A recent United States Supreme Court decision may potentially affect all CPA firms that provide tax services to clients. In light of this, it is important for CPAs to understand the professional liability implications of this decision.
The history
In Quill Corp. v. North Dakota[1], the U.S. Supreme Court held that a state could not require a seller to collect and remit sales tax in a state unless the taxpayer had a physical presence in the state. Since that decision, CPAs generally have advised their clients that they were not required to collect and remit sales tax in another state unless the client had a physical presence in the state.
In 2016, South Dakota directly challenged the Quill decision by enacting a law requiring remote sellers (sellers without a physical presence in the state) to collect and remit sales tax to the state if the seller had sales exceeding $100,000 or 200 separate sales transactions with South Dakota customers[2].
The decision
On June 21, 2018, the Supreme Court overturned Quill in South Dakota v. Wayfair, Inc.[3], concluding that “the physical presence rule of Quill was unsound and incorrect.” In doing so, the Court struck down the physical presence standard to create state sales tax nexus and instead, established economic nexus as the new standard.
Uncertainty remains
The Supreme Court remanded the case to a lower court to determine if the South Dakota law was constitutional. In its decision, the Court cited several factors that appeared to support the constitutionality of the law.
Currently, more than 20 states have enacted similar legislation and more states are expected to follow. Under these laws, remote sellers are required to collect sales tax (or comply with use tax notification requirements) in a state if their business — measured by either sales volume and/or the number of sales transactions — exceeds certain minimum thresholds. The precise thresholds and effective dates of these laws vary from state to state. These laws are likely to face court challenges to determine if they are constitutional.
Further adding to the compliance complexity, many states have enacted economic nexus standards for state income tax, not just sales/use tax. Other states are likely to follow suit.
Professional liability risk to CPA firms
Physical presence is no longer the nexus standard when evaluating whether a client should collect and remit sales tax to a specific state. A client who is not timely informed of the change in nexus standard may assert that they did not have sufficient time to understand and prepare for additional filing and reporting responsibilities in a cost-effective manner. This may result in claims against the CPA firm, seeking to recover the additional costs incurred by the client to quickly implement the required changes.
If a CPA fails to inform a client about their responsibility to collect and remit sales tax in a particular state and this is uncovered by the state, the client may contend that the CPA firm failed to advise them of the change. They may assert that the CPA firm should be held responsible for not only the penalties and interest assessed by the state but also for the uncollected taxes. Notably, taxes are not typically part of recoverable damages in a professional liability claim.
From an income tax perspective, clients who fail to file tax returns in economic nexus states may claim that their CPAs failed to advise them of their filing obligations or failed to update them regarding the impact of the Wayfair decision, seeking to recover their costs for penalties and interest. If the client is subject to double taxation due to the inability to amend returns in their home state, they may also seek recovery of the additional taxes.
How to address the risk
In 2017, approximately 38% of tax claims made against CPA firms in the AICPA Professional Liability Insurance Program asserted a failure to advise clients or the provision of improper tax advice[4]. In fact, these are the most common assertions in tax claims on an annual basis.
To mitigate the risk of a claim related to the Wayfair decision and advise clients regarding its impact on nexus, CPA firms should:
Review the Supreme Court decision and guidance issued by the AICPA and others to determine how the ruling affects a CPA firm’s clients.
Research the nexus standards for sales, use and income tax laws in other states and its application to the CPA firm’s clients.
Review engagement letter templates. Templates should include:
a detailed scope of service. Identify the tax returns that will be prepared, or the specific advice requested by the client. The use of “limited tax consulting” in describing the scope of service is vague and may permit a client to assert that the CPA should have advised the client about the impact of the Wayfair decision on their specific situation; and
a provision stating that tax services do not include tax planning or tax consulting, but those services can be provided by the firm pursuant to a separate engagement letter.
Proactively inform all clients about the change in nexus standards for sales, use and income tax purposes. A general newsletter or another form of written communication could be presented to clients, stating that previously-issued guidance related to state filing obligations for sales, use and income taxes may no longer be appropriate in view of the 2018 Supreme Court decision and that the client should contact the CPA for further advice. Consider using the AICPA Tax Section’s Wayfair client notification letter as a template.
If the CPA believes that the Wayfair decision may apply to a specific client’s tax situation, contact the client directly to share these thoughts and advise the client to engage your CPA firm or another qualified professional for further evaluation.
If the CPA is engaged to perform a nexus study or provide other state and local tax consulting services, confirm the service in a new engagement letter. A sample tax consulting engagement letter can be found in the AICPA’s Tax Section Annual Tax Compliance Kit.
Detail any conversations with the client about the Wayfair decision in written correspondence to the client and include your recommendation that the client engage your firm or another qualified professional to further investigate the relevant issues.
The Wayfair decision may require clients to register, collect and remit sales tax in additional states or to modify their notifications to online purchasers regarding use tax reporting obligations. Some clients may have computer software applications that can be updated to comply with these obligations, but most will need to use third parties to modify their online sales platform and may seek recommendations from their CPA. However, vicarious liability may arise for the CPA firm should the third-party referral make an error. To reduce this risk, follow these tips:
Refer more than one vendor, in writing, and in alphabetical order.
Review qualifications of all third parties, including confirming any professional designations and the ability to do business in the state.
Inform the client that providing the list of vendors does not represent an endorsement by the firm of the vendors and is simply a list of potential vendors that the client may wish to engage.
Advise the client, in writing, to perform their own due diligence to ensure that the third party selected meets their needs.
Review client files to identify potential state income tax filing obligations. If it appears that the client should file in additional jurisdictions, recommend in a written communication that the client do so for the upcoming tax year. If the client refuses, consider the additional risks in rendering services to a client that disregards their filing obligations.
Some CPA firms may not have the experience to consult about sales and use tax filing obligations. If so, consider referring the client to a tax attorney or another CPA firm to provide assistance. Follow the same guidelines for referrals as outlined above.
Regardless of when and how states react to the Wayfair decision, CPA firms should inform their clients of this important Supreme Court decision. Addressing this significant change sooner rather than later represents the best course of action to help mitigate a CPA firm’s professional liability risk.
Deborah K. Rood is a Risk Control Consulting Director for the Accountants Professional Liability Insurance Program of Continental Casualty Company, a CNA company and the underwriter of the AICPA Professional Liability Insurance Program. She previously practiced public accounting for 19 years with regional public accounting firms as a state and local tax practice leader. Deborah has provided consulting and compliance services to clients in a variety of industries including but not limited to manufacturing, distribution, professional services and transportation. She is also actively involved in the AICPA and state CPA society conferences and has authored numerous articles.
[1] 504 U.S. 298 (1992)
[2] S.D. Codified Laws Chapter 10-64
[3] 585 U.S. ___ (2018)
[4] Source: CNA Accountants Professional Liability Claim Database. Underwritten by Continental Casualty Company © 2018. All rights reserved.