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.
Retired, no salvage value.
 

#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.
 

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