Brainstorming to identify and manage tax risks: identifying and managing risks associated with tax engagements is critical for firms providing tax services. This article explains how firms can use brainstorming sessions effectively to identify and manage such risks, to protect both themselves and their clients.

• Author: Beasley, Mark S.

EXECUTIVE SUMMARY

* Brainstorming can be an effective tool for firms to identify risks of tax client acceptance and continuance, compliance and development and tax strategy recommendations.

* Techniques include open, round-robin and electronic brainstorming.

* Brainstorming sessions can be more effective in identifying tax risks when certain fundamental rules are followed.

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Risk management is critical for CPA firms and their clients today, due to an increased focus on corporate governance, greater Federal and state regulation and intensive scrutiny by the media and the general public. Press reports of widespread involvement by individuals and corporations in tax shelters have cast attention on tax advisers, who are increasingly under fire for developing and/or recommending such transactions to their clients. While most CPA firms are aware of the importance of managing the risks of financial statement audits, they can no longer ignore tax engagement risks. Otherwise, they will face malpractice suits, lose clients, damage their firm's reputation and incur Federal and state penalties. In addition to the normal array of preparer penalties assessed by the IRS and state revenue departments, firms are now also being disciplined by government entities.

This article describes how firms can identify potential risks associated with tax engagements by brainstorming. Firms can (1) manage risks within the firm to avoid malpractice claims, loss of clients and reputation risks and (2) help clients identify and manage risks related to tax functions.

Risks within the Firm

Managing risks within a firm generally centers on (1) client acceptance and continuance, (2) compliance and (3) development and recommendation of tax strategies.

Client Acceptance and Continuance

A prospective client's appetite for risk may not always be acceptable to a firm. For example, does the client's aggressiveness in tax planning translate to practices that stretch its compliance with statutes and regulations? Does the client consistently interpret tax compliance requirements beyond normal, acceptable views? If so, the firm may have to fire the client or not accept the engagement.

Additionally, a CPA firm has to assess whether it can adequately service clients. For example, does it have sufficient expertise and resources to advise on multiple taxing jurisdictions on myriad tax issues? Does it have expertise in sales and use tax, as well as income tax? Can it deal effectively with foreign tax, as well as U.S. taxation?

Compliance Engagements

While taxpayers retain ultimate responsibility for complying with tax law, they frequently blame their CPA firm for post-audit tax bills, interest and penalties. They often accuse the firm of providing inadequate or faulty advice, not notifying them about a compliance obligation or not warning them of potential risks associated with a tax return position--regardless of whether the firm has been explicitly engaged to file the particular return or advise about a particular transaction. While the use of engagement letters can help minimize misunderstandings between firms and their clients, the risk associated with compliance engagements should still be assessed because they may be largely influenced by the client's competency and tax expertise.

Development and Recommendation of Tax Strategies

Tax professionals have the responsibility to help clients minimize their tax liabilities and advocate on their clients' behalf. Also, they have to avoid taxpayer and preparer penalties for recommending overly aggressive return reporting strategies. For example, penalties have been assessed for taking return positions that do not have a realistic possibility of success, have no substantial authority or do not meet other standards as outlined in the Code, the AICPA's Statements on Standards for Tax Services and Circular 230. (1)

Over the last few years, however, the penalty potential for developing and recommending abusive tax strategies has increased substantially. For example, the American Jobs Creation Act of 2004 (AJCA) enhanced penalties aimed at both taxpayers and promoters of abusive tax shelters. These penalties include $200,000 fines for corporate taxpayers that do not disclose participation in so-called "listed" transactions; promoters are fined 50% of the gross income derived from abusive transactions. (2) Besides penalties and fines, tax professionals and...