Tax Practice Quality Control

Editor: Thomas J. Purcell III

In recent years, legislative, administrative, and other developments have created a new era in tax practice. Changes to the Internal Revenue Code, including to Sec. 6694 and other preparer penalty provisions, have had a significant impact on CPA tax practices, as have revisions to Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10); new IRS pronouncements, including preparer registration; an increased emphasis on ethical responsibilities, including in the AICPA Code of Professional Conduct (AICPA code) and Statements on Standards for Tax Services (SSTS); state and local law changes; state board of accountancy rule changes; increased client expectations regarding services; and a generally more litigious society. In this context, practitioners should consider implementing a tax practice quality-control (TPQC) system as an appropriate professional response.

Overview

A TPQC system is a set of organizational structures, policies, and procedures that provides reasonable assurance of compliance with applicable statutory, regulatory, and professional requirements. It generally is evidenced by a TPQC document. The system applies to all sizes of practice units, assists compliance with statutory and regulatory requirements and professional standards, and minimizes the risk of professional liability.

Circular 230, Section 10.36(b), Requirements for tax returns and other documents, states:

Any practitioner who has (or practitioners who have or share) principal authority and responsibility for overseeing a firm’s practice of preparing tax returns, claims for refunds, or other documents for submission to the Internal Revenue Service must take reasonable steps to ensure that the firm has adequate procedures in effect for all members, associates, and employees for purposes of complying with Circular 230. . . . [Emphasis added.]

This section of Circular 230, along with the IRS’s preparer visits and registration, indicates an increased emphasis by the IRS on monitoring practice units and their procedures. This emphasis increases the responsibility of preparers within these firms. Although Circular 230, Section 10.36, does not require a quality-control system, having one should be considered an adequate procedure within the meaning of that section.

A System of Quality Control

The AICPA has long-standing and well-established principles of quality control for accounting and auditing practices, which are outlined in AICPA Statement on Quality Control Standards No. 8, A Firm’s System of Quality Control.

The AICPA Tax Practice Responsibilities Committee is drafting sample tax practice quality-control guides for different sizes of firms. It is anticipated these sample documents will provide firms (or practice units) with a sample to follow in preparing a firm TPQC guide.

A system of quality control is influenced by:

• Size of practice;
• Number of offices;
• Degree of authority granted;
• Knowledge and experience of involved professionals;
• Nature of practice;
• Specialties; and
• Cost/benefit considerations.

The system should establish a benchmark for the practice unit and produce ideas to enhance the practice. The ultimate goal is to improve each practitioner and practice unit.

The majority of AICPA members are in small practice units. Each practice unit is different, and systems vary depending on firm size. One size does not fit all. However, even the smallest practice units are not exempt from the Circular 230, Section 10.36(b), requirements. Practitioners should know their individual practice needs and adopt a system that meets those needs. Small practice units already implement quality-control measures in a continually evolving process. The purpose of quality control is not to discourage small practice units from the process but to recognize that the elements of the system necessarily differ with the size and scope of the practice unit.

Elements of a Tax Practice Quality-Control System

The six elements of a TPQC system are:

• Leadership responsibilities;
• Ethical requirements;
• Acceptance of client relationships;
• Human resource function;
• Engagement performance; and
• Monitoring the TPQC system.

Communication and documentation are significant parts of quality-control systems in practice units of all sizes.

Leadership Responsibilities

The leadership responsibilities element implies that one person assumes ultimate responsibility for the tax practice unit. Included in this element is the philosophy that the quality of the work performed overrides profits. This person would have appropriate experience and authority for the leadership position. There would also be clear and continual communication with all involved and sufficient resources committed to the implementation of the quality-control system.

It is imperative to demonstrate a total commitment to the quality-control system. The internal culture should reinforce the importance of not compromising quality for the sake of profits. Individuals assigned operational responsibility for the quality-control system should have appropriate experience and authority. Performance evaluations, compensation, and advancement of personnel should also demonstrate commitment to the system.

Ethical Requirements

The ethical requirements element includes adherence to all applicable laws, regulations, and professional standards. Examples of ethical responsibilities include:

• Adherence to tax return reporting standards (Sec. 6694; Circular 230, §10.34; SSTS No. 1, Tax Return Positions; and levels of confidence—e.g., more likely than not, realistic possibility of success, and substantial authority);
• Respect for the confidentiality of client information (Secs. 7216, 6713, and 7525; Circular 230, §10.20; and AICPA code, Rule 301, Confidential Client Communications);
• Avoiding conflicts of interest (Circular 230, §10.29; AICPA code Rule 102, Integrity and Objectivity, and Interpretation 102-1, Knowing Misrepresentations in the Preparation of Financial Statements or Records);
• Exercise of due diligence (Circular 230, §10.22; and SSTS No. 3, Certain Procedural Aspects of Preparing Returns);
• Appropriate action when learning of a client’s error (Circular 230, §10.21; and SSTS No. 6, Knowledge of Error: Return Preparation and Administrative Proceedings);
• Use of contingent fees (Circular 230, §10.27; and AICPA code Rule 302, Contingent Fees, and Interpretation 302-1, Contingent Fees in Tax Matters); and
• Written tax advice (Circular 230, §10.35; and SSTS No. 7, Form and Content of Advice to Taxpayers).

All practice unit members should know these and other ethical responsibilities. In addition, compliance with these rules should be documented. This information is readily available at:

• The Internal Revenue Service;
• Circular 230 ; and
• AICPA Professional Standards and Ethics.

Other rules could apply to a practice, depending on the practice’s specialty areas and jurisdiction, including foreign countries.

Communication to all members of the practice and documentation of adherence to these rules is a necessary component of this element of a quality-control system.

In many tax engagements, the practitioner could be acting as an advocate for the client. Adherence to these ethical requirements generally should not interfere with this advocacy undertaking.

Acceptance of Client Relationships

The complexities of tax practice today necessitate both evaluating prospective clients and regularly reevaluating existing ones in terms of suitability, ability of the practitioner to provide the necessary professional services, and exposure areas that might affect the practitioner’s ability to provide the professional services requested.

Each practice unit should annually determine if it has the necessary capabilities and resources to service the client base. Many other factors are involved in this element, including:

• Review of prior years’ returns;
• Determination of whether information furnished by the client is questionable;
• Competence to handle the engagement;
• Unreasonable timing for completing the engagement;
• Personality conflicts;
• Seasonal issues; and
• Ability to serve specialized needs (e.g., clients with international issues, or issues with Sec. 199, uniform capitalization rules, etc.).

Documenting the understanding, the scope of services to be performed, and the responsibilities for any tax return advice or returns is imperative in adhering to this element of quality control. An engagement letter or other documentation is the proper way to communicate these items.

Human Resources Function

The human resources function element of a TPQC system applies to practice units with staff. These firms should:

• Implement and maintain a hiring program;
• Monitor assignment of personnel to engagements;
• Monitor continuing professional education of employees; and
• Evaluate qualifications for advance­- ment.

IRS considerations are also a part of this element, such as who meets the definition within the firm of a “return preparer,” determining who are “supervised employees,” current rules for preparer registration, and maintaining current preparer tax identification number registration.

Engagement Performance

The most important—and sometimes most complex—element of a TPQC system is engagement performance. This element intersects with those previously mentioned. Factors include:

• Engagement planning and assessment of risk;
• Supervision and review;
• Compliance with quality-control standards;
• Communication of results to clients;
• Documentation of results and of their communication to clients;
• Necessity of using consultants;
• Procedures to resolve differences of opinion among staff; and
• Tax practice documents.

This element is the most wide-ranging of all the elements of a TPQC system and applies to all practice units regardless of size. It entails more communication and documentation than other elements.

The supervision and review factor is especially difficult for sole practitioners and small partnerships with limited staff. These practitioners must adopt a method to supervise and review their own work. This can be accomplished many ways. In some cases, a sole practitioner may prepare a return and then review the same return after some time has elapsed, such as a day or two. In addition, some practitioners arrange with similarly situated practitioners to cross-review each other’s returns.

The practice unit should be concerned about the confidentiality, safe custody, integrity, accessibility, and retrieval of tax practice documents. Implementation of engagement performance includes:

• Firm policy on the use of engagement letters;
• Use of checklists;
• Due date lists, reports, and monitoring;
• Firm policy on substantiation of client-submitted information;
• Fee structure;
• Cutoff dates for submission of information by clients; and
• Firm policy on communications with clients, including oral advice, taxpayer elections, and filing extensions.

Monitoring the TPQC System

Factors in monitoring the system include:

• Document compliance;
• Establishing an inspection program;
• Evaluation of compliance;
• Assigning responsibility for monitoring; and
• Providing a process for client com- plaints.

This element, like the preceding one, may be difficult for small practice units, especially sole practitioners and small partnerships.

Conclusion

The current regulatory environment and recent changes in oversight of tax return preparers, including those under Circular 230, require all CPAs engaged in tax practice to consider implementing TPQC procedures. All tax practitioners should consider what form of TPQC applies to their practice environment.

A TPQC system will help practice units provide the highest quality tax services to clients and meet the regulatory requirements of the IRS, AICPA, and others.

EditorNotes

Thomas Purcell III is a professor of accounting at Creighton University in Omaha, Neb. Gerard Schreiber is a partner with Schreiber & Schreiber CPAs in Metairie, La. Prof. Purcell and Mr. Schreiber are members of the AICPA Tax Practice Responsibilities Committee. For more information about this article, contact Mr. Schreiber at ghschreiber@bellsouth.net.