Managing a Tax Practice to Avoid Malpractice Claims
Yancey, William F., The CPA Journal
Preparing tax returns and giving tax advice carries liability riskat higher rates than audits.
Tax engagements give rise to approximately half of all malpractice claims against public accounting firms. Taxmalpractice claims studies and eight specific cases involving malpractice tell us why practitioners were sued and provide a basis for establishing policies to avoid such suits in the future.
Approximately half of all malpractice claims against public accounting firms arise from tax engagements. Although auditrelated claims receive more publicity and are more costly to settle, tax claims occur more frequently. During 1987 to 1993, the AICPA Professional Liability Insurance Phn received 3,295 new malpractice claims, of which 48% were from tax engagements, 17% from audits, and 35% from other accounting and consulting engagements.
The Accountants' Professional Liability System, another large accounting malpractice insurer, reports tax engagements generate 38% of members' fee income, but create 55% of all malpractice claims.
Malpractice Insurance Claim Studies
The most frequently quoted statistics on tax malpractice by public accounting firms are based on insurance claims submitted to the AICPA Professional Liability Insurance Plan. The relative frequency of new tax claims jumped from 22% in 1986 to 51% in 1987, and then varied between 42% and 51% between 1988 and 1992. IRS persistence in attacking tax shelters resulted in the large jump in tax malpractice claims in 1987. When the tax and economic benefits of tax shelters failed to meet clients' expectations, many sued their tax accountants. About onethird of the plan's tax claims result from procedural errors, including late returns and omitted or incorrect elections. Similar to most other civil suits in the U.S., approximately 95% of the claims submitted to the AICPA plan are resolved without a court trial.
Another study showed that the decline in tax shelter related claims was offset in part by an increase in claims for estate tax returns. Many of the estate tax return problems arose from late filings and failure to make tax-reducing elections. State tax returns, particularly in California, resulted in a number of claims where the accountant failed to identify different treatments between Federal and state tax laws.
Other problem areas include qualified plans, S corporation elections, late filings, partnerships, and divorces. Claims appear to be more likely with nonroutine than routine events.
The largest published classification study of tax-related malpractice claims against attorneys is derived from legal malpractice claims filed in 1983 to 1985 collected by the American Bar Association (ABA). The ABA study classified claims in several different ways. In the classification by type of alleged error, there were 537 claims alleging an attorney's failure to understand or anticipate a tax, of which 30.5% were a consequence of document preparation and 29.8% for tax reporting. In the classification by area of law, there were 458 claims arising from tax engagements of which 31.7% alleged the attorney failed to understand and anticipate a tax and 29.9% for late or missed filings. Inexperience with the law does not appear to be a major cause since 69.4% of the tax engagement claims were against attorneys with ten or more years in legal practice and 96.7% with four or more years experience.
The general conclusion from these insurance claim studies is that no area of tax practice is immune from alleged malpractice. Claims are caused by both incorrect tax planning, such as tax shelter advice, and compliance failures, such as late filings.
Judicial Decisions in Tax Malpractice Cases
Although the conclusion of the insurance claim studies is that preventing malpractice should be a significant strategic issue for practice management, they do not reveal enough details for modifying tactics on particular tax engagements. …