Client wants to sue over missed deduction/election. Any Help

Prefacing this I already know this is a situation where E & O insurance would help, but I want to get a feel if the taxpayer actually has a case. A co-worker of mine who is also an EA, has had these client for years. Clients are a married couple who own and operate a small private school as an S Corp and are partners in a few rental partnerships ( two of which are partnerships that are self-rentals to the school). This issue is our state, South Carolina, has a special SE/ Pass-Through entity deduction and tax rate. For years co-worker believed the software is doing its job and allocating the S Corp income to the right worksheets and forms to calculate the correct result. This year she discovers it had not. She makes sure the 2017 return is right then goes back and fixes the ones still within the three year statute of limitations. She's able to get in 2014 15 and 16, but the other years back to 2009 (when the law for this provision was passed) are now lost. She does the right thing and tells clients. The last three years have been some of their better years and the amount recovered from these is greater than the projected refund from the other 5 years. Instead of "thank you, we know you did your best", clients get upset over the 5 years that can't be recovered. Clients now want to seek legal action. So the TLDR version of this would be " Can a client sue you over a missed deduction that would have resulted in a refund." Also no we did not have any sort of Engagement Letter or other legal instrument in place. As said they were the type of perennial client you would not think would get sued by. Another side note. The SE/Pass-through 'Active Trade or Business" Deduction is considered an election. You can decide to let it tax you at the normal tax rate in the case if your taxable income is below filing threshold or take the reduced tax rate on that income if you normally would fall in a higher tax bracket.

I think the proper thing to do would be for the firm to pay the client the amount of tax that would have been saved had the proper deduction been taken on years 2009-2013. Since the firm made the mistake and it is too late to amend, the firm should make it good, in my opinion.

Of course client can sue and client has a right to be angry. You want an award for fixing part of the problem? The bottom line is that the client relied upon you, and you didn't do what you should have. Mistakes happen, it's not a big deal, but I don't understand the attitude that because you fixed some of the years you have no professional responsibility for the closed years. Client would have more money in pocket had they relied upon someone else and has a right to be made whole.

You need to contact your E&O insurer right away. If you delay, they can deny coverage due to you not meeting notification requirements. They want to know as soon as you know so that they have the opportunity to mitigate damages.

I totally agree with these replies. It is our responsibility to make sure that the software works properly.

One year I accidentally hit the statutory employee indicator on a self employed client. I didn't receive an error message that there was no W2. Client received a huge refund which I should have looked into because my estimated taxes had always been spot on. The following year, new software vendor and client was hit with underpaid of estimated taxes penalty. My jaw dropped because I had to tell them they owed plus I had to amend last year. I refunded the previous year, did the current return for free and paid all penalties and interest. They still wanted to pay me! This was about ten years ago and I still prepare their returns.

The right thing is to make them whole. And since they had to threaten the lawsuit, I would refund all fees that were paid

Excellent advice Cathy, if you take care of the client (hopefully) they'll take care of you.

Clients now want to seek legal action.

When two parties can't resolve their differences and the result is a lawsuit, a court will settle it for them. It doesn't have to be that way.

To the OP: Call E&O. Do not pass go, do not collect $200.

The following year, new software vendor and client was hit with underpaid of estimated taxes penalty. My jaw dropped because I had to tell them they owed plus I had to amend last year. I refunded the previous year, did the current return for free and paid all penalties and interest. They still wanted to pay me! This was about ten years ago and I still prepare their returns.

This result is in part due to who those clients are as people, and how you handled it. You've got keepers for clients, but they certainly feel the same way about you, too.

In general state tax treatments that are different than federal can be a big PIA! Here in MA a lot of tax treatment differs from the Federal and every time I found an error after the fact it had to do with the state tax treatment. So now I really don't trust the software for state tax treatment and on complex returns I actually have to do a manual check to make sure it is done correct. This problem is further complicated if there are more than one state involved that requires manual allocations.

For what it's worth, as a reference point: when I worked for H&R back in the Aughts, their policy regarding refunds was this: if you (the client) discovered, by the end of the calendar year in which the return was completed, that H&R did not obtain the maximum refund, they would refund your prep fee (and probably amend the return for free, but I'm not sure about that). H&R also requires clients to agree to arbitration in the client service agreement (engagement letter), which the client can opt out of within 30 days of original agreement.

I'm not saying it's right or wrong; but the concept of a statute of limitations can apply to situations such as this, IMO, IANAL. I could easily understand the client deciding to go elsewhere from now on, but I don't agree in general that there is an unlimited open door to claim some harm for tax returns prepared many years ago, and that the tax preparer is always, indisputably, on the hook.

How are they suing: in small claims court? Hopefully the E&O insurance will just handle it. But then, I don't know how much your rate will go up as a result.

If clients are financially made whole then they have no valid reason to sue unless the IRS took drastic action against them.

Do you use engagement letters? Do they have language that puts a time limit on things like this? (This is not a judgment, but rather a suggestion of something to consider. - Everyone has missed something at some point - it's scary to think about getting sued for a mistake from ~ 10 years ago.)

What software are you using?? UltraTax claims it transfers data to the I335 screen when the K1 has a South Carolina zip code, but that is not the case. It works properly with Schedule C activity. When you run diagnostics, it does not show up as Critical or e-File issue...it is under "FYI" which I know a lot of preparers ignore.

Is the amount you're discussing large or small? IF small, I would be inclined to have firm cover it. If larger, this is partly why we carry E&O.

UltraTax ... it is under "FYI" which I know a lot of preparers ignore.

I pay for UT these days. My first year in business I paid for Drake. I know what these programs cost... so I don't understand why preparers would pay the money for a program like UT just to ignore the diagnostics, especially now that you can globally ignore the less useful FYI diagnostics (such as "use TSJ because this is a MFJ return")

If you ever would have to defend yourself against an attorney or the IRS, I'd imagine that generally ignoring the diagnostics could be used to help paint a picture of a preparer not exercising due care.

When you run diagnostics, it does not show up as Critical or e-File issue...it is under "FYI" which I know a lot of preparers ignore.

How do you know that? It seems the height of laziness or worse to do so. Good diagnostics is one of the main reasons I selected UT when I established my own practice.

When you run diagnostics, it does not show up as Critical or e-File issue...it is under "FYI" which I know a lot of preparers ignore.

How do you know that? It seems the height of laziness or worse to do so. Good diagnostics is one of the main reasons I selected UT when I established my own practice.

I clear each and every ELF critical and Critical. But the FYI’s drive me nuts. There might 40+ on an average return. I’ll glance through them, but to read each one would likely double my time in each return. It’s extrememly rare I find anything that’s remotely relevant.

When you run diagnostics, it does not show up as Critical or e-File issue...it is under "FYI" which I know a lot of preparers ignore.

I clear each and every ELF critical and Critical. But the FYI’s drive me nuts. There might 40+ on an average return. I’ll glance through them, but to read each one would likely double my time in each return. It’s extrememly rare I find anything that’s remotely relevant.[/quote]

Correct. I look through them and they have helped me catch a few things here and there, but overall, waste of time to go through and acknowledge/clear every FYI as most of them are absolutely irrelevant. That is why I have witnessed so many UT users completely overlook the FYI tab when reviewing diagnostics.

How do you know that? It seems the height of laziness or worse to do so. Good diagnostics is one of the main reasons I selected UT when I established my own practice.

Because I have witnessed it! They often only look at the CRITICAL and ELF CRITICAL, not FYI since it contains so many irrelevant warnings or things that have already been taken care of (I've had UT show missing contact info under FYI even though it is clearly entered when you go to the appropriate screen).

Something new for UT17 is the ability to turn off certain FYI diagnostics globally. So, the ones that you don't need to see (i.e. "use TSJ because this is a married return" or "taxpayer didn't max out the 401k") you can set to not show. I do look through all FYI diagnostics, even if at the end of the day I right-click and hit "mark all as read"

Also, for a weird reason sometimes the FYIs do not auto-remove until you preview the return. I'm not sure why.

One more point -- the FYIs are perhaps more relevant on the state side than the federal side.