Running an accounting practice comes with risks. A minor mistake can snowball into a costly issue when filing client tax returns. The Canada Revenue Agency (CRA) might view a typo or mistaken statement as tax fraud and penalize the taxpayer.
Whether your accounting firm is liable for an incorrect tax return depends on the context of the situation. A client may pay penalties and then sue for compensation if they deem that the penalties arose from your negligence.
Other times, tax penalties are the taxpayer’s fault. They may provide incorrect supporting documentation or try to conceal information. In such situations, it’s crucial to review your contract with that client.
This article describes an accountant’s liability to incorrect tax returns. It explains the responsibilities of a tax preparer, what happens if you incorrectly file a return, whether you’re liable for tax return mistakes and errors, and how you can protect your business from lawsuits.
What are the responsibilities of a tax preparer?
Tax return preparers help taxpayers file their annual returns. This includes meeting with clients, reviewing T4s and other tax documents, and submitting their returns to the CRA. You may also act as a tax adviser and provide advice on what credits a person can claim or how to utilize tools like a tax-free savings account and registered retirement savings plan.
Many tax returns are straightforward. But Canada’s tax code is one of the most complex systems we have. A simple mistake might lead to a client tax liability that costs them thousands. That’s why tax preparers have inherent risks in their role.
What might occur if you incorrectly file a client tax return?
After preparing a client income tax return, you submit it to CRA. CRA reviews it to assure everything lines up and that there’s no suspicious activity.
A CRA agent might be suspicious of a taxpayer for many reasons. For example, suppose a taxpayer states they’ve only earned $30,000 of income this year. However, the taxpayer’s bank account shows regular deposits that amount to significantly more than $30,000 in the year.
In this situation, CRA would conduct an audit to learn more. Maybe those deposits were gifts or used to make business purchases and were not unreported income. But if CRA does find unreported income, they could reassess the taxpayer for additional tax and levy penalties and interest.
After the reassessment, a taxpayer can object or pay the assessed amount. A taxpayer can continue to object until they reach the federal court system.
The audit, reassessment, and court processes are expensive. It usually involves the help of a lawyer or accountant. The taxpayer might then sue you for the fees they spent to fight the reassessment if they felt your negligence caused these problems.
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Are accountants liable for mistakes, typos, and errors?
Errors and omissions in tax preparation easily occur. You enter numbers incorrectly, misstate a client’s circumstances, or claim a credit the client isn’t entitled to.
Your liability depends on the situation. Suppose CRA reassessed your client because they discovered they failed to report income. If the client never told you about this income, it’s not likely your fault they were reassessed.
In contrast, if you miscalculated a client’s GST/HST payables and the CRA determined your client owed more GST/HST than reported, you might be liable for the error.
In determining liability, retainer agreements are crucial. It often spells out precisely what you are and aren’t responsible for.
Situations of accountant liability are often murky. Suppose an accountant advised a client to claim a particular credit. The client technically doesn’t qualify, but the accountant suggests it’ll be fine. The client relies on the accountant and signs off on the claim.
Although the accountant acted unethically, it’s hard to understand whether they’re legally liable. At the end of the day, the taxpayer chose to take the risk by signing off.
How to protect yourself in case of tax preparer negligence
Everyone makes mistakes. That’s why it’s vital to set up protections if you’re found legally liable for negligence in your tax preparation work.
There are a variety of methods to protect yourself. These methods aren’t isolated options. Instead, you should use them in conjunction to afford the best protection.
Set up the proper retainer agreement
It’s essential to have an air-tight and clear contract between you and your clients. This retainer lays the foundation of your relationship. It can exclude certain liabilities that you’re otherwise liable for. However, there’s a limit, and you can’t expect to exclude everything via contract.
Visit an experienced corporate lawyer to design a template retainer agreement if you haven’t already. Whenever you change it, you should run any modifications by your lawyer to ensure it’s in your interest to make such a change.
Purchase professional liability insurance
Professional liability insurance covers the financial costs when you face a lawsuit for negligence, unmet expectations, or poor services. It compensates for expenses related to hiring lawyers and paying out damage awards.
Not only does a professional liability policy protect you when you’re negligent or in the wrong. It further covers you when a client claims damages because they believe you were careless.
So suppose CRA reassesses your client and imposes a penalty and interest. The client claims it was your negligence in preparing the tax returns that led to the reassessment. However, you argue that the client signed off on the tax return statements at issue and knew the risks.
Even if you’re correct, your client may still sue. And their lawsuit still requires you to fork over thousands in legal fees. They might even win the case, which would result in damage awards.
Professional liability insurance continues to cover you up to your policy limit in this situation.
Despite the benefits, professional liability insurance is very affordable. With APOLLO, professional liability insurance starts as low as $18.15/month. Get a quote and purchase tax preparation and accounting insurance online in under five minutes with APOLLO.
Whether your accounting practice is held liable for incorrect tax returns depends on numerous factors. It can depend on a retainer agreement, who made the mistake, whether something was left out, whether the client signed off, and more.
Mistakes happen. By ensuring you have an air-tight retainer template and the right professional liability policy, you can mitigate the risks and potential financial fall out of any negligence lawsuit.
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