConnex

Sarah Ference, CPA, an author of the JofA’s Professional Liability Spotlight column, returns to the JofA podcast to discuss recent column topics and the advice CPAs can gain from them. In particular, Ference details some of the risks for CPA firms engaging in mergers and acquisitions, the subject of a recent two-part series.

The articles discussed in this episode are:

• June: “Form 1065: Pay Attention or Pay Up.”
• July: “Professional Liability Risk Stemming From CPA Firm Acquisitions: Part 1.”
• August: “Professional Liability Risk Stemming From CPA Firm Acquisitions: Part 2.”
• September: “Start Risk Management With Employee Onboarding.”

What you’ll learn from this episode:

• Why CPA firms should pay close attention to recent changes in tax compliance for partnerships.
• A summary of the two-part article on professional liability risk related to CPA firm acquisitions.
• The importance of cultural alignment in firm acquisitions.
• What “tail coverage” is and why it’s essential for post-transaction protection.
• How a strong onboarding process can serve to mitigate some risks for firms — and why that topic is timely this month.

Play the episode below or read the edited transcript:

— To comment on this episode or to suggest an idea for another episode, contact Neil Amato at Neil.Amato@aicpa-cima.com.

Transcript

Neil Amato: Hello. This episode of the Journal of Accountancy podcast focuses on recent Professional Liability Spotlight columns. You’ll hear that conversation with a CPA after a brief sponsor message.

[Sponsor message]

Amato: Welcome back, Journal of Accountancy podcast listeners. This is Neil Amato, the host of the show, and I’m recording today with Sarah Ference. Sarah is a CPA who serves as a risk control director at CNA, which is the underwriter of the Professional Liability Insurance Program with the AICPA. Sarah is also an author of the JofA’s Professional Liability Spotlight column, and we’re going to discuss some of those column topics today as part of a recurring series. Sarah, welcome back to the podcast. We’re glad to have you on.

Sarah Ference: Oh, great to be back. Thanks, Neil.

Amato: Yes, let’s first review the June Professional Liability Spotlight. I personally love a good, straight-to-the-point headline. This article has that. The headline is “Form 1065: Pay Attention or Pay Up.” First, especially for those non-CPAs like me, what is Form 1065 and what are some of its risks for firms?

Ference: Well, I typically love a catchy headline with a play on words or some other sort of whimsy, but I really like the straightforwardness of this headline, too. Form 1065 is the income tax return for partnerships, and the article identifies and describes a variety of recent or recent-ish changes that involve tax compliance for partnerships that, when you look at these changes individually, they may seem minor, but taken as a whole could lead to a greater likelihood of an error on those returns. Then when errors on tax returns are made, claims are likely to follow.

I’m not going to go into the detail of the changes described in the article. Remember, I was an auditor, not a tax practitioner by background, so I probably wouldn’t do them technically a lot of justice. But in general, some of the changes that we noted involve partnership forms that provide more information to the IRS, and this makes it easier for the IRS to mine that information to identify instances of noncompliance more efficiently, in the passage of the Bipartisan Budget Act of 2015 and how changes to previous filed tax returns are made.

Then there’s other tactical and technical changes that just, again, taken as a whole, provide a greater likelihood that there’s going to be an error on a partnership return and, therefore, a claim made against the CPA.

Amato: One subhead in that article says, “Get Ahead of the Risk.” What are some of the suggestions for CPAs and CPA firms who do want to get ahead of that risk?

Ference: Well, one of the things to remember about CPA firm claims is that a claim might not arise for several years until after the service is delivered. While there may be a big question mark that hangs over enforcement and examination rates at the IRS right now, that question mark might not always be the case. Clients or their CPAs shouldn’t have a false sense of security and be tempted to play audit roulette. And so really the risk of errors on a partnership return is now, it’s present now, which makes now the time to get things right to help avoid a problem in the future.

Some of the things that CPAs can do, again, these and others are detailed in the article, is to make sure you have a copy of and understand the executed partnership agreement, even if a previous preparer has already looked at it.

Don’t underestimate the technical competency needed to prepare partnership returns. This is not an area in which to dabble. Then finally, be mindful of the risk of a conflict of interest or really the perception of one. Chances are you deal with one partner primarily. Perhaps you do their individual return or other services as well. But in business partner squabbles, the CPA often gets put in the middle, and allegations of favoritism towards one of the partners or a couple of partners, not everybody, just complicate matters.

Amato: Thank you for that June article summary. July was Part 1 of a two-part series on professional liability risk stemming from CPA firm acquisitions. Clearly, in news we’ve covered in the JofA, there are mergers and acquisitions happening regularly among firms, so this is a timely topic. Tell me more about the focus of that Part 1 article by CPA Deborah Rood.

Ference: Yeah, the acquisition market certainly is busy right now, whether it’s a firm looking to grow or enter into a niche market, or maybe they have some extra cash on hand from a PE transaction or other investment. But regardless of what it is, the reason for an acquisition, we do see claims arise when CPA firms make those, and so we thought now is a good time to revisit this topic for Professional Liability Spotlight readers.

There are risk management practices that firms can employ throughout all phases of a transaction, whether it’s identifying the target to performing due diligence, to negotiating the contract, and finally integrating the acquired entity. Part 1, that’s in the July issue, focuses on those pre-transaction activities, namely due diligence. Because sometimes in the haste to do a deal, sometimes the due diligence isn’t deep enough and risks of a transaction aren’t identified.

The article discusses several key areas of due diligence, suggests evaluation steps, and really articulates why each of those areas is important to help manage a firm’s future risk. But of all the areas, however, that we identify in the article, alignment of cultures I think is probably the most important. If you don’t have this, it’s really hard to maximize the value of the transaction. When firm cultures, including how each the acquiree and the acquirer view quality and quality control and when those things don’t align, the likelihood of a future claim is just greater.

Amato: Great, thank you for that. August is Part 2 of that topic. The Part 2 focus is on negotiating the purchase agreement, post-acquisition integration, and how risk can arise during those phases. That feels like an entire podcast episode on its own, even just on negotiation. But what from a professional liability standpoint would you like to highlight about that part of a transaction?

Ference: Someone once told me that the rules of war are drawn up during peacetime, and I think you can apply that to a variety of things, whether that be engagement letters or whether it’s an acquisition agreement. It’s really just identifying certain risks and certain areas that you can agree upon during this before you have a future problem or future dispute.

Things like addressing how work-in-process is going to be completed. Chances are the transaction is not going to happen when all engagements are complete and before new engagements start, especially depending on when the time of year that the transaction is completed. Be sure to address who’s going to finish up the in-process work.

Another thing to make sure you address is the acquired firm’s responsibility to secure tail coverage. That is colloquially called tail coverage, but it’s really extended claims reporting period coverage, which allows a firm to report claims for a longer period after an active policy has lapsed. You want to make sure you have coverage in place at the time a claim is made. Because like I said, claims can arise several years after a service is delivered. As an acquired firm, you want to make sure you buy the tail to extend that period that you have to report claims related to pre-transaction services.

Amato: Great. On all of these articles mentioned, we will include a link to them in the show notes for this episode. After that transaction, the integration of firms or entities is a big deal, of course, from a culture standpoint, a leadership standpoint. What about specifically the integration of firms from the lens of professional liability risk?

Ference: Integration, I think, and I’ve talked to firms that have done a lot of acquisitions, integration is probably where they spend the most amount of their time. And firms that are successful at acquisitions do make sure that they’re spending the time to truly integrate the firms. Because we see problems when, let’s say a firm acquires another firm that’s in a different geographic area and doesn’t take steps to really integrate those teams, whether it’s putting someone in the new physical location or having combined teams of professionals from one firm and the other firm working together.

Because when you tend to still operate as two firms with maybe two sets of processes, two ways of doing things, then errors can arise. Again, when we see errors, there’s risk there. Taking time to truly integrate the firms, the quality, the cultures, the people and really bring together that one firm mindset that helps support a culture of consistency and a culture of quality.

Amato: Then to close out this episode, the September article headline is “Start Risk Management With Employee Onboarding.” Again, we’ll include that article link in the show notes. But, Sarah, to end this episode, will you hit on some of the highlights of that one for the listeners?

Ference: Yeah. September is often a time when new employees start with firms. When I started with my firm, way back when I actually started, it was Sept. 2. But we thought that was a good timely topic because as firms are bringing on their new sets of hires, they’re going probably through their independence training, their conflicts-of-interest training. There are other kinds of technical trainings.

Another thing to consider and include as part of a new employee’s onboarding is risk management training and helping new employees to develop that risk management mindset from Day 1 of their time with the firm, which then can grow and develop over time and supports that culture of risk management.

Amato: That is great. Sarah, anything you’d like to add in closing?

Ference: No, I really appreciate the opportunity to talk with you again today and really share some of the things that we’ve been writing about and promote what we do.

Amato: Sarah Ference, thank you very much.

Ference: Thank you, Neil.

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 podcast episode provides information, rather than advice or opinion. It is accurate to the best of the speaker’s knowledge as of the publication date. This podcast episode 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.