Want to Avoid Being Blamed by Your Client? Clarify the Scope of Your Engagement!

It’s happened to you before; one of your clients received an audit notice related to its sales, use, rental, and/or business license tax compliance. Naturally, your client is not excited about the upcoming audit, and the first reaction is to call you to develop a game plan. One problem, though: you only prepare your client’s income tax returns and an annual set of financial statements. Your client prepares all other tax returns. And you’ve never even discussed your client’s sales or business license tax obligations before—at least not that you can remember.

During the meeting, you quickly realize that your client may indeed have some potential sales tax exposure. And worse yet, if you’re right, they’ll owe sales tax to the State, county and city (or multiple counties and cities). As it turns out, your client wasn’t charging sales tax on otherwise taxable sales to churches which, generally, are not exempt from Alabama and local sales tax, and churches are your client’s major customers. Or your client has been delivering a substantial amount of its goods into cities for which it never bought a business license. The potential liability could be significant. It could be enough to put your client out of business. It’s a classic “OH, NO!” moment.

While you immediately begin to think of ways to minimize your client’s potential liability, your client’s first question is “why didn’t you warn me about this before?!” Suddenly, your focus switches from how can we can help our client to how can we retain our client and prevent at least a threatened malpractice claim. It’s an awkward moment, and it’s one that we as a law firm that works with many CPAs see all too often. The client blames their unsuspecting CPA.

In our experience, most clients view their CPA as their advisor for all things financial and tax-related, and oftentimes much more than that. Unfortunately, that may include, as in the above example, matters on which the CPA has never been consulted or offered unsolicited advice. As a result, when things start to go badly, the CPA may become the scapegoat.

At the outset, it should be noted that most of the time these issues resolve themselves. In fact, the CPA and the client are usually able to work through the audit and the CPA retains the client. But, that’s not always the case.

The obvious question is, how can you avoid this dilemma? At a minimum, we suggest two things: (1) clearly define the scope of your services in your engagement letter; and (2) routinely meet with your client to discuss the idea of expanding the scope of your services. Frankly, the two work well together.

Your engagement letter should be regularly updated (at least annually) to accurately set forth the nature of the services that your client has asked you to perform. For instance, if you simply prepare your client’s income tax returns and compile its financial statements, your engagement letter should clearly state that the scope of your services to your client “shall include only income tax preparation and financial statement compilation, unless the client requests that the scope of our services be expanded and our firm agrees in writing to the additional responsibilities.” Additionally, when drafting or updating your engagement letter, you may also add that the scope of your engagement does not extend to compliance with other taxes, such as sales, use, rental, business license, property, excise, etc. That way, when your client later asks why you didn’t warn her that she needed to buy a business license in City X, you can politely point out that it’s not something you were engaged to handle.

By itself, modifying your engagement letter may just seem like a nice way to cover your rear end, but it doesn’t necessarily help you preserve your relationship with your client. That’s why, in conjunction with having a clear statement of services in your engagement letter, you also should meet with your client regularly to consider expanding the scope of your engagement to include a review of certain other tax obligations. As a result, you may be engaged to perform a “reverse audit,” so you can advise the client—ahead of an audit by the State Department of Revenue or other taxing authorities—what it likely owes or perhaps of a refund that it’s entitled to claim. [Please read our October 2014 column regarding the benefits of voluntary compliance programs if your client discovers that it owes back taxes to state or local governments.] For example, you can do this by including it as a question in your new client packet or in your annual income tax questionnaire, or in a separate letter after Tax Season subsides. If you did, then instead of officially responding to the worried client that business license taxes are “outside the scope of our engagement,” you can say, “Well, I offered to review that for you, but remember, you didn’t want to spend the time (or the money).” Obviously, those conversations should be documented in your files.

These steps should allow you to create a closer relationship with your client that results in more business for you and value added from their perspective. And it may also result in minimizing your client’s potential tax liabilities or discovering an unknown refund claim, thus enhancing your reputation as your client’s most trusted advisor. It’s a win-win outcome!

Republished with permission. This article first appeared on page 11 of the December 2014/January 2015 issue of Alabama CPA Magazine.