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Paying clients penalties

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#1
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Hi,

The previous CPA I am taking over for would sometimes pay a clients IRS or state penalties if she thought the penalty was her fault.

It could be something major, or it could be a small underpayment penalty, or an estimated tax penalty.

Is there some kind of a consensus about this? What do you do in these situations?

After doing this for a little while, I am starting to feel that mistakes will always happen, and that it doesn't seem like a good business practice to pay client penalties. i.e. I am leaning more towards the stance of "yes I made a mistake but you hired me, and if it unacceptable to you then with all due respect you should find a new CPA".

Any thoughts?
 

#2
Taxaway  
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...and if it unacceptable to you then with all due respect you should find a new CPA".


If I were a client who heard that, 100% of the time I would look for someone else. It means you're not going to 'stand by your work' and if the client incurs penalty and interest because of your mistake, your answer is tough #$%$? How would the client trust you with the next tax return?

It makes great business sense to stand behind your work.

Don't you have E&O insurance? The point is we all make mistakes, and the ability to take care of the 'injury' to clients is a sign of being a professional who accept responsibility for their work. Your answer doesn't. I'd advise you to get insurance and have some coverage at least, sure it'll cost some but one less worry.
 

#3
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Right,

I would never actually say that to a client. What I mean is that I don't think I should offer to pay client's penalties.

Actually, I doubt many clients would have the nerve to ask me to pay either.

We have liability insurance: Would E & O insurance cover a $150 penalty, I would imagine it wouldn't be worth dealing with insurance over small amounts???

Taxaway, are you saying that you do pay client penalties when they occur?
 

#4
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telaxman wrote:...are you saying that you do pay client penalties when they occur?


I certainly do. In fact, I often tell clients right up front that if I make a mistake that I can correct, I will file the amendment without any cost and if I make a mistake that I can't correct, I will pay the penalties. I won't pay the tax, of course, and usually not the interest.

I feel the client comes to me with the presumption that my work will be 100% correct, 100% of the time. From a practical standpoint, that's not going to be reality, which is why we have insurance. It's also why your pricing needs to account for complexity and other risk factors.

IMO, paying penalties in this manner is a cost of doing business and an investment in the greatest asset you have...the trust of your clients.
~Captcook
 

#5
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I usually take the penalty off the tax prep fee. Luckily, its only happened a handful of times in 30 years.
 

#6
sjrcpa  
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CaptCook wrote:I often tell clients right up front that if I make a mistake that I can correct, I will file the amendment without any cost and if I make a mistake that I can't correct, I will pay the penalties. I won't pay the tax, of course, and usually not the interest.

That's what I do.

Insurance will not cover a $150 penalty. There is a deductible. The insurance is mainly there to protect you if a client sues you for a mistake - real or perceived.
 

#7
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Bushmaster wrote:I usually take the penalty off the tax prep fee. Luckily, its only happened a handful of times in 30 years.


Do you itemize the tax prep fee to show that the penalty has reduced the total? i.e. it is clear to them that there was a mistake and you are paying the penalty? (I assume you would).

Also, only a handful of times in 30 years is impressive.

I feel like it is very easy to incur penalties...I am relatively new to being the final signature on returns, so I am still getting my systems in place. But we seem to get little penalties often.

For instance, I am sure it is obvious to everyone here, but I discovered that every single extended return should not have a balance owed, otherwise there will be a late payment penalty.

I normally project estimates on the 100% of next year's liability basis, rather than the 100/110% prior year basis. But, in particular the last few years with the craziness of the stockmarket, it has been difficult be accurate regarding capital gains.
 

#8
sjrcpa  
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telaxman wrote:every single extended return should not have a balance owed, otherwise there will be a late payment penalty.


Correct, but I'm generally not eating that. Did client give you adequate info in a timely manner to compute an extension pmt? If no, it's their fault not mine.
 

#9
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Right,

My client gets a penalty, and then I am searching for a reason that it is not my fault.

And, sometimes it is hard to find a reason, e.g. I didn't keep the greatest notes, or their tax year was all over the place with sales and trusts and various other things...

I am not set one way or the other.

But, to me a comparable profession is financial advisors. They definitely don't take any responsibility when they recommend investments that lose thousands of dollars...
 

#10
Taxaway  
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telaxman wrote:...
Taxaway, are you saying that you do pay client penalties when they occur?


Yes, if it was my preparer error. If small P&I (and less than my deductible), I give the client an option that I'll reimburse or credit them a speck more on next year's tax prep. I haven't had a client upset with me because I explain that no one is perfect, and that's why I have E&O insurance to ensure they aren't paying for something that I caused. Not the tax, just P&I. And explain they are obligated to contact me with the original IRS notice and cooperate with me if I can alleviate it (ie, FTA).
 

#11
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Okay, thanks for the response.

Actually, I reimbursed a client for a penalty that was my fault today.

That should be a non-deductible expense for me right? since it is a penalty.

So I was wondering, is it technically cheating if you lower the client's tax prep fee to compensate for the penalty. i.e. a round-about way of deducting a non-deductible expense.

Let me know if I am looking at this the wrong way?
 

#12
HowardS  
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I reimburse for penalty and interest and book it under Returns & Allowances. I figure my mistake doesn't warrant the full preparation fee so I'm discounting it.
I suffer from depreciation.
 

#13
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For you as the professional, this is a fully deductible expense.
~Captcook
 

#14
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Okay thanks, good news!
 

#15
Miami88  
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I have paid the P&I when it was my fault. I do not pay P&I for underpayment due to filing an extension. 99% of the time I don't even have enough (or any) information to determine if they may owe. Their delay in getting me information in not my problem.
 

#16
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Yes, pay the penalty and interest if you are at fault. Or credit next year's invoice when you prepare their taxes.

It is important to factor in your potential liability when billing a tax return. For example, a taxpayer with $1 million of taxable income should be billed a lot more than someone with $100,000 taxable income. The potential penalty you have to pay for a mistake is higher, therefore the fee you charge should also be higher.
 

#17
sjrcpa  
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Maybe. If the $1 million is from a W-2 and the $100K is from a Schedule C with crappy records, the low income return is more risky.
 

#18
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Taxman40 wrote:Yes, pay the penalty and interest if you are at fault. Or credit next year's invoice when you prepare their taxes.

It is important to factor in your potential liability when billing a tax return. For example, a taxpayer with $1 million of taxable income should be billed a lot more than someone with $100,000 taxable income. The potential penalty you have to pay for a mistake is higher, therefore the fee you charge should also be higher.


That is a good point
 

#19
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sjrcpa wrote:Maybe. If the $1 million is from a W-2 and the $100K is from a Schedule C with crappy records, the low income return is more risky.


How many tax returns have you prepared with $1,000,000 of income and only a W-2?
 

#20
sjrcpa  
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I was exaggerating to make the point.
 

#21
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Taxman40 wrote:How many tax returns have you prepared with $1,000,000 of income and only a W-2?


The last two years, I've had two. They were both mortgage brokers...their 2022 income is significantly less, though, as you may expect.
Other than an ER doc I had as a client for a while, those are the only two 7 digit W-2s I've seen.
~Captcook
 

#22
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Like everyone else, Yes, I pay for P&I for errors that are my fault.

Exceptions are:
I Do not pay underpayment P&I for extensions
I Do not pay P&I relating to estimated tax


I always reimburse/pay/"cut a check" to the client as separate transactions, instead of discounting it from invoices.

The clients trust you because you stand by your work AND they have itemized reminders on their bank statements
 

#23
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Thanks for the explanation Pure Peace. It is helpful to hear where other people draw the line.

The two exceptions you listed, I would guess, would cover about 99% of penalties...At least at my office.
 

#24
novacpa  
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I haven't in 40 years.
 

#25
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novacpa wrote:I haven't in 40 years.


Nice!!!

Is that because your clients don't receive penalty notices, or you just don't pay them?

How do you handle it?


Thanks!
 

#26
ShawnE  
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I pay penalties when I've made an error.
I do not pay interest - since they got the use of that money. I also do not pay interest on returns for which an extension was filed. Not my fault they can't get stuff together before MY deadline. I do advise those needing an extension regarding sending money in with the extension.

I cut a separate check!

Rarely happens - but it does happen. If it was huge I'd use my E&O. But so far none have been huge.
 

#27
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Thanks for the response ShawnE.

One thing I want to encourage is my clients to extend their returns, so I am a little hesitant to do anything to discourage that.
 

#28
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It depends on the mistake. If a client got a tax penalty that can't be abated because of a mistake I made like putting in the wrong numbers then even putting aside the business angle, from a moral perspective I would feel obligated to pay. No different than any other damage I caused someone.

If the penalty was because of some obscure tax law that MOST accountants on my level of practice would not know but now he is getting slammed over it then I would feel less obligated. The guy came to me knowing that I was charging less and less knowledgeable than some hot shot accounting firms . He also took on some degree of risk by doing so. Therefore unless I took on a client knowing he was above my abilities while he was blissfully unaware of that fact I would feel less obligated to pay. The situation would call for an independent assessment on a case by case basis
 

#29
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telaxman wrote:Right,

My client gets a penalty, and then I am searching for a reason that it is not my fault.

And, sometimes it is hard to find a reason, e.g. I didn't keep the greatest notes, or their tax year was all over the place with sales and trusts and various other things...

I am not set one way or the other.

But, to me a comparable profession is financial advisors. They definitely don't take any responsibility when they recommend investments that lose thousands of dollars...


I question the comparison . Anyone going to a financial advisor is hopefully doing so with the knowledge of the risks he is taking beforehand. Plus most financial advisor explicitly mention there are risks in taking their advice. A guy going to his accountant
thinks his accountant is taking care of everything and he won't run into any further problems.
 

#30
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I have maybe paid 2 or 3 penalties in the last 10 years.

I've never paid interest - but I would be especially hesitant to do so lately when inflation is significantly more than the interest.

I don't think I would make a blanket statement to say that I would never pay penalties or interest, but I can't really see myself paying any underpayment/estimated/extension penalties. Mostly because I so carefully disclaim these things starting right at engagement (and not just in my agreement). I continue to disclaim these things as I operate for the client. Even for extensions, I encourage the client to finish with me as soon as possible, to prevent the compounding of an error in the estimate. In the very next statement I disclaim that our firm will not cover late fees of any kind under any circumstance.

For new clients, I tell them right off the bat that there will be an extension, and that estimated taxes and extension taxes must be paid AND that I don't guarantee the amounts will be enough to avoid plenty, AND I disclaim that I won't pay them. I do so very politely and apologize for not having the bandwidth to finish with them prior to the deadline. I leave it up to them to accept or decline and find another preparer.

If the market changes, so might my tune.

When I deliver a tax return for review, I tell them to check that all income was included (1099R/1099B etc) and that I won't pay the penalties for missing items.

I'm basically a professional nag.

I probably spend more time (= money) disclaiming these things than I save on not paying the penalties.

I feel like I should consider changing the way I operate and not worry about it and just pay them from time to time.
 

#31
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telaxman wrote: every single extended return should not have a balance owed, otherwise there will be a late payment penalty.

That's not true. There's 10% leeway. 90% of total tax has to be paid in to avoid late paying penalty. How often can you be underestimating by more than 10%?

The majority of my extensions are returns I have all or most of the info so a fairly accurate estimate can be made. Many extended returns are taxpayers making quarterly estimated tax payments. The first quarter estimated tax payment is added to the extension payment giving a fairly substantial cushion.

For returns I don't have the info, if my estimate is off, it's usually because the late info shows substantially higher income than past years and the client is informed they will receive a penalty letter.
Dave

Taxation is the price we pay for failing to build a civilized society. ~ Mark Skousen
 

#32
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telaxman wrote:Okay, thanks for the response.

Actually, I reimbursed a client for a penalty that was my fault today.

That should be a non-deductible expense for me right? since it is a penalty.

So I was wondering, is it technically cheating if you lower the client's tax prep fee to compensate for the penalty. i.e. a round-about way of deducting a non-deductible expense.

Let me know if I am looking at this the wrong way?


You paying client's penalty that is your fault is a cost of doing business and deductible IMO.
 

#33
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I made a mistake on two years filings for one client. It is my fault as much as it is theirs, so I'm giving them a couple of years of free tax prep which they are happy receiving vs. me paying the full penalties. Fortunately, they realized they were equally at fault.

Another client tried to hold me liable for her failure-to-pay penalties and I quickly shot back with the tax code on that subject. We'll see if she returns next year--I kind of hope not, she was a bit of a PITA.
 

#34
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If it's my mistake I cover the interest and penalty.
I will offer a credit towards next year, or cut them a check.

I don't cover underpayment or late paid penalties.

Refusal, when you are technically liable... you would lose in court.

This is why I keep E and O, but thankfully I've never made an error big enough to have to call them.
 

#35
deniz  
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I credited the client this year on a penalty for missing the tax estimated payment calculation on a 1040 extension. Why Ultratax doesnt have the payment calculation set as the default when you file an extension is beyond me. Clients expect us to be perfect on routine matters and while the client didnt expect me to pay, it is for a good client and the issue would have plagued the relationship.
 

#36
Preppie  
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I pay the penalties and interest if it is my fault.
Filing or paying late is never my fault. Neither is failing to pay estimated tax.

telaxman wrote:But, to me a comparable profession is financial advisors. They definitely don't take any responsibility when they recommend investments that lose thousands of dollars...

I do both, and I don't see tax prep and investment advice as comparable. Investment expectations are projections into the future based on statistical analysis and always contain variance. Tax return outcomes are based on known past events. What is the standard deviation of the (legal and most advantageous) tax owed for a given taxpayer in a given year? I'd call it $0. It is completely knowable. Investment outcomes in the future - not so much.
 

#37
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SlipperyPencil wrote:That's not true. There's 10% leeway. 90% of total tax has to be paid in to avoid late paying penalty. How often can you be underestimating by more than 10%?


If I HAVE to file extensions for a client, it is because I do not have sufficient information to even ascertain an approximation of their tax liability. If I did, I would file their returns by the original due dates! Heck, a lot of my clients do not even have their K1s from investments until September!
 


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