Accounting Expert Witness Discusses S Corporation Status

This case involves accounting malpractice. The plaintiff, a large, multinational “S-Corporation,” manufactured automobile parts. The plaintiff hired the defendant, one of the country’s premier CPA firms, to perform accounting and consulting services. Specifically, the defendant was responsible for assisting the plaintiff in retaining its tax status as a sub-chapter “S-Corporation”, which included computing the plaintiff’s passive investment income, as defined by the Internal Revenue Code. The plaintiff’s status as a sub-chapter S corporation would be dismissed if their passive investment income exceeded a specified percentage of its gross receipts for three consecutive taxable years. If it was too high, the defendant was to advise the plaintiff to move its investments to those that would classify as non-passive investment income. For three consecutive years, the defendant provided services to the plaintiff and “under-calculated” their passive investment income. Thus, the defendant did not advise the plaintiff to shift its investments elsewhere. After the third consecutive year, the plaintiff was contacted by the IRS, who notified the plaintiff that its status as a sub-chapter “S-Corporation” was dismissed. The plaintiff then commenced a suit against the accounting firm for negligent accounting practices.

Question(s) For Expert Witness

1. What are the standardized practices within the industry for providing accounting and consulting services to a corporation?

Expert Witness Response

When an accounting firm is providing accounting and consulting services to a large corporation, it is important that they accurately represent the company’s investments on the financial statements. Failure to do so can result in catastrophic results for their client. In the case, the plaintiff lost its subchapter S corporation listing because the defendant under calculated the plaintiff’s passive investment income and failed to appropriately advise the corporation to switch its investments to avoid passive investment income. In order to determine if the accounting firm acted negligently, however, the financial statements, any reports prepared by the firm, and emails and other communications between the firm and the plaintiff must be examined. In most circumstances, especially with the different corporate statuses, an accounting firm is aware of any unique circumstances, and can focus on specific elements when monitoring a corporation's finances. This usually involves communication between numerous parties in an accounting firm, and should be done on a semi-regular basis. Overall, however, even basic monitoring by an accounting firm should reveal any under-valuations, which are usually indicative of serious errors by a firm. I am a certified CPA and have a Masters in Business Administration from one of the nation’s premier universities. I have spent the past twenty-seven years working for a large accounting firm, doing business for corporations and providing consulting services.