Third-party verification requests

By Dave McClain, CPA

Editor: Ami Oppe, CPA, CGMA
 
As a trusted adviser, a CPA is often the first resource clients turn to for many financial issues. While often these questions are in the context of a service the CPA may already be engaged to provide (tax compliance, estate planning, etc.), it is not uncommon to receive other requests that seem simple but can carry unique challenges. One such request is for a third-party verification letter, often referred to as a "comfort letter."

Comfort letter requests increasingly come from a wide variety of sources, most commonly lenders, insurance providers, employers, and various government agencies. These requests can range from simple confirmations to requests that a CPA attest to the accuracy of a variety of information. Most commonly, these requests may ask that a CPA:

  • Attest to the accuracy of an individual's income;
  • Attest that an individual owns a business;
  • Verify that an individual is self-employed;
  • Provide assurance that a business will continue to be profitable; or
  • Provide commentary on the effect that additional debt or a withdrawal of funds from a business would have on its continued operations.

Clients and the parties requesting those letters often turn to the CPA because they believe the CPA can provide reasonable assurance to the facts requested. Likewise, the CPA profession is client-centric and, as a result, the first inclination may be to view a response as a low-risk way to provide good client service. However, the combination of these expectations can lead to potential issues. These requests carry important considerations, both legal and ethical, that a CPA must consider before responding and in crafting an appropriate response.

Confidentiality

Paramount to any response is first considering the standards related to client confidentiality. The "Confidential Client Information Rule" of the AICPA Code of Professional Conduct (ET §1.700.001) establishes that confidential client information may not be disclosed without the client's specific consent. Further, Sec. 7216 imposes criminal penalties and fines on any return preparer who discloses taxpayer information without specific written consent from the client using specific language and formatting as outlined in Rev. Proc. 2013-14.

Businesses often turn to their CPA to provide tax return information as a part of these requests as a matter of convenience. It is often simpler and less time-consuming for them to ask the CPA to pull this information from his or her electronic files and pass it along to the party that made the request rather than gathering the information from their own personal files. Once the CPA explains the requirements of Sec. 7216, it often eliminates some of the convenience the clients were hoping to find. As a simple alternative, the CPA can send the requested information directly to the client, rather than to a third party. The client is free to pass this information along to whomever the client chooses. This provides an option for practitioners to provide a level of client service the client is hoping for without creating an ethical or legal issue.

Facts vs. attestation

At the heart of most of these requests is the question of attestation. Lenders, employers, government agencies, etc., are all trying to ascertain if the client has available funds, the ability to generate sufficient funds, or the means to service a level of debt. Unfortunately, most clients and, even more importantly, most parties making these requests often confuse a CPA's ability to confirm facts with the ability to provide additional attestation of the business's solvency.

CPAs can simply confirm the facts as they understand them. However, this is generally not what a client is ultimately requesting when seeking a comfort letter. The distinction between verifying facts and providing a level of attestation may be narrow, but this distinction separates providing client service from potentially creating a professional liability risk.

One common request is that the CPA confirm the income reported on a tax return is accurate. The attestation that the items of income and deduction reported on a return are in fact true and accurate is a very different assertion than that the items were reported based on information provided by the client. Section 10.34 of Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10), and Statement on Standards for Tax Services (SSTS) No. 3, Certain Procedural Aspects of Preparing Returns, generally provide that a tax preparer may rely on information a client has provided in the course of preparing a tax return absent contradictory information. Both these standards only set forth a requirement to make inquiries in the event the preparer has reason to believe the information provided is inaccurate or incomplete. This level of responsibility is significantly less than the level of professional responsibility required in an attest engagement.

In an attestation request, a statement that the income reported on a tax return is accurate would lead the party requesting this verification to believe that the CPA has undertaken certain procedures to verify the data provided are accurate. This belief could lead to a professional liability issue. For example, if a lender relied on the assertion that the income was accurate and, ultimately, it was incorrect and led to default on a loan, the lender could potentially sue the CPA for recovery of the funds, arguing that the CPA attested the income was accurate.

Rather than making a statement that items of income and deductions are accurate, a return preparer could instead provide a copy of the return as filed (provided the CPA complies with the disclosure requirements of Sec. 7216) along with a statement that the items reported on the return were from information the taxpayer furnished and that the return preparer did not audit or otherwise verify the information provided and is not providing any assurance as to the validity of the numbers as reported.

Representation of solvency

While requests to verify items of income and deductions are one common request, another common request concerns the taxpayer's solvency. Commonly, banks and other lenders ask a CPA to comment on a taxpayer's solvency, either in its current form or after considering the required cash flow to service the loan in question. Interpretation No. 1, "Responding to Requests for Reports on Matters Relating to Solvency," of AT-C Section 105, Statements on Standards for Attestation Engagements (AICPA Professional Standards, AT-C §9105, ¶¶.01-.11), prohibits a CPA from providing any level of assurance through any examination, review, or agreed-upon procedures that an entity is, or will continue to be, solvent, does not have an unreasonably small amount of capital, has the ability to make debt service payments, etc.

While from a client's or banker's perspective, a CPA is in a position to comment on the financial impact of debt service and solvency, whether a business is "insolvent" is a question of law rather than a pure accounting question. For this reason, the standards prohibit a CPA from making an assertion regarding solvency. A CPA can provide information that can assist the requesting party in making its own determination on solvency. For example, a CPA can provide audited or reviewed financial statements or agreed-upon procedures reports, so long as those engagements are entered into under the appropriate engagement standards and make no explicit attestation specifically regarding solvency.

Navigating the winding road of third-party verifications

It is important to remember that third parties requesting a form of verification are typically unaware of the various standards CPAs are required to adhere to. Likewise, many clients view these types of requests simply as part of the service CPAs offer their clients. While there are certain types of verification CPAs simply cannot offer, generally the first step in assisting a client is an in-depth discussion on what exactly the third party is truly attempting to verify. Once the need has been determined, a CPA should review the various standards to determine how to best respond.

Several AICPA resources are available to help assess how to respond to these requests. The AICPA Financial Reporting Center has a technical practice aid relating to comfort letters, which is available at www.aicpa.org. The AICPA Tax Section also has a third-party verification toolkit for practitioners. The AICPA Accounting and Auditing Technical Hotline is also available to assist with technical guidance on how a CPA may respond to these requests (877-242-7212; 9 a.m. to 8 p.m. ET, Monday-Friday).   

 

Contributors

Dave McClain, CPA, is a tax partner with BDO USA LLP in Akron, Ohio. Ami Oppe, CPA, CGMA, is a tax manager with Walsh, Kelliher & Sharp in Fairbanks, Alaska. Ms. Oppe is the chair, and Mr. McClain is a member, both of the AICPA Tax Practice Management Committee. For more information about this column, contact thetaxadviser@aicpa.org.

 

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