Tax practice quality control document.

Editor's note: Mr. Holub chairs the AICPA Tax Division Tax Practice Management Committee. Mr. Scutellaro is a member of that committee and its Voluntary Tax Practice Review subcommittee.

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

Many firms (including ones with separate tax departments) do not have separate Tax Practice Quality Control Documents (TPQCDs). Every firm that undergoes a peer review must have a Quality Control Document (QCD) for its accounting and auditing practice; according to the AICPA Code of Professional Conduct, Article VI--Scope and Nature of Services (ET section 57.03),"members should practice in firms that have in place internal quality-control procedures to ensure that services are competently delivered and adequately supervised." Effective Jan. 1, 1997, AICPA Professional Standards Section QC was updated, based on the May 1996 AICPA report, "Recommended Framework for Establishing a Required or Voluntary Quality Control System." This report was the basis for QC Section 20, "System of Quality Control for a CPA Firm's Accounting and Auditing Practice," which replaced QC Section 10. Also effective Jan. 1, 1997, QC Section 30, "Monitoring a CPA Firm's Accounting and Auditing Practice" was added.

QC Section 20 was a major change from existing QC Section 10, replacing the nine elements of Quality Control with five elements:

* Independence, integrity and objectivity;

* Personnel management;

* Acceptance and continuance of clients and engagements;

* Engagement performance; and

* Monitoring.

These five elements are the foundation of any QCD, accounting and auditing or tax. However, as can be seen from the rifle, there is no requirement in AICPA Professional Standards, not even in the "Statements on Responsibility in Tax Practice" to have a quality control system for a tax practice. Even if we look at Treasury Department Circular No. 230 (which governs the practice of attorneys, CPAs, enrolled agents, enrolled actuaries and appraisers before the IRS), there is no mention of a quality control system for any of the professionals practicing before the Service. Of course, practitioners are not required to be independent with respect to their clients when they provide tax services; however, they must maintain their integrity and objectivity.

Need for TPQCD

Thus, the first question is why a TPQCD is needed. The answer is multidimensional:

1. To reduce exposure of a firm's professionals to clients, especially clients who do not want to pay their bills and those who might consider suing.

2. To reduce the firm's (and its professionals') exposure to preparer penalties and disciplinary procedures or both under Circular 230 or other regulatory authorities.

3. To adopt controls and procedures to improve the firm's service and effectiveness to its clients.

4. To develop suggestions for improvement in the quality of the firm's tax services and the lives of its tax professionals.

5. To have the opportunity to put in writing all the practices the firm uses so that this information is readily available to all the firm's personnel (especially new staff).

6. To recognize opportunities for the firm, its staff and clients.

Legal exposure. Although all of these are good reasons to implement a TPQCD, the first and second answers are especially important. For several years, tax malpractice claims have outnumbered accounting and audit claims; in fact, tax claims represent approximately 60% of all claims against CPAs. Thirty-five percent of the claims arising from tax issues are from individual returns (despite the increased use of tax software), 41% involve corporate returns, 4% are from tax planning and 4% from non-income-related corporate tax issues. Exhibit 1 presents causes of loss activity.

Exhibit 1: Causes of Loss Activity

                            1998   1997   1996

filing errors                24%    23%    22%
Election errors              35%    37%    42%
Preparation errors           26%    27%    19%
Negligent advice              7%     7%    11%
Engagement scope disputes     3%     4%     4%

Examples of claims filed during the three-year period 1996 through 1998 are:

* A CPA was engaged to file for an extension and prepared the tax return of an individual. The extension was granted until August 15, 1998. The client provided the CPA with the necessary documentation to finalize the return on June 1, 1998, but the CPA failed to prepare the return by the extended due date. The client incurred penalties and interest due to this error, which was not caught until the following April.

* A CPA firm was engaged to prepare corporate Federal and state tax returns. The state income tax return omitted a capital goods excise credit. The state statutes indicated that the capital goods excise credit must be claimed on a return or amended return within 12 months of the end of the tax year in which the credit may be elected. The error was not discovered until preparation of the next year's return, which was more than 12 months later.

* A CPA has been preparing annual tax returns for a client and his wife for over 10 years. The client suddenly calls the CPA to inquire as to the tax consequences of selling some stock to purchase real estate. The CPA provides the client with a general analysis of the potential impact the transaction will have, but finishes by asking the client to provide her with more information when the client has specifics of the stock he wants to sell and the cost of the real estate. The client goes forward with the transaction without any further advice or review by the CPA, and incurs significant capital gains tax. The client claims the CPA advised him that there would be no tax consequences as long as he purchased the real estate during the same tax period.

The above statistics and examples are based on CNA claim data from the AICPA Professional Liability Insurance Plans from 1996 through 1998. The AICPA Professional Liability Insurance Plan provides insurance to all size firms, from sole practitioners to group B firms.

Preparer penalties. The penalties (and other disciplinary procedures), although not very common, can be devastating. Return preparer penalties fall into four groups:

1. Sec. 6694--Negligent or Fraudulent Return Preparation;

2. Sec. 6695--Standards of Return Preparation;

3. Sec. 6107--Disclosure Penalties; and

4. Sec. 7407--Injunction for Improper Conduct.

Circular 230 also contains disciplinary procedures:

1. Section 10.50--Authority to Disbar or Suspend;

2. Section 10.51--Disreputable Conduct; and

3. Section 10.52--Violation of Regulations.

Violation of any of the provisions in Circular 230 can lead to temporary or permanent suspension of privilege to practice before the Treasury Department (including return preparation). In some cases, it can also lead to disciplinary action by other regulatory authorities, such as state Boards of Accountancy, the AICPA or the state CPA societies.

Developing a TPQCD

The second question is how a TPQCD can be developed, especially since (as previously discussed) none of the official pronouncements address quality control procedures for a tax practice.

The first place to look is the AICPA Tax Division's "Guidelines for Voluntary Tax Practice Review" (Guidelines) (product #061065YN). This document adapts QC Section 20 for a tax practice. This is done by making only one modification, changing "independence" which is contained in the first element of quality control, to "advocacy" This change is important: Although independence is critical to an accounting and auditing practice, it is not required in a tax practice; however, a tax practitioner is called on to be an advocate for a client.

Because the TPQCD is to provide a firm's road map through the elements of quality control, a solid understanding of these elements is required. (The following discussion of the five elements and how they should be applied in creating a TPQCD is taken from Section A of Guidelines--Statement on Guidelines for Tax Practice 'Quality Control.)

Advocacy, Integrity and Objectivity

In its tax practice, a firm acts as an advocate for the client. In fulfilling this role, the firm should establish policies and procedures to provide reasonable assurance that the personnel maintain independence (in fact and in appearance) in all required circumstances, perform all professional responsibilities with integrity and maintain objectivity in discharging professional responsibilities. As advocates, members of the firm seek to advance the client's position, as long as that position and their efforts are within standards set by the law and by the appropriate regulatory bodies. Positions advocated should not compromise the credibility of the practitioner or go beyond sound and reasonable practices, nor may they pose an unreasonable risk of impairing the reputation of the practitioner, or subordinate the practitioner's judgment to that of the client.

Personnel Management

Personnel management encompasses hiring, assigning personnel to engagements, professional development and advancement activities. A firm should establish policies and procedures to provide reasonable assurance that those hired possess the appropriate characteristics to enable them to perform competently. Work is assigned to personnel having the degree of technical training and proficiency required in the circumstances. Personnel participate in general and industry-specific continuing professional education (CPE) and other professional development activities that enable then to fulfill the responsibilities assigned and satisfy applicable CPE requirements. Personnel selected for advancement have the qualifications necessary for fulfilling the responsibilities they will be called on to assume.

Acceptance and Continuance of Clients and Engagements

A firm should establish policies and procedures for deciding whether to accept or continue a client relationship and whether to perform a specific engagement for that client. Such policies and procedures should provide the firm with reasonable assurance that the likelihood of association with a client whose management lacks integrity is minimized. These policies and procedures should also provide reasonable assurance that the firm undertakes only those engagements that can be completed with professional competence and appropriately consider the risk associated with providing these services.

Engagement Performance

A firm should establish policies and procedures to provide reasonable assurance that the work performed by engagement personnel meets applicable professional standards, regulatory requirements and the firm's standard of quality. These policies and procedures should encompass all phases of the engagement's design and execution. To the extent appropriate and as required by applicable professional standards, these policies and procedures should cover planning, performance, supervising, reviewing, documenting and communicating the results of each engagement. The extent of the appropriate supervision and review in a given situation depends on many factors, including the complexity of the subject matter, the risk of taxpayer or preparer penalties, the qualifications of the persons performing the work and the extent of the consultation available and used.

Monitoring

A firm should establish policies and procedures to provide it with assurance that the policies and procedures established for each of the elements of the quality control system are effectively applied and revised as practice needs change.

Sample QCDs

The Guidelines contain three sample QCDs, based on three different types of practice units--a sole-practitioner CPA firm with limited staff, a local CPA firm without a structured tax department and a local CPA firm with a structured tax department. Without examples, such as those in the Guidelines, the development of a TPQCD can be slow going. It is generally easier to "tweak" a model and adjust it to the firm's specific circumstances, its environment, size and structure than to start from scratch. Other firms' TPQCDs would also provide a good starting point. Although firms may be hesitant to share their entire documents, they might be willing to share an outline. Similarly sized firms from other regions may be more forthcoming, especially when a firm belongs to an association of firms.

Once this material is examined and digested and a TPQCD is implemented, the next step should be a tax practice self-review (inspection). The Guidelines provides all the tools required to do this with a minimum of downtime. Once a TPQCD is developed and a self-review conducted, a firm will be ready for the final step of a firm-on-firm tax practice review.

Editor: Steven F. Holub, CPA Pender, Newkirk & Company Tampa, FL

FROM JOSEPH F. SCUTELLARO, CPA JUMP, SCUTELLARO AND COMPANY TOMS RIVER, NJ3