While engagement letters are required for attest services, they are not required for certain other accounting services. However, best practices would dictate using them, especially when providing tax services. When investigating a complaint against a CPA, the first question most Board of Accountancy investigators ask the respondent is, “What does your engagement letter say?”

The most common source of malpractice claims against CPA firms are tax issues, as much as 72 percent in 2016 (according to CNA Financial Corporation). Reasons for those claims often arise from misunderstandings between the CPA and client. Among those reasons are:

  • Improper advice
  • Filing errors, including math and clerical error
  • Conflict claims in divorces or business separation
  • Foreign asset disclosure forms (FinCEN Form 114)
  • Lack of disclosure when there is a questionable basis for a deduction

Though the engagement letter itself may vary with the specifics of the engagement and should be tailored to the client’s specific needs, there are common provisions in most letters, including the following:

  • Identify the client. It seems obvious, but since your work often affects the interests of third parties, narrowly identifying the client not only reduces the lawsuits from potentially aggrieved parties but also makes your life easier if a dispute arises later and multiple business owners begin giving you conflicting instructions. Or as another example, when a couple who has been long-term clients asks you to prepare their returns related to a divorce. While easier said than done, pick one side or the other and avoid the conflict altogether.
  • Identify the type of return(s) being prepared. Do not combine multiple returns, e.g., an S-corporation return and the individual’s returns, especially if not all the shareholders are clients.
  • Identify the periods. Include a disclaimer that the engagement pertains only to the specific tax year(s).
  • Identify the scope of the engagement. The letter should indicate what services are to be rendered and what will not be provided. It should indicate that the prepared returns will rely on information provided by the client and that the CPA will not audit or verify this information, and therefore, the engagement cannot be relied on to disclose errors, fraud, etc. It also should outline what’s expected of the client, such as providing the information on a timely basis, cooperating with the CPA, and reviewing the return prior to filing.
  • Delineate payment terms. This can help avoid fee disputes before the work begins. You should detail how and when the client will be billed. Describe the retainer (if any), when payment will become due, and billing rates for services outside the scope of the engagement. Disclose interest on late payments or when it may become necessary to suspend work or cancel the engagement for fees not paid.
  • Client signature.  Again, this seems obvious. However, when investigating complaints, investigators often see instances where the respondent has failed to retain the signed copy of the letter. Consider requiring the client to affirm the accuracy of records provided to the CPA and advising the client of potential IRS penalties that could be imposed if the deductions cannot be substantiated.

Another thing to consider is sending out the engagement letter with the tax organizer. A properly completed organizer can often defuse a client’s complaint when it is pointed out (tactfully, of course) that the CPA has relied on the information provided by the client.

Many, if not most, lawsuits and disciplinary complaints filed with boards of accountancy involving CPAs are the result of a communication breakdown between the CPA and the client. The use of an engagement letter can go a long way to reduce the “expectation gap.” To that end, one should avoid guaranteeing outcome or results. After all, it’s a contract, not a marketing tool!

Other items you may want to consider are, alternative dispute resolution (ADR), extensions, underestimated tax liability, taxing authority examinations, tax planning advice, subpoena or summons, records retention, etc.

Article by Patrick Thorne, Board Investigator (Nevada State Board of Accountancy)