Technology QC issues in tax practice.

In the aftermath of Enron and the enactment of the Sarbanes-Oxley Act of 2002 (SOA), CPA firms have recognized the importance of reapprising their audit quality control (QC) standards. However, limiting such efforts to audit services is shortsighted, especially when one combines the SOA's effect with the recent revisions to IRS Circular 230, state CPA licensing requirements and, most importantly, the AICPA's Statements on Standards for Tax Services (SSTSs) (available at www.aicpa.org/download/tax/SSTSfinal.pdf). These pronouncements clarify that failing to enhance tax practice QC systems could expose professionals to liability. Fortunately, numerous technological tools and resources for enhancing these systems are available through the AICPA and various publishers and software makers.

Firms of all sizes need to evaluate their tax practice QC systems. This column offers information on technological resources and how to apply them.

Background

Since 1997, AICPA Professional Standards have defined five QC elements for accounting and auditing:

* Independence, integrity and objectivity;

* Personnel management;

* Acceptance and continuance of clients and engagements;

* Engagement performance; and

* Monitoring.

These elements form the foundation of any CPA firm's QC system, whether accounting, auditing or tax. Although a tax practice is not required to have a QC system under either the AICPA Professional Standards or Circular 230 (for professionals practicing before the IRS), the AICPA has urged firms to adopt one. Its Guidelines for Voluntary Tax Practice Review adapted the five QC elements for accounting and auditing to tax practice by making only one modification--changing "independence" to "advocacy." This was an appropriate change: although independence is critical to accounting and auditing, it is not always required in tax practice. Rather, a tax practitioner/adviser is frequently called on to be a client's advocate.

Guidelines addresses the QC systems appropriate to (1) sole practitioners, (2) local firms without a tax department, (3) local firms with a tax department and (4) medium-sized firms with a tax department.

Implementing a QC System

A strong QC system reasonably assures a firm or sole practitioner that he or she is complying with ethical requirements while, at the same time, limiting liability exposure. QC systems should be reviewed periodically to ensure compliance and encourage enhancement and change, when necessary. Outside reviewers should be periodically evaluated as well, as is the case with accounting and auditing.

QC manual: Every firm should have a tax practice QC manual, outlining in-house policies and procedures and providing checklists for various services. The AICPA'S Tax Practice Quality Control Guide assists Tax Section members in creating such a manual and implementing a QC system; see www.cpa2biz.com/ResourceCenters/Tax/Tax+Practice/default.htm. The AICPA also offers Tax Practice Guides and Checklists, in both Microsoft Word[TM] and Adobe Acrobat[TM] formats, available on CD-ROM. Other publishers offer similar products.

Communication: Even an excellent QC system is useless unless it is rolled out properly to firm members in the context of the professional standards and ethical guidelines. For new staff, the starting point should be a training session outlining the firm's systems and procedures. This training should be combined with a formal tax continuing education program that updates staff on technical issues. Firm employees also need to understand the firm's privacy guidelines and the parameters of CPA-client confidentiality, particularly Sec. 7525's limited accountant-client privilege rules.

Further, the practitioner's role, responsibilities and limits should be communicated to clients, as well as the latter's part in providing the data necessary to perform the services desired. To clarify responsibilities, the firm should use an engagement letter; a cover letter should accompany any tax returns or written advice. The letter should outline the assumptions and nature of the work performed and any restrictions. Any digression from firm policy and procedures should be formally approved and documented by a "responsible partner."

Technology: Documentation procedures should integrate traditional written methods with digital communication systems. E-mail is one of the most valuable tools available to expedite the resolution of questions on a return and to document the source and timing of a client's response. It is particularly useful in complying with many of the SSTSs, as discussed below.

However, practitioners often need remote access to e-mail to communicate and to do tax research in the field, which can be cumbersome. The ability to access e-mail remotely has increased somewhat with the introduction of wireless platforms--offering a phone, e-mail and data all in one--such as BlackBerry[R] products and other "smartphones" and "pocket" PCs.

Despite these technological advances, however, conducting Internet tax research while away from the office can still be difficult. But, exciting new technology, such as an "express network connection," now being offered by the major cell-phone companies, is an improvement. This service does not require close proximity to a "hot spot" or the need for a wired computer network for e-mail or Internet-based tax research. It offers not only e-mail access, but also fast Internet access, for a minimal monthly charge. Express network connections require a special data card (costing $99-$150) for insertion into a notebook computer.

Several vendors offer tools that can provide written documentation of a response to a client's questions. These products, such as "TaxTools," by CFS Tax Systems, Inc. and "Tax Answer" by Image One[R] (formerly Independent Preparer Services), offer templates and worksheets that can personalize client work and bill accordingly.

QC Systems and Tax Practice

Technology offers several tools that can enhance a tax adviser's compliance with the SSTSs.

SSTS No. 1, Tax Return Positions:

According to this statement, to meet the standards for a return position:

A member should in good faith believe that the tax return position is warranted in existing law or can be supported by a good-faith argument for an extension, modification, or reversal of existing law. For example, in reaching such a conclusion, a member may consider a well-reasoned construction of the applicable statute, well-reasoned articles or treatises, or pronouncements issued by the applicable taxing authority....

The tax research process has been enhanced tremendously by Internet access to research libraries from client locations and by new research tools that can bridge with ease the generation of a tax memorandum into a word-processing or spreadsheet application. These tools also help to ensure an updated research source.

SSTS No. 2, Answers to Questions on Returns: To comply with this standard, which requires tax preparers to "make a reasonable effort to obtain from the taxpayer the information necessary to provide appropriate answers to all questions in a tax return ...," most software vendors now include electronic organizers in their tax preparation software. This usually allows specific information about a taxpayer to be readily copied to his or her tax return preparation file. The organizers include many important questions integral to completing returns properly, such as: "Do you have a household employee?" "Do you have a foreign bank account?" Organizers normally do not include state-specific questions, which also need to be addressed by return preparers.

SSTS No. 3, Certain Procedural Aspects of Preparing Returns: This standard recognizes that information used in preparing returns is primarily the taxpayer's responsibility. Preparers can resolve open items or unanswered questions, and document responses simply by requesting the client to transmit information via e-mail.

SSTS No. 4, Use of Estimates: This standard allows a preparer to use estimates when obtaining actual data is not possible. Electronic communication of these "estimates" by the client via e-mail, for example, serves to document the source of the data used on a return and when it was communicated.

SSTS Nos. 6, Knowledge of Error: Return Preparation, and 7, Knowledge of Error: Administrative Proceedings: These two standards require a preparer to communicate to a client discovery of an error in (1) a prior-year return or (2) an administrative procedure, respectively. The preparer must also quantify the consequences of such an error, by estimating the additional tax and any penalties and interest. The use of e-mail documents such communications, while other software applications (such as spreadsheets) can compute the related penalties and interest.

The Paperless Office

QC systems in the 21st century will be functioning in a paperless office, triggered by the need to control storage costs, enhance quick access to client information from remote locations and eliminate costly searches for lost client records. The major software preparation firms and independent sellers of paperless office software have embraced this reality and are eager to assist in the transition.

Final regs. approve paperless filing systems: Final regulations (TD 9119, 3/25/04) adopted the temporary regulations (TD 9053, 4/24/03) on signing returns and retaining copies, without change. The regulations permit preparers to maintain electronic (paperless) filing systems. Specifically, tax preparers can avoid keeping paper copies and, instead, digitally retain and furnish copies of returns to taxpayers in an electronic or digital format approved by the IRS (e.g., .pdf format, which is a digital snapshot of a document that is read-only and cannot be edited).

The temporary regulations eliminated the references to manually signed returns in Regs. Sec. 1.6695-1(b). In addition, the Service may prescribe in forms, instructions or other appropriate guidance, the manner in which preparers may satisfy their obligations under Sec. 6107 to furnish returns to taxpayers and to retain copies.

Current tax preparation software enables practitioners to save tax returns in .pdf file format.

Arguments in favor: Technology has given the tax professional the opportunity to digitize copies of tax returns and the volumes of supporting information and documentation that are part of the tax preparation and planning record. Besides eliminating errors, a paperless office has several other advantages, including the ability to:

* Cut down on filing space, making it available for other uses;

* Access data from a central location;

* Access data remotely;

* Archive information more efficiently;

* Reduce the time consumed in searching for misfiled and misplaced client information;

* Eliminate manual tasks; and

* Streamline engagement workflow.

Implementation: A commitment of financial resources to staffing is needed to make the transition to a paperless office, as is an upfront investment in hardware and software. Some firms with strong in-house, electronic data-processing staff can implement the conversion with generic software applications. But, firms without dedicated staff should use third-party software.

Software: Most major software makers recognize the importance of embracing paperless office applications, to retain and build on their existing client base. Software applications can assist in the movement of physical files, and combine and convert documents; see the exhibit at left.

Hardware: Major hardware manufacturers offer multifunctional copiers, scanners and printers to facilitate software application. Their speed and capabilities continue to increase, even as the cost of hardware continues to decline.

Conclusion

Today, an effective QC system is crucial to an ethical performance of tax work by CPA firms of all sizes. Further, liability exposure is an immediate cause for concern and peer review could be just around the corner. Computer technology has made the enhancement of tax QC systems an achievable goal.

Exhibit: How technology can increase tax practice QC, functionality,
coordination and efficiency

Remote access             Electronic binders or folders mimic physical
                          files and are stored securely in a "digital
                          central file room." This enables those with
                          authorized access to copy binders and to work
                          simultaneously on an engagement, from their
                          office, home, a client's office or elsewhere.

Fast communication        Electronic management of binders can promptly
                          handle open items, review notes, worksheets
                          and workpaper delegation. It can update files
                          with the latest revisions and enable an
                          engagement team to respond quickly to
                          matters.

Improved workflow         An electronic system can update and
                          synchronize Microsoft Word[TM] and Excel[TM]
                          files with the trial balance. It can
                          automatically update workpapers, lead-sheets
                          and financial statements for journal entries.

Accounting and return     An electronic system can bridge all trial
preparation integration   balance changes directly to tax returns.

Co-Editors:

Steven E Holub, CPA

Aidman, Piser & Co.

Tampa, FL

T. Chris Muirhead, CPA

Porter, Muirhead, Cornia & Howard

Casper, WY

Author:

Stephen P. Valenti, CPA

Stephen P. Valenti, CPA

Plainview, NY

Editor's note: Mr. Holub is the former chair of the AICPA Tax Division's Tax Practice Management Committee. Mr. Muirhead is the Chair of the AICPA Tax Division's Tax Practice Improvement Committee. Mr. Valenti is a member of that Committee.

For more information about this column, contact Mr. Holub at [phone] or [e-mail], or Mr. Valenti at [phone] or [e-mail].