Best practices for firms to promote a culture of ‘due professional care’

Editor: Heidi A. Ridgeway, CPA   When managing a tax practice in a CPA firm, one of the primary goals is to establish and comply with best practices by operating with “due professional care,” according to the auditing standard of AU Section 230, Due Professional Care in the Performance of Work (see also AICPA Code of Professional Conduct (the AICPA Code), “Due Care” (ET §0.300.060) and “General Standards Rule” (ET §1.300.001)). Tax practices come in all shapes and sizes, where best practices may be interpreted and implemented differently. However, whether a solo practitioner or a multipractitioner firm, all CPA tax practices are obligated to adhere to established quality-control and professional standards. Many firms accomplish this goal by implementing policies and procedures in a quality-control (QC) system that helps communicate to partners and staff the firm’s best practices.

The “Due Care” principle applies to all services provided by members, including tax services. However, the requirements to establish and maintain a QC system, as outlined in AICPA Quality Control (QC) Section 10, A Firm’s System of Quality Control, only apply to a firm’s accounting and auditing practice. Hence, many firms do not employ a formal QC system to document their tax practice policies and procedures as they would for their accounting and auditing practices.

This difference in approach to the formal documentation of a QC system is amplified by the requirement that a firm’s accounting and audit practice participate in a peer review program (see AICPA Standards for Performing and Reporting on Peer Reviews). Because the same peer review requirement does not apply to a CPA firm’s tax practice, nor does QC Section 10 specifically apply, many firms talk about best practices and due professional care in their tax practices rather than documenting their established tax policies and the procedures employed to achieve these goals.

Treasury highlighted the need to establish and maintain a formalized system of quality control for tax services by first adding aspirational Section 10.33, Best Practices for Tax Advisors, in June 2005, to Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10), and then later adopting Section 10.36, ­Procedures to Ensure Compliance, in ­August 2011. The latter of the two relatively recent additions to Circular 230 places responsibility on the individual who has principal authority for overseeing a firm’s tax practice (for Circular 230 purposes) to take reasonable steps to ensure that the firm has adequate procedures in place for all personnel to provide their tax services with the requisite measure of due care. Because Section 10.36 is an enforceable provision of Circular 230, a responsible individual may be subject to sanctions by the IRS Office of Professional Responsibility for any violations. These sanctions can include censure, suspension, a financial penalty, and even termination of rights to practice before the IRS (Circular 230, §10.50).

If the AICPA Due Care rule and the above-outlined provisions of Circular 230 are not enough to prompt a firm to implement a QC system, then professional liability risk may provide an additional incentive: Every year, 65% to 75% of CPA professional liability claims are related to tax services, and more than half of those tax-related claims relate to improper tax treatment or advice (see the table below, which is based on data provided by CNA Financial Corporation from 2012 to 2016). Unlike the relatively high thresholds applicable to Circular 230 sanctions (willful, egregious, etc.), the threshold for malpractice is the relatively low standard of negligence. Negligence is defined as the absence of due care (i.e., the lack of diligence), and due care in professional liability cases is often evaluated in accordance with AICPA standards.

For all these reasons, and to help practitioners and firms in their quest to successfully implement best practices, the AICPA recently updated its Tax Practice Quality Control (TPQC) Guide, which includes a sample TPQC document for its members.

AICPA Tax Practice Quality Control Guide

The TPQC Guide focuses on six elements that are essential to any QC system: (1) leadership responsibilities for quality within a firm; (2) relevant ethical requirements; (3) acceptance and continuance of client relationships and specific engagements; (4) human resources; (5) engagement performance; and (6) monitoring. This column briefly highlights the importance of each of these elements and how they relate to the sample TPQC document (see QC §10).

A TPQC document should be the go-to source for tax personnel to understand their firm’s basic workflow and system processes. These workflow and system processes help a firm comply with the relevant ethical requirements while promoting an efficient and effective tax practice. That said, every firm’s tax practice will have a slightly different composition of size, structure, and focus; therefore, as a way of making the TPQC system more flexible, a scalable TPQC document has been developed to assist firms with identifying the targeted areas above and providing more detailed considerations to be adopted by their own practice.

The sample TPQC document identifies several areas where there may be differences based on firm structure (e.g., a sole proprietorship vs. a multipractitioner firm), using brackets to indicate an optional choice of language and footnotes for paragraphs that may not apply to some practitioners or firms.

Leadership responsibilities for quality within a firm

Leadership responsibilities, including QC responsibilities, should be given to personnel who have appropriate experience and authority for those responsibilities. The promotion of quality among leadership indicates that it is a priority in firm culture. A firm’s commitment to quality should be reflected as a consideration in performance evaluations, compensation reviews, and employee advancement. A greater understanding of how quality contributes to error reduction, greater client satisfaction, and team performance may ultimately result in potential growth and higher profitability for a firm, which benefits partners and employees.

In the sample TPQC document, paragraph 1 of the “Leadership Responsibilities for Quality Within the Firm” section states, “The firm’s leadership team is required to assume ultimate responsibility for the firm’s system of TPQC.” For a tax firm, usually one or two individuals will assume these roles, while a sole practitioner is the only person who carries this responsibility. Paragraph 3(a) further identifies individuals who have principal authority over the firm’s tax practice as described in Section 10.36(a) of Circular 230. Those in leadership roles are the people who will define and promote quality throughout the firm.

Relevant ethical requirements

A firm’s tax practice has an obligation to comply with all relevant professional responsibilities, and compliance with these responsibilities should be documented as part of the TPQC system. These responsibilities are often interdependent and include the professional obligation to adhere to prescribed standards, acting with competence, and performing the necessary due diligence to meet client needs and advocate for clients, if required. (For purposes of this column, “advocate” and “advocacy” mean acting within the context of 5 U.S.C. §500 (Administrative Practice); see also AICPA Code, “Client Advocacy” (ET §1.140.010), “Competence” (ET §1.300.010), and “Due Care” (ET §0.300.060)).

A firm’s tax practice should also be mindful of potential conflicts of interest, which may arise through the advocacy of an existing client or taking on a new client (see AICPA Code, “Conflicts of Interest” (ET §1.110)). Conflicts of interest may impair the reputation of the firm or its personnel. Communication and transparency with clients is necessary when a conflict situation arises, and a firm should always document actions taken to include in the client’s file.

The sample TPQC document has three identifiable practices: (1) making practitioners aware of applicable ethical standards; (2) determining how the firm notifies relevant individuals of firm policies; and (3) monitoring compliance with the TPQC system. Paragraphs 1(a)-(c) of the “Relevant Ethical Requirements” section of the sample TPQC document detail how practitioners should respond to ethical dilemmas where a responsible person should (1) be appointed to resolve ethical questions, and (2) have authority to communicate with outside parties, should the need arise. The most important part of resolving ethical questions is documenting the resolution of the issue as described under paragraphs 3(a)—(b) of the sample TPQC document’s “Relevant Ethical Requirements” section.

Acceptance and continuance of client relationships and specific engagements

As part of a firm’s TPQC system, it is necessary to evaluate and document potential risks when accepting a new client or a new engagement for an existing client. Some of the risks for a firm to consider include (1) the suitability of information a client provided for an engagement; (2) the identity of the client and potential risks to the firm taking on the engagement; (3) potential conflicts of interest that may arise from accepting the engagement; (4) the timeline for completing the engagement; (5) the availability of firm resources required for the engagement; and (6) whether firm personnel involved in the engagement have the necessary knowledge to perform the services required.

Internally documenting the evaluation of potential risks of accepting a new client or engagement, as well as documenting the scope of services in the form of an engagement letter, are ways to increase communication with clients and reduce misunderstandings should they arise during an engagement.

While firms look to enhance efficiency, it may become necessary to discontinue a client relationship. Some typical reasons for terminating a client relationship are enumerated in the sample TPQC document, including (1) the client’s failure to provide adequately substantiated information; (2) disputes with the client over tax positions that are inconsistent with tax laws or regulations, the AICPA Statements on Standards for Tax Services (SSTSs), or firm policies; (3) engagements the firm is not competent to handle; (4) unreasonable demands made on firm personnel due to timing; (5) insurmountable personality conflicts; (6) a conflict of interest; (7) return on the engagement is too low for effort expended and risk taken; (8) the client is chronically slow to pay; or (9) the client misleads the firm.

Human resources

Human resources are key to any respected firm’s tax practice, and establishing human resource policies emphasizing QC is key to the TPQC system as well. Therefore, a firm’s practices regarding hiring, assignment of personnel to engagements, professional development, and advancement should be considered as part of the TPQC process. Formalizing the human resources element of TPQC allows a firm to determine if it has sufficient personnel with the skills necessary to perform services competently and in accordance with all applicable professional standards, laws, and regulatory requirements.

The TPQC Guide sets out a model for firms to consider in their human resource practices and details a process from hire to promote. Included in this model are the considerations necessary for personnel to comply with the applicable professional standards such as tax return preparer requirements and maintaining a preparer tax identification number. Additionally, the support of continuing education for personnel will enable them to obtain the requisite CPE credits to maintain professional licenses and qualifications.

Monitoring, although a separate element of the TPQC Guide, is also an important consideration within human resources. Firms should have procedures to monitor personnel assignments to build competency, diversify experiences, and provide for coaching and mentoring opportunities.

The sample TPQC document acknowledges that the human resources element will probably be the section that varies most between midsize firms and sole practitioners. While a sole practitioner may never hire another CPA, he or she needs to be cognizant of the requirements of Circular 230 that allow the practitioner to rely on the work of others, whether that be seasonal or temporary help or a third-party consultant. These requirements include proper engagement, supervision, training, and evaluation. The “Human Resources” section of the sample TPQC document offers procedures to help define what is proper engagement (paragraph 1), supervision (paragraph 2), training (paragraph 3), and evaluation (paragraph 5).

Engagement performance

A formalized process of engagement performance within a firm’s TPQC system is a way to provide reasonable assurance that client engagements are being performed consistently and in compliance with communicated expectations to firm personnel. The element of engagement performance combines many of the previously discussed elements of the TPQC, including leadership responsibilities, client acceptance, and personnel development. It also emphasizes that a firm’s TPQC system is important throughout the entire client engagement life cycle — from engagement planning to documenting and communicating results of the services provided.

Moreover, there is growing focus on client confidentiality, the safe custody of client records, and data breaches due to cyberattacks or lack of internal controls. Inside their tax practice, firms hold the client’s trust over some of their most sensitive financial information. Names, birthdates, and Social Security numbers should always remain confidential, with accessibility restrictions imposed upon internal personnel.

During and after an active engagement, firms should have established procedures regarding the disclosure of client information, and proper client consents should be received, if required. The improper disclosure of client information could have criminal consequences. This consent requirement may also apply to the disclosure of information to consultants hired by a firm. All firm personnel should be aware of these procedures, including any consultants and firm administrators.

Implementing the following policies and procedures will assist the firm’s efforts when developing a TPQC system for engagement performance: (1) use of the AICPA’s checklists; (2) due date trackers; (3) data privacy training; (4) a formalized document retention policy; (5) protocols for access to client files; and (6) password protection for client material.

Monitoring

Monitoring is the final element outlined in the TPQC Guide, and it serves as an oversight measure to provide a firm reasonable assurance that its policies and procedures have been implemented properly, working to ensure effective operational compliance with quality measures. When evaluating whether it is doing enough to monitor QC, a firm should consider the following: (1) establishing an inspection program; (2) assigning responsibility for monitoring; (3) evaluating compliance with established procedures; and (4) providing a process for addressing client complaints. Although a formalized internal or external monitoring process of a firm’s tax practice review is not mandated by the AICPA or Circular 230, it provides a useful mechanism for enhancing quality within the firm.

For example, the sample TPQC document creates a monitoring function in paragraph 1 of the “Monitoring” section by including language that “[t]he firm conducts an inspection program regarding its TPQC policies and procedures for conformity with the SSTSs, Circular 230, and other applicable professional standards, laws, and regulations, and industry-preferred practices.”

Acknowledgment of the TPQC

The sample TPQC document in the TPQC Guide ends with a sample written acknowledgment. On a yearly basis, everyone who handles tax issues in a firm should review the TPQC document and acknowledge that they have read and understand it. Tax professionals should also acknowledge that any issues or questions regarding the document were discussed with an immediate supervisor, which will encourage personnel to ask questions about the document and quality control in general to gain a better understanding of firm procedures.

Ultimately, the goal of the AICPA’s TPQC Guide is to assist firms in establishing a successful quality-control system within their respective tax practices, and to help members understand and implement the basic policies and procedures necessary to comply with relevant professional and ethical requirements, while also promoting efficient and effective tax practices. 

The views expressed in this column are solely those of the authors and do not necessarily represent the views of Ernst & Young LLP. Moreover, they should be read in the context of the time they were expressed.