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California CPA Magazine

Fast Tax Facts

CAMICO has been developing risk management solutions for CPAs for more than 37 years, and we recognize and understand the challenges facing CPA firms navigating each tax season’s nuances. For example, the pandemic years’ economic and tax relief programs had complex, wide-ranging impacts on CPAs, tax practitioners and their clients.

Although most agree that the current tax season has signs of returning to normalcy after the pandemic-induced chaos of recent years, CPA firms continue to face unique challenges and risks they should not ignore. For example, in addition to trying to keep up with the increasing complexities of evolving tax law and regulations (e.g., state pass-through entity taxes, K-2s/K-3s), and ongoing challenges working with the IRS and other taxing authorities, many firms are experiencing significant capacity challenges as they struggle to find and retain qualified talent to support and meet their clients’ service needs.

It can be difficult to stay current on risk management and loss prevention practices when dealing with these significant challenges. With more than 60 percent of CAMICO’s claims originating from tax-related matters, addressing and managing the risk stress points associated with problematic clients can significantly improve a firm’s risk profile.

Now, more than ever, CPA firms need to be proactive. To mitigate these risks, firms need to prioritize performing the “right services” for the “right clients.”

Considering the following questions may help you identify client scenarios that may pose higher risk to your firm.

Proactively evaluate your client list. From a timing perspective, there is no better time than now to review your client list. Do so before the final phase of tax season to decide whether clients remain a good fit for your firm. Disengaging from clients that do not meet that threshold—ideally after they have paid their bills—will better position you going forward.

CAMICO’s experience indicates the following are red flags of potential problem clients which, if not managed appropriately, will present elevated risks to firms:

Pay particular attention to difficult or manipulative clients who are slow in accommodating your requests, do not return your calls or are otherwise non-responsive. When a client seems unwilling to provide you with the information needed to complete an engagement, assess the underlying cause—is the problem merely sloppy recordkeeping, or is the client deliberately delaying or withholding information?

Be cautious in situations where it appears that documents are deliberately withheld, or you are urged by a client to proceed without appropriate or sufficient documentation.

Abrupt changes in a client’s behavior may be indicative of a failing business, financial problems or other personal problems. Trying to uncover the source of the problem could be beneficial, but whatever you do, don’t ignore the warning signs of a deteriorating relationship. And always be on the lookout for potential conflicts of interest.

It is extremely important to examine potential or actual conflicts of interest from each party’s point of view, considering the client’s perspective as well as those of other owners, investors, partners, beneficiaries, spouses, etc.

Conflicts of interest have long been a major factor in professional liability claims against CPAs. Part of the problem is that if CPAs are not proactive and sensitive to their existence, potential conflicts of interest are not perceived before the incidents that trigger these claims. If potential conflicts are identified, you must assess whether you can objectively represent the parties involved and if you determine you can, assess whether there are reasonable safeguards to eliminate or reduce the threat to an acceptable level. If unsure, contact CAMICO. We will work with you to address your potential conflict of interest dilemmas.

Is the engagement a good fit for the firm’s expertise?

In CAMICO’s experience, firms who dabble have a much higher risk of having a claim. Learning the art of saying “no” to clients is an important, but often overlooked, risk mitigation tool.

If clients seek your help with transactions and/or activities outside your comfort zone or skillset [… did someone mention Employee Retention Credit (“ERC”) or virtual investment opportunities such as non-fungible tokens (“NFTs”) …?], you will be better served suggesting they seek the advice and counsel of professionals with expertise in those areas.

It is important to recognize, embrace and maintain your competencies. As such, it is critical that CPAs never feel compelled to dabble in practice areas outside of their expertise. Frankly, this rule is fundamental to our profession as the preeminent standard of the Code of Professional Conduct’s General Standards requires CPAs to only undertake professional services they can reasonably expect to complete with professional competence.

Advising clients regarding ERC and their digital asset transactions are opportunities for some firms, but unfortunately these opportunities also pose considerable liability exposure for firms who lack the requisite skills and dabble—tread carefully, arm yourself with knowledge, know your limitations and be willing and able to say “no.”

Are you taking the right steps to manage (and document) client expectations?

Effective communication is a key factor in any CPA-client relationship, and when you work to stay informed and in control of managing client expectations, you help to safeguard your firm. To that end, good documentation is critical to successfully managing client expectations. Jurors (members of the public) generally consider CPAs to be experts in documentation, and falling short of that expectation may be viewed as negligent and perceived as falling below the standard of care.

Here are some helpful documentation tips to get you through the remainder of tax season:

. While engagement letters won’t immunize you from lawsuits, they can be your first line of defense if a client makes a claim against you. Although you likely already have executed engagement letters in place with your tax clients, for those engagements that have had some engagement creep, memorialize the additional services by updating your engagement letter or obtaining a signed addendum clarifying the revised scope and limits.

Numerous CAMICO engagement letter templates are available on the Members-Only Site’s Engagement Letter Resource Center.

Always document significant meetings, communications and follow-up

. Follow up with written communications in circumstances including, but not limited to:

‘Advise’ clients of opportunities and ‘warn’ clients about risks.

 Consider obtaining a tax representation letter or stand-alone certification letter to mitigate high-risk scenarios such as the following:

In addition to the above examples, there is a new area of potential risk associated with the Corporate Transparency Act, which introduces a new and expansive reporting regime for entities deemed to be Reporting Companies to report “beneficial owner” information to the Financial Crimes Enforcement Network (FinCEN).

CAMICO strongly recommends that CPA firms inform and advise their clients of the beneficial ownership reporting requirements under CTA. (Refer to CAMICO’s article titled, “Corporate Transparency Act/Beneficial Ownership Information Reporting—

Risk Management Considerations for CPA Firms”).

Written documentation should be factual, professional and without personal commentary or unsubstantiated opinions

. Unprofessional and/or inappropriate comments can damage the integrity of documentation. Ask yourself whether your documentation would be helpful or harmful if presented at trial.

: The challenging economy has brought fee issues to the forefront as clients experiencing financial difficulties struggle to meet their financial commitments, including bills owed their CPAs. Good communication with non-paying clients is important and may spur payment. At the very least, contemporaneously memorialized communications create a defensive documentation trail demonstrating that the client, by not responding to your communications, did not have a valid basis to claim your fees were not owed. When dissatisfied with work, clients normally respond to such communications by detailing their dissatisfaction.

Fees, billings and collection issues can and should be managed proactively. For additional information and resources on this topic, including sample collection letters, access CAMICO’s Engagement Letter Resource Center on the Members-Only Site.

: Disengagement is an art form. Skillfully handled transitions can be mutually beneficial to firms and clients.

However, care is needed when disengaging from engagements after they have begun. Disengaging too late and without sufficient cause may increase the likelihood a firm could face allegations of damages if the successor is unable to meet the deadline.

Whether you decide to disengage a specific client, type of business or area of practice, it’s important to terminate relationships professionally, formally and in writing. At a minimum, your disengagement letter should contain clear statements, a description of your work and a list of any due dates or filings. Effective disengagements are a good risk management tool for your firm and doing it skillfully and professionally will help you grow your practice and avoid potential liability exposure.

An article detailing disengaging best practices, “

,” and illustrative CAMICO disengagement letters are available on the Members-Only Site within the Engagement Letter Resource Center.

Early reporting of potential claim situations

: Promptly report potential claims, including potential errors or omissions, to CAMICO to protect your firm’s full policy limits and possibly benefit from CAMICO’s tax penalty abatement services, which provide expertise on abatement requests.

reducing the deductible by 50 percent, up to $50,000

, for any potential claim that is reported before a claim is made. Further, if CAMICO determines that it is appropriate to retain counsel to assist with a potential claim, the related expenses preceding a claim will be absorbed by CAMICO and not impact policy limits or charged to the deductible.

Subpoena and consultation services are included in these potential claim benefits

. Early reporting helps our claims specialists achieve effective resolutions and mitigate the impact of errors and omissions.

Risk Management

CPA firms face numerous challenges as they navigate each tax season’s nuances. Now, more than ever, CPA firms need to be proactive to mitigate risks and prioritize performing the “right services” for the “right clients.”

Since accountants are often hired as expert witnesses on forensic accounting, economic damages and business valuation issues, it’s wise to be aware of the rules governing the admissibility of expert testimony in both state and federal courts. Recently, changes were made to Federal Rule 702 to keep unreliable opinions away from juries, which has already resulted in the exclusion of expert testimony.

Rule 702 of the Federal Rules of Evidence governs the admissibility of expert testimony in federal courts. Prior to the changes made in December 2023, the last time Federal Rule 702 had been amended was in 2000 in response to 

Daubert v. Merrell Dow Pharmaceuticals, Inc

, the court noted it is the trial judge’s responsibility to act as a gatekeeper and exclude unreliable testimony. The changes made in December 2023 were designed to fix what has been deemed widespread misapplication of Rule 702 by the courts. Often, expert testimony was allowed under the theory that concerns can be addressed through cross-examination and because of this, there was inconsistency in expert exclusion. 

Intending to re-establish the court’s role as gatekeeper, Rule 702 (the updates highlighted in bold) now states that, “a witness who is qualified as an expert by knowledge, skill, experience, training, or education may testify in the form of an opinion or otherwise if the proponent demonstrates to the court that it is more likely than not that:

Does Federal Rule 702 Impact Accounting Expert Witnesses?

Forensic accounting, economic damages and business valuations often involve complex financial transactions, accounting principles, auditing standards and forensic techniques.

These topics may be beyond the common knowledge of the judge and jury, and therefore require the assistance of expert witnesses to explain the evidence and provide opinions on the existence and extent of damages, fraud, etc. Rule 702 sets the criteria for the qualification and reliability of such experts, and assigns judges the gatekeeping role of determining whether the expert testimony is admissible or not.

What are the Implications of Rule 702 for Accounting Expert Witnesses?

As financial experts, it is important to be aware of the requirements and challenges of Rule 702, especially if you are hired as an expert witness. Here are some implications of the rule for accounting experts:

Recent Cases Highlighting the New Impacts on Expert Testimony

There have been recent exclusions of expert testimony that may have been a result of the recent changes. For example:

As the standards for admitting expert testimony tighten, it is increasingly important for accountants who serve as expert witnesses to stay informed. Recent developments emphasize the courts role as the gatekeeper and for the necessity of experts to have applicable relevant qualifications and sound methodologies.

Recent Changes Impacting Admissibility of Expert Testimony

As the standards for admitting expert testimony tighten, it is increasingly important for accountants who serve as expert witnesses to stay informed. 

CalCPA Staff

Welcome to our annual at-a-glance compilation of federal and state tax information. User-friendly tax rate schedules, facts, figures and assorted data make this time-saving section a handy companion.

Our annual, easy-to-use guide of federal and state tax information is packed with updated tax rate schedules, essential facts, figures and key data. Designed to help you breeze through tax season, keep this time-saving resource by your side during the busy tax season.