For accountants, bookkeepers, tax preparers, and certified public accountants (CPAs), managing risk is a critical part of running a professional practice. One of the most effective — and often underutilized — risk management tools is the engagement letter. These legally binding agreements not only define the scope of services and payment terms, but also help reduce misunderstandings, limit liability, and provide crucial legal protection in the event of a dispute.
This article explores how engagement letters and key contract provisions can serve as a foundational loss control strategy, helping financial professionals protect themselves and their practices.
What is an engagement letter?
- An engagement letter is a legally binding contract that clearly defines terms and conditions of the scope of services to be rendered by the professional, as well as fees and payment terms
- Engagement letters are a strategy for loss control and reduce misunderstandings, protect both parties, and establish a clear professional relationship and expectations before services are even rendered
Key Elements of Engagement Letters and Contracts:
- Exclusion clause to identify what services will not be provided
- Deadline for submitting return information to establish the exact date the client must provide all pertinent documents so the professional can complete all agreed upon services on time (including tax returns)
- Stop-work provisions specify what conditions may halt services, including conflict of interest situations, untimely submission of documents by the client, refusal to take professional advice, unethical conduct or refusal to pay fees
- Tax position clause provides language that establishes the professional standard of care, which must be clarified as it may not match client expectations
- Taxing authority examination specifies the conditions under which the client requires representation in front of the Internal Revenue Service (IRS) as well as next steps. These services, if offered, should be covered by the terms of a separately signed engagement letter. This clause will clarify next steps, if services become more involved than standard tax preparation or bookkeeping
- Limitation on use of returns helps to control the liability of the professional when a client may submit a tax return to a third party in lieu of a more comprehensive financial statement. This clause can limit how the tax return may or may not be distributed to third parties
- Indemnification clauses are key because third parties are not bound by engagement letters, and many professional liability claims result from third-party lawsuits. Implementation can help the professional be reimbursed for losses for time spent providing testimony or involved with investigations and inquiries.
- Limitation of liability, consequential damage disclaimers, and statute of limitations will help ensure fairness in the process in the case of a lawsuit
- Supporting documentation expectations will state the client’s responsibility for maintaining their records to support the professional services rendered, including the length of time the records must be maintained in case of a discovery process for a lawsuit
- Outcome or results wording should clearly state that the professional cannot guarantee outcomes or results
