Practice Management Tip: Engagement Letters

Practice Management Tip: Get Clients to Sign Engagement Letters Before Preparing Their Returns

Let me begin this installment with a little forward-thinking scenario.

It’s March of 2021, and you are meeting with Joe and Loretta King, a married couple who file a joint return. Their income for 2020 was $72,000. Joe and Loretta have six dependent children, ranging in age from 3 to 12. 

The subject of Economic Stimulus Payments comes up during your interview. Joe and Loretta emphatically tell you they received no advance payments and were looking forward to that money and hope they can receive it now. You query them and conclude they must be correct; after all, how could anyone forget receiving $5,400 in the first round, which was $1200 for Joe and Loretta each plus $500 for each of their six dependent children. Not to mention the most recent round of stimulus, which should have been another $4,800 ($600 for each member of the family). They appear to be entitled to $10,200, which your software calculates as part of their refund. The returns are filed, the fees are paid, and you move on to your next client.

In early April, an irate Joe King calls your office and is so inconsolable that your office manager pulls you away from a meeting to talk with him. He states the IRS is refusing to pay the $10,200, indicating the King family had already been sent these advance payments. You suggest Joe check his bank accounts, and reluctantly, he ends the call with you.

In early June, you are taken aback when the county sheriff serves you a court summons. You are being sued for the $10,200 plus pain and suffering and court costs for the “contractual promise” you made to the King family and the “irreparable harm” and anguish you caused them.

You try and remember who this client was and discover you didn’t keep any notes from the original appointment, nor did you use an engagement letter to outline the terms of your work with the King family.

While this scenario may seem outlandish, wouldn’t a well thought out engagement letter have spelled out the terms of what is expected when a client works with a tax professional and what is expected from either party in the case of a disagreement?

An engagement letter for tax preparation services should be the first written communication a tax practice has with its client each year. It can also end up being an important piece of evidence if the tax office (or preparer) is ever sued. Therefore, an engagement letter can be either a means of defense or actually be used against the tax practice.

Coming up with the most suitable language to include in an engagement letter is not easy. For a beginning point, tax offices should reach out to their liability insurance carrier and ask what the insurer expects an engagement letter to contain. The insurance company may have sample engagement letters for you to review. Even so, the engagement letter should be reviewed annually. Sample engagement letters may also be found on the Internet or even provided by your tax software vendor. Still, these samples can never replace a meeting with an attorney to make sure you are protected.

Tax offices should consider several points in their engagement letters:

Who is the client: Are you representing an individual, a married couple, an entity, the fiduciary of an estate or trust or the beneficiaries, etc.? When working with a client with multiple interests, it may be necessary to have an engagement listing each activity the client is involved in.

The time period the engagement covers: Are you engaging with the client for this calendar year, or a fiscal year, or even a short year? Due dates of various types of filings may be important to list since taxpayers may not be aware of recent changes in filing deadlines.

Just what services will your firm provide: An engagement letter should outline what services the firm will provide. Will you offer just preparation of returns, or are other services such as tax planning, IRS representation, or other services available to the taxpayer? If so, those services and the potential costs for additional services should be spelled out, or at least indicated that they would be performed for the extra cost to the taxpayer.

You may wish to outline other available services, or, perhaps not available such as:

• Bookkeeping services. Will your firm prepare and organize financial information, or do you expect the taxpayer to get their information in proper order before bringing it to you;
• Preparing profit and loss, balance sheets, or other financial statements;
• Calculation of basis schedules for shareholders or partners;
• Preparation of less common returns such as federal excise tax returns and multiple state filings;
• Limitations or additional fees for addressing taxing authority inquiries or proposed changes to the returns prepared by your office or a previous firm.

Relying on the information the client provides: Taxpayers need to understand that they are ultimately responsible for the information they provide. The engagement should spell out that the tax firm’s responsibility is to make reasonable inquiry as to the validity of what is being submitted. This responsibility includes information from other parties such as investment firms, which may provide information on gains or losses on invested asset transactions. The information is not being audited unless required, and the engagement letter spells out this requirement.

Fees: Many complaints stem from misunderstandings in this area. At the very least, ranges of costs should be explained and listed and when they are due, and how they are to be paid.

Signed acceptance by the client: If they don’t want to sign, you are likely to start behind the eight ball so I think you should move away from the potential engagement. Besides, if an engagement letter isn’t signed, do you have an engagement?

From personal experience, I started using engagement letters about ten years ago. We would send out the letter along with an appointment reminder.  We also projected how much our fee would be, assuming no changes in the client’s situation from the previous year. I must admit that we did lose a few clients over this new procedure, but just a few.  We were genuinely surprised at the number of clients who came to their appointment with the engagement letter signed and a check attached. It sure makes collecting a lot easier.

After reading all of this, I hope you have several takeaways:

1. Communicate with your client to prevent misunderstandings.
2. Document your notes while (or soon after) meeting with your client, especially if you have concerns.
3. Realize, in the final analysis, if it comes down to a decision between you and the taxpayer, the taxpayer will leave you stranded.
4. If it’s not in writing, it didn’t happen.

Could any of my advice today save our unfortunate preparer from the earlier scenario? Maybe not, but then again, perhaps it would have.

Let’s be careful out there.

by Tom O’Saben, EA