Why and How to Conduct a Tax Practice Inspection

By Mark A. Sellner, CPA, J.D., LL.M., CFP

Co-Editors: Steven F. Holub, CPA, and Jane T. Rubin, CPA

As an accounting firm expands its practice, personnel, and geographic locations, it becomes more challenging to ensure that an effective system of tax quality control is in place to identify and assess high-risk engagements. These engagements can cause trouble for both the client and the tax adviser. For example, the author's firm had a client who had been presented a plan by a management company for moving to the U.S. Virgin Islands and claiming a 90% exemption from income tax on his U.S.-based business income. The firm terminated its long-standing individual income tax engagement after the client declined to engage the firm to research and assess the proposal. Even though the firm terminated the engagement, the author was subsequently subpoenaed as a trial witness for the IRS, which reportedly has surveillance tapes and wiretaps of the client to support its case of criminal tax evasion against him and the management company. Fortunately, a tax quality control system was operating that precluded a continued engagement with this client.

Tax quality control is a firmwide issue, not just a tax department concern. At the grand jury deposition, the assistant U.S. attorney asked whether the chairman of the firm had been involved in the discussions of the U.S. Virgin Islands tax proposal. He had not, but he would have been had the matter not been resolved to the satisfaction of the managing partner of tax.

The tone at the top—senior management's commitment to an ethical culture of advocacy, integrity, and objectivity in the firm's tax practice—and senior management's willingness to lead by example in holding all professionals across the firm to the same ethical rules may be the most critical elements in ensuring that all professionals providing tax services are doing the right thing. To that end, a tax practice inspection can assess the degree of compliance with a firm's tax quality control program.

Circular 230 encourages tax practitioners to aspire to follow best practices in providing tax services. A firm can use a tax practice inspection as a tool to test the quality of tax services provided to clients, to develop specific recommendations for improvement, and to prepare or update a tax services policies and procedures manual.

How to Conduct a Tax Practice Inspection

Using the AICPA's voluntary tax practice review guidelines, a tax practice inspection can be planned and conducted as a peer review–type assessment of a single office or a multi-location tax practice for compliance with accounting firm, IRS, state, and professional ethics and practice rules. The reviewer can use checklists and interview forms to implement the approach. (The AICPA Tax Quality Control Task Force is in the process of updating its Tax Practice Quality Control Guide and Guidelines for Voluntary Tax Practice Review .)

Tax Practice Rules

Rules a firm should consider in planning and conducting a tax practice inspection include:

  • Accounting firm policies, including new client acceptance and client retention procedures; tax return review, processing, and signing procedures; and tax research and planning guidelines;
  • Internal Revenue Code provisions, such as the Sec. 6694 preparer penalty rules and the restrictions on disclosure or use of tax information by return preparers under Sec. 7216;
  • Circular 230, including best practices for tax advisers in §10.33 and the more-likely-than-not standard for written tax advice in §10.35;
  • Statements on Standards for Tax Services (SSTS), the enforceable standards adopted by the AICPA (an exposure draft of updated SSTS has been issued for comment);
  • State board of accountancy rules (usually available at each state board's website); and
  • State CPA society rules.

Case Study

A tax practice inspection was conducted just before tax season for a multi-office, top-25 national CPA firm. The firm's larger offices have separate tax departments; the smaller offices combine audit and tax services.

The process included the following steps:

Issuance and acceptance of an engagement letter: The engagement letter clearly identified the scope of the review and the deliverables, such as a written report that presented the findings and provided specific recommendations for improvement.

It was agreed that the review of client files complied with the IRS and any state board or state society confidentiality rules. The engagement letter also addressed limitations on liability and fees and expenses.

Agreement on a timeline and schedule: The timing of the review and the deadline for deliverables, selection of internal reviewers, and scheduling of office visits were established.

Preparation of a discussion outline for reviewed offices: The discussion outline served as a guide for providing an overview of the reviewed office's tax practice. The office's partner in charge of tax discussed it with the team captain of the tax practice inspection. Written responses were not prepared.

Topics discussed included an overview of the office's tax practice, tax policies and procedures, tax personnel and tax client base, and tax return and tax consulting processes.

Use of a tax engagement review checklist: The checklist served as a guide for reviewing each selected tax engagement. Each checklist was submitted to the team captain of the tax practice inspection, and copies were not retained.

Because it was not practical to review every aspect of each selected tax return or tax planning and tax research engagement, the reviewers exercised professional judgment in making an assessment of, and providing comments on, the overall quality and correctness of the work product.

Preparation of a discussion outline for staff providing tax services: The discussion outline served as a guide for providing an overview of the reviewed office's tax practice. A sample of staff providing tax services discussed it individually with the team captain of the tax practice inspection. Written responses were not prepared.

Topics discussed included an overview of the office's tax practice, tax policies and procedures, tax personnel and tax client base, and tax return and tax consulting processes.

Presentation of tax practice inspection results: The agenda for presenting the results of the tax practice inspection included the scope of the review, a summary of the deliverables, an executive summary of the findings, next steps for adopting specific recommendations for improvement, and the adoption of a tax services policies and procedures manual.

A summary of the deliverables provided an assessment of the quality of tax services and specific recommendations for improvement, an assessment of best practices for tax advisers, and a tax services policies and procedures manual.

The tax services manual addressed the following issues in accordance with the SSTS and Circular 230:

  • Tax return positions;
  • Answers to questions on tax returns;
  • Certain procedural aspects of preparing returns;
  • Use of estimates;
  • Departure from a position previously concluded in an administrative proceeding or court decision;
  • Knowledge of error: return preparation;
  • Knowledge of error: administrative proceedings;
  • Form and content of advice to taxpayers;
  • Issuance of written tax opinions;
  • Taxpayer disclosure of reportable transactions;
  • Preparation of returns for nonfilers;
  • Provision of tax information to third parties and former clients;
  • Conflicts of interest; and
  • Tax services for publicly traded assurance clients.

A written report was provided to the partner in charge of tax, who presented the findings to the firm's management committee. The firm provided the results of the tax practice inspection, along with tax ethics training, to all the firm's tax personnel at its annual tax update.

Conclusion

An effective tax quality control system is a firmwide risk management tool. A tax practice inspection can assess the degree of compliance with a firm's tax quality control program. Deliverables from the process could include specific recommendations for improvement and a policies and procedures manual for distribution to all personnel providing tax services.

Adapted with permission from an article by the author that appeared in the Minnesota Society of Certified Public Accountants' Footnote magazine, October 2008, pp. 15–17.


EditorNotes

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. Mark Sellner is director of graduate studies in taxation and a professor at the Carlson School of Management at the University of Minnesota in Minneapolis, MN; he teaches in the Master of Business Taxation Program. He is a member of the AICPA Tax Practice Improvement Committee and the Quality Control Task Force. For information about this column, contact Mr. Sellner at selln001@umn.edu.

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