Texas court reduces limitations period.

The Texas Court of Appeals, Austin, ruled that the statute of limitations in a tax malpractice case begins on the date the Internal Revenue Service issues a notice of deficiency to the taxpayer. In this case, the court reduced the period during which an accounting firm can be sued for malpractice.

This case began in 1980 when the shareholders of Colonial Food Stores engaged Touche Ross to act as the company's tax accountants and auditors. In 1983 the shareholders decided to sell Colonial if each shareholder could realize $2 million from the sale after payment of the corporation's federal income tax. The firm was asked to advise on the tax aspects of the sale.

The buyer proposed a tax treatment that would allow the shareholders to realize the amount they wanted at a price the buyer was willing to pay. On April 27, 1983, the firm told the shareholders this tax treatment was acceptable and would yield each shareholder $2 million after taxes. Based on this representation, the shareholders accepted the buyer's proposal.

Colonial was dissolved and its assets distributed on April 24, 1984. The IRS issued a notice of tax deficiency, due to the tax treatment of the sale, on June 11, 1987, and the Tax Court rendered a judgment against Colonial for the deficiency on November 16, 1989.

The shareholders did not file a malpractice suit against the firm until June 11, 1991. Their suit alleged both negligence by the firm in giving tax advice and fraud based on a conflict of interest. It claimed the firm had given tax advice to both the buyer and the seller during the sale. All the parties involved agreed that a four-year statute-of-limitations period applied to the fraud claim and a two-year period applied to the negligence claim. However, they disagreed about when the clock started. The firm argued that the cause of action began when the shareholders received the notice of deficiency from the IRS, while the shareholders argued it was when the Tax Court rendered its judgment.

In ruling for the accounting firm, the appeals court noted that an IRS notice of deficiency clearly informs the taxpayer that the IRS will seek additional taxes and creates a specific and substantial risk that the taxpayer actually will face additional tax liability. Such a notice triggers the requisite concrete risk of tax liability that starts the statute-of-limitations period. Accordingly, the appeals court ruled that all of the shareholders' claims, with the exception of the fraud action, were barred by limitations.

By electing the deficiency notice date as the operable date for the running of the statute, the Texas Court of Appeals shortened the period during which firms must be alert to potential claims arising from tax advice and preparation. (Estate of Rochester et al. v. Robert Campbell et al., Court of Appeals of Texas, Austin, WL 688656, November 22, 1995)