Why Every Entrepreneur Needs Both a Lawyer and a CPA to Form a Company
Our law firm has taken the unusual step of requiring our clients to have CPAs. We even turn away clients who aren’t working with accountants. Most would agree that forming a business entity involves tax and legal issues. After nearly twenty-five years of forming companies, it just doesn’t seem possible to me to structure a business without a CPA and a lawyer on the team. So we won’t do it any other way.
Over the years, we’ve seen clients who prefer to first work with a lawyer to form the company, and then select and hire a CPA. Others prefer to form the company, and then wait until the business is “profitable” before hiring a CPA (learning about the penalty for failure to file a tax return the hard way). Far too many jump online to incorporate and sort it all out later. Some just avoid a lawyer altogether by working with an accountant who can “handle” the whole thing. None of these approaches make any sense.
If you are an entrepreneur reading this article, forming a business entity is the intersection of law and tax. Incorporating with both a lawyer and a CPA on your team is the key to getting the best result. If you are a CPA reading this article, handling or coordinating the formation of an entity can result in unwittingly taking on unintended risks.
The importance of having lawyers and accountants work together to cover both spheres has been highlighted by many state courts. Here’s what the Ohio Supreme Court says:
While we recognize that certified public accountants perform a valuable function in advising on financial matters in the formation of a company, such as how best to structure a business entity for tax benefits, there are still many remaining issues that require legal analysis in choosing a business structure. This case highlights the dangers when those lines are blurred. In this case, respondent [a certified public accountant] helped his clients choose a business structure, a decision that ordinarily requires a significant amount of legal judgment in addition to tax and other accounting considerations. Clients need to know the legal differences between and formalities of available structures and then be advised according to their best interests, taking into account personal and practical concerns, not just tax consequences. Where there is more than one principal involved in the venture, the existing and potential conflicts also must be assessed.
A lawyer with a basic understanding of the tax issues, would not be able to to adequately provide the specific tax advice to a client regarding his or her particular tax and financial situation. Similarly, the cases from Ohio (and others from around the country) point out why accountants cannot take on the legal issues involved in entity formation. The risks for CPAs who cross the legal line are (1) the obligation to refund fees paid for services, (2) fines, and (3) the loss of liability insurance coverage.
The Unauthorized Practice of Law
A CPA who engages in the unauthorized practice of law risks being obligated to repay all amounts paid to him or her for the service that constituted the unauthorized practice of law and pay the client’s attorney’s fees and costs occasioned by errors made in providing the service.
The “practice of law” means more than just appearing in court. It also includes “the preparation of legal instruments and contracts by which legal rights are secured, whether the matter is pending in court of not.” This is true even if the legal documents being drafted are “not complex.” As a result, the courts have agreed that “the preparation of charters, bylaws and other documents necessary to the establishment of a corporation, being the basis of important contractual and legal obligations, comes within the definition of the practice of law[.]”
It follows that for someone not licensed as an attorney “to draft documents creating a business entity on another’s behalf is unquestionably the unauthorized practice of law.” In one case, a CPA had drafted articles of organization, using forms available from the Secretary of State’s office as a baseline, to establish a limited liability company on behalf of two individuals who had consulted him about how best to structure their power-washing business. But the CPA failed to have the individuals execute an operating agreement to govern the company. The Court found that the CPA had engaged in the unauthorized practice of law. The court enjoined the CPA from preparing legal documents and required him to pay the costs and expenses associated with the action.
State courts agree that accountants and others cannot recover for rendering services that constitute the unauthorized practice of law and may have to refund any fees already collected for rendering such services. Missouri goes even further, allowing a person who has paid a fee for services rendered by a person engaged in the unauthorized practice of law to sue for three times the amount paid for the services.
Fines and Penalties
The fines and refunds can add up. In one case, a CPA was found to have engaged in the unauthorized practice of law numerous times by preparing incorporation or dissolution papers for at least 82 business entities. Business owners paid the CPA fees ranging from $250 to $650 for his services, although in some cases part of the fee was for his work as an accountant. The court enjoined the CPA from performing any acts constituting the unauthorized practice of law, including “advising others on how to establish and protect legal interests through incorporation,” and “preparing documents to form, organize, or dissolve a corporation.” The court also imposed a civil penalty of $8,200, which represented a $100 fine for each of the 82 times that the CPA had engaged in the unauthorized practice of law.
The court did not order the CPA to repay the fees paid to him by the business owners, but did require him to send letters to the principals of all the entities that he assisted with incorporation notifying them that his conduct constituted the unauthorized practice of law and enclosing a copy of the court’s decision. Having been notified that the CPA had engaged in the unauthorized practice of law, the business owners could then have brought their own actions seeking refunds of the fees they had paid to the CPA.
The penalty was much steeper in another case involving an accountant decided two years earlier. In that case, the accountant charged “hundreds of dollars in fees” to advise five different clients “about advantages and disadvantages associated with incorporation, although he sometimes also mentioned partnerships and other business structures.” The accountant then filled out, and sometimes filed, basic forms available from the Secretary of State to establish articles of incorporation and appoint a statutory agent for each corporation. Finding that the accountant had engaged in the unauthorized practice of law, the court enjoined him from “prepar[ing] on another’s behalf legal papers necessary to form a business entity .” In addition, the court imposed a civil penalty of $20,000, $4,000 for each violation.
Loss of Liability Insurance Coverage
A final issue not mentioned in the statutes or case law concerns the possible loss of the accountant’s liability insurance coverage for actions that are considered to be the unauthorized practice of law. If the action is one that constitutes the practice of law, rather than the provision of accounting services, then the action may, by definition, not be covered by the accountant’s liability policy. In addition, the unauthorized practice of law is a criminal offense and may, therefore, fall within the exclusion for criminal acts by the insured that is contained in most liability insurance policies.
Lawyers and CPAs have complementary skills. CPAs cannot prepare documents needed to form a business entity without running afoul of statutes prohibiting the unauthorized practice of law, which carries the potential of serious and costly consequences. On the other hand, lawyers who are authorized to prepare and file incorporation papers do not have the expertise to deal with the tax issues involved in forming a business entity. As such, it simply makes good legal and business sense for lawyers and accountants to work together when forming corporations and other business entities.
Columbus Bar Ass’n v. Verne, 99 Ohio St. 3d 50, 2003-Ohio-2463, 788 N.E.2d 1064, ¶ 5; accord Miami County Bar Ass’n v. Wyandt & Silvers, Inc., 107 Ohio St. 3d 259, 2005-Ohio-6430, 838 N.E.2d 655, ¶ 12.
In re Garcia, 335 B.R. 717, 728 (B.A.P. 9th Cir. 2005) (applying California law); accord Benninghoff v. Superior Court, 136 Cal. App. 4th 61, 68, 38 Cal. Rptr. 3d 759, 763 (2006), review denied (Apr. 19, 2006); see also Wynns v. Adams, 426 B.R. 457, 462 (E.D.N.Y. 2010) (in New York, the practice of law includes “drafting legal documents”), aff’d, 435 F. App’x 27 (2d Cir. 2011).
Garcia, 335 B.R. at 728.
Fla. Bar v. Town, 174 So. 2d 395, 397 (Fla. 1965); see also Fla. Bar v. Mills, 398 So. 2d 1368, 1368 (Fla. 1981) (“Drafting articles of incorporation is the practice of law.”).
Columbus Bar Ass’n, 99 Ohio St. 3d 50, 2003-Ohio-2463, 788 N.E.2d 1064, ¶ 4.
Id. ¶ 6.
Cal. Bus. & Prof. Code § 6126.5(a)(2), (4).
See, e.g., Agran v. Shapiro, 127 Cal. App. 2d Supp. 807, 273 P.2d 619 (Super. Ct. 1954) (plaintiff CPA could not recover compensation for accounting services in preparing defendants’ income tax returns for five years where the CPA unlawfully engaged in the practice of law in providing the services); People ex rel. Dunbar v. McClellan, 164 Colo. 202, 205, 434 P.2d 126, 128 (1967) (en banc) (respondent who was not attorney but charged $500 to prepare articles of incorporation ordered to refund fee within 20 days or be subject to incarceration until order was carried out); El Gemayel v. Seaman, 72 N.Y.2d 701, 705, 533 N.E.2d 245, 248 (1988) (a contract to provide services in violation of the statute prohibiting the unauthorized practice of law is unenforceable in New York).
See Mo. Rev. Stat. § 484.020(2); Janson v. LegalZoom.com, Inc., 802 F. Supp. 2d 1053, 1058 (W.D. Mo. 2011).
Dayton Bar Ass’n v. Stewart, 116 Ohio St. 3d 289, 2007-Ohio-6461, 878 N.E.2d 628, ¶ 5.
Id. ¶ 38.
Id. ¶ 39.
Id. ¶ 38.
Miami County Bar Ass’n, 107 Ohio St. 3d 259, 2005-Ohio-6430, 838 N.E.2d 655, ¶ 4.
Id. ¶ 13.
Id. ¶¶ 7, 13.
See, e.g., Farmer ex rel. Hansen v. Allstate Ins. Co., 311 F. Supp. 2d 884, 894 (C.D. Cal. 2004), aff’d, 171 F. App’x 111 (9th Cir. 2006); cf. Bancroft v. Indem. Ins. Co. of N. Am., 203 F. Supp. 49, 55-56 (W.D. La.) (coverage would be extended where it was a close and difficult question whether the insured CPA had provided legal or tax advice in incorrectly advising the clients that certain stock transactions would not involve any federal gift tax), aff’d, 309 F.2d 959 (5th Cir. 1962).