Engagement Letter Best Practices for Tax Pros

Although engagement letters are a base requirement for the preparation of all tax returns, these letters also walk a fine line. Good ones are a balance between providing enough information and clarity to the tax client about the services you are providing, but not so detailed that the client is scared off by the length of the letter.

There is also an element of tone to the letter. The letter should assume that the client is honest, but it needs to protect you if the client is questionable. Of course, if honesty is not part of the relationship, would you have the client at all?

The engagement letter must address additional work if needed. For example, is additional bookkeeping required because the client’s books are provided in a haphazard manner? This may be due to an unusual transaction, such as sale of a rental property, which calls for additional computational work. The engagement letter can address this by stating additional work will be discussed with the client prior to starting work. Price and delivery time should also be spelled out.

Part of a new tax client engagement is to request prior year tax returns. This may be one year or more depending on a variety of factors, including the complexity of the tax work and type of activities on the returns. Discussion of findings should be addressed, as well as the action that should be taken.

Business tax returns for corporations, partnerships and limited liability companies require a few additional considerations. Business returns may have better accounting as support for the tax return preparation, but regardless what is provided to you, the supporting work must to reviewed prior to starting the tax return. The engagement letter for business entities should contemplate all additional steps needed to do a quality job. You should also have some experience in the client’s industry or business to do a good job. For example, if you have no experience in construction, then you should not be taking on the tax preparation work for such a business.

Unless you’re new to the profession, you probably have examples of letters you’ve already prepared. That’s great, but make sure you cover your bases. These include the following elements:

• The scope of work is clearly identified – for example, “preparation of 2016 federal and state personal income tax returns.”
• Fee structure for the scope of the work.
• Source of the information, prepared from documents the client provides.
• Use of an organizer, which may have prior year information.
• Timing to complete the engagement.
• What happens if all information is not received by due date.
• Requirement to file electronically under most circumstances.
• Manner in which difficult issues will be handled, to be reviewed with the client. Make sure state the outcome will be put in writing in the file.
• Highlight any higher visibility issues, such as foreign income, underpaying estimates, under reporting or non-reporting of income.
• How examinations and/or tax authority letters will be handled with regard to fee structure, timing and method to resolve.
• Any discussion of additional services after the tax return is prepared.

If you work with clients in the cannabis industry, you’ll also want to consider the following eight points for your engagement letters:

1. Have a discussion of the fact that, federally, any business in the cannabis industry is illegal.
2. Our firm only provides services to legally operated businesses. In light of the first point above, the business must be in the process of obtaining, have, and maintain property licensing at the local and state levels. Note: We only work in California, so each state will vary.
3. If the business is ever out of compliance regarding the second point above, the company must immediately (within 24 hours of notification of non-compliance) notify our firm, and is subject to immediate termination of our engagement.
4. Always state that a deposit is taken at the time of the signing of the engagement.
5. Short terms for payment are included.
6. State that the deposit is not used, but remains on the account until the engagement is terminated or completed.
7. Billings should not exceed the value of the deposit, so the firm is never out of pocket for money.
8. Notification that if payment is by cash, the firm will file Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business, to reflect cash received.

The field of tax is very exciting and fulfilling, but to enjoy your work, it’s very important that your clients understand their relationship with you and the expectation of the work to be performed. The engagement letter should provide that understanding.

Editor’s note: This article was originally published Dec. 15, 2017, and updated on Nov. 1, 2019.