Insurance claims on the rise

For accountants, the risk of being wrong, or of being right but creating an impression of negligence, is enough to cause sleepless nights. And the comfort of having an ally to turn to when the professional is unsure of what to do next can be invaluable.

Accountants are currently coming out of a “hard market” for professional liability insurance, according to Stephen Vono, senior vice president at McGowanPro. “States with large metropolitan areas are still hard, while the less populated states are softening up some as far as the market is concerned, based on what we are seeing. Then there is the Employee Retention Credit — the claims will be coming in for those. … When this happens, underwriting guidelines tighten up, and premiums tend to go up because, in general, companies saw an increase in costs in 2020 and 2021 when the costs of litigation increased due to court closures across the county. There has been a higher frequency of claims, although not so much higher severity.”

Hard markets tend to be cyclical, said Vono: “They tend to occur every five to eight years, but COVID change that.”

Sarah Ference, risk control director for professional services at CNA, agreed that ERC issues remain a threat. “The IRS has up to five years to audit payroll tax returns claiming the ERC, longer than the typical three-year statute of limitations for income tax return,” she explained. “Positions taken on tax returns prepared now may not be overturned until several years down the road, and the third party that performed the ERC calculator may no longer be in business. The two-year difference in statute of limitations may result in the loss of otherwise available income tax wage deductions in years that are closed. Along with the disallowed ERC and assessment of penalties and interest on underpaid employment taxes, the CPA may be blamed for the client’s losses.”

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Be prepared

CPA firms continue to face unique risks they should not ignore, according to Suzanne Holl, a CPA and senior vice president of loss prevention services at CAMICO. “In addition to trying to keep up with the increasing complexities of evolving tax legislation, changes to accounting standards, and other regulations impacting the profession, many firms are experiencing significant capacity challenges as they struggle to find and retain qualified talent to support and meet their clients’ service needs,” she said. She suggested firms consider the following risk management best practices:

1. Prepare for risk by setting the “tone at the top.” Encourage and reward transparency within the firm hierarchy when risk stress points are identified.

2. Perform the right services for the right clients. Holl noted: “Difficult times have put unprecedented challenges on even the best of firms’ client base … . Now is the time to assess the firm’s staffing constraints as well as risk tolerance with respect to clients and look to disengage from those clients that pose undue risks or create staffing and/or other challenges for the firm.”

3. Manage client expectations. Proactively managing and documenting expectations with your clients to minimize the risks associated with potential client expectation gaps is a critical first line of defense to help safeguard a firm. For example, the dilemmas surrounding the ERC present tax, accounting, ethical and financial statement challenges and risks to CPAs. These can be exacerbated with clients who have engaged ERC mills to assist them, if the CPA has concerns and does not agree with the assessment of their clients’ eligibility for the credit or the amount they qualify for. To mitigate these risk stress points, it is critical that firms have written documentation in services specifically related to the ERC that memorializes the client’s understanding regarding the underlying risks associated with applying for and receiving the credit, and documents the client’s representations to the firm regarding their eligibility for the credit.

4. Tread carefully as you navigate new service opportunities. For instance, the Corporate Transparency Act introduces a new and expansive reporting regime for entities deemed to be “reporting companies” to report “beneficial owner” information to the Financial Crimes Enforcement Network. There has been much discussion about whether CPAs are in a position to provide guidance and advice to clients regarding whether legal relationships constitute beneficial ownership. CPA firms at a minimum need to exercise caution as it relates to advising clients regarding CTA compliance to reduce the likelihood of facing an accusation of practicing law without a license. Firms should also do the following:

Inform and advise clients in writing regarding the new beneficial ownership reporting requirements under the CTA and recommend that they seek legal guidance.Modify engagement letters to include language that specifically disclaims the firm’s involvement in assisting clients with the CTA.CTA compliance services, if performed, should be under a separate stand-alone engagement letter.Prepare for their own firm’s compliance if they are deemed to be a reporting company under currently promulgated CTA guidance.

5. Implement cyber best practices. In CAMICO’s claims experience, the weakest link in most cybersecurity attacks today is the human element, so it is important to remember that firm employees are a vital line of defense. Firms should arm employees with education, awareness and reminders.

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More audits, more claims

There has been an increase in claims, in part due to the sluggish economy, noted John Raspante, director of risk management for McGowanPro: “People are more litigious and there has been an increase in income tax examinations at both the federal and state levels,” he said. “It could be that taxing authorities were more quiet during the last couple of years. Generally, an increase in assessments generated from tax audits generates an increase in claims against CPAs.”

Raspante agreed with other insurance professionals that the ERC will foster claims against CPAs. He also foresees other claims arising as a result of the the Pass-Through Entity Tax. “The election for the PTET varies state by state,” he said. “They’re new in many states. The due date varies, but it has to be made timely. It’s a rough landscape for CPAs.”

Some of the biggest challenges accounting firms face are related to adapting to new tax and regulatory changes while still meeting the needs of their clients and facing staffing challenges, according to Alvin Fennell, vice president and senior risk advisor at Aon, the national program manager for the American Institute of CPAs’ professional liability program. He also pointed to changing standards and requirements as a perennial source of problems facing accountants.

Additionally, he cited engagement creep as a major risk for CPAs that is often overlooked: “Lack of documentation and unspecific engagement letters lead to gray areas and misunderstanding regarding what the client’s expectations are and what the CPA’s role is.”

Even long-time clients may resort to a lawsuit if they feel the accountant has let them down. “I’ve had a lot of firms tell me that they know their clients and they would never sue them,” said Rudy Rudolph, senior risk advisor at Aon. “But you can’t predict the future. … Having some level of insurance coverage and taking proactive measures, such as using engagement letters, keeping up with industry trends and being aware of the potential risks that may come from new innovations, technology and regulations can help you protect what you’ve worked so hard to build.”