CPA firms might be able to reduce insurance claims by paying more attention to four key areas: estate tax returns, entity selection, form 5471 and 5472 tricky filing requirements and improperly documented client extensions. Based upon 20 years of claims experience, CAMICO Mutual Insurance Company has identified these frequent sources of tax claims and offers tips for CPAs.

Estate Tax Return Penalty Issues
Filing Penalties. The estate tax return’s irregular filing due date, which is based on the decedent’s date of death, is the primary reason for the missed estate tax return filings. Due to the high tax amounts reported on estate tax returns, the late filing penalties often exceed $100,000.

CPAs caught by such claims usually: (1) did not have any sort of estate tax return due date calendaring system; or (2) did not pay enough attention to any system they did have implemented.

Consider the following recommendations:

(1) Have one person in the office assume responsibility for tracking estate tax return filing deadlines (rather than each tax partner or tax manager tracking individual deadlines).

(2) Have a due date tracking system for estate tax returns. The system can be extremely simple (such as a large paper calendar devoted solely to estate tax return due dates). A calendar is effective as long as it is posted in a conspicuous, frequently viewed area.

(3) Continually review the estate tax return tracking system to ensure your firm meets any impending due dates.

Payment Penalties. CPAs also incur late payment penalties by not realizing an estate tax payment extension request requires a separate section of federal form 4768 be completed. Also, the payment extension is not automatic (like the filing extension) and requires evidence demonstrating “reasonable cause.” Additionally, the IRS can exercise discretion with respect to granting the payment extension (because of the “reasonable cause” requirement), so the payment extension should be completed well in advance of the estate tax due date in case the IRS denies the payment extension request.

Entity Selection Issues
Claims in this area arise because the CPA (not the client) chose the “best” entity for the client’s new business, and because the CPA did not document the advice provided to the client.

The client must select the entity that he or she feels is the best fit for the new business – not the CPA. Each entity type has positive attributes and negative attributes, and the selected entity's type negative attributes could surface if certain unforeseen future events occur. The client will then be able to successfully assert a different entity type, which would have better addressed the unforeseen future event that occurred.

CPAs can provide a client with available entity alternatives and attributes and detriments for each. The client can then choose the entity which best complements his or her business. This helps insulate the CPA from liability if the client’s choice does not prove to be “best,” as long as the CPA can document the information provided to the client.

Federal Form 5471 and 5472 Penalty Issues
A $10,000 penalty applies where either a form 5471 or 5472 was due but not filed. The penalty most often is triggered because a CPA was not aware of the form’s filing requirements.

Both federal form 5471 and 5472 have extremely complex filing requirements that are beyond the scope of this article. However, your firm can use the following easy-to-memorize rules to help identify situations where a federal form 5471 or 5472 might be required:

(1) Is an individual client an officer or director of a foreign corporation, or is any client a shareholder in a foreign corporation where the share ownership equals 10 percent or more of a foreign corporation’s stock? If so, your firm should consult the federal form 5471 instructions to determine whether your client must file the form.

(2) Is any corporation client a foreign corporation or owned 25 percent or more (directly or indirectly, by vote or value) by a foreign individual or entity? If so, your firm should consult the federal form 5472 instructions to determine whether your client must file the form. Note: several filing exceptions exist if the client did not have reportable transactions (see the “reportable transaction” definition in the federal form 5472 instructions).

The best way to be aware your client is a foreign corporation (form 5472), or owns foreign corporation stock, or is a foreign corporation’s officer or director (form 5471) is to make sure your firm requests the applicable information from the client.

Improperly Documented Client Extensions
Another recurring claim involves income tax filing extension payment calculations. A typical scenario involves a CPA obtaining missing tax data over the phone from the client. The CPA calculates the due tax payment. The client mails the tax extension and payment prior to April 15.

Later in the year, though, when the CPA has the client’s actual tax data, the client’s previously provided oral estimates prove to be wildly off the mark. The actual amounts are much higher, and the client will owe a much greater tax amount (with accompanying late payment penalties). Once the client sees the late payment penalty amount, the client “forgets” the phone conversation on April 15 and now demands that the CPA pay the due penalty.

A written confirmation of the amounts used to calculate the extension payment should be sent to the client with the extension form. This gives the client an opportunity to review the information and to change any information that appears incorrect, prior to April 15. The confirmation also serves as a record of the client’s representations in case the client incurs a late payment penalty and “forgets” the representations made in April.

Reprinted with permission from CAMICO.  All rights are reserved.

About the Author
Keith Lee, JD, CPA is staff tax counsel/tax services manager with CAMICO Mutual Insurance Company (www.camico.com). He works internally with the CAMICO claims department to resolve tax claims and provides CAMICO’s policyholders with information regarding corporate income, gift and estate tax transactions. He also serves as a resource for several national publications.

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