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Preventing Liability Claims

Don’t let sound risk management practices slide during the rush of tax season. Follow these tips, including tax engagement documentation, to safeguard your practice from liability claims.

By Chris Piety, Esq.
Good risk management practices are often forgotten in the rush and stress of tax season. In the midst of the pressure, though, you may save yourself a lot of time and trouble by remembering a couple of facts: tax claims against CPAs occur with greater frequency than any other type of claim (Figure 1) and your documentation practices will determine the effectiveness of your legal defense in the event of a claim.

Think of the documents in your engagement files as evidence being presented to a jury. Plaintiffs attorneys like to request “correspondence files,” so it’s wise to think about your files in terms of how a legal defense would be affected by them. These would include e-mails and electronic and hard copies of work papers, review notes and different versions of a tax return.

E-Mail
E-mail is a major double-edged sword in the claims arena. While e-mail can serve as an excellent documentation tool, as it usually includes dates, times, recipients and senders—and sometimes a chain of previous correspondence on the subject—it is prone to informal, unprofessional or inappropriate messages. A personal comment about someone can damage a sender’s credibility and harm a legal defense. And since e-mail can continue to exist on both the sender’s and recipient’s hard drives, servers and back-up systems, the potential recipients and problems can multiply.

Etiquette and standards are essential to the value of e-mail and other forms of documentation. Some rules to follow include:

Document only facts, avoid speculation and refrain from comments on personalities or performance issues. Remember that nothing is “off the record.”
Only maintain the final version of a tax return or other work product.
Document contemporaneously. If you keep documentation notepads by every telephone, the process becomes a reflex action when the phone rings. Include the dates and times on telephone notes. Phone company records can corroborate these if they are disputed in a claim.
Always document significant communications and follow up. Every client contact that is important can be used for or against a CPA, so it’s essential that all contacts are documented in a detailed manner. Follow-up communications are especially important when there is a change in the scope of an engagement; negative knowledge (e.g., the tax return is already late); a material action to be taken by the client; and a judgment call (e.g., the client has been informed of and has consented to a tax position).

New Engagement Letters
Draft additional engagement letters when necessary. When in fast-moving transactions, some CPAs draft new engagement letters based upon two criteria:

Additional services in the existing engagement’s subject matter exceed a pre-determined fee (e.g., the original engagement included the tax ramifications of a sale, but the client now wants an analysis of a business merger); or
Services cross into a different area (e.g., the original engagement included the tax ramifications of a sale, but the client also wants business valuation services).

Where a CPA has carefully defined an expanding job with a series of engagement letters, the client will have much more difficulty trying to hold the CPA responsible for matters not encompassed by the engagement letters. If it is not possible or practical to issue a new engagement letter, a confirming e-mail or letter to the client documenting the new situation will help.

Memorandums
Memorandums are effective in following up on significant client discussions or meetings. To ensure that both you and the client are proceeding with the same expectations and assumptions, memorandums should include:

A general description of the various subjects discussed;
Any additional services that you agreed to perform;
When there is more than one professional involved, such as a lawyer or a valuation specialist, your understanding of which professional assumed primary responsibility for advising the client with respect to the transaction, and/or which professional assumed responsibility for the final services to be rendered;
The services your firm will not be performing. This can be most important because it highlights the areas where the client may want to consider engaging
other professionals;
If you do not feel your firm possesses the technical or subject matter expertise to properly address a matter discussed, a clear statement that: 1) you do not feel you can adequately address the subject matter for the client, and 2) the client should engage another professional if the client wants further information on the given topic;
Any items that you feel require more clarity or feedback from the client. For example, if your understanding is that your role is to provide general comments on a potential transaction’s taxation, and the client then asks whether you feel that the client is getting a “fair deal” in the transaction, the memorandum should address that comment;
A list of additional items that might not have been discussed, but would be the logical progression for the items that were discussed. Indicate that the list is not all-encompassing and that the client should consult other professionals and seek additional information sources to ensure that all potential issues are addressed before implementing the contemplated transaction;
A statement that the discussion was only general or superficial, and a request for the client to contact you if he or she desires more detailed information or is contemplating engaging in an actual transaction.

Jury Expectations
As a general rule, any advice or practice area that can result in adverse tax or financial consequences is at high risk and deserves detailed documentation. While there is always debate about whether certain documents will come back to haunt CPAs in a claim, good documentation almost always improves the CPA’s legal defense.

Studies have shown that jurors generally consider CPAs to be experts in documentation, and falling short of that expectation may be viewed as negligence.

Record Retention
Claims, lawsuits and trials can occur years after the events in question, and memories of those events will fade over time. A disappointed client’s memory of critical events may begin to differ significantly from the CPA’s memory of the same events, so it’s a good practice to retain documents for a minimum of five to seven years, unless a longer time period is required by law. Also, consider communicating your record-retention policy in writing to clients as part of the engagement letter.

And when in doubt, consult your risk adviser or legal counsel.
Christopher Piety, Esq. is vice president of claims for CAMICO Mutual Insurance Company.