Engagement Letters: Review Them Before It Is Too Late

Co-Editors: Heidi A. Ridgeway, CPA, MST, and Thomas J. Purcell III, CPA, J.D., Ph.D.

Tax practitioners may not think about revisiting their policy on tax engagement letters until they are actually preparing one, or perhaps when they experience an issue with a client that might have been avoided had they revised their policy. But it is often too late at that point. Before the next busy season begins, practitioners should consider taking a fresh look at their tax engagement letter policy.

Tax engagement letters, when used correctly, are a prime example of where doing the right thing pays off for everyone. It is a best practice encompassing regulatory compliance, as well as other risk management and financial management considerations.

Since many firms seem to have a love-hate relationship with tax engagement letters, below are some practical considerations to help practitioners change for the better their relationship status with tax engagement letters (and, perhaps, with clients).

One of the more compelling reasons for using a tax engagement letter is to comply with the best practice standard in Section 10.33(a)(1) of Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10), which requires tax practitioners to communicate clearly with clients regarding the terms of the engagement. The engagement letter should engender a conversation between the client and the engagement team, which can have multiple positive outcomes, including:

• Understanding the client better;
• Making sure the client understands this is a relationship that needs to work for both parties;
• Identifying additional service opportunities;
• Helping with client acceptance and continuance; and
• Specifying the fee arrangement, including what the client is paying for, which should reduce conflicts later and encourage discussions about out-of-scope work.

An equally compelling reason for having an updated engagement letter policy—especially for the tax practitioner—is malpractice avoidance. Malpractice insurance carriers typically recommend and sometimes even require the use of engagement letters, including specific provisions within the letters. Engagement letter language should be explicit, stating clearly the project’s terms and conditions, such as the exact scope, where the work takes place, when the engagement ends, etc.

Tax engagement letters also provide an opportunity to enhance a practice’s bottom line. As previously mentioned, the letter should stipulate the services that are part of the project and highlight additional services that are not included, making clients fully aware of other services that may be available from the team.

Below is a list of suggested do’s and don’ts for a tax engagement letter policy review:

Do’s

• Use the AICPA draft engagement letters as a starting point for the letters;
• Customize the services and scope sections—be specific;
• Engage legal counsel to draft the “terms and conditions” section—make sure counsel is conversant in all the states in which the firm practices;
• Discuss the letter with a trusted colleague or counsel who can offer a different viewpoint;
• Have the team working on the engagement read the letter—this will help them understand the scope of services; and
• Send them out early—respect the client’s time and capitalize on the opportunity to deepen the relationship.

Don’ts

• Avoid tough conversations—understanding the client’s perspective is an important part of client service;
• Be surprised if the client wants to negotiate certain terms—this should not be viewed as an entirely negative development;
• Begin work without getting the engagement letter signed; and
• Worry about losing a client over having something in writing—even if they say, “ABC firm won’t make me sign one.”

Tax engagement letters do not have to be feared. But the longer practitioners put off reviewing their policy, the more likely they will dread doing so. Remember that tax engagement letters offer practitioners and clients peace of mind as they embark on a new relationship together.