There’s no shortage of words of wisdom used to reconcile mistakes: “Accidents happen,” “Nobody’s perfect,” and the old standby from literary sage James Joyce, “Mistakes are the portals of discovery.” The problem is that when some accidents happen, the only thing you “discover” is a budget-crushing bill. This is where professional liability insurance comes into play, especially for tax preparers and bookkeepers.
When you work for a small agency, the limited clientele and modest income can further magnify the impact of errors and omissions. What follows is an example of what happens when you’re cited for an errors and omissions issue and how professional liability insurance comes to the rescue.
The Issue: A Restaurant Owner’s Missing W2
A restaurant owner with ten employees hires a tax preparation company to ensure they give the IRS its fair share while minimizing their tax burden. In the agreement signed by the tax preparer and the company, all taxes, including those of the client, are to be prepared, filed, and paid.
But the restaurant’s books are a mess, receipts are everywhere, and their point of sale system and accounting software aren’t linked. Despite the melee that ensues, you end up getting all of the restaurant’s financial information in order, filing their return, and saving them several thousand dollars.
But here’s the problem: You never filed the owner’s personal taxes. They keep themselves separate from the restaurant, which is its own entity, and file a W2 to pay their taxes. But even though you took care of the restaurant’s taxes, you accidentally left out the taxes the owner owes as an individual working for the restaurant.
The IRS Discovers the Error
From the perspective of the IRS, the restaurant owner didn’t file any taxes and, therefore, had zero income. However, one of their agents in charge of investigating potential tax fraud starts doing some digging.
Later, the restaurant owner goes on a vacation to the Cayman Islands. Her Facebook, Instagram, and Twitter are packed with pics and videos of her living it up in the Caribbean. Everything from sunset cruises to trips to the casino ends up on social media.
The investigator takes notice and then submits an audit request. It’s granted, and the restaurant owner gets a letter informing her of the upcoming audit.
In her mind, there’s nothing to worry about because she hired you to handle her taxes, so she should be good. But she gives you a call as a friendly heads up. A few minutes into the conversation, you realize your mistake. It feels like a brick in your chest.
The Audit
For the IRS, this is one of the simplest audits possible, primarily because they’re merely after the personal income of the restaurant owner. Their investigation takes only a few hours: They check her bank account, gathering income data over the past year.
The outcome surprises no one: She didn’t claim any of her $250,000 in income. At a marginal tax rate of 35% and an effective rate of 23.06%, her tax burden adds up to $57,642.
On the bright side, other than the oversight, your work was flawless. The auditor found nothing wrong with any of the business’s filings. But even though the audit verified the quality of your work, that wasn’t enough to eclipse the effect of the oversight. To make matters worse, there’s also a fine.
The Fine
Your client’s bill of $57,642 is only the beginning. The IRS decides to take it to the next level. They also assess the full understatement fee of 20% of the amount by which she understated her taxes: $11,528.40.
Needless to say, she’s furious—not so much about the $57,642 but the understatement fee of $11,528.40. She feels you should’ve filed her taxes—and on time.
Interest Payments
Then there’s the matter of interest on the overdue taxes. The IRS charges the Federal rate plus 3%. The Federal rate the IRS decides to use is 2.5%, which means your client has to pay an additional 5.5% interest, compounded daily. Due to the amount of time that’s passed, the interest fee ends up tacking on an extra $3,170 to her bill.
This brings the total amount she owes to $72,340.40—$14,698.40 of which is your fault.
The [Possible] Lawsuit
The IRS decides to take an aggressive stance and digs a little deeper into your client’s tax history. They discover what they claim to be an additional $16,000 that she owes due to getting refunds she didn’t deserve over the last ten years. The situation is getting worse for your client—and her daily phone calls aren’t making things any easier.
Now, here’s the good news: Your company has professional liability insurance that covers these kinds of slip-ups.
Professional Liability Insurance to the Rescue
Your client has no problem paying the $57,642 the IRS says she owes. But she’s—justifiably—irate over the extra $14,698.40 they’re asking for, which is a combination of the understatement fee and interest payments. If she takes too long to pay, the situation may end up in court, where the IRS says they will also pursue the additional $16,000 they say she owes.
But since you have liability insurance, the resolution is simple: Your client pays the $57,642 she owes, and your company takes care of the $14,698.40 on her behalf. Then, thanks to your insurance policy, you get those funds back.
The Importance of Professional Liability Insurance for Tax Preparers
These kinds of situations happen all the time. Oversights and errors, as the adage says, “happen” because, after all, “nobody’s perfect.” For some tax professionals, these mistakes end up being “portals of discovery” as they realize they can mitigate the financial impact of the situation using professional liability insurance.
But there’s no need to lock the barn door after the horse has already been stolen. You can keep yourself and your company a step ahead of liability landmines by getting the right insurance today. With 360 Coverage Pros, you can apply for a policy online in 10 minutes, get instant proof of insurance from “A” rated carriers, and have 24/7 access to legal advice online. To learn more, connect with 360 Coverage Pros today.
