Can CPAs be held liable for sales tax non-compliance?

The liability for sales tax non-compliance is clear for companies. A “responsible person” is liable for the sales and use tax owed, as is the business entity and any of its other responsible persons.

Responsible parties can trickle down to the person whose duties involve managing and paying taxes or any other person who has the authority or ability to control business payments and decisions. This liability extends beyond the business, as well, even to potentially seizing an exec’s personal assets.

But what if a company hired a tax pro, such as a CPA? Who’s responsible then? And how can a CPA protect themselves?

Documentation rules

Even if you the preparer make a major error regarding a client’s sales tax, the client taxpayer, as with the IRS, is fundamentally liable for most if not all of the additional tax, interest and penalties.

Lawsuits are another matter. A New York accounting firm has found itself on the business end of a malpractice lawsuit from a large construction company that restructured its business based on what it called flawed advice from the firm. According to published reports, the accounting firm had been retained under written engagement agreements to perform specific services such as preparing and auditing financial statements and preparing corporate and partnership income tax returns.

These agreements also included a clause requiring notice and mediation before any lawsuit could be filed. The agreements did not mention sales tax advice, though they did allow for “Additional Services” through a separate written agreement. No such agreement was reportedly created when the firm, at the plaintiffs’ request, provided sales tax advice in 2015.

In 2021, New York State audited the construction firm. The plaintiffs alleged that the firm again became involved, this time representing them in defense of the sales tax guidance it had given in 2015. “That continued involvement became central to the court’s conclusion that the firm’s representation extended into the audit process, supporting the application of the continuous representation doctrine,” news reports said.

“Firms should be diligent in ensuring all additional services are covered by written agreements, particularly in areas with regulatory or tax implications.”

The AICPA Professional Liability Insurance Program has said it’s experienced more claims asserted against CPAs for providing tax services than all other accountants’ claims combined. “While the volume of claims is greater for tax services, the severity, or the dollar amount paid on defense and indemnity, is typically low and usually not fatal to the survival of a CPA firm. However, tax claims related to state and local taxes … can be an exception.

Among other examples, offered by the American Society of CPAs (AICPA):

A Virginia CPA was engaged to prepare a tax return for an Illinois-based executive coaching client. The client’s employees met face to face occasionally with their clients throughout the country, but most coaching was performed via an internet platform. The CPA identified the possibility of nexus in states besides Illinois due to business travel associated with these engagements.

However, the CPA concluded that the cost of preparing additional state tax returns would probably exceed the potential tax liability in each state. The CPA did not discuss this with the client and only filed the Illinois state tax return. Several years later, the client complained about the amount of tax owed to Illinois and asked the CPA if it could be minimized.

The CPA consulted with a SALT specialist, who identified that Illinois had changed its revenue apportionment methodology. Because the coaching services were delivered remotely, there was, in fact, an opportunity to reduce Illinois income and file other state returns showing little or no income and related tax, thus reducing the client’s overall state tax liability. When the client realized this methodology could have been employed for previous years, it made a claim against the CPA.

A CPA firm had a client that operated fitness clubs across the country. When expanding to a new state, the client would ask the CPA firm to research the income and sales tax consequences of the expansion. The CPA firm performed the research and added the new state to a previously drafted memo, which included the research performed for all previously requested state evaluations.

One year, in the middle of busy season, the client requested an analysis for Texas. The CPA firm’s SALT specialist, who was new to the engagement, misunderstood the scope of services to be provided and only researched the franchise tax treatment and failed to research the sales tax implications of doing business in Texas. Due to staffing demands and the confidence placed in the SALT specialist’s work, the memo was not reviewed prior to delivery to the client.

After it was audited, the client discovered membership fees were subject to sales tax in Texas. The taxes were no longer recoverable from its members. The client contended that the CPA firm should be held responsible for the uncollected sales tax.

A client sold medical supplies to physician practices throughout the country. Sales representatives visited customers in all 50 states, and the CPA assumed all their activities were considered solicitation of orders protected by the Interstate Income Act of 1959. The engagement letter stated that “federal and state” tax returns would be prepared.

A Minnesota auditor reviewing the client’s website noted the duties of the client’s sales representatives included storing and delivering replacement supplies and obtaining deposits from new customers. Based on this discovery, the Minnesota Department of Revenue mailed the client a nexus questionnaire. The client told the CPA to complete the nexus questionnaire and return it to the state. The client did not review the questionnaire prior to the CPA’s submission to Minnesota. After receipt of the questionnaire, the state initiated an income and sales tax audit. When the CPA told the auditor that the client did not have nexus, the auditor explained her findings and alleged that the nexus questionnaire was improperly completed because it failed to contain the information she had discovered. In addition, the auditor requested sales tax exemption certificates, which the client had not obtained from its customers.

The client instituted a claim against the CPA for the additional payments and asserted that no additional fees could be charged since the Minnesota returns were included in the scope of “state” returns.

Precautions

A tax pro’s best defense against being sued over a client’s sales tax is solid prep beforehand:

• Understand the client’s business. Annually discuss client activities in other states with the client to ensure a complete understanding of the client’s business. Review company websites and social media, where materials sometimes written by marketing departments may overstate the client’s services, potentially creating unintended nexus issues.
• Define the scope of services in the engagement letter. In your letter, specify state and local tax returns for which a CPA is responsible. Engagement letters should specifically identify those state tax returns that will be filed, including form numbers.
• Insist that clients review all contracts they have with you and that they clearly understand your engagement letter.
• Keep up to date on states’ and local jurisdictions’ sales tax laws for jurisdictions where you’ll be helping clients meet their obligations. CPA and other tax pro societies can offer insight and even practitioner partnerships to help protect the client – and yourself.

Clients’ sales tax non-compliance can add significant risk to your accounting practice. We can advise you on compliance and help you stay on top of this ever-changing tax environment. Contact us to learn about the latest developments in sales-tax nexus and what they mean to you and your firm.