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By Suzanne M. Holl, CPA

CPA firms are experiencing an uptick in clients trying to embed indemnification and hold harmless clauses in various agreements. Many of the clauses are inappropriate for CPA services or overly broad, even to the point of shifting all liability to the CPA firms.

Indemnification and hold harmless clauses dictate the degree of liability of each party and the extent that each party takes on or shifts risk. Certain courts have found that “hold harmless” is not distinct and is the same as indemnification, while others have found the duty to hold harmless is broader than indemnification and requires protection against liability.

CPAs are being pressured more by their clients to take on the “indemnitor role” and to agree to such language in engagement letters, nondisclosure agreements (NDAs), business associate agreements under the Health Insurance Portability and Accountability Act (HIPAA), and other agreements that may be executed between CPAs and their clients.

It’s important that before you contractually bind the firm to an arrangement of this significance, take the time to understand all the implications of the legalese in the agreement. Make sure you are comfortable with the agreement and the expectations that will fall on the firm – and ask the following questions before agreeing to any indemnification and hold harmless clauses:

Indemnification Hierarchy of Risk:

• Who is asking you to indemnify them? Most often you will be asked by your clients to indemnify them. Sometimes a third party may ask.
• Why are you being asked to indemnify? Determining the answer may provide information in order to suggest an alternative that is acceptable to all parties.
• What exposure is the subject of the indemnification request? It is almost never appropriate to agree to indemnify your client or third party for exposures directly related to the client’s obligations to you. For example, any request that provides indemnity for your client’s failure to accurately and timely inform you of information necessary to complete your work is very risky and not appropriate. On the other hand, client requests for indemnity for exposures unrelated to your professional services is far less risky. For example, clients may ask for indemnity for risks arising as a result of your personnel being in the client’s offices (e.g., slip and fall, damage to property, etc.). We often see large corporations, municipalities and other governmental entities making such requests.
• Is the indemnity request limited? A broad blanket indemnification, again, is almost never appropriate. Remember, unless specifically limited, an indemnification does not require you to be negligent in order to trigger your duty to indemnify. On the other hand, indemnification agreements limited to exposures in which you are judicially found negligent, and the sole cause of the loss, create very little additional exposure to you.
• What insurance issues need to be considered? By far the most important insurance issue to consider is the impact of your acceptance of indemnification on your professional liability insurance. Before you agree to any indemnification, check with an attorney in your jurisdiction or your insurance company. The other insurance issue to consider is the extent to which you can protect against the indemnity risk through other insurance. For example, many business owner policies (BOPs) address the premises risk exposure from your personnel being in the client’s offices. If you cannot insure against the risk created by the indemnification, you must consider fee/exposure leverage. Assess the size of the indemnity risk versus your fees. If the indemnification exposure is much greater than your fees, risk increases, and the reward is limited.

If you are still considering the indemnity request after asking these questions, consult your legal adviser. Never decide on your own (here are more Risk Management Tips to consider before agreeing to any indemnification and hold harmless clauses). Indemnification law varies by state, so this risk discussion does not address every possible issue or solution on a per-state basis.

Suzanne M. Holl, CPA, is senior vice president of loss prevention services with CAMICO (mickey.camico.com). With almost 30 years of experience in accounting, she draws on her Big Four public accounting and private industry background to provide CAMICO’s policyholders with information on a wide variety of loss prevention and accounting issues.

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“Hope for the best, plan for the worst” — a very sound risk management approach. When it comes to your client being exposed to cryptoasset risk “plan for the worst” is necessary. No one at CAMICO, or anywhere else, knows whether cryptoassets will suffer a crash in value. What we at CAMICO do know is if it happens, your clients are likely to wonder why their CPA did not warn them. Remember, 36 years of jury research and experience informs us that the CPA’s job, in the eyes of the jury, is to “advise of financial opportunity and warn of financial risk.”

Risk Management Fundamentals…Prioritize “Proactive Documentation”

Proactive documentation, sometimes referred to as defensive documentation, is the first line of defense in any claim scenario. When there is no accurate written description of the terms and conditions of an engagement, claimants can more easily assert the CPA was responsible for:

1) providing services the CPA did not consider part of the engagement, and

2) guaranteeing the success of whatever transaction claimants initiated while the CPA’s services were engaged.

Therefore, it is critical engagement letters include a clause regarding the IRS’s reporting requirements for virtual assets and to clarify a client’s responsibility to provide the CPA with the necessary information. (Refer to CAMICO’s tax engagement letter templates on the Members-Only Site under the Engagement Letter Resource Center).

CAMICO suggests the language below be added to engagement letters for the following clients:

a) all individual tax clients, whether invested in cryptoassets (directly or indirectly)

b) all other clients known or suspected to be invested in cryptoassets

Sample Engagement Letter Language:

Please note the Internal Revenue Service (“IRS”) considers virtual currency (e.g., Bitcoin) and other digital assets (e.g., non-fungible tokens “NFTs”) as property for U.S. federal tax purposes. As such, any transactions involving cryptoassets or transactions that use or exchange virtual currencies are subject to the same general tax principles that apply to other property transactions. If you had any cryptoasset or virtual currency activity during the [year] tax year, you may be subject to tax consequences associated with such transactions and may have additional foreign reporting obligations.

You agree to provide us with complete and accurate information regarding any transactions in cryptoassets or transactions using any virtual currencies during the applicable tax year. Please ask us for advice if you have any questions. If you require additional consulting services to evaluate the specific treatment of digital assets or virtual currency and we agree to perform such services, such services will be covered under a separate engagement letter.

In addition, for those clients who have known virtual asset transactions, it may be prudent to also have them sign a tax representation letter or a stand-alone certification letter at the conclusion of the engagement that includes language addressing cryptoassets. (Refer to CAMICO’s letters on the Members-Only Site under Knowledge Tree, CAMICO Publications, IMPACT, 2022, IMPACT 121). The additional defensive documentation provides support and evidence of clients’ understanding and acceptance of their responsibilities with respect to virtual asset transactions and the limitations of the services the CPA is providing.

Educate your clients.

CAMICO suggest the best way to inform clients of the risks and the tax consequences of cryptoassets are to provide a robust written client communication.

A limited example of such a communication may include the following:

Directly or indirectly investing in cryptoassets involves significant risks that should be seriously considered. As an investor, some of the risks to consider include:

• Cryptocurrencies are speculative because they have no intrinsic value, and their market value is based on a high level of uncertainty and dependent upon investor confidence. Many commentators believe that a crash in value is inevitable.
• The virtual asset marketplace is largely unregulated and investments in cryptoassets are not insured by any government agency. Transactions are irreversible, anonymous, and occur in any location around the globe.
• Transactions occur instantaneously — there are no “gatekeepers” so anyone can download the associated software.
• There may be periods of illiquidity.
• There is a significant risk of theft of cryptoassets through fraud or cyber-attacks with little or no recourse for the victimized investor.
• There are specific tax rules regarding virtual asset transactions.

Your client communication should also include some “call to action.” For example, you could include the following: Please advise us if you are investing in any cryptoassets or whether you have taxable or sales transactions or exchanges using virtual assets.

Download CAMICO’s suggested and simple way to warn your client base about crypto risk with a client notification letter. Click on the link to download the sample template:

Additional Risk Management Steps for CPA Firms

1. Get educated and stay current on the rules and risks associated with virtual and other cryptographic assets even if you refer the client to a specialist outside the firm. Risks will likely continue to escalate as new virtual investment opportunities arise. For example, you may have a client who has invested in NFTs. These are unique cryptographic assets (tokens), like a one-of-a-kind baseball card and can be anything digital such as drawings, music, and digital art. Understanding what a NFT is, how NFTs work, what sort of software tracking is available for recording the sales and purchases of NFTs, are just a few of the uncertainties CPAs need to address if they have clients entering into this new cryptoasset community.
2. Don’t dabble. As you can imagine, crypto is a whole new world of possibilities but also potential liability risks for CPAs who dabble — tread carefully, arm yourself with knowledge and know your limitations.

CAMICO policyholders with questions regarding this communication or other risk management questions should contact the Loss Prevention department at lp@camico.com or call our advice hotline at 800.652.1772 and ask to speak with a Loss Prevention Specialist.

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Arthur J. (Kip) Dellinger, Jr., CPA

It is not news to CPAs and their firms that the profession began undergoing an enormous consolidation a few years ago, which is expected to accelerate over the next several years. This is a result of many factors — retirement planning, monetizing of client values, staggering advances in technology, market share and services expansion, among many other reasons.

The consolidation typically takes the form of mergers and acquisitions and sometimes a combination of both. And it involves not only very large firms merging — or bringing in firms of significant size in a local or regional market — but also includes local firms and even sole practitioners combining or acquiring practices of retiring practitioners.

When a proposed merger or acquisition transaction is undertaken, questions arise about the professional obligations and responsibilities of the target firm, including any required communication pertaining to its clients’ confidential information and the transfer of client files to the successor entity.

Professional Standards — American Institute of Certified Public Accountants (AICPA)

Two provisions of the AICPA’s Code of Professional Conduct address merger and acquisition issues.

The first and most significant provision is ET § 1.400.205 – Transfer of Files and Return of Client Records in Sale, Transfer, Discontinuance or Acquisition of a Practice¹ — and additionally interpreted in Frequently Asked Questions: General Ethics (updated March 18, 2022).

ET § 1.400.205 provides that when a CPA’s practice is sold or transferred to another firm and the seller/transferor will no longer retain an ownership in the successor practice, each client must receive a written request for consent to transfer its files to the successor firm. The notification may state if a negative response is not provided within 90 days, permission will be assumed by the successor to transfer the files. Moreover, the files should not be transferred until client permission is obtained or the 90 days period expires. Additionally, the acquiring firm is equally responsible for compliance with these requirements. However, there are conflicting requirements discussed below when tax information will be transferred in a sale of a practice.

Equity vs. Non-Equity Transferors

The Frequently Asked Questions addressing “Transfer of client files in a merger” clarify that if a target CPA firm’s owner(s) become equity partners, the client notice requirements do not apply — regardless of the percentage of ownership.

Alternatively, if the target CPA firm’s owner(s) are admitted as non-equity partner(s), the client written notice requirements discussed earlier will apply.

There may also be hybrid situations — for example, when the target CPA firm’s partner, equity or non-equity, “own” clients. In that event, each client situation must be evaluated and treated in a manner consistent with these rules pertaining to equity and non-equity owners in successor entity.

Conflict of Interest Considerations (ET § 1.700.010)

In some circumstances, the parties must consider possible conflicts of interest. For example, when two CPA firms are combining and each represent industry competitors, or when a practice being acquired includes a competitor of a client of the acquiring firm (where one or both clients would prefer not to share the same CPA firm) can create a conflict-of-interest issue. How such matters are handled should be specified in the agreement to the contemplated merger or acquisition.

Accountancy Laws

CPAs and CPA firms are regulated by Boards of Accountancy in the states and other geographical locations where they practice. When one or both firms are pursuing an acquisition or merger, the parties should ascertain which Boards have jurisdiction and determine the applicable jurisdictional rules that apply to the contemplated transaction. Fortunately, the overwhelming number of jurisdictions adopt (specifically or impliedly) the ethics rules of the AICPA (for example, Rule 58 of the California Board of Accountancy).

The California Board of Accountancy recently proposed a specific rule regarding CPA firms’ duties when there was a sale or transfer of a licensee’s practice (Proposed Rule Sec. 54.2) but withdrew the proposal in February 2022. This presumably means California continues to default to the AICPA provisions.

CPAs Must Comply with Onerous Treasury Regulation Requirements

Internal Revenue Code Section § 7216 (“the Code” or “7216”) is a criminal statute regulating tax preparers with regards to their “uses” and “disclosure” of a taxpayer’s return information. The Code is very general and provides that Treasury issue regulations governing the application of Code Section § 6713, which provides civil monetary penalties for similar violations. Its application is governed by 7216 regulations and the provision is more likely to be asserted by the Internal Revenue Service (“the IRS” or “Treasury”) because proving a criminal violation has a much higher bar than meeting a civil violation.

Treasury has issued three regulations under Sec. § 7216 – Reg. Sec. 1.301.7216-1, 2 and 3. These regulations should be reviewed annually by firm leadership to ensure continued compliance with their requirements, IRS Section 7216. Regulation 1.301.7216-1 addresses, definitions and the respective penalties associated with violations of the Code. The significant portion states that “taxpayer information” is any information pertaining to the taxpayer. For example, the use or disclosure of the taxpayer’s name can result in a violation and the regulation is not limited to financial information or identification numbers.

The second regulation, 1.302.7216-2, is key to a firm’s practice because it sets forth those “uses and disclosures” that a tax preparer may make or engage in without prior written approval of the taxpayer, whose information is to be used or disclosed. One of the uses may be to compile a list for solicitation of tax return preparation business (1.302.7216-2(n)). While the CPA firm, as a compiler of the list, is not generally permitted to transfer it, an exception is made when there is a transfer in combination with the sale or disposition of the firm. The typical due diligence conducted prior to the proposed sale of the CPA’s tax preparation business will not represent a transfer of the list if: the CPA selling the firm has a written confidentiality agreement with the acquiring firm that expressly prohibits any use or disclosure of information permitted to be on the list for any purpose other than the purchase of the firm’s business.

If the use or disclosure is not contained in the second regulation, then strict adherence must be made with the third regulation, which sets forth specific, detailed requirements for obtaining the taxpayer’s prior written approval.

Regulation Section § 301.7216-2(d)(1) permits, without taxpayer approval, the use and disclosure of taxpayer information among preparers and processors of a firm regarding tax return preparation and related-tax advice. Therefore, when a merger takes place between two firms and there is continuity of personnel from the target firm in the successor firm, the IRS can be expected to apply the same principles as the AICPA to the transaction. When the target firm’s owners do not retain an equity interest in the successor firm, an abundance of caution would be to comply with the stricter request for permission requirements set forth in Reg. Sec. 301.7216-3. Unfortunately, the request for consent does not specify the number of days within which the client must respond, which can be problematic for the successor firm, instead requiring affirmative consent must be given by the taxpayer before a transfer takes place.

The regulations do not provide for an acquiror’s quality review of tax returns in connection with a sale or merger of a CPA firm’s practice. This is different than the AICPA rules and consequently, the CPA firm whose clients’ returns will be the subject of a review, must obtain client permission for the use and disclosure of their return information when contemplating a sale or merger.

This may present challenges to the two firms, as the acquiror will be limited in identifying particular returns and therefore may request to review it (because they cannot have access to any return information in the selection process). Or, the target firm would have to seek permission from every tax return client to enable the acquiring firm to make its selection. The parties must find a satisfactory solution to the quandary — perhaps a random selection from a list identified (only by numbers) that correspond to an alphabetized master retained by the target firm.

It is critically important to remember in merger and acquisition transactions that the requirements under tax laws must be complied with in addition to complying with the CPA profession’s ethical standards.

Arthur J. (Kip) Dellinger, Jr., CPA, provides services as an expert in the areas of CPA tax practice regulatory discipline and malpractice matters.

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¹

ET1.400.205

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