Voluntary Tax Practice Reviews

In recent years the complexity of tax practice has increased significantly for a variety of reasons, including exponential expansion of the technical content of tax laws; significant new and revised regulations; far-reaching judicial decisions; the imposition of new and revised statutory penalty provisions for tax return preparers and tax advisers; expanded calls for oversight from legislatures, regulators, and public interest groups; and expansion of civil liability for professional malpractice in tax-related engagements. As a result of this complexity, it has become even more challenging to manage a tax practice. One tool that can assist both the person responsible for managing the tax practice and the professional firm generally is a regular review of the tax practice.

Currently, there is no statutory, regulatory, or professional regimen requiring a regular tax practice review. This column explores the primary reasons for implementing a tax practice review and the development of the AICPA voluntary approach to tax practice management.

Why Do Tax Practices Need a Tax Practice Review?

Treasury Department Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10), contains the rules governing tax practice before the IRS. The two provisions of Circular 230 that are most relevant to the subject of this column are discussed below.

The June 2005 revisions to Circular 230 added Section 10.33, Best Practices for Tax Advisors. This section provides that practitioners “should provide clients with the highest quality representation concerning Federal tax issues by adhering to best practices in providing advice and in preparing . . . a submission to [the IRS].” The section met with some controversy when it was proposed and finalized, since it does not by its terms impose a penalty for failure to follow best practices, nor does it preclude a penalty. The IRS indicated at the time that the section was intended to be aspirational. Besides stating some generally accepted indicia of best practices, Section 10.33(b) also imposes a duty on the person responsible for tax practice oversight to take steps to ensure that all members of the firm, not only those with Circular 230 credentials, take actions consistent with best practices.

In the June 2014 revisions to Circular 230, Section 10.36, Procedures to Ensure Compliance, was revised to impose IRS disciplinary authority over the person with the “principal authority” for “overseeing a firm’s practice governed by [Circular 230].” Practice governed by Circular 230 includes advice about federal tax matters and tax compliance, claims for refund, or documents to be submitted to the IRS. The scope of the responsibility of this person is to ensure the firm has adequate procedures for compliance at both the individual practitioner and firm level with any parts of the tax practice that are subject to the provisions of Circular 230. The potential for penalties exists if the person, through willfulness, recklessness, or gross incompetence, does not take steps to ensure that the firm has adequate procedures to comply with Circular 230, and to ensure that the adequate procedures are in fact being followed by firm members. (For an expanded discussion of the changes made in Section 10.36, see Blatch, et al., “New Rules on Written Tax Advice and Other Revisions to Circular 230 and Their Effect on CPAs,” (The Tax Adviser December 2014).)

The sanctions provisions of Circular 230 are contained in Sections 10.50–10.53. Section 10.52, Violations Subject to Sanction, indicates that a practitioner may be sanctioned for willful violations of any of the Circular 230 provisions (other than the Section 10.33 best practices provisions) and also for reckless or grossly incompetent behavior that violates, among others, Section 10.36. Thus, the tax practice oversight professional could be personally sanctioned for not only his or her own actions, but also for egregious behavior by others within the firm that the oversight professional willfully or recklessly disregarded or, through gross incompetence, failed to properly oversee. Clearly, a system of tax practice oversight that is regularly monitored would substantially reduce, if not totally eliminate, the risk of sanctions under Sections 10.36 and 10.52.

The AICPA Statements on Standards for Tax Services do not impose a duty or an expectation that a firm has a system to oversee the individual Standards. The Standards are written to apply to the individual practitioner and what he or she should do in a variety of tax compliance, advisory, and representation engagements. The Preface to the Standards places the focus on members, not firms. Paragraph 8 indicates that the Standards “delineate members’ responsibilities to taxpayers, the public, the government, and the profession” (emphasis added). Although there is no Standard related specifically to tax practice oversight, Paragraph 9 of the Preface does encourage members to “assess the adequacy of their practices and procedures for providing tax services in conformity with these standards.” The AICPA’s Voluntary Tax Practice Review (VTPR) process and materials in the AICPA Tax Practice Quality Control Guide are designed to assist members in addressing Paragraph 9.

What Is a Voluntary Tax Practice Review?

The concept of a VTPR program was originally developed by the AICPA Tax Division’s Tax Practice Guidelines Task Force. The task force was composed of tax practitioners with local firms, and it was charged with designing a program of tax practice review that would be beneficial and practical for local firms, similar to the programs already being used by larger CPA firms. The project was moved to the Tax Practice Management Committee and ultimately approved by the Tax Executive Committee (TEC). The first edition of the Guidelines for Voluntary Tax Practice Review was published by the AICPA in 1995, and the first edition of the Tax Practice Quality Control Guide was published in 2002 to provide guidance for structuring tax practices to comply with the recently adopted enforceable Standards.

The original VTPR program was conceived and developed by the AICPA Tax Division long before the regulatory changes made to Circular 230 that added Sections 10.33 and 10.36. Thus, although the VTPR resources were designed to be used voluntarily to improve a tax practice, they can also serve the dual purpose of helping a tax practice comply with these relatively recent regulatory provisions.

The AICPA sets out quality-control standards applicable to the accounting and auditing practice in Statement on Quality Control Standards (SQCS) No. 8, A Firm’s System of Quality Control. Since SQCS No. 8 does not apply to tax practice, a major focus of the original VTPR Guide was to apply the elements of quality control set out by the Quality Control Standards to a tax practice.

Proposed AICPA SSTS No. 9, Quality Control in a Tax Practice

After the issuance of the original VTPR Guide and the first edition of the Tax Practice Quality Control Guide, and before the implementation of Circular 230, Sections 10.33 and 10.36, the TEC released proposed Statement on Standards for Tax Services (SSTS) No. 9, Quality Control in a Tax Practice. (At that time there were eight standards before the 2009 revisions that consolidated old SSTSs No. 6 and No. 7 into new SSTS No. 6, Knowledge of Error: Return Preparation and Administrative Proceedings.) Proposed SSTS No. 9 provided that a CPA firm should have a system of quality control for its tax practice. It described elements of quality control and other matters essential to the effective design, implementation, and maintenance of the system. It broadly defined a tax practice quality-control system as a process to provide the firm with reasonable assurance that its personnel comply with applicable professional standards and the firm’s standards of quality.

The proposed SSTS indicated that the nature, extent, and formality of a firm’s tax quality-control policies and procedures should be appropriately comprehensive and suitably designed in relation to the firm’s size, the number of its offices, the degree of authority allowed its personnel and its offices, the knowledge and experience of its personnel, the nature and complexity of the firm’s practice, and, most importantly, with appropriate cost/benefit considerations (from the introduction of Proposed SSTS No. 9).

The proposed SSTS took the existing AICPA quality-control standard (QC) for an accounting and auditing practice, QC No. 20, and redefined the five elements of quality control to apply to a tax practice. (Subsequent to the draft of SSTS No. 9, QC No. 20 was superseded by SQCS No. 8. SQCS No. 8 added an element of quality control: Leadership responsibilities for quality within the firm (the tone at the top).) After the public comment period, the TEC decided to withdraw the proposal, and Proposed SSTS No. 9 was not adopted. Nonetheless, the commitment to the concept of tax practice quality control remained and was embodied in the AICPA’s VTPR Guide and the three sample quality-control documents contained in its appendix. In fact, once Proposed SSTS No. 9 was withdrawn by the TEC, the Tax Division began the process of creating the Tax Practice Quality Control Guide from portions of the VTPR Guide. The latest version of the Tax Practice Quality Control Guide was published Feb. 15, 2013, and can be found on the AICPA’s website.

Tax Practice Quality Control Guide

The essential elements of quality control for a tax practice adapted from the current SQCS No. 8 are:

• Leadership responsibilities for quality within the firm (the tone at the top);
• Relevant ethical requirements;
• Human resources;
• Acceptance and continuance of clients and engagements;
• Engagement performance; and
• Monitoring.

The Tax Practice Quality Control Guide broadly defines a tax practice quality-control system as a process to provide a firm with reasonable assurance that it and its personnel (partners, officers, employees, and other associates of the tax practice) will comply with applicable professional, statutory, and regulatory requirements for its tax practice. A system of quality control for a tax practice should encompass the organizational structure and the policies adopted and the procedures established to provide reasonable assurance that the tax practice complies with these requirements. A firm’s system of tax practice quality control should take into account the unique aspects of the firm and its tax practice. (The Tax Practice Quality Control Guide is available at www.aicpa.org (member login required). For additional guidance, see Etienne, “Implementing the New Tax Practice Quality Control Guide,” May 17, 2013, webinar slides, available at www.aicpa.org.)

In addition to outlining the elements required for a tax practice quality-control system, the Tax Practice Quality Control Guide provides three sample systems for various sizes of tax practices. The Tax Practice Quality Control documents integrate the broad concepts of quality control and the six elements of quality control and propose three model control systems based on the size of the tax practice:

Sole practitioner CPA with limited staff: The sole practitioner sample document contains general parameters for operating a tax practice and establishes the basic foundation of preferred practices for a sole practitioner’s tax practice.

Local CPA firm without a structured tax department: The sample document for a local CPA firm without a structured tax department is much more detailed than the sole practitioner document. It concentrates on establishing responsibilities for tax matters within the firm and addresses some specialization within the tax area, even when a firm does not have a structured tax department.

Local CPA firm with a structured tax department: The sample document for a local CPA firm with a structured tax department contains detailed policies and procedures for a firm’s tax practice. This document reflects structures, policies, and procedures that commonly exist in firms with a separately structured tax department. (Neither the Tax Practice Quality Control Guide nor its predecessor documents fully explore the concept of a “separately structured tax department.” In the authors’ opinion, at a minimum such a department would exist if the firm has multiple professionals at various levels of responsibility that spend a majority of their professional time on tax compliance and consulting matters for clients and others.)

Tax Practice Quality Control Document

Quality in a tax practice is multidimensional: The practitioner must consider the needs and expectations of clients, fellow professionals, the various taxing authorities, professional ethics pronouncements of the AICPA and relevant CPA state societies, and regulatory agencies such as state boards of accountancy. A good system of quality control helps to maintain and improve quality and can also improve profitability. A quality-control document is simply the formal recording of a firm’s existing quality-control systems and procedures (“best practices”) in one place for the owners and staff to review and reference. Every firm that undergoes a peer review of its accounting and auditing practice, which is now required in substantially all U.S. licensing jurisdictions, must have a Quality Control Document. (In accordance with SQCS No. 8, peer reviews are generally required for all AICPA members engaged in the practice of public accounting that includes issuing reports in accordance with GAAP, and 52 of the 54 boards of accountancy in licensing jurisdictions currently require peer reviews for practitioners issuing financial statements accompanied by an accountants’ report.)

Although most firms may have long-established and well-thought-out tax quality-control systems, few may have memorialized these systems into a separate Tax Practice Quality Control document. So, even if the firm does not have a Tax Practice Quality Control document in place, it may already have a quality-control document for its accounting and audit practice that can be easily reworked to encompass the tax practice. If the practice does not perform any attest services, then the starting point can be one of the three sample Tax Practice Quality Control documents from the Tax Practice Quality Control Guide.

How Does a Tax Practice Conduct a VTPR?

Once a firm has a Tax Practice Quality Control document in place, it can start the process of a self-assessment (inspection) of the tax practice performed entirely by in-house personnel. The recommended procedures for a self-assessment listed in the VTPR Guide were broken down into four simple steps:

• Assess the current system, looking for quality-control strengths and weaknesses;
• Interview at least one staff member at each level regarding the staff member’s knowledge of the firm’s system and procedures relating to tax practice quality control;
• Perform a technical review of randomly selected tax returns and other tax-related engagements; and
• Write down conclusions about how to improve the tax practice quality-control system and discuss with staff.

If a firm does undergo a peer review of its accounting and audit practice, it should consider having the person in the firm responsible for the peer review also be in charge of the self-assessment tax practice review.

The VTPR Guide included helpful tools to assist a firm with its self-assessment specific to the four steps outlined above, including:

• Questionnaire on tax practice quality-control policies and procedures;
• Suggested review procedures checklist;
• Tax engagement review checklist; and
• Conclusions about the tax practice review worksheet.

Once a firm has developed a Tax Practice Quality Control document and performed a self-assessment, the next step would be to have someone from outside the firm perform a review of the tax practice, i.e., a “firm-on-firm review.”

The important first step to any firm-on-firm review is to find a tax practice reviewer who the firm believes will be able to make a significant contribution to its understanding of how the quality of the firm’s tax practice can be improved. It is key to select a reviewer who has experience with a firm of the same size or larger. A firm can use this process to improve its own systems and processes and will need someone with practical experience to accomplish that.

The firm should come to terms with the reviewer regarding what degree of consultation the firm expects from the reviewer and document these terms, including the cost, in an engagement letter.

Next Steps in Tax Practice Quality Control

Ultimately, any system of quality control should lead to a continuous improvement of the systems involved. The review of such quality-control systems can come from outside (e.g., an audit, a peer review, or an outside accrediting agency) or inside (the internal review). Over several review and response cycles, the quality-control system becomes stronger and more reliable.

The essence of any good self-review program is a critical analysis of the existing processes and systems in place to help practitioners become more efficient and effective. The VTPR process discussed above essentially contains the following steps:

• Establishing a system of quality control;
• Documenting the system;
• Monitoring the system; and
• Making adjustments based on the monitoring process.

The first two steps in the above sequence are accomplished by the thoughtful selection of the appropriate Tax Practice Quality Control document from the three options provided in the Tax Practice Quality Control Guide. The remaining two steps require testing the system that has been established and adjusting it as necessary.

The VTPR approach above does not specifically include a risk assessment of the control system. However, given the environmental risk factors discussed in the introduction to this column, it seems that thoughtful consideration of specific risks faced by the tax practice should be undertaken regularly, and that systems and controls in place should be modified, implemented, tested, and adjusted to address the perceived risks. By taking these additional steps, the self-review program can become a process of continuous practice improvement, a process in which the professionals in the practice continually upgrade knowledge and skills to address emerging issues and risks in their unique tax practice.

Summary

This column provides an overview of the various provisions and resources that should be consulted if a tax professional is considering a review of his or her tax practice systems and procedures. None of the relevant ethical provisions—the overall AICPA standards, the Statements on Standards for Tax Services, and Circular 230—requires an affirmative, regular review of the controls in place in a tax practice to ensure compliance with the various statutory, regulatory, and ethical expectations. Ultimately, it is the tax professional who must decide if the system of controls in place is sufficient to meet the various requirements and whether a voluntary tax practice review is a prudent professional undertaking.