Signing an engagement letter is not a legal requirement to start an engagement with accounting firms, law firms or consulting firm. As the world of business moves forward, it learns from mistakes, errors, malpractices and evolves to define & adopt best practices.

The best practices would expect accounting firms to use engagement letters, especially while providing tax services.

When a dispute arises between client and an accounting firm, and if it is taken to appropriate authority e.g. board of accountancy investigators, the first and foremost question they would ask is

What is written in your engagement letter?

And both parties have to provide documentation of what was agreed; a signed engagement letter is quickly accepted as an agreement document and referred for the judgment.

It has gotten accounting firms in trouble

It gets very serious when one starts looking at the insurance claims against CPA firm. In its finding the CNA Financial Corporation listed

1. 73% of claims in 2021 were tax issues due to malpractice
2. 9% of claims against accounting & bookkeeping services
3. 8% of claims against consulting services
4. 5% of claims against audit & attest service

Typical Claims against Tax Service

Various miscommunication reasons are listed for such insurance claims against tax service disputes such as

1. Sub-standard or misleading advice
2. Tax filling errors due to mathematical or clerical mistakes
3. Missing or lack of disclosures while disputable deductions are claimed
4. Conflicting claims in case of separations: divorce or business
5. Disclosure of foreign assets

How to Prevent Such Disputes?

Now, not all of these reasons can be taken at face value. These are submitted as insurance claims.

What does it mean to you, if you are a tax service firm, accounting & bookkeeping firm?

You need to protect yourself, and your firm from any such miscommunication and disputes arising because of missing information or lack of clear information.

Accounting engagement letter or tax engagement letter will save your troubles.

Because, as mentioned above, the dispute resolution authority is going to as this question

“What does your engagement letter say?”

What should tax engagement letter include?

While there is no one fit-for-all engagement letter solution; you can follow a basic structure and customize it for different clients depending on the engagement.

What should you cover in your engagement letter for tax services?

1. Specify client being served
2. Specify type of tax returns being prepared
3. Specify duration of the returns
4. Specify scope of the engagement
5. Specify terms/services which are out of the scope of engagement
6. Specify payment term, clauses and payment schedule
7. Specify signature

Let’s look at each point in brief

Who is the client?

In your client engagement letter for tax services, you should specifically identify who is the client. If there are multiple parties involved, multiple contacts involved in the engagement, the engagement letter should categorically specify who will be giving instructions from each party and who will be communicating on behalf of the part.

If a dispute arise later and client claims some document was left or email was sent by a person and that document/email had financial information, which got excluded in tax filling. Now it is not an excuse but you will be able to protect your firm since you don’t have to recognize the person who shared the document or financial information was not shared by designated person as per the engagement letter. You may even receive conflicting information from different people from the same client. It is not your job to solve their conflict/confusion; rather a clear understanding in the engagement letter should stop any such issue being escalated or turning out to be legal dispute.

What kind of return(s) will be filled?

The engagement letter should specifically identify what kind of return will be filled: Is it for

• S-Corp
• C-Corp
• LLC
• individual

You should not combine multiple returns in one engagement letter; especially avoid it if there are multiple stakeholders. You should specify it in your engagement letter and if the need arises, you should create a separate engagement letter for tax return filling for multiple stakeholders.

What is the duration of tax return filling?

While tax returns are to be filled every year; you can’t assume the engagement letter will keep going without specifying it.

What we mean is, the tax service engagement letter should specify the period/ duration of the engagement is for a year e.g. FY 2022. For FY 2023, you can renew the engagement by sending a separate engagement letter.

Clients tend to assume things. Hence, if you do not intend to continue to serve the client,

1. Your engagement letter will clearly say the duration
2. Even better, you should get a disengagement letter signed to prevent any future issues

Do not put vague duration in your tax service engagement letter which can land in some trouble later.

What is the scope of the tax service engagement?

If you are simply going to file a specific type of tax return for a given year, say so. How you are going to process tax information, and tax return filling – clarify those.

If the scope of service engagement is not clearly specified, it will be left for interpretation.

Say it clearly what process you will follow to process the tax info e.g.

1. No verification of the financial information provided
2. If erroneous, fraudulent data is shared, it will be the responsibility of client
3. Specify tax computation will be dependent on the timely sharing of information by client
4. Review of Tax Return information before filling

What is not in the scope of the tax service engagement?

If you are simply going to file specific type of tax return for a given year, say so. If the scope of service engagement is not clearly specified, it will be left for interpretation; and clients may interpret that you will be performing bookkeeping as well.

Say it clearly if you not intent to provide services such as

1. Bookkeeping (of what level)
2. Accounting, preparation of financial statements
3. Internal audit
4. Tax computation
5. Tax Return filling
6. Tax consulting of specific kind

What are your payment schedule and payment term?

This part of the engagement letter will help you & your clients avoid the disputes over fees, well before before the actual engagement work begins.

The payment term should specify

1. How and when the client will be billed: is it transfer by wire, check or what options are available
2. If it is a retainer work, specify when payment will be due,
3. What are the billing rates for services outside the scope of the engagement
4. Also do not forget to highlight and specify the interest on late payments
5. If fees are not paid on time or after the due date, if you will suspend work or cancel the engagement

Get client signature

 

Yeah, sounds obvious but CPAs get surprised (and shock of life) when they realize

1. Client has not signed the engagement letter or required disclosures/ forms
2. CPA/ enrolled agents (EA) are unable to find the signed copy of engagement letter or required documents

It is crucial for the client to sign some of these documents as they concur, affirm the correctness of the financial data/ records to CPA, tax agencies.

Signing some of these documents will help clients understand that there will be IRS penalties if deductions can not be substantiated with the records provided by client.

Finally, the basic premise for the engagement letter should be to bring clarity of service being delivered, terms of services, fees, etc.

What does engagement letter exactly do?

It brings more clarity to both parties, it reduces the expectations-gap. It forms a legal basis for the service engagement to avoid confusion and a reference in case dispute is raised.