Tài liệu Taxation without Representation in Contemporary Rural China ppt

CONTENTS
LIST OF CONTRIBUTORS vii
EDITORIAL BOARD ix
AD HOC REVIEWERS xi
AIT STATEMENT OF PURPOSE xiii
MAIN ARTICLES
PROFESSIONAL LIABILITY SUITS AGAINST TAX
ACCOUNTANTS: SOME EMPIRICAL EVIDENCE
REGARDING CASE MERIT
Donna D. Bobek, Richard C. Hatfield and Sandra S. Kramer 3
AN EMPIRICAL ASSESSMENT OF SHIFTING THE
PAYROLL TAX BURDEN IN SMALL BUSINESSES
Ted D. Englebrecht and Timothy O. Bisping 25
AN EMPIRICAL EXAMINATION OF INVESTOR OR DEALER
STATUS IN REAL ESTATE SALES
Ted D. Englebrecht and Tracy L. Bundy 55
CHARITABLE GIVING AND THE SUPERDEDUCTION:
AN INVESTIGATION OF TAXPAYER PHILANTHROPIC
BEHAVIOR FOLLOWING THE MOVE FROM A TAX
DEDUCTION TO A TAX CREDIT SYSTEM
Alexander M. G. Gelardi 73
v
vi
HOW ENGAGEMENT LETTERS AFFECT CLIENT LOSS
AND REIMBURSEMENT RISKS IN TAX PRACTICE
Lynn Comer Jones, Ernest R. Larkins and Ping Zhou 95
THE ALTERNATIVE MINIMUM TAX: EMPIRICAL
EVIDENCE OF TAX POLICY INEQUITIES AND A RAPIDLY
INCREASING MARRIAGE PENALTY
John J. Masselli, Tracy J. Noga and Robert C. Ricketts 123
AN EMPIRICAL INVESTIGATION OF FACTORS

INFLUENCING TAX-MOTIVATED INCOME SHIFTING
Toby Stock 147
RESEARCH NOTES
ACADEMIC TAX ARTICLES: PRODUCTIVITY AND
PARTICIPATION ANALYSES 1980–2000
Paul D. Hutchison and Craig G. White 181
EDUCATORS’ FORUM
EXPORT INCENTIVES AFTER REPEAL OF THE
EXTRATERRITORIAL INCOME EXCLUSION
Ernest R. Larkins 201
LIST OF CONTRIBUTORS
Timothy O. Bisping Department of Economics and Finance, Louisiana
Tech University, USA
Donna D. Bobek School of Accounting, University of Central
Florida, USA
Tracy L. Bundy School of Professional Accountancy, Louisiana
Tech University, USA
Ted D. Englebrecht School of Professional Accountancy, Louisiana
Tech University, USA
Alexander M. G. Gelardi College of Business, University of St. Thomas,
St. Paul, MN, USA
Richard C. Hatfield Department of Accounting, University of Texas at
San Antonio, USA
Paul D. Hutchison Department of Accounting, University of North
Texas, USA
Lynn Comer Jones Department of Accounting and Finance,
University of North Florida, USA
Sandra S. Kramer Fisher School of Accounting, University of
Florida, USA
Ernest R. Larkins School of Accountancy, Georgia State University,

USA
John J. Masselli Area of Accounting, Texas Tech University, USA
Tracy J. Noga Department of Accounting, Suffolk University,
USA
Robert C. Ricketts Area of Accounting, Texas Tech University, USA
Toby Stock School of Accountancy, Ohio University, USA
vii
viii
Craig G. White Area of Accounting, University of New Mexico,
USA
Ping Zhou Stan Ross Department of Accountancy, City
University of New York – Baruch College, USA
EDITORIAL BOARD
EDITOR
Thomas M. Porcano
Miami University
Kenneth Anderson
University of Tennessee, USA
Caroline K. Craig
Illinois State University, USA
Anthony P. Curatola
Drexel University, USA
Ted D. Englebrecht
Louisiana Tech University, USA
Philip J. Harmelink
University of New Orleans, USA
D. John Hasseldine
University of Nottingham, England
Peggy A. Hite
Indiana University-Bloomington,

USA
Beth B. Kern
Indiana University-South Bend,
USA
Suzanne M. Luttman
Santa Clara University, USA
Gary A. McGill
University of Florida, USA
Janet A. Meade
University of Houston, USA
Charles E. Price
Auburn University, USA
William A. Raabe
Columbus, USA
Michael L. Roberts
University of Alabama, USA
David Ryan
Temple University, USA
Dan L. Schliser
East Carolina University, USA
Toby Stock
Ohio University, USA
ix
AD HOC REVIEWERS
James R. Hasselback
Florida State University, USA
Ernest R. Larkins
Georgia State University, USA
Cherie J. O’Neil
Colorado State University, USA

Robert C. Ricketts
Texas Tech University, USA
Janet W. Tillinger
Texas A&M – Corpus Christi, USA
Patrick J. Wilkie
George Mason University, USA
xi
ADVANCES IN TAXATION
EDITORIAL POLICY AND
CALL FOR PAPERS
Advances in Taxation (AIT) is a refereed academic tax journal published
annually. Academic articles on any aspect of federal, state, local, or international
taxation will be considered. These include, but are not limited to, compliance,
computer usage, education, law, planning, and policy. Interdisciplinary research
involving, economics, finance, or other areas also is encouraged. Acceptable
research methods include any analytical, behavioral, descriptive, legal, quantita-
tive, survey, or theoretical approach appropriate for the project.
Manuscripts should be readable, relevant,andreliable.To be readable, manuscripts
must be understandable and concise. To be relevant, manuscripts must be directly
related to problems inherent in the system of taxation. To be reliable, conclusions
must follow logically from the evidence and arguments presented. Sound research
design and execution are critical for empirical studies. Reasonable assumptions
and logical development are essential for theoretical manuscripts.
AIT welcomes comments from readers.
Editorial correspondence pertaining to manuscripts should be forwarded to:
Professor Thomas M. Porcano
Department of Accountancy
Richard T. Farmer School of Business Administration
Miami University
Oxford, Ohio 45056

Phone: 513 529 6221
Fax: 513 529 4740
E-mail:
Professor Thomas M. Porcano
Series Editor
xiii
PROFESSIONAL LIABILITY SUITS
AGAINST TAX ACCOUNTANTS:
SOME EMPIRICAL EVIDENCE
REGARDING CASE MERIT
Donna D. Bobek, Richard C. Hatfield
and Sandra S. Kramer
ABSTRACT
As with most professional service occupations, liability claims are a major
concern for accounting professionals. Most of the academic research on
accountants’ professional liability has focused on audit services. This study
extends research onaccountants’ professional liability by examining liability
claims arising from the provision of tax services. In addition to a descriptive
analysis, the current study explores the role of merit in tax malpractice
litigation. Hypotheses are developed based on the legal construct of claim
merit, which requires the presence of accountant error and damages as a
result of that error for a claim to be considered meritorious. The hypotheses
are tested using logistic and OLS regression of 89 actual claims filed with
an insurer of tax professionals. The results suggest that the components
of merit are significant in determining both the presence of compensatory
payments to the client and the dollar amount of those payments, although
the hypothesized interaction effect is only significant for the dollar amount of
compensatory payments.
Advances in Taxation
Advances in Taxation, Volume 16, 3–23

Copyright © 2004 by Elsevier Ltd.
All rights of reproduction in any form reserved
ISSN: 1058-7497/doi:10.1016/S1058-7497(04)16001-8
3
4 DONNA D. BOBEK ET AL.
INTRODUCTION
This study examines the relationship between merit and outcome in tax malprac-
tice claims. Although this relationship seems intuitive, prior research focusing
on accountant liability in an audit setting has been unable to find a significant
link. The role of merit is of importance to accounting firms who have a vested
interest in legal reform. For example, the large accounting firms have stated
that unwarranted litigation (i.e. lacking merit) and coerced settlements are the
“principal cause” of the profession’s liability problems (Arthur Andersen & Co.
et al., 1992). Using detailed claim files from an accountant insurance company,
we explore this issue in the tax accounting profession.
Palmrose (1997) undertook a review of the audit malpractice literature in an
effort to answer the question, “do the merits of a case matter with regards to bring-
ing and resolving claims against auditors?” Kinney (1993)asserts thatmeritorious
claims against independent auditors require three elements: substandard financial
statements, substandard audits, and compliance with relevant legal standards
(e.g. detrimental reliance on the financial statements). However, Palmrose (1997)
suggests that the low probability of bringing a claim to court actually severs
the theoretical tie between merits and outcome. The empirical data drawn from
several studies (e.g. Dunbar et al., 1995; Palmrose, 1994) suggest that the role
of merit is inconclusive (particularly with regard to outcome). This result is due
in part to the fact that prior research generally does not undertake the question
of merit directly, and has been unable to find an adequate proxy for claim merit.
Palmrose (1997) concluded her study with a call for research that examines the
role of merit in accountant malpractice claims.
Although most research examining the issue of malpractice liability in the

accounting profession deals with auditor liability, the issue of tax professional
liability is also of concern. Several different sources have quantified the fact that
tax accounting engagements result in more claims brought by clients than any
other area of accounting practice (although audit claims are higher in total costs).
In fact, the AICPA reports that 60% of all accountant malpractice claims in the
AICPA Professional Liability Insurance program arise from tax engagements
(Anderson & Wolfe, 2001). This is up from 43% ten years ago. Donnelly et al.
(1999) note that the frequent enactment of tax law changes and the relatively
recent inclination of the IRS and the Tax Court to hold practitioners responsible
for client information has put additional pressure on small and midsize accounting
firms. This pressure, they add, has led to “more frequent and more severe mal-
practice claims arising from tax planning and preparation” (p. 59). Although the
occurrence of taxmalpracticeclaims is quite high,the research regarding this issue
has been limited.
Professional Liability Suits Against Tax Accountants 5
This study extends prior research in both auditing and tax litigation. Tax
research in this area is fairly new and has yet to address the important relationship
between claim merit and claim outcome. And, although some audit research has
directly addressed the issue of merit (e.g. Carcello & Palmrose, 1994; Dunbar
et al., 1995), audit researchers typically have a difficult time finding an adequate
proxy for claim merit. We begin by developing a definition of claim merit based
on caselaw (Anderson, 1991; Rockler vs. Glickman, 1978). Specifically, we define
a meritorious case as one that contains both tax professional error and damages
occurring as a result of that error. We also hypothesize that meritorious claims
should be more likely to result in compensation being paid to the client, as well as
larger payment amounts. We examine these hypotheses with data from the files of
an insurance company (the files contain good proxies for these two components
of merit).
As prior audit research has suggested, it appears that a claim does not have to
meet the strict legal criteria of a meritorious claim in order to result in a compen-

satory payment to the client. Our results suggest that the existence of either error
on the part of the tax professional or damages incurred by the client is enough to
result in compensatory payments. However, there is a fairly large and significant
difference in the magnitude of payments for claims with both error and damages
compared to all other claims, after controlling for the overall size of the claim.
In fact, claims with both components of merit resulted in average compensatory
payments that were more than four times larger than other claims in our sample
($62,921 vs. $15,284).
1
Thus, we conclude that the effect of the components of
claim merit, as suggestedbycaselaw,areasignificant determinant of both thelike-
lihood of compensatory payments being made, and the amount of those payments.
The remainder of this article is organized as follows. In the next section, prior
research regarding professional liability of accountants is discussed; followed by
a definition of claim merit and development of the hypotheses. This is followed
by a description of the variables and descriptive data regarding the sample. In
the next section, results are reported and discussed. Finally, conclusions and
opportunities for future research are discussed.
PRIOR RESEARCH
There are two streams of research on which this study draws. First, there is
some prior research that deals directly with tax accountant liability, although
this research does not address the issue of claim merit. Second, there is a larger
body of research regarding audit litigation. The audit environment shares some
key characteristics with the tax environment. For example, both originate from
6 DONNA D. BOBEK ET AL.
accounting firms that may have relatively deep pockets. Second, the rate at which
tax claims are brought to trial is similarly low (11% for our sample vs. 10% for
Palmrose (1991)). However, there also are differences. The key difference is that
tax professionals serve as paid advocates of the client, while auditors work for the
shareholders and are required to be independent of the client’s managers. Further,

in the current study we focus on tax professionals from small firms, while most
audit research has examined Big 5 accountants. Russell (2002) presents survey
results demonstrating that the median firm size of CPAs in private practice focused
on tax work is just one or two professionals, while the average firm size is around
four professionals.
Prior Tax Research
The literature on tax practitioner liability is in the early stages and primarily de-
scriptive in nature. Prior descriptive research has addressed issues such as: which
areas of tax planning/compliance are more likely to result in malpractice claims
(e.g. Anderson & Wolfe, 2001; Demery, 1995; Donnelly & Miller, 1990, 1995;
Donnelly et al., 1999), and tips for avoiding malpractice claims (e.g. Anderson,
1991; Bandy, 1996; Holub, 2001; Kahan, 1999; Yancey, 1996). Areas that were
repeatedly identified as problem areas include S Corp elections, complex areas
such as estate tax and partnership taxation, like-kind exchanges, and filing errors
(Anderson & Wolfe, 2001; Donnelly & Miller, 1995; Donnelly et al., 1999). Com-
mon tips for avoiding malpractice problems include the use of engagement letters,
avoiding “problem” clients and situations (e.g. divorce), proper documentation
of procedures, proper communications with the client, and adequate malpractice
insurance coverage (Anderson, 1991; Bandy, 1996; Holub, 2001; Yancey, 1996).
Although there has been some research considering factors that influence
the decision to file a claim against a tax professional (Krawczyk & Sawyers,
1995; Schisler & Galbreath, 2000), research has not yet addressed which factors
influence whether a filed claim will result in the tax professional actually making
compensatory payments. Krawczyk and Sawyers (1995) report the results of an
experiment that varied the nature of the engagement letter and the magnitude of
the IRS assessment. As hypothesized, the magnitude of the IRS assessment was
positively associated with both the likelihood of filing suit and the dollar amount
requested. Further, an engagement letter that included a statement limiting the
preparer’s financial liability to the amount of the fees paid had the expected
effect of decreasing the dollar amount requested in the suit. However, it had

the surprising effect of increasing the probability of filing a suit. Schisler and
Galbreath (2000) found that relative to non-involved observers, subjects who were
Professional Liability Suits Against Tax Accountants 7
placed in the perspective of the taxpayer were more likely to hold tax preparers
responsible for bad outcomes, while taking credit for positive outcomes.
Prior Audit Research
Palmrose (1997) reviewed the relevant audit literature in an attempt to answer
the question “does merit matter” in malpractice litigation. Her motivation for
the study was to provide input for the ongoing debate over legal reform and the
reduction of auditor liability. For example, she cites a Statement of Position by the
Big Six (Arthur Andersen & Co. et al., 1992, p. 1) which claims that “the principal
causes of the accounting profession’s liability problems are unwarranted litigation
and coerced settlements.” Palmrose’s ultimate conclusion was that the evidence
to date was not conclusive, particularly with regard to the outcome of filed claims.
Alexander (1991) provides a rationale for why merit may not be important in secu-
rities litigation. The involvement of insurance companies, officers and directors as
defendants, and certain rules of law combined to make the likelihood of carrying
such cases to court very small. Alexander argued that once the option of trial is
virtually eliminated, the outcome of malpractice claims is no longer a function
of claim merit.
Although Alexander’s conclusion may seem disturbing to the accounting
profession, it appears to be consistent with audit research involving the outcome
of audit malpractice claims. Carcello and Palmrose (1994) and Dunbar et al.
(1995) were unable to find significant results when regressing claim merit on
settlement amount. In addition to the theoretical reasons why merit may not
“matter enough” (Palmrose, 1997, p. 365), there also has been the issue of finding
an adequate proxy for claim merit.
While not satisfactorily addressing the issue of claim merit, prior research on
auditor liability has identified a number of factors that were related to litigation
outcomes. The first is characteristics of the auditor. Research has found that

firm size, experience, and number of years on the particular engagement are
significantly related to litigation outcome (Palmrose, 1988; St. Pierre & Anderson,
1984). Second, characteristics of the client, such as industry membership, financial
condition, market value, variability of return, bankruptcy, and size have been
related to audit litigation outcome (Lys & Watts, 1994; Palmrose, 1994; Stice,
1991). Third, research also has examined the event that triggered the error search.
For example, negative financial signals from the client and the client’s industry
and regulatory reviews (e.g. SEC action) have been determined to prompt the
search for errors (St. Pierre & Anderson, 1984). Finally, characteristics of the
audit also may influence the outcome (e.g. structure of the audit, portion of total
8 DONNA D. BOBEK ET AL.
revenues/independence, report type given, error type). Several of these variables
(e.g. firm size, experience, client relationship) also may be related to tax mal-
practice litigation. While we consider these variables in our “additional analyses”
section of our results, the purpose of the current study is to focus on the definition
of claim merit in a tax setting and to assess its effect on the outcome of tax
malpractice claims.
DEFINING MERIT IN A TAX SETTING
The focus of this study is to examine the relationship between the merit of a
malpractice claim and the likelihood that compensatory payments are made by
the accounting firm (or their insurance provider). Accountants are held to the
same standards of care as lawyers, doctors, and other professionals (Rockler vs.
Glickman, 1978). Anderson (1991) details the extensive malpractice case law
precedent directly related to lawyers and accountants. This case law requires both:
(1) an actual breach of duty by the professional; and (2) damages to the client
because of that breach of duty, before there can be a holding of malpractice.
2
These two factors
3
should be the hallmarks of a meritorious case and should be

the distinguishing factors between the group of claims for which compensatory
payments are made and the group of claims where there are no compensatory
payments.
Breach of duty or error(s) on the part of the tax professional include at least
two broad categories. First, the tax professional may provide inaccurate planning
advice or may inaccurately complete the tax return. Second, the tax professional
may inappropriately file a tax return or other tax related document (e.g. elections).
Although legally, the tax professional should not be liable unless he/she makes an
error resulting in damages to the client, the client may incur tax related damages
for reasons other than error on the part of the accountant. For example, the client
may provide inaccurate or incomplete information to the tax preparer or may
not completely follow the tax professional’s advice/instructions. Any resulting
damages would not be due to the work of the tax professional.
An error on the part of the tax accountant is only the first requirement for a
meritorious malpractice claim. The client also must incur financial damages as
a result of the error. Unfavorable consequences can originate with the IRS when
it assesses penalties for late or procedurally deficient filings or selects the return
for audit. If the return is audited, additional taxes, penalties and interest may be
assessed or the IRS may determine the return is correct as filed. While additional
taxes, penalties and interest assessed by a tax authority are likely to be the major
source of financial damage, there certainly are other tax-related damages that can
Professional Liability Suits Against Tax Accountants 9
occur as the result of an incorrect tax return. For example, missing the required date
for filing an S election could mean a firm had to file as a C corporation. If the error
was found and the proper C corporation return filed, there would be no IRS penalty
but the corporation would still suffer financial damages in the form of an increased
tax liability.
Theoretically speaking, only meritorious claims should result in compensatory
payments to the client. However, prior audit research, as well as anecdotal obser-
vation, shows that there are other reasons, including the cost involved in defending

a claim, the low likelihood of the case ending up in court, and the uncertainty
involved in proving that a claim is not meritorious, that may lead accountants (and
their insurance company) to make some form of compensatory payment even
though the merits of the claim are not completely clear. Thus, we hypothesize that
claims filed against tax professionals that are meritorious are more likely to result
in compensatory payments by the tax professional (or their insurance company)
to the client. Additionally, the compensatory payments should be, on average,
larger for claims that are meritorious than for non-meritorious claims. This leads
to the following two hypotheses, stated in alternative form:
Hypothesis 1. Claims where both tax professional error and tax-related
damages (i.e. claim merit) are present will result in a greater frequency of
compensatory payments to the client than will claims where both of these
characteristics are not present.
Hypothesis 2. Claims where both tax professional error and tax-related
damages (i.e. claim merit) are present will result in a larger dollar amount of
compensatory payments to the client, than will claims where both of these
characteristics are not present.
DATA
An insurance firm that provides liability insurance to accountants in local and
regional accounting firms with 1–100 professionals provided access to all the tax
malpractice claim files thatwereclosedduringtheperiodofJanuary1994toMarch
1997. All cases were no longer active (dropped, settled, or litigated) by May 1998.
The insured accounting firms are required to report to the insurer any situation
in which the accountant thinks a claim may be filed. If a claim of malpractice
is filed, the insurance company hires a tax expert to gather the facts, assess the
situation, and to recommend action to the CEO of the insurance firm. The claim
can be settled by the insurance company, dropped by the client, or litigated. The
insurance company files included the facts as set out by the tax expert, information
10 DONNA D. BOBEK ET AL.
Table 1. Descriptive Data about the Claims.

Claim Information
Number of claims in sample 89
Range of dates of incident 1989–1996
Average # of months claim opened 18 months
Who identified the issue
IRS 44%
Client 29%
CPA 11%
Other/don’t know 16%
Outcome (%)
Dropped
a
44%
Settled 42%
Judge/Jury verdict 11%
Claim denied by Ins. Co. 3%
Financial Detail
All Claims Only Claims with Payments
Damage payments
Number 89 43
% of total with payments 48%
Mean payment/claim $24,811 $49,047
Legal expenses
Number 89 48
% of total with legal expenses 54%
Mean legal expense/claim $13,700 $25,116
a
Includes claims where CPA was concerned about a malpractice claim and notified the insurance
company, but client never followed up.
abouttheaccountingfirminvolved,andinformationaboutcompensatorypayments

and costs paid by the insurance company.
4
Tables 1 and 2 present descriptive information about the claims, the accountants
and the clients. The dates the claims were reported to the insurance company
range from 1989 to 1996. The average amount of time it took these claims to be
closed was 18 months (considerably shorter than the 4.3 years Palmrose (1997)
reported for the non-payment auditing claims). Forty-four percent of the claims
were eventually dropped, 42% were settled and only 11% were the result of a
judge or jury verdict. Forty-eight percent of the claimants received some amount
of compensatory payment. This is similar to the percentage reported for audit
claims by Palmrose (1997). For those 43 claims that resulted in compensatory
Professional Liability Suits Against Tax Accountants 11
Table 2. Characteristics of Client, CPA/Firm and Claim Issue.
Mean Median
CPA and firm info
Years experience of CPA 20.6 years 20 years
Number of partners in firm 5.7 5
Number of other (non-partner) CPA’s in firm 9.3 7
Number of total employees in firm 29.7 23
Percentage of billing from tax services 38 38
Client info
% of claims with established clients (>3 years) 43
% of claims with engagement letters 54
% of claims with tax-only clients 58
Client entity type
Corporation 40%
Individual 31%
Estate 4%
Other/don’t know 25%
Claim issue

a
% of claims clearly about a tax issue 70
% of claims arising from a fee or tax dispute 34
% of claims where accountant alleged client provided
erroneous information
17
Partial list of tax issues
Number of claims relating to S corps and partnerships 10
Number of claims relating to estates and trusts 6
Number of claims relating to pensions 4
Number of claims that were not related to federal taxes 14
Number of claims that involved erroneous filings 12
a
These categories are not mutually exclusive.
payments, the average payment was $49,047. For the 54% of the claims where
legal expenses were incurred, the legal expenses averaged $25,116. For the entire
sample of claims, the total average cost per claim (compensatory payments and
legal expense) was $38,511, and 35% of this amount was for legal expenses.
The typical CPA was from a small CPA firm and had over 20 years of
experience. Approximately 38% of firm billings were from tax services and there
were, on average, 30 employees employed by their firm. Most of the clients in our
sample were either individual or corporation tax service-only clients. Forty-three
percent had been clients of the respective tax professionals for four years or
more. Fifty-four percent of the claims reported the presence of an engagement
letter.
12 DONNA D. BOBEK ET AL.
There was a wide array of issues from which the claims arose. The tax
areas that were identified in the claims were similar to those noted in prior
descriptive research, including S Corporations, partnerships, estate and trust
issues, non-Federal income tax issues (e.g. sales tax, excise tax, payroll taxes and

state income tax), and failure to properly file required tax forms. Interestingly,
however, a number of claims, at least partially, arose from “non-tax” issues. For
example, 34% of the claims reported either a fee dispute between the accountant
and the client, or a client who was disgruntled about the amount of tax they owed.
5
Fee disputes have been mentioned in prior descriptive research (e.g. Anderson,
1991; Stimpson, 2001; Yancey, 1996), and are not a new concern. Yancey (1996)
notes a case that involved a fee dispute from the 1960s; and Stimpson (2001) goes
so far as to recommend that accountants not sue for fees, as this may lead to an
increase in the frequency of malpractice claims. The number of claims that we
identify as involving fee disputes seems to confirm that advice. Finally, for 17%
of the claims, the accountant alleged that the problem occurred because the client
provided either erroneous or untimely information.
Variables
Hypothesis 1 examines factors that influence whether or not compensatory
payments are made to the client and Hypothesis 2 considers the magnitude of
such payments. To test Hypothesis 1, the occurrence of compensatory payments,
we use a binary dependent variable (one if compensatory payments occurred, zero
otherwise). The independent variables of interest for this analysis are whether
or not the tax professional committed an error in completing and/or filing the
tax return and whether or not damages occurred. Both of these variables and the
surrogates developed are discussed below.
The first independent variable measures whether the tax professional committed
an error. The insurance files contained an expert’s determination of whether there
was a clear error by the accountant. In a number of cases, the accused accountant
readily admitted to the insurance company investigator that he had made a mistake
in completing the return. In other cases, the insurance company’s investigator
determined that the accountant had made a mistake. If either the accountant or the
insurance company investigator determined that a mistake was made in preparing
the tax return, the variable CPA ERROR is coded one. In addition, many of the

claims involved cases where the IRS assessed penalties because a tax return
was filed late (or not filed at all) or filed with procedural errors such as missing
signatures.
6
If the filing was late or procedurally incorrect and the investigator
determined that the error was the CPA’s error, this also resulted in the variable
CPA ERROR being coded one. In all cases where it was not clear that the CPA
Professional Liability Suits Against Tax Accountants 13
made either an error completing or filing the return, the variable CPA ERROR
is coded zero.
The second characteristic necessary for a claim to have merit is that damages
were incurred by the client. Case law indicates that if there are no damages that
result from any act of malpractice, then no compensatory payments should be
assessed against the professional. The variable TAX DAMAGES is a measure
of whether the damages alleged were tax-related damages (such as interest or
penalties). Increased present or future costs that resulted from the cause of action,
although more difficult to accurately quantify, also were included as tax-related
damages.
7
Other alleged damages such as loss of time, and pain and suffering
were included as zero values for this variable. The theoretical relationship is that
tax/financial damages must exist for a case to have merit. Accordingly, there is no
expectation about the size of the tax damage, only the existence of tax damage.
Further, the data available often made it difficult to quantify the amount of tax
damages (e.g. present value of future tax payments). Therefore, TAX DAMAGES
is an indicator variable equal to one if there were tax-related damages and zero if
there were no tax-related damages. Therefore, Hypothesis One will be tested with
the following regression:
Compensatory Payments = ␤
0

+ ␤
1
(CPA ERROR) + ␤
2
(TAX DAMAGES)
+ ␤
3
(CPA ERROR × TAX DAMAGES)
Hypothesis 2 considers the magnitude of compensatory payments made by the tax
professional. To consider this continuous dependent variable, a control for the size
of the claim is necessary since both independent variables are indicator variables.
The best proxy we have for a size control variable is the amount of compensation
requested by the client in the original claim (COMP REQUESTED). Hypothesis 2
is tested with the following regression:
Compensatory Payments = ␤
0
+ ␤
1
(CPA ERROR) + ␤
2
(TAX DAMAGES)
+ ␤
3
(CPA ERROR × TAX DAMAGES)
+ ␤
4
(COMP REQUESTED)
RESULTS
Hypothesis 1
Hypothesis 1 predicts an interaction effect between CPA ERROR and TAX

DAMAGES. Specifically, Hypothesis One predicts that when the legal require-
ments for a meritorious claim are present (CPA ERROR and TAX DAMAGES),
14 DONNA D. BOBEK ET AL.
Table 3.
Panel A – Logistic Regression
Compensatory Payments
a
= ␤
0
+ ␤
1
(CPA ERROR) + ␤
2
(TAX DAMAGES)
+ ␤
3
(CPA ERROR × TAX DAMAGES)
Independent Variable
b
Wald p-Value
Chi-Square (Two-Tailed)
Intercept 4.883 0.027
CPA ERROR 4.903 0.027
TAX DAMAGES 17.329 0.000
CPA ERROR × TAX DAMAGES 2.710 0.10
Model statistics
Chi-square = 30.349, p-value = 0.000
Cox & Snell R
2
= 0.289

% correctly classified = 77.5%
Panel B – Percentage of Cases with Compensatory Payments by Condition
CPA Error
Damages Occurred No Yes Total
No 17.6%
c
(n = 34) 75% (n = 4) 23.7% (n = 38)
Yes 70% (n = 30) 82.4% (n = 17) 74.5% (n = 47)
Total 42.2% (n = 64) 80.9% (n = 21)
a
The dependent variable, Compensatory Payments, is a dichotomous variable with a value of “1” when
compensatory payments occurred due to the claim and “0” otherwise.
b
The independentvariables areas follows: CPA Error isvalued at“1” if an insurance expert determined
that there was CPA error involved and zero otherwise; Tax Damages was valued at “1” if there was any
cost to the client which was tax related (e.g. interest, penalties, additional taxes), and zero otherwise.
c
This condition had a significantly smaller occurrence of compensatory payments (p = 0.000).
the likelihood of compensatory payments being made to the client will increase.
Logistic regression was used to explore the relationship between the independent
variables and the dichotomous dependent variable. The results of this logistic
regression are reported in panel A of Table 3.
Theregressioncorrectlyclassified 77.5%oftheclaims, andthemodel chi-square
statistic is significant at the 0.000 level. The main effects of both independent vari-
ables are significant, suggesting that each individual characteristic of claim merit
increases the probability of compensatory payments. An error on the part of the
CPA (CPA ERROR) was significant at p = 0.027, while the presence of damages
(TAX DAMAGES)was significantatthep < 0.001 level.HypothesisOnepredicts
a significant interaction effect such that the probability of compensatory payments
Professional Liability Suits Against Tax Accountants 15

occurring are the largest when both CPA error and tax damages are present. Panel
AofTable 3 shows a marginally significant interaction coefficient (p = 0.10).
However, the effect is difficult to interpret given the dichotomous nature of
the variables.
To further explore the interaction effect, we report the percentage of claims
receiving compensatory payments in each of the four possible conditions in
Panel B of Table 3. An examination of these percentages reveals that rather than
both conditions being necessary for compensatory payments to be made (i.e. both
CPA error and tax damages), either factor is sufficient. That is, if there is CPAerror
only, tax damages only, or both, then compensatory payments are more likely to
be made. This finding is not completely consistent with Hypothesis 1’s prediction
that merit (as defined by case law) is necessary for compensatory payments to be
made. However, the components of merit do matter, and when neither component
is present, the percentage of claims with compensatory payments is significantly
lower than in the other three conditions.
Hypothesis 2
Hypothesis 2 predicts that the existence of a meritorious case will affect the
magnitude of compensatory payments made. To test this proposition, we use the
dollar amount of compensatory payments made as the dependent variable. To
control for the size of the claim, we include the amount of the compensatory
payment requested (COMP REQUESTED) in the regression.
8
The results of this
regression are displayed in panel A of Table 4. Again, both independent variables
representing merit have significantly positive main effects (CPA ERROR and TAX
DAMAGES significant at p = 0.000 and p = 0.014, respectively). The interac-
tion, as predicted by Hypothesis 2, also was significant (p = 0.051). Panel B of
Table 4 provides the mean values of compensatory payments for the four possible
conditions. An examination of the cell means reveals that the dollar amount of
compensatory payments is consistent with the prediction of Hypothesis 2. Further,

we do a contrast test comparing the mean compensatory payment where both
CPA error and tax damages existed (cell 4) with the other three conditions. This
contrast test is significant (p < 0.05), suggesting that claim merit, as defined by
case law, is important in determining the magnitude of the compensatory payment.
Although we do not consider hypotheses regardingthetotalcostofamalpractice
claim, it is of interest to know how much (if any) the relationship between claim
merit and cost is weakened by considering the cost to investigate and defend the
claim. The total cost of the claim includes not just the amount paid to the client,
but also the legal costs. As noted earlier, the legal costs are significant and amount
16 DONNA D. BOBEK ET AL.
Table 4.
PanelA–Regression Results
Compensatory Payments
a
= ␤
0
+ ␤
1
(CPA ERROR) + ␤
2
(TAX DAMAGES)
+ ␤
3
(CPA ERROR × TAX DAMAGES)
+ ␤
4
(COMP REQUESTED)
Independent Variable
b
Coefficient t-Statistic

Value ( p-Value)
Intercept 51,190 5.271 (0.000)
CPA ERROR 48,835 3.977 (0.000)
TAX DAMAGES 55,297 2.512 (0.014)
CPA ERROR × TAX DAMAGES 48,417 1.984 (0.051)
COMP REQUESTED 0.104 8.126 (0.000)
PanelB–Average Amount of Compensatory Payments by Condition
CPA Error
Damages Occurred No Yes Total
No $12,794 (n = 34) $2,250 (n = 4) $11,684 (n = 38)
Yes $19,845 (n = 30) $62,921
c
(n = 17) $35,425 (n = 47)
Total $16,099 (n = 64) $51,365 (n = 21)
Note: Model R
2
= 0.539 (p-value = 0.000).
a
The dependent variable, Compensatory Payments, is the dollar amount of compensation paid to the
client by the accountant and/or insurance carrier.
b
The independentvariables areas follows: CPA Error isvalued at“1” if an insurance expert determined
that there was CPA error involved and zero otherwise; Tax Damages was valued at “1” if there was any
cost to the client which was tax related (e.g. interest, penalties, additional taxes) and zero otherwise;
Compensation Requested is the dollar amount of compensation originally requested by the client.
c
This cell was significantly larger than the other three cells (p < 0.05).
to 35% of the total cost of the claim. Results from a regression using the same
independent variables used to test Hypothesis 2 with total costs as the dependent
variable showed that “Compensation Requested” and “CPA Error” were the only

significant variables (R
2
= 0.593). The coefficient for CPAError was very similar
to that reported in Table 4 ($48,135), while the coefficient for “Compensation
Requested” increased to 0.180 (or 80% higher than in Table 4). Additionally, TAX
DAMAGES and the interaction term were no longer significant. Weconclude from
this analysis that while merit is significantly related to the amount of compensatory
payment made to the client, it would appear that the size of the compensation
requested drives the amount of effort that is expended to defend the claim, and thus
the total costs.
Professional Liability Suits Against Tax Accountants 17
Additional Analyses
Though not the primary focus of this study, we also consider six other possible
influences on malpractice claim outcome. We examined four non-merit variables
suggested by prior accounting research: firm size, tax professional experience,
client relationship, and engagement letter. We examined one legal issue, contrib-
utory negligence; and finally we analyzed the effect of the presence of “non-tax”
issues that led to claims on the likelihood and magnitude of compensatory
payments. Firm size, tax professional experience, and client relationship were
suggested by prior audit research. Firm size is measured as number of employees.
Experience is measured as the tax professionals’ years of experience. We use
length of relationship (client tenure) as our client relationship variable.
9
Due
to data limitations, this variable is treated as an indicator variable.
10
Prior tax
research showed an influence on likelihood to sue based on the wording of
the engagement letter (Krawczyk & Sawyers, 1995). Additionally, a number
of commentators suggest that the use of engagement letters will reduce the

likelihood and/or cost of a malpractice claim (e.g. Bandy, 1996; Stimpson, 2001;
Williams, 1997). We include a variable, “engagement letter” that was coded one
if the services were covered by an engagement letter, otherwise it was coded,
zero.
As noted earlier, a few of the accountants (17%) in our sample indicated that
the reason the client incurred damages was not because the tax professional had
made an error, but instead because the client had provided the accountant with
erroneous information. The legal precedent surrounding contributory or compara-
ble negligence is complex and differs somewhat by jurisdiction (Anderson, 1991).
However, there is some recognition by the courts that the accountant should not
be held fully responsible if the client’s negligence contributed to the accountant’s
error (Steiner Corp. vs. Johnson & Higgins, 1998). Although our measure may
be influenced by the involved accountant’s bias, it provides the best available
measure of the quality of the client-provided information. Accordingly, the vari-
able CLIENT BAD INFO was set to one if the accountant alleged that the client
provided incomplete or inaccurate information. If no such allegation was made,
the variable was set to zero. Thus, we use this variable, CLIENT BAD INFO, as
an initial exploration of whether or not contributory negligence is related to the
outcome of tax malpractice claims.
Finally, although not explicitly suggested by prior accounting research, we also
investigated the phenomena of tax malpractice claims arising from non-tax issues.
We consider a variable labeled FEE/TAX DISPUTE, because as noted earlier, we
observed that there were a number of claims that arose either because the client
was unhappy with the fees charged by the accountant or with the amount of taxes
18 DONNA D. BOBEK ET AL.
he/she had to pay. This variable was coded one if there was evidence of either of
these concerns; otherwise it was coded zero.
We performed three analyses with these six variables. For the dichotomous
variables, we performed univariate t-tests comparing the percentage of claims
with compensatory payments and the dollar amount of compensatory payments at

each level of the independent variable. Second, we added these six variables to the
logistic regression reported in Table 3 to see if any of these variables improved
the predictive ability of this model; and third, we added these six variables
to the regression model reported in Table 4 to see if any of these variables were
significant in explaining the dollar amount of the compensatory payment.
The univariate results are reported in Table 5. The means for relationship,
CLIENT BAD INFO and FEE/TAX DISPUTE were significantly different
between the groups of claims (although the FEE/TAX DISPUTE difference was
not significant for the dollar amount). Table 5 shows that a longer relationship is
Table 5. Additional Variables – Univariate Tests.
Independent Variable
a
% of Claims with Average Dollar Amount
Compensatory Payment of Compensatory Payment
Relationship
< 4 years 37.2% $11,397
4 years or more 65.8% $42,215
p-value for difference 0.007 0.02
Engagement letter
Yes 52% $20,308
No 50% $32,302
p-value for difference 0.850 0.367
Client bad info
Yes 13.3% $3,214
No 56.8% $29,071
p-value for difference 0.000 0.001
Fee/Tax dispute
Yes 29.0% $13,418
No 60.3% $30,360
p-value for difference 0.004 0.186

a
Relationship refers to the length of the accountant/client relationship; Engagement Letter refers to
the presence or absence of an engagement letter between the accountant and the client; Client Bad
Info refers to whether or not the accountant alleged that the client provided incomplete or inaccurate
information; and Fee/Tax Dispute refers to whether or not the claim, at least partially, arose because
of a fee dispute or a client disgruntled about paying taxes.
Professional Liability Suits Against Tax Accountants 19
associated with a greater likelihood of compensatory payments. While that is in
contrast to prior research which showed that errors were more likely to occur with
new clients (St. Pierre & Anderson, 1984), further analysis of the data explains the
result. Claims involving clients with long relationships were more likely to have
resulted from an IRS Audit (71% for long relationships vs. 28% for shorter rela-
tionships), and thus more likely to be deemed to have actual damages incurred by
the taxpayer (71% for long relationships vs. 43% for shorter relationships). There-
fore, our tentative conclusion is not that clients who have a long tenure are more
likely to sue, but instead, that claims by clients with a long tenure are more likely
to be meritorious.
Regarding CLIENT BAD INFO, both the percentage of claims with com-
pensatory payments (13.3% vs. 56.8%) and the dollar amount of compensatory
payments ($3,214 vs. $29,071) were significantly lower in claims where the
accountant alleged that the client had provided incomplete or erroneous infor-
mation. This suggests either that these claims were less likely to be meritorious,
and/or that the legal concept of contributory negligence served to reduce the
liability of the accountant. Similarly, when the claim involved a fee or tax dispute,
it was much less likely to result in compensatory payment (29% vs. 60.3%), and
although the dollar amount of the claims was lower when the FEE/TAX DISPUTE
variable was “yes,” the difference was not statistically significant. This seems to
imply that a number of unsuccessful claims arise, not as a result of actual error
on the part of the accountant or damages, but because of general dissatisfaction
on the part of the client. For the subset of claims where fees were at issue and

no compensatory payments were made, the cost to settle the claims was still over
$2,000 (and this amount does not include any foregone fees, which often were
waived in these cases).
When these variables were added to the logistic regression from Table 3, only
the relationship variable significantly affected the result.
11
The p-value of the
relationship variable was 0.053, the Cox and Snell R
2
of model improved to 0.373,
and the predictive ability of the model increased to 80.9%. However, none of the
additional variables were significant when they were added to the Compensatory
Payment regression from Table 4.
In summary, after considering a number of variables suggested by prior
research, we conclude that while a few of these variables (i.e. relationship,
CLIENT BAD INFO, and TAX/FEE DISPUTE) are related to claim outcome,
the components of claim merit, (CPA Error and Tax Damages) appear to be the
primary determinants of claim outcome. Additionally, one could argue that the
pattern of influence of relationship, CLIENT BAD INFO and TAX/FEE DISPUTE
is consistent with all three of these variables being additional proxies for the merit
of the claim.
20 DONNA D. BOBEK ET AL.
Limitations
This study is only a first step to understanding malpractice claims involving tax
professionals. It is limited by the data set. The data set has only 89 claims from one
insurer.In addition, all of the claims came from small firms, thus we were unable to
test a “deep pockets” hypothesis, which is a prominent issue in auditing research.
Also, with regard to the contrast test done for Hypotheses 1 and 2, small cell
size and the noise of the control for size should be considered when interpreting
our results.

CONCLUSIONS AND FUTURE RESEARCH
Legal precedent would suggest that no client should be able to successfully sue
his/her tax accountant unless there are both error on the part of the accountant
and damages sustained by the client as a result of that error. However, recent
audit research has been unable to find a significant link between case merit and
case outcome. The results of our test of merit differ somewhat depending on
whether we consider the occurrence of compensatory payments or the magnitude
of compensatory payments. When considering the occurrence of compensatory
payments, the pattern of results suggests that either error or damages are required
to result in compensatory payments being made to the client. The hypothesized
interaction effect is not significant when assessing the presence of compensatory
payments. However, it does appear that merit has a significant effect on the
magnitude of payments made. Compensatory payments made in claims having
both CPA error and tax damages were significantly larger than payments made
for other claims (more than four times larger). However, it should be noted that
claims lacking either characteristic still resulted in an average compensatory
payment of $12,794.
While these results are mixed, we believe they do represent a positive and
significant development in the study of merit in accountant malpractice. We were
able to clearly specify the determinants of a meritorious malpractice claim based
on legal precedent, develop adequate proxies for these determinants, and identify
statistically and practically significant results. In addition, we considered a
number of other possible influences on claim outcome suggested by prior research
and observations from our data set. Only one of these additional variables, the
length of the relationship with the client, had a significant effect on the likelihood
of compensatory payments, and none of them had a significant effect on the dollar
amount of the payment. Additionally, the nature of the effect is not inconsistent
with our findings regarding claim merit.