WHY WE NEED TAX ENGAGEMENT LETTERS
Why we need engagement letters
Accounting firms of all sizes continue to be subject to claims and lawsuits arising from tax services. More than two-thirds of professional liability claims in the AICPA Professional Liability Insurance Program arise from client allegations of professional lapses in tax practice. In such disputes, your engagement letter could become a crucial controlling factor in determining the responsibilities of both parties.
A review of claims maintained over several years for the AICPA Professional Liability Insurance Program reveals that in over 40% of all claims, no engagement letter was issued.
5500 - QUALIFIED RETIREMENT PLAN RETURN ENGAGEMENT LETTER
CLIENT NAME
STREET ADDRESS
CITY, STATE ZIP
Subject: Preparation of Your Qualified Retirement Plan Tax Returns
Dear ADMINISTRATOR NAME:
Thank you for selecting (YOUR FIRM NAME) to assist you with tax compliance for the (NAME OF PLAN). This letter confirms the terms of our engagement for the plan year ended YEAR(0000) and clarifies the tax services we will provide. To indicate that the letter correctly states your understanding of our and mutual responsibilities, we ask you to confirm that by returning a signed copy.
We will prepare your YEAR(0000) Form 5500 (or other 5500 series form) from information you provide. We may need to ask you for clarification of some of the information, but we will not audit or otherwise verify the data you submit. We will provide checklists, questionnaires, and/or worksheets to help you efficiently gather information required for a complete return. Use of the forms will assure that pertinent information is not overlooked.
Your responsibilities include providing information required for preparation of a complete and accurate return. Documents and other data that support the Form 5500 filing may be needed to prove the accuracy and completeness of the returns to the IRS and/or Department of Labor should the return be selected for examination, so you should retain all original documents. Since you have final responsibility for the return, you should review it carefully before you sign it.
Our work in connection with preparation of your Form 5500 does not include procedures to verify your representations, or to discover defalcations or other irregularities, including the presence of “prohibited transactions.”
The law imposes substantial penalties on “prohibited transactions”. If you would like information about those penalties, or you would like us to include procedures to detect them should they be present, please call this officeus.
We will use our judgment in resolving questions where the tax law is unclear, or where there may be conflicts between the taxing authorities’ interpretations of the law and other supportable positions. We will apply the “more likely than not” reliance standard to resolve such issues in order to avoid penalties that might be assessed against us as return preparers. You agree to honor our decisions regarding disclosure of return positions to avoid or mitigate penalties.
Penalties of as much as $100,000 can be imposed on the plan for failing to disclose participation in “reportable transactions,” that is, certain arrangement the IRS has identified as potentially abusive. We will insist that all such transactions be properly disclosed.
Unless you instruct us otherwise, we will apply the “realistic possibility of success” standard to resolve such issues in your favor where possible.
The Internal Revenue Service and/or the Department of Labor may select any Form 5500 for examination. Proposed corrective adjustments by an examining agent are subject to appeal. We can arrange to be available upon request to represent you in the event of such government examination. That service is not included in our engagement to prepare returns. We will prepare a separate engagement letter for it and render additional invoices for fees and expenses incurred.
Our fee for preparing the returns discussed above will be based on the time required at standard billing rates plus out-of-pocket expenses. All invoices are due and payable upon presentation. To the extent allowed by state law, an interest charge will be added to all accounts not paid within thirty (30) days.
We retain copies of the records you supply to us along with our work papers for your engagement for seven years. After seven years, our work papers and engagement files are destroyed. All of your original records will be returned to you at the end of this engagement, and you should store them securely.
This engagement letter relates only to the plan(s) specified above. Please notify us if you have additional employee benefit plans that require our attention.
To affirm indicate that the contents of this letter describe your understanding of the service we are to provide, please sign the enclosed copy in the space indicated and return it to us in the envelope provided.
If there are other projects you would like to discuss, or if you have comments you wish to call to our attention, please note those just below your signature.
We appreciate your confidence in our firm.
Sincerely,
YOUR FIRM NAME
______
ACCOUNTANT IN CHARGE
Accepted By: ______
Title ______
Date: ______
Sincerely,
YOUR FIRM NAME
ACCOUNTANT IN CHARGE
Accepted By:
Date:
Introducing Engagement Letters to Clients
Proper communication of your firm’s risk management program is important. Although other accounting firms may have used engagement letters for years, introducing them in your practice may be new to many clients and will require some advance preparation.
Be prepared to explain to the client why an engagement letter is required. Make the explanation from the client’s perspective to help build understanding of the change. An engagement letter:
· Defines the services the accountant is being engaged to perform;
· Identifies engagement responsibilities of both the accountant and the client;
· Explains fees, billing, and payment terms; and
· Assures the client that additional services will not be initiated without advance approval
You may wish to emphasize that engagement letters will be required of all clients.
Some accountants also mention “insurance requirements” when introducing engagement letters into a client relationship for the first time.
It is best for the accountant in charge of a client relationship to discuss the contents of an engagement letter with the client before its delivery for signature. That allows time for review and consideration of the scope of the engagement, any agreed upon limitations, client responsibilities, engagement staffing and time considerations, billing and payment terms, and other relevant matters before the letter is finalized.
Policy
Your Company’s policy should be to use engagement letters for all tax return engagements, all audits by taxing authorities, and all tax consulting engagements.
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TAX ENGAGEMENT LETTER EXAMPLES
Here are examples of letters you can use to document the terms of an engagement for:
§ Estate Tax Return (Form 706)
§ Individual Income Tax Return (Form 1040)
§ Income Tax Return for Estate or Trust (Form 1041)
§ Income Tax Return for Partnership/LLP/LLC (Form 1065)
§ Corporation Income Tax Return (Form 1120)
§ S Corporation Income Tax Return (Form 1120S)
§ Qualified Retirement Plan Return (Form 5500)
§ Examination of Returns
§ Tax Advice protected by Confidentiality Privilege
We also have included several optional paragraphs that you might use instead of paragraphs in the examples, or to provide additional information. Optional paragraphs discuss:
substantial understatement penalty disclosures,
disclosure of reportable transactions
limiting the scope of the engagement,
client records,
use of an outside processing service,
outside disclosure for peer review programs,
finance charges,
the negligence penalty, and
electronic filing.
We recommend use of engagement letters for all tax services. In order to assure that their content is appropriate, you should review them carefully and modify them for your use. Be sure to consider the following:
Treasury Circular 230, Standards of Practice
AICPA Statements on Standards for Tax Services,
State law relating to disclosure of finance charges,
State Board of Accountancy rules regarding disclosure of outside processing,
Value of signed confirmation of arrangements when dealing with complex matters, and
Need for separate engagement letter, or separate language, for separate services (such as providing privileged tax advice, or preparing certain state returns).
These letters serve as examples. Please read them carefully and consider the engagement you are attempting to document. Engagement letters can and should be tailored to the specific circumstances of each engagement. A “canned” engagement letter might be more dangerous than none at all.
Before introducing engagement letters into your tax practice, we urge you to consult your attorney, or discuss the matter with your professional liability insurer. They may have important information that will affect how you use engagement letters and what your engagement letters must contain to comply with rules in your state.
706 - ESTATE AND INHERITANCE TAX RETURN ENGAGEMENT LETTER
Dear FIDUCUARY NAME:
Thank you for selecting (YOUR FIRM NAME) to assist you with tax compliance for the (NAME OF ESTATE). This letter confirms the terms of our engagement and clarifies the nature and extent of services we will provide. To assure mutual understanding of our responsibilities, please confirm arrangements for our services by signing and returning the enclosed copy of this letter.
We will prepare required federal and state estate and inheritance tax returns from information you furnish to us. While we may ask you for clarification of some of the information, we will not audit or otherwise verify any data you provide. We will provide checklists, questionnaires, and/or worksheets to help you secure the necessary information. Please use those forms to be sure important information is not overlooked.
It is your responsibility to provide information required for preparation of complete and accurate returns. You should keep all documents, appraisals, and other data that support the calculation of the gross estate and allowable deductions. Because taxing authorities frequently challenge values, and review documentation, assumptions, and calculations, they may be needed to prove the accuracy and completeness of the returns. You have final responsibility for the estate and inheritance tax returns and you should review them carefully before you sign them.
Our work in connection with preparation of the estate and inheritance tax returns will not include procedures to discover defalcations or other irregularities. Nor do we warrant the accuracy of any valuations or the appropriateness of values used in the preparation of the returns.
We will use our judgment in resolving questions where the tax law is unclear, or where there may be conflicts between the taxing authorities’ interpretations of the law and other supportable positions. Unless you instruct us otherwise, we will apply the “realistic possibility of success” standard to resolve such issues in your favor where possible.
The law includes penalties that may be imposed when taxpayers understate their tax liability. If you would like information about those penalties, please call this office
Your returns may be selected for review by the taxing authorities. Any proposed adjustments by an examining agent are subject to certain rights of appeal. In the event of such an examination, we can arrange to be available at your request to represent you. A separate engagement letter will be provided for such services. Our fee for return preparation does not include representing you in any examination or dispute with the taxing authorities.
Our fee for these services will be based upon the amount of time required at standard billing rates plus out-of-pocket expenses. All invoices are due and payable upon presentation. To the extent allowed by state law, an interest charge may be added to all accounts not paid within thirty (30) days.
We retain copies of the records you have supplied to us along with our work papers for your engagement for seven years. After seven years, our work papers and engagement files are destroyed. All original records will be returned to you when the returns are completed. You should keep the original records in secure storage.
To indicate that, this letter correctly summarizes your understanding of the arrangements for this work, please sign the enclosed copy of this letter in the space indicated and return it to us in the envelope provided.
Thank you for your confidence in our firm.
Sincerely,
YOUR FIRM NAME
______
ACCOUNTANT IN CHARGE
Accepted By:
Date:
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1040 - INDIVIDUAL TAX RETURN ENGAGEMENT LETTER
Dear CLIENT NAME:
Thank you for selecting (YOUR FIRM NAME) to assist you with your tax affairs. This letter confirms the terms of our engagement with you and the nature and extent of services we will provide.
We will prepare your (0000) federal and all state income tax returns you request using information you provide to us. WE may ask for clarification of some items, but we will not audit or otherwise verify the data you submit. We’ve enclosed an “Organizer” to help you gather the information required for a complete return. If you use the Organizer, it will help you avoid overlooking important information and contribute to efficient preparation of your returns. That helps keep the cost of our services as low as possible.
It is your responsibility to provide information required for preparation of complete and accurate returns. You should keep all documents, canceled checks and other data that support your reported income and deductions. They may be necessary to prove accuracy and completeness of the returns to a taxing authority. You are responsible for the returns, so you should review them carefully before you sign them.
Our work will not include any procedures to discover defalcations or other irregularities. The only accounting or analysis work we will do is that which is necessary for preparation of your income tax returns.
We will use our judgment in resolving questions where the tax law is unclear, or where there may be conflicts between the taxing authorities’ interpretations of the law and other supportable positions. Unless you instruct us otherwise, we will apply the “realistic possibility of success” standard to resolve such issues in your favor where possible.
The law imposes penalties when taxpayers understate their tax liability. If you have concerns about such penalties, please call us.
Your returns may be selected for audit by a taxing authority. Any proposed adjustments are subject to appeal. In the event of a tax examination, we can arrange to be available to represent you. Such representation will be a separate engagement for which an engagement letter will be provided to you. Fees and expenses for defending the returns will be invoiced in accordance with terms we agree on for that engagement.