Addressing risks related to the TCJA and Wayfair
Featuring Matt Mitzen, CPA, and Deborah K. Rood, CPA
CPAs have been dealing with two significant developments during 2018 — the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, and the Supreme Court's decision in South Dakota v. Wayfair, Inc., 138 S. Ct. 2080 (2018), allowing states to impose sales tax collection obligations on sellers without a physical presence in the state. We sat down with Deb Rood, CPA, and Matt Mitzen, CPA, from CNA, the AICPA's professional liability insurer, to talk about how CPAs can mitigate the associated risks.
What concerns does CNA have for CPA policyholders related to the TCJA?
Rood: I'm concerned that CPA firms in the AICPA professional liability program will see more professional liability claims. Specifically, I anticipate an increase in the number of failure-to-advise claims related to how the TCJA impacts a firm's client. For example, a client might allege their CPA did not tell them to review activities to maximize the Sec. 199A deduction.
Guidance from the IRS has been slow coming out, possibly being released during filing season. Without clear guidance, CPAs may take positions on tax returns without consulting their clients. If that position is not supported when guidance is issued, the client may owe money and blame the CPA.
What can a CPA firm do to defend itself from such claims?
Rood: A firm can take several measures to reduce the likelihood of a successful claim related to the TCJA:
Educate themselves by taking relevant CPE throughout the year;
Update engagement letters to clearly indicate that the firm's services are limited to tax compliance and limit the firm's responsibilities to provide tax advice. AICPA Tax Section members have access to the Annual Tax Compliance Kit [available at tinyurl.com/y99f7ovk], which includes samples;
Ask clients to contact them to discuss the TCJA's application to their specific circumstance and issue a separate engagement letter if subsequently engaged; and
Review revised tax forms and software to understand how they work.
What should firms do if they are unable to definitively answer questions arising from theTCJA?
Rood: When clear guidance has not been issued by the IRS, the CPA should bring the issue to the client's attention and share available options and resultant outcomes. CPAs can recommend options, but the client needs to make the final decision. And ensure that process, including the client's decision, is documented.
Why should every CPA be concerned about Wayfair?
Rood: I anticipate Wayfair having far-reaching effects. South Dakota's law basically says that if a client has $100,000 in sales or 200 transactions in the state, the client should collect and remit South Dakota sales tax. Even clients providing services to South Dakota residents could be subject to the tax because the state taxes services.
The Wayfair decision is not simply a South Dakota issue. Dozens of states have enacted similar legislation or adopted regulations or administrative guidance implementing so-called economic nexus.
If a client has sales of $10 million equally divided in all 50 states, that is $200,000 of sales in each state. South Dakota's sales tax rate is 4.5%, resulting in an annual collection responsibility of $9,000. It may take South Dakota seven years to realize your client is not complying. That is about $63,000 of sales tax liability. And other states are likely to find out. If the client is subject to tax in 10 states, we are talking about $630,000 of tax, plus interest, penalties, and professional fees.
If the client is unable to collect the tax from its customers, it may ask its CPA to pay the liability, including the tax! It is easy to see how claims in this area may become expensive.
What can firms do to reduce the likelihood of such
Rood: There are several things a CPA should do. None is a get-out-of-jail-free card, but each is helpful. Much of the advice related to tax reform also applies to the Wayfair decision.
Educate yourself. AICPA members have access to the South Dakota v. Wayfair webpage [available at tinyurl.com/ya4d4hya];
Inform all of your clients about the decision — you can leverage a sample Wayfair client notification letter from the AICPA's webpage; and
Review engagement letter templates to ensure they identify exactly which state returns you will prepare, including form numbers, and limit the firm's responsibility to provide tax advice including advice about state taxes.
Because of the potential for large liabilities, CPAs should also proactively talk to clients for whom the decision most likely applies and document both the conversation and decisions reached.
It sounds like there will be Wayfair consulting engagements. Any tips?
Rood: The starting point with any new engagement is an engagement letter. Do not simply say, "Research how Wayfair applies." Be specific and identify what you're going to do and for which states.
Many CPAs will be unable to provide all of the services clients will need, for instance software implementation. If asked for referrals, CPAs should refer more than one product or service. Make the referral in writing and remind clients of their responsibility to perform due diligence.
So do only tax practitioners need to worry about the TCJA and Wayfair?
Mitzen: Our accounting and attest friends need to be paying attention to the new playing field, too. Failure to account for the impact of the TCJA and Wayfair in the financial statements may lead to misstatements.
In what ways?
Mitzen: The TCJA makes many changes to the federal tax code, one of the most obvious being the reduction in corporate tax rates. For accounting purposes, that change became effective the date the president signed the act, December 22, 2017. This meant there were likely some income and expense items where the tax treatment was not determined by the tax return due date, much less the date of financial statement issuance. FASB issued guidance in early 2018 allowing nonpublic entities to mirror public entity accounting, meaning you would do the best you could with the facts at hand and later true-up the results.
So what other changes due to the TCJA might concern auditors?
Mitzen: Many CPAs may have heard about changes to the tax treatment of net operating losses and extreme restrictions on meals and entertainment deductions. There are a couple of other types of taxable income the TCJA created. I would strongly advise talking to your tax friends about this. See FASB Staff Q&As on ASC Topic 740, Income Taxes [available at tinyurl.com/ydfzesu5], for some details on accounting issues arising under the TCJA.
What about Wayfair?
Mitzen: First, Wayfair relates to sales taxes, not income taxes, so any potential liability arises from ASC Topic 450, Contingencies (formerly FASB Statement No. 5, Accounting for Contingencies), not from ASC Topic 740. Thus, potential liability in any given year would need to be evaluated as to whether it was "probable," "reasonably possible," or "remote" that the sales tax liability and/or related penalties and interest would be assessed to the entity, which drives recording and disclosure. In the example, $6,300 for South Dakota may not be material and might not warrant disclosure. However, if there were 10 states, the total may well be a disclosure item, if not an accrual. By year seven, that could be a whole new ballgame for financial statement purposes, not just tax filing purposes.