Setting proper boundaries with a clear, concise engagement letter.

• Author: Moise, Robert M.

Although tax engagement letters are often the topic of discussion in professional journals and presentations, in many situations CPAs neglect to use this tax management tool. As a result, the importance of reviewing this method to reach an understanding with clients is always relevant. Every CPA (and client) needs to know what is expected of both parties in a professional engagement.

Ralph Picardi, a risk management consultant to North American Professional Liability Insurance Agency (NAF'LIA), stated in an April 2014 interview with Alexandra Swan of NAPLIA that for malpractice claims against CPAs, "Mndustry statistics have generally shown that the largest number of claims comes out of the tax side of the practice, while the highest severity claims come out of the accounting and auditing side of the practice." Because of the legal cost of defending tax malpractice claims, accountants' risk management programs need to include a good understanding between both parties to the engagement.

CPAs in practice are constantly reminded by their professional liability carriers to issue engagement letters and request that their clients read them and indicate they understand and accept the terms presented. In professional liability litigation, the first question from the defense attorney is usually, "Did you have an engagement letter?"To help reduce their exposure to malpractice claims, many professional liability insurance carriers will present free risk management seminars, and some include a premium discount for attending. Most of these seminars specifically cover tax services engagement letters.

This column considers the contractual nature of engagement letters. In addition, it addresses some common criteria that should be considered, and terms that should be included in, most engagement letters.

Contractual Status of Engagement Letters

An "engagement letter" is not a "con-tract"--or is it? An engagement letter can form a basis for an enforceable contract (see "Engagement Letters for the Individual Tax Practitioner," 217 Journal of Accountancy 32 (January 2014)). However, even if a court concludes that the engagement letter is a contract, only certain terms may become the subject of a malpractice suit. In the cases cited below (Apple Bank for Savings v. Pricewater-bouseCoopers, 18 Misc, 3d 1137(A) (N.Y. Sup. Ct. 2008), rev'd, 895 N.Y.S.2d 361 (N.Y. App. Div. 2010), and Tayebi v. KPMG, 18 Misc. 3d 1139(A) (N.Y. Sup. Ct. 2008)), sections of the engagement letter were called into question. These rulings reinforce the importance of careful wording.

Regardless of the contractual status of engagement letters, it is clear that these communications serve the important function of communicating with the client, from the accountant's perspective, the professional work to be performed, the terms and conditions of performing that work, any limitations on that work, and what the professional expects from the client, including the terms and conditions for payment.

In addition to clarifying the services to be performed in the agreed-upon engagement, the engagement letter can also be used to promote possible related extended services arising from the subject matter that are beyond the specific scope of the engagement and for which the accountant has not in fact been engaged.

Mentioning other, related, extended services that are available strongly implies that these services are not a part of the present engagement as the CPA understands it. A provision excluding all other services except those specifically described should effectively limit the scope of services.

The need to solicit the client's understanding of, and agreement to, the terms of an engagement letter cannot be overemphasized. As in any business transaction, all concerned parties should understand the expectations of each party as to their contribution in completing the task at hand. All aspects of the engagement should be included. If a formal tax engagement proposal was submitted to the client, the specific obligations usually have already been stated, and the engagement letter operates as an acceptance, with any changes noted, to the terms of the proposal. For this reason, the terms presented in the formal proposal should be reviewed in conjunction with the drafting of the tax engagement letter to reduce any potential misunderstandings. While a proposal can include promotional ideas such as a discussion of how competent the...