Client record retention and tax workpapers.

Recent changes to the AICPA Code of Professional Ethics, involving ET Section 501,"Acts Discreditable" of AICPA Professional Standards, and, in particular, Interpretation 501-1, Retention of Client Records (effective April 30, 2000), might appear simple: any attempt to retain client records after a demand is made for them is an "act discreditable to the profession" in violation of Rule 501. However, on further reading, the interpretation is not clear at all.

Confusion exists in two areas addressed in the interpretation: (1) identifying which records are client records (as opposed to tax workpapers) and (2) determining whether practitioners can require payment of fees due on engagements, before providing clients with such records.

Workpapers or Client Records?

In determining when tax workpapers become client records, paragraph 4 of AICPA Interpretation 501-1 states, "in some instances a member's workpapers contain information that is not reflected in the client's books and records, with the result that the client's financial information is incomplete." The original interpretation includes examples such as (1) adjusting, closing, combining or consolidating journal entries and (2) information normally contained in books of original entry and general ledger or subsidiary ledgers.

Item (2) creates the ambiguity. Most practitioners agree that depreciation schedules, prepaid schedules (e.g., insurance, taxes, etc.) and loan amortization schedules are client records. However, the revised rule adds a new Item (3),"Tax and Depreciation Carryforward Information," to paragraph 4 that raises the question about whether some other schedules (such as prepaid assets and loans) are client records, as these are not specifically mentioned in the new rule. The fact that tax and depreciation carryforward schedules were specifically mentioned does not necessarily exclude other tax workpapers from being information normally contained in books of original entry. However, it would seem that, with the addition of Item (3), there is no doubt that Rule 501 covers some tax workpapers. Therefore, practitioners should examine what normally constitutes a set of tax workpapers, regardless of whether financial statements are also prepared.

The new section clearly covers all carryforward schedules, including net operating losses (regular and alternative minimum tax), capital losses, contributions, passive activity losses and others. But does it also cover M-1 adjustments, such as cash-to-accrual differences, income recognition differences and Sec. 263A adjustments, to name a few? To be prudent, practitioners should consider these items as tax carryforward schedules, as they are temporary differences that will affect subsequent years.

The question becomes more difficult when determining to which group other tax workpapers that are not carryforward in nature (such as permanent M-1 adjustments and state apportionment schedules) belong. Referring to Item (2) of paragraph 4 for determining what is information "normally contained in books of original entry and general ledger or subsidiary ledgers," it would appear a good argument could be made for not considering such schedules as books of original entry and thus not providing them. Therefore, it now seems that, under the revised rule, a member is not required to release any client records until such time as he is paid for creating those records.

Engagement Fee Payments

Prior to these changes, the rule specifically limited a CPA's ability to hold back information until fees are paid only on completed engagements. The revised rule expands this right, deleting the reference to completed engagements and including a specific reference pertaining to "fees for the above services," with apparent reference to Paragraph 4, Items (1),(2) and (3).

Although the changes to Rule 501 make it easier for members to retain records until they receive payment for services, they must also consider their particular state's accountancy board rules. For example, a CPA licensed in New Jersey must also adhere to New Jersey State Board of Accountancy rules of professional conduct, which are similar to AICPA Rule 501 but do not include language on the payment of fees before providing documents.

Practitioners should keep in mind that attempting to retain client records until payment of fees is received might result in an increase in malpractice claims, specifically as a means of clients negotiating for information without paying such fees in full.

Information Format

A related issue involves the medium in which a member is required to provide information to a client. Another addition to paragraph 4 of the revised rules addresses this issue, stating, "the information should be provided in the medium in which it is requested, provided it exists in that medium. The member is not required to convert information that is not in electronic format to an electronic form." According to the new rules, if the information is in an electronic format, members would be in violation of the rules if they provide only a printout and not the information in the electronic format of such information (if it had been so requested). The new rules also clearly indicate that, if the information was never in electronic format or the electronic information was deleted, a member is under no obligation to convert data to an electronic format. However, the member can agree to convert such data into a specific electronic format for an additional fee.

Exhibit 1 shows the revised rule.

FROM JOSEPH SCUTELLARO, CPA, JUMP, SCUTELLARO AND COMPANY, TOMS RIVER, NJ

Exhibit 1: INTERPRETATION 501-1 UNDER RULE 501: Retention of Client Records

Retention of client records after a demand is made for them is an act discreditable to the profession in violation of rule 501 [ET section 501.01].The fact that the statutes of the state in which a member practices may grant the member a lien on certain records in his or her possession does not change this ethical standard.

A client's records are any accounting or other records belonging to the client that were provided to the member by or on behalf of the client. If an engagement is terminated prior to completion, the member is required to return only client records.

A member's workpapers--including, but not limited to, analyses and schedules prepared by the client at the request of the member--are the member's property, not client records, and need not be made available.

In some instances a member's workpapers contain information that is not reflected in the client's books and records, with the result that the client's financial information is incomplete. This would include, for example, (1) adjusting, closing, combining, or consolidating journal entries, (2) information normally contained in books of original entry and general ledgers or subsidiary ledgers, and (3) tax and depreciation carryforward information. In those instances when an engagement has been completed, such information should also be made available to the client upon request. The information should be provided in the medium in which it is requested, provided it exists in that medium. The member is not required to convert information that is not in electronic format to an electronic form. The member may require that all fees due the member, including the fees for the above services, be paid before such information is provided.

Once the member has complied with the foregoing requirements, he or she need not comply with any subsequent requests to again provide such information.

(The Professional Ethics Executive Committee has adopted a new ethics ruling under the Code of Professional Conduct [AICPA Professional Standards, ET section 191.222-223].)

Editor's note: Messrs. Holub and Scutellaro are members of file AICPA Tax Division's Member Tax Practice Improvement Committee.

If you would like additional information about this article, contact Mr. Holub at [phone] or [e-mail] or Mr. Scutellaro at [phone] or [e-mail].

Steven F. Holub, CPA Aidman, Piser & Co. Tampa, FL