Fast Times for Accounting Firms: Emerging Professional Liability Risks for 2019
With changes to the accounting profession coming fast and furious, it’s imperative that CPAs stay on top of their game, or potentially suffer the consequences in the form of a professional liability lawsuit.
Before the 2019 tax filing season kicks off, now is the perfect time to get up to speed on recent changes impacting the accounting profession, and, in turn, risks to CPA firms.
Common Types of Malpractice Claims
In the AICPA Professional Liability Insurance Program, historically, tax practice generates approximately 80 percent of all malpractice claims made against small CPA firms. The most common allegations reported to the program in 2017 included the following:*
- 26% — Returns not filed or late filing
- 21% — Improper tax treatment
- 6% — Improper tax advice/failure to advise
- 5% — Failure to detect fraud
- 42% — Other (conflicts of interest, improper practice, failure to communicate, etc.)
Tax Cuts and Jobs Act (TCJA)
The TCJA is the biggest change to the tax code since 1986. Practitioners need to be particularly mindful of the multiple facets to the law and consider how it may impact their clients.
“There are a lot of unanswered questions and issues,” said Alvin Fennell, vice president of underwriting at Aon Affinity. “The IRS continues to issue updated guidance regarding application of the law.”
Maintaining up-to-date training on this subject is critical in both preparing accurate tax returns and providing tax planning advice. “Unsure of how to keep up?” Fennell added. “Consider joining the AICPA Tax Section. They’re one of your best resources for information.”
South Dakota v. Wayfair
The June 2018 U.S. Supreme Court decision in South Dakota vs. Wayfair effectively reversed the longstanding “physical presence” rule used to determine the obligation to collect sales taxes. While the case has been remanded to the South Dakota Supreme Court to consider other relevant issues, the decision will significantly impact the obligations of certain business clients to collect and remit state sales and use taxes.
“This ruling has the potential to affect hundreds of thousands of small businesses that sell over the internet,” said Stan Sterna, vice president of risk management at Aon Affinity. “This will be a boon for CPA practices, as it will drive an increase in revenue — but it comes with an increase in risk.”
Like the TCJA, questions remain. What defines presence in a state generating sales tax obligations: Revenue? Transactions? Number of clients? States may stand by their current business nexus rules, issue updated rules or emulate what South Dakota does in response to the ruling. The U.S. Congress also is considering bills that will impact these obligations. Maintaining up-to-date training on the ramifications of the case will be critical in minimizing your risk of providing incorrect advice.
Face Time with Clients
With the evolution of tax preparation and filing software to process income tax returns and the use of cloud-based client portals, many CPAs today often have little direct contact with their clients. That’s fine if you’re dealing with simple 1040 returns, but when it comes to individuals with more complex income tax returns and business clients, you need to bring to their attention the changes wrought by the TCJA and Wayfair decision. Spread the word via newsletters or email, and invite them to set up an appointment to confer with you to obtain tax planning advice.
“You need to have a discussion and ask a whole series of questions to figure out what your client may need,” Fennell said. “If you don’t, three years from now, your client may get hit with a sales tax audit and end up owing $80,000. At that point, they’re likely to blame their CPA.”
Years ago, a professional liability policy providing $100,000 of insurance coverage to a small tax practitioner may have been adequate protection. That is no longer the case. The costs to defend a claim involving a significant pending tax dispute with the IRS or state department of revenue can easily exceed $100,000.
“As your clients increase in number and wealth, the size of the potential claim likewise increases,” Sterna said. “What is the average annual revenue of your largest business clients? That’s a simple way to help determine what limits of liability to carry.”
While professional liability insurance provides coverage for claims that arise from rendering professional services, cyber liability covers privacy breach claims that don’t arise from professional services.
For example, consider the CPA firm that inadvertently infects the database of a third-party vendor with malware. Cyber liability coverage can pay for a plethora of related expenses, including computer forensics, remediation, lost income due to business interruption, and the costs of complying with state and federal privacy breach notice laws.
“CPA firms should carefully consider the experience, expertise and resources available from their broker and insurer when comparing cyber policies,” Sterna said. “Are they adding an endorsement to your business package policy that offers minimal coverage? Or do they provide a crisis response team that will walk you through what can be a complex claim?”
Additional Risk Considerations
- A particularly risky practice is to provide “off-the-cuff” tax planning advice. Blaming the CPA in hindsight is a frequent client reaction when they learn of a lost tax planning opportunity or receive notice of an IRS or state audit. Always require clients to sign an engagement letter detailing the scope and limitations of your tax advice prior to advising them.
- Professional liability risks extend to other areas of practice beyond tax. Claims arising from audit and attest services are historically the highest in severity, routinely alleging damages in the millions.
- Client accounting services becomes problematic when clients expect their CPA to perform management functions and the scope of services has not been adequately defined in the engagement letter. When CPAs assume management duties on behalf of their client, it can trigger insurance policy exclusions that apply in the event of a claim.
- With the high percentage of baby boomers retiring, there has been a wave of accounting firm mergers and acquisitions. When two firms merge, it can be one of the highest liability exposure events they will face. You need to perform extensive due diligence on the culture and practice management at the other firm before moving forward with the transaction.
While the nature of professional liability claims has remained consistent over the years, the complexity of laws, regulations and professional standards applicable to rendering professional services has increased. Before the 2019 tax season consumes your practice, take the time to evaluate your insurance coverage and access the practice and risk management tools available from your insurance advisor.
*Broker-Administrator Report, The AICPA Professional Liability & Personal Liability Insurance Programs Committee, Aon, February 6, 2018.
This article is provided for general informational purposes only and is not intended to provide individualized business, insurance or legal advice. You should discuss your individual circumstances thoroughly with your legal and other advisors before taking any action with regard to the subject matter of this article. Only the relevant insurance policy provides actual terms, coverages, amounts, conditions, and exclusions for an insured.
Robert Albertini is Senior AICPA Risk Advisor for Aon Insurance Services, the national Administrator of the AICPA Professional Liability Insurance Program since 1974, and has more than 20 years of experience with Aon.