Accounting
Liability insurance experts examine the current landscape of risk.
CPA firms continue to face unique challenges as they navigate some of the current liability issues and trends facing the profession, including beneficial ownership information filing under the Corporate Transparency Act, artificial intelligence, and cyberthreats.
“We strongly encourage firms to proactively prepare for risk by following some basic best practices,” advised Suzanne Holl, a CPA and executive vice president at insurance company Camico.
These best practices include:
- Set the right “tone from the top.” Encourage and reward a culture of transparency within the firm hierarchy to identify and communicate risk issues to help minimize potential exposures and enable the firm to early report liability concerns to their professional liability carrier and benefit from any proactive risk management guidance and support that may be available.
- Prioritize performing the right services for the right clients, as not every client is a good fit for every firm. Evaluating the firm’s client base has become even more important as firms face staffing constraints.
- Close the expectation gap. Proactively manage and document client expectations to minimize the risks associated with potential gaps between what they expect and what you’re offering.
Corporate Transparency Act risks
The new beneficial ownership reporting requirements under the CTA took effect on Jan. 1, 2024, and months later, the small-business community remains woefully unprepared for compliance with this complex reporting regime. As many small businesses look to their CPA for guidance and assistance, this poses potential added risks to firms.
One of the overarching concerns is whether CTA-BOI advisory services would be deemed the unauthorized practice of law for CPAs and nonattorney tax professionals. Given that each state has its own definitions of what services are considered UPL, this is a complex and nuanced risk requiring firms to stay current on the UPL issue in the states where they are licensed, as well as the states in which clients reside.
John Raspante, director of risk management at McGowanPro, sees the CTA as a source of controversy.
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“It hasn’t caused a claim yet, but we’ve received more than 1,000 calls regarding beneficial ownership reporting requirements,” he said. “The forms have to be filed by the end of the year for existing entities, with FinCEN. The questions revolve around whether CPAs are allowed to do this work, and if they do it, will they be covered under their policy. It’s more than likely that claims will be forthcoming on this issue. Once the form is filed, there has to be continual monitoring since modifications to the form have to be filed as well. If the accounting firm is sold, if the filer or a beneficial owner changes their residence, or the business adds an additional owner, it all has to be reported.”
Camico continues to advise CPAs to be vigilant and prepared to minimize the potential of additional liability exposures by following risk management best practices, which at a minimum should include:
Informing and advising clients in writing regarding the new beneficial ownership reporting requirements under the CTA, and recommending that they seek legal guidance.
Modifying traditional tax and financial statement engagement letters to include language that specifically disclaims the firm’s involvement in assisting clients with CTA compliance under the terms of that agreement.
Using standalone engagement letters if the firm is rendering CTA-related services to clients that specify the limited nature of the services the firm is providing, such as the filing of the initial BOI report or the filing of a corrected or updated BOI report, and that contain appropriate disclaimer language for such limited services.
Preparing your own firm for compliance if you are deemed to be a “reporting company” under current CTA guidance.
Generative AI
“Generative AI is no longer just a buzzword,” said Holl. “The technological advancements that generative AI promises have the potential to reshape how firms provide professional services, communicate with clients, and even how leaders manage their firm.”
Although generative AI solutions can provide benefits for CPA firms, she said, “From a liability perspective, there are critical risks associated with generative AI that should be vetted by firms and mitigation strategies implemented to minimize potential exposures.”
Among those risks are concerns with accuracy and quality control, confidentiality, privacy, security, and ethical issues. Successful integration of generative AI requires a well-crafted implementation plan that should include, among other things, appropriate education and training to ensure responsible use.
“We believe a clear and concise generative AI policy to document a firm’s authorized usage is paramount in minimizing risk and achieving firm goals using AI,” Holl said.
Cyber exposures
Cyber exposures have become increasingly problematic as cyber criminals are targeting CPA firms and tax professionals due to the type of information they gather and store. If the criminals are successful in gaining access to the firm’s information, costly measures may need to be taken including, but not limited to, hiring IT forensic experts to determine the extent of a potential breach, consulting with attorneys specializing in data breach laws and notification obligations, and providing credit monitoring to those impacted by a breach.
A far-too-common scenario is when a fraudster controls the client’s and the firm’s email, commonly referred to as a “man in the middle” attack. In these situations, the fraudulent request may mimic previous legitimate requests, which can make it very difficult for a firm to identify the request as illegitimate. As fraudulent wire transfers frequently cause large dollar losses, firms need to be hypervigilant in their efforts to protect the firm and clients against wire transfer fraud.
Insurance experts strongly recommend that firms have written protocols in place with clients who need such services that outline the protocols to be followed when executing wire transfer requests.
Preparing defenses
It’s important to have a “meeting of the minds” at the outset of a client relationship, according to Sarah Ference, risk control director for the Accountants Professional Liability Program at CNA, the underwriter for the AICPA Professional Liability Insurance Program. An engagement letter is the tool that not only helps achieve this, but is also a first line of defense if a relationship sours.
“An engagement letter helps set the stage for success throughout the engagement. That kind of understanding really aids in mitigating risk and resolving issues that might arise, or may even prevent them from arising. Yet CPAs tend to shy away from using engagement letters,” she said.
“We continue to see areas of practice like tax which lack engagement letters,” Ference noted. “Of the claims asserted in 2023 against CPA firms in the AICPA Professional Liability Insurance Program, about 75% stemmed from tax services. Of those, over 50% didn’t have an engagement letter, which puts the CPA in a difficult position to defend the claim. We have seen similar percentages in prior years. Intuitively, if there was an engagement letter that spelled out what you’ve agreed to do, what a client’s responsibility was, and limitations of your responsibility, a claim may never arise. In that case, a client disagreement wouldn’t appear on our radar because the disagreement would have already been resolved before it turned into a claim.”
Anytime a CPA is delivering a service, they should consider an engagement letter, according to Ference: “Engagement letters are critical when doing any kind of consulting. The more specific, the better. Make sure that the letter is structured in such a way that there is no ambiguity. Ambiguity opens the door to broad interpretations and makes it difficult to align expectations between the CPA and the client.”
“It’s all about relationships,” according to Alvin Fennell, vice president and senior risk advisor at Aon, manager of the AICPA Professional Liability program. “CPAs are extremely customer-sensitive. Where they have a longtime client, they hate to request an engagement letter. I tell them: ‘Blame it on your insurance carrier. They require me to get an engagement letter!'”
“The most prevalent current risk is changes in regulations and accounting standards,” he said.
The lack of talent coming into the profession is a problem. “A lot of individuals are coming out of college and going into industry rather than accounting firms, causing more competition for talent in firms now. Big firms are acquiring smaller firms just to get at the talent they need,” Fennell said.
Finally, Raspante noted that, while accountants may not have handled a lot of Employee Retention Credits, many were confronted with the need to amend the business tax return to include the proceeds of an ERC.
“If the underpinnings of the ERC were incorrect, it can cause issues with us,” he said. “The voluntary disclosure program will create more claims. If an accountant didn’t tell us about the voluntary disclosure, it can cause a lot of damage.”
Captive audience; some disagreement; game of 21; and other highlights of recent tax cases.
Barrington, Illinois: Tax preparer Gary Sandiego has been sentenced to 16 months in prison for preparing and filing false returns for clients.
He owned and operated the tax prep business G. Sandiego and Associates and for 2014 through 2017 prepared and filed false income tax returns for clients. Instead of relying on information provided by the clients, Sandiego either inflated or entirely fabricated expenses to falsely claim residential energy credits and employment-related expense deductions.
Sandiego, who
He was also ordered to serve a year of supervised release and pay $2,910,442 in restitution to the IRS.
Ft. Worth, Texas: A federal district court has entered permanent injunctions against CPA Charles Dombek and The Optimal Financial Group LLC, barring them from promoting any tax plan that involves creating or using sham management companies, deducting personal non-deductible expenses as business expenses or assisting in the creation of “captive” insurance companies.
The injunctions also prohibit Dombek from preparing any federal returns for anyone other than himself and Optimal from preparing certain federal returns reflecting such tax plans. Dombek and Optimal consented to entry of the injunctions.
According to the complaint, Dombek is a licensed CPA and served as Optimal’s manager and president. Allegedly, Dombek and Optimal promoted a scheme throughout the U.S. to illegally reduce clients’ income tax liabilities by using sham management companies to improperly shift income to be taxed at lower tax rates, improperly defer taxable income or improperly claim personal expenses as business deductions. As alleged by the government, Dombek also promoted himself as the “premier dental CPA” in America.
The complaint further alleges that in promoting the schemes, Dombek and Optimal made false statements about the tax benefits of the scheme that they knew or had reason to know were false, then prepared and signed clients’ returns reflecting the sham transactions, expenses and deductions.
The government contended that the total harm to the Treasury could be $10 million or more.
Kansas City, Missouri: Former IRS employee Sandra D. Mondaine, of Grandview, Missouri, has pleaded guilty to preparing returns that illegally claimed more than $200,000 in refunds for clients.
Mondaine previously worked for the IRS as a contact representative before retiring. She admitted that she prepared federal income tax returns for clients that contained false and fraudulent claims; the indictment charged her with helping at least 11 individuals file at least 39 false and fraudulent income tax returns for 2019 through 2021. Mondaine was able to manufacture substantial refunds for her clients that they would not have been entitled to if the returns had been accurately prepared. She charged clients either a fixed dollar amount or a percentage of the refund or both.
The tax loss associated with those false returns is some $237,329, though the parties disagree on the total.
Mondaine must pay restitution to the IRS and consents to a permanent injunction in a separate civil action, under which she will be permanently enjoined from preparing, assisting in, directing or supervising the preparation or filing of federal returns for any person or entity other than herself. She is also subject to up to three years in prison.
Los Angeles: Long-time lawyer Milton C. Grimes has pleaded guilty to evading more than $4 million in federal taxes over 21 years.
Grimes pleaded guilty to one count of tax evasion relating to his 2014 taxes, admitting that he failed to pay $1,690,922 to the IRS. He did not pay federal income taxes for 23 years — 2002 through 2005, 2007, 2009 through 2011, and 2014 through 2023 — a total of $4,071,215 owed to the IRS. Grimes also admitted he did not file a 2013 federal return.
From at least September 2011, the IRS issued more than 30 levies on his personal bank accounts. From at least May 2014 to April 2020, Grimes evaded payment of the outstanding income tax by not depositing income he earned from his clients into those accounts. Instead, he bought some 238 cashier’s checks totaling $16 million to keep the money out of the reach of the IRS, withdrawing cash from his client trust account, his interest on lawyers’ trust accounts and his law firm’s bank account.
Sentencing is Feb. 11. Grimes faces up to five years in federal prison, though prosecutors have agreed to seek no more than 22 months.
Sacramento, California: Residents Dominic Davis and Sharitia Wright have pleaded guilty to conspiracy to file false claims with the IRS.
Between March 2019 and April 2022, they caused at least nine fraudulent income tax returns to be filed with the IRS claiming more than $2 million in refunds. The returns were filed in the names of Davis, Wright and family members and listed wages that the taxpayers had not earned and often listed the taxpayers’ employer as one of the various LLCs created by Davis, Wright and their family members. Many of the returns also falsely claimed charitable contributions.
Davis prepared and filed the false returns; Wright provided him information and contacted the IRS to check on the status of the refunds claimed.
Davis and Wright agreed to pay restitution. Sentencing is Feb. 3, when each faces up to 10 years in prison and a $250,000 fine.
St. Louis: Tax attorneys Michael Elliott Kohn and Catherine Elizabeth Chollet and insurance agent David Shane Simmons have been sentenced to prison for conspiring to defraud the U.S. and helping clients file false returns based on their promotion and operation of a fraudulent tax shelter.
Kohn was sentenced to seven years in prison and Chollet to four years. Simmons was sentenced to five years in prison.
From 2011 to November 2022, Kohn and Chollet, both of St. Louis, and Simmons, who is based out of Jefferson, North Carolina, promoted, marketed and sold to clients the Gain Elimination Plan, a fraudulent tax scheme. They designed the plan to conceal clients’ income from the IRS by inflating business expenses through fictitious royalties and management fees. These fictitious fees were paid, on paper, to a limited partnership largely owned by a charity. Kohn and Chollet fabricated the fees.
Kohn and Chollet advised clients that the plan’s limited partnership was required to obtain insurance on the life of the clients to cover the income allocated to the charitable organization. The death benefit was directly tied to the anticipated profitability of the clients’ businesses and how much of the clients’ taxable income was intended to be sheltered.
Simmons earned more than $2.3 million in commissions for selling the insurance policies, splitting the commissions with Kohn and Chollet. Kohn and Chollet received more than $1 million from Simmons.
Simmons also filed false personal returns that underreported his business income and inflated his business expenses, resulting in a tax loss of more than $480,000.
In total, the defendants caused a tax loss to the IRS of more than $22 million.
Each was also ordered to serve three years’ supervised release and to pay $22,515,615 in restitution to the United States.
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