Accountants Beware: Tax Services Ranks as Highest Generator of Malpractice Claims
Here’s a word of caution to accountants as tax preparation season cranks up: allegations of errors in tax services account for more than half of the insurance claims filed with one of the nation’s largest providers of malpractice insurance for accounting professionals, Camico Mutual Insurance Co.
In its most recent study of claims experience, from its more than 7,000 accounting professional clients in 44 states, the Redwood City, Calif.-based insurer has found tax work accounts for the most claims filed and the highest total dollar volume of damages sought. Camico is second, behind a program sponsored by the American Institute of CPAs (AICPA), among the profession’s most prominent professional liability insurance carriers.
Tax ranks highest among the service areas generating claims because it is among the services accounting professionals are most likely to offer and its technicalities can mean a minefield of risks. The technical nature of tax work “places most of the burden for decision-making on the CPA (s),” who at the same time “are limited in what they can ask clients,” says Ron Klein, Camico’s vice president of claims.
“It's much like a patient seeing a doctor about a serious, complex medical condition; the problem and treatment are so critical that the patient will ultimately go with the treatment the doctor recommends.” he adds.
Following tax on the list of leading areas for generating claims are, in respective order: financial statements, investment fraud and defalcation. Within tax work, technical income tax issues are the primary area of loss, followed by S and C corporation elections and estate planning.
Among the basic tenets in professional liability insurance is that the failure to meet clients expectations often lead to accusations that result in malpractice claims. That makes client screening and the development of thoughtful engagement letters, paramount in reducing the risk of claims.
"All clients and engagements should be re-evaluated on a regular basis, at least annually, to assure the firm is capable of performing the services required by the engagement and that the firm is practicing the services often enough to be proficient," Klein says.
While tax work is the most common type of claim filed, financial statements has long been the leader in severity—the highest dollar loss per incident. Klein notes that this work often is done at the request or requirement of third-party creditors, such as a client’s bank, which means the work can place the client's interests at odds with the creditor’s. “Clients are often inclined to pressure the CPA to create statements that satisfy the bank, and as the process becomes more routine, the CPA becomes complacent and loses the skepticism necessary for a competent review or audit,” says Klein.
A typical area of trouble is in the valuation of inventory or assets, where the CPA “goes along with the client on how valuation is determined, which then results in a possible significant material misstatement," Klein says. "The lender is left with an inaccurate view of the client's business, and the CPA is exposed to liability for the misstatement, especially if the business fails."
The third most frequent and/or severe area of claims involves investment fraud, which includes reviews, audits, tax and investment advice. Camico’s list of risk management tips for tax work is available at its Web site www.camico.com.