Many tax preparers love what they do. They enjoy the challenge of learning tax law and then applying that law to different scenarios. They're also devoted to helping clients. The assistance they provide could be planning for a transaction before it happens. Or, it could be sorting out the particulars and applying the law to those details after the fact. Either scenario is fascinating to many tax preparers.
But anyone who's dealt with tax law, even for a short while, understands that it's complicated. Plus, it's always changing. And, it's disputed often. Provisions are complex and often have lengthy regulations attached to them. The Internal Revenue Service (IRS) issues rulings regarding its position on elements of the law. But that doesn't mean there is agreement with all IRS interpretations. Often, there are different understandings of the same provisions. The complexity of the tax law and the often-differing opinions of its understanding increase the risk involved in practicing in this area.
The process of helping a client means getting all the facts. It also means understanding what's occurred or what's planned. Like the law, fact-gathering can be involved. Potential misunderstandings make the whole activity risky, especially if the numbers are significant. Why? Because the consequences of a miss can be high. Most taxing authorities assess penalties and interest when mistakes are found. In other words, the fact-gathering work of a tax preparer is fraught with potential hazards.
An excellent risk management step is to emphasize to clients the importance of planning. This can help them get into the mode of consulting with their tax professional before a significant transaction has taken place. That way, potentially bad facts can be dealt with beforehand. A transaction might even be approached differently, mitigating adverse tax consequences.
But often, that's not what happens. Here's a typical scenario. Joe had been the tax advisor to Phillips Trucking for the last five years. Joe had always tried to emphasize the importance of including him in the planning process for any anticipated large transactions. But, Steve Phillips, the founder, and CEO didn't always heed Joe's advice. He liked to wheel and deal and, so far anyway, Joe had always been able to ease the tax pain from the times Steve didn't consult with him before pulling the trigger on a deal. But, not this time. Steve had been negotiating the sale of about 20 large semi-tractor/trailer rigs from his fleet. He'd told Joe it would be a strictly-cash deal. Joe told him to stay away from an installment sale since all the depreciation would have to be recaptured and reported in the first year regardless.
When the facts came in, Joe found out the sale wasn't as Steve had indicated it would be. The deal was over time and with a minimal down payment. There was a lot of tax due on the transaction and not a lot of cash to pay for it. Steve was not happy that his company had to dig into savings to pay the tax. And, even though Joe was able to show Steve where the tax law showed the proper treatment, it still didn't make Steve much happier about how things turned out. Maybe he'll be more satisfied in future years when the cash comes in, and he doesn't have to pay much out in taxes.
Many errors are not found for years. Once a return is filed, a taxpayer may not look at it again ever. Or, it may be picked up again toward the end of the subsequent year, when it's time to consider tax planning. But that doesn't mean the error will be found then. In fact, depending on the issue, the treatment may be consistent over time. And that doesn't mean that IRS will agree with that treatment. The first thing that an IRS agent generally asks for is a copy of the prior and succeeding year returns. One reason is to review those returns for any errors that are found in the year under review. The agent typically then goes to those other returns to check for consistent wrong treatment. If it's there, an adjustment may be made to those returns as well. If the modification is in the government's favor, the result is more tax to the taxpayer, plus interest and penalties. And, those penalties and interest have multiplied over the years.
Having an engagement letter or contract for significant jobs is essential. The process helps to ensure that both preparer and client understand what needs to be completed for the project to be successful. But even if a detailed engagement letter is signed between parties, things can go wrong. And, depending on the dollar amount and the type of disagreement involved, disputes can result in expensive lawsuits. And, here's the thing about suits. Not only do they cost money, but they also require time. And, what a lot of people find is that the time element is the most expensive part of the whole dispute. What's often more important is to put the difference in the rearview mirror so that the preparer can return to more productive use of the time available.
Perhaps the most valuable asset that a tax preparer has is the reputation that's been built over years. Slowly and steadily is how most tax advisors make a name for themselves as an expert in their field. But that reputation can be quickly dashed if a client dispute is not handled carefully and correctly. Protecting one's reputation should be a high priority for any tax preparer who wants to continue to build a successful tax practice.
A solid tax professional helps clients to manage their tax risk by timely filing and paying their appropriate tax liabilities. But that same tax professional needs to manage the risks of their practice by being aware of specific facts and taking appropriate risk management steps. Understand that the tax law is complex, and fact-gathering is critical. But also know that errors happen, and they may not be found for years. Plus, we live in an increasingly litigious society where reputations, built over time, can be ruined quickly.
All these items point to the need for professional liability insurance. It can help to manage risk, including reputational risk. It can also help to ensure that valuable time is spent productively and not on disputes that take time away from building and running a successful tax practice. It's an essential tool to keep a firm focused on client service and building the excellent name that's the hallmark of a successful firm.