Malpractice Liability: And Choice of Business Entity for Accounting Firms

By Auster, Rolf | The National Public Accountant, November 2002 | Go to article overview

Malpractice Liability: And Choice of Business Entity for Accounting Firms


Auster, Rolf, The National Public Accountant


Accountants frequently advise their clients with respect to choice of business entity. In the 1990s, the entities of choice other than the sole proprietorship, were primarily partnerships and corporations. Of the latter, about one-half, or some three million, were S corporations. In the new millennium, the Limited Liability Company, or LEG, is surpassing S corporations by replacing general partnerships, while Limited Partnerships, or LPs, so popular as tax-shelter vehicles in the 1960s and 1970s, are used almost exclusively in the estate planning area ("Family Limited Partnerships").

The recent explosion of malpractice lawsuits against accounting firms, involving staggering amounts of potential damages, shows that it is high time for accounting firms to review their choice of business entity. It can be argued that the accounting partnership belongs in the past!

CHOICE OF ORGANIZATIONAL FORM IN TODAY'S ENVIRONMENT

Historically, most accounting firms (including the largest-the "Big Five") have been, and remain, general partnerships. In today's environment, this choice should no longer be considered intuitively obvious. At a minimum, it should be questioned for the following reasons:

* Malpractice lawsuits are proliferating. The potential damage awards are enormous, and all partners (even if retired at the time of judgment) are jointly liable for malpractice by the firm and by another partner. It is crucial for an accountant to avoid being a partner for malpractice liability purposes.

* Types of business entities are proliferating. The classic entity choice, "Corporation or Partnership," has been complicated by the introduction of the S corporation election, including the "QSub" election, Limited Liability Companies (LLCs), including Single Member LLCs (SMLLCs), Limited Partnerships (LPs), and Limited Liability Partnerships (LLPs). In addition, an unincorporated entity, including an LLC, may "check the box" and elect to be federally taxed as a corporation. As explained below, despite the number of seeming choices, only two fundamental alternatives remain, corporation or partnership, and accountants who care about malpractice exposure should not form partnerships!

When revisiting the accountants' old-fashioned partnership, two conclusions emerge: (1) the historical justifications for it no longer exist, and (2) the partnership form no longer serves today's legal and business needs.

WHAT S "MALPRACTICE?"

Malpractice is a tort, or "civil wrong?' In the broadest sense, it occurs when a client sustains damages as a result of a breach of duty owed to that client. It is important to note that malpractice insurance and Limited Liability Partnership statutes do not cover or apply to malpractice liability arising out of behavior that is criminal, intentional, grossly negligent, or shows reckless disregard of the law, rules or regulations. Nevertheless, regardless of the degree of negligence, intent, or even criminal behavior, an accountant is equally liable for the civil damages resulting from the actionable conduct (and so are all the partners of the firm).

Who Is Liable for Malpractice?

Here are some common and major misconceptions regarding malpractice liability exposure:

* All liabilities are created equal. It is frequently believed that a corporation has limited liability for malpractice exposure. While it is true that a corporation's liability for debts is limited to everything it owns, every accountant is personally liable for his/her own malpractice, regardless of legal status as employee, "member," or partner!

* Only the "wrongdoer" is liable. If an employee commits malpractice, the employer is also liable under the doctrine of "respondeat superior," but the other employees are not responsible. In a partnership, all partners are jointly liable for each other's malpractice and for that of the firm. Each jurisdiction has laws concerning who, in substance, is a partner for this purpose. …

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