Tax practitioners do their best to plan for every contingency. They make capital decisions to avoid the possibility that something in the system may break down during tax season. However, what if that breakdown applies to them and their own ability to perform? Too few sole practitioners have a plan in place to address a situation in which they may become unable to operate the practice due to disability or death.
Many clients would look elsewhere if their phone calls and e-mails were not answered for several weeks during tax season. Would practitioners’ spouses or assistants be able to keep the office running during a busy season without them?
Protecting the Practice
By one estimate, in the event of a sole practitioner’s sudden death where there is no practice continuation arrangement in operation, 20% of clients will leave within one week and another 21% will be gone by the end of the second week. Within a month, all but 20% of a firm’s clients will likely be lost to another tax professional (Gray, “Succession Planning,” Catalyst 22 (May–June 2009)).
A practice continuation agreement can help mitigate these losses and maintain a tax practice’s integrity in case of the practitioner’s disability or death. Such an agreement is a written contract between a sole practitioner and an acquiring CPA firm, which may be a larger firm. Who will take over the sole practitioner’s practice is the threshold question.
Generally a professional practice is built based upon relationships between the practitioner and his or her clients. Will a larger firm be able to provide the personal touch on which the sole practitioner has built the practice? On the other hand, will another sole practitioner be able to absorb the additional work of the disabled or deceased sole practitioner? Perhaps a small firm set up to absorb additional work in situations like this can take on additional clients while still providing the personal service clients require. How well will other stakeholders (e.g., employees, vendors, family members, etc.) work with the potential successor? The sole practitioner should develop a list of possible successor firms or practitioners and then carefully evaluate who is best qualified to take over the practice, because a practice continuation agreement will work out well only if there is a successful transition of the practice.
An effective practice continuation agreement contains strategies to deal with temporary and long-term disability as well as death. Its general provisions typically will address:
- Immediate coverage of accounting services. It is important in a tax practice to ensure a minimum delay or disruption of service so as to maximize client retention. In the case of disability, a long-term buyout provision comes into play after a certain period or when it becomes clear that the disability is permanent.
- Per diem payments to the practitioner or heirs. Based on revenues from retained clients, payments accrue to the practitioner and compensate staff. The acquiring firm is obligated to maintain the practitioner’s regular and usual fee structure.
- Guidelines for mandatory transfer of the accounting practice. This spells out terms for purchase in the event of the practitioner’s death or permanent disability.
- Termination provisions. If the disability is temporary, what happens when the sole practitioner is ready to return to practice?
Buyout or transfer provisions ideally include:
- A purchase price for the practice. Typically the practitioner is willing to accept slightly less than fair market value for the guarantee of a practice continuation agreement.
- Payout provisions. The normal term for a payout is between three and five years. Fees are due when the acquiring firm receives payment. Establishment of a minimum annual payment floor gives the practitioner a guaranteed payment regardless of client retention levels. Accounts receivable at the date of transfer belong to the practitioner.
- A covenant not to compete. In the case of disability, a noncompete agreement executed by the seller in relation to the acquiring firm is included as a general precaution.
- Assumption of leases and other obligations. Unless these terminate upon death or disability, arrangements specifying who will be responsible for these obligations must be clear.
- Allocation of assets in the practice. The exchange of Form 8594, Asset Acquisition Statements, by the buyer and seller facilitates this process.
- Terms for retaining staff. Plans for employment and integration of the practitioner’s key staff with the acquiring firm are detailed in the agreement.
Other elements of the practice continuation agreement may be covered less formally but still benefit from thorough consideration and planning.
- Conversion of files into the acquiring firm’s tax software. If practical, this is usually best accomplished in the off season.
- Notification of clients. Any communication must be strategically handled to maximize client retention. If a temporary disability provision is in force and the practitioner’s long-term health is in question, the preferred approach would position the change as a team effort involving the practitioner and the acquiring firm. A well-planned continuation agreement contains pre-approved, anticipatory wording for announcements regarding temporary disability, permanent disability, or death. This expedites the notification process and provides for a smoother transition.
- Staff notification. Having a plan in place for proper notification of staff can reduce turnover or—worse—staff “raiding” of clients.
- Checklist of important resources and phone numbers. Anyone assuming the responsibility for a practice will need this information.
- Documentation of office
procedures. The practitioner needs to provide the acquiring
firm with the following written instruction and
- The location and terms of the employee manual as well as time and payroll tax records.
- Computer passwords and contact information.
- Copies of leases for real property and equipment.
- Major vendors, such as a professional library service.
- All recent tax returns to assist in the transfer to the acquiring firm’s computers or conversion to different tax software.
In some instances it is not possible to execute a practice continuation agreement with a larger firm. If there is no suitable candidate in the immediate geographical area, the only choice may be to come to an agreement with a similarly sized firm. This presents a challenge. The potential for a sudden and overwhelming burden on the acquiring firm as it works to absorb and integrate a second practice could be a deterrent to negotiations. Thus, it is worth looking at ways to reduce the risks inherent in such a plan.
Cross life insurance policies can be structured to allow payment of an insurance settlement at death to offset the costs of acquiring a practice. Similarly, cross disability insurance can address the financial hardship for the acquiring firm if the disability buyout should come into effect. A disability situation may also call for a lower buyout price contingency and a plan for longer-term payout of the practice value.
Finally, before choosing a partner for an office continuation agreement, it is key for the sole practitioner to exercise due diligence and know the buyer’s reputation. A thorough investigation would examine any prior practice continuation agreements or purchases of practices by the acquiring firm.
Although it takes much thought and work, a properly executed practice continuation agreement can provide peace of mind to the sole practitioner and financial stability to his or her heirs.
Steven Holub is a partner in Cherry Bekaert & Holland, LLP, in Tampa, FL, and is former chair of the AICPA Tax Division’s Tax Practice Management Committee. Jane Rubin runs Educational Strategies Co. in St. Louis, MO, and is chair of the AICPA Tax Division’s Tax Practice Improvement Committee. Robert Caplan is a sole practitioner in Foster City, CA, and is a member of the Tax Practice Improvement Committee. For information about this column, contact Mr. Caplan at firstname.lastname@example.org.