In general how long should I retain Engagement Records?

It may be recommended to tie the record retention policy to the statute of limitations for professional liability actions in your jurisdiction.  We suggest that you consult a local attorney and/or the State Board of Accountancy or State Society, to identify the appropriate statute of limitations.  For example, in Massachusetts, there is a three-year statute of limitations for actions against accountants for negligence.  Because the statutory period does not begin to run until the potential plaintiff knows or should know that damages have been sustained, it is possible that the statutory period could extend beyond three years.  Generally, a period of six to ten years for retaining files of past engagements is sufficient.

What about the question of electronic files?  Do I need to maintain the original letter after I scan it in? 

We do not, as a general rule, recommend destroying original signed documents after scanning.  Documents such as engagement letters, management representation letters, and lawyers’ letters are very important documents and may become central to defense of a future claim.  Original signed documents carry great weight in the law, and it is best to have them.  Because the courts are usually slow to adapt to change, and are just now struggling with all of the technology changes, we recommend erring on the side of retaining original signed documents, even if they also scanned. 

Should I include in my engagement letter a paragraph informing the client that I will only maintain electronic files of the letter?
It is a good idea to include in all of your engagement letters a brief discussion of your firm’s document retention policy, so there is no misunderstanding.  One highlight should be that you will return any original client documents as soon as possible after completion of the engagement, and will not destroy them without the client’s written consent.

We recently instituted an updated retention policy and have plans to destroy records beyond 7 years that we have in storage.  These files include corporate and individual returns with, and without, original documents.  We will purge several years to bring us up to date.  Each year thereafter, we will purge 1 year of records for both corporate and individuals.  Is this an acceptable process?

My only concern is regarding the original client records that may exist within those older individual tax files (and possibly within the older corporate tax files).  Although it will be more tedious than just destroying the old files in their entirety, I recommend removing original client records from those files before destroying the files.  The firm should then make an effort to return those records to the clients.  For those instances where the clients cannot be located, I recommend retaining the original records even longer that the proposed 10 years.  If the is inclined to simply destroy those original records it cannot return to the clients, it should be careful not to destroy any original record that appears to of high importance (e.g., an official corporate record, an original executed contract, note, mortgage, etc.).   

What should we be advising clients as far as record retention policies go?  Is the seven year policy applicable for them as well? 

The information we provide focuses only on accountants and tax preparers, and their retention practices.  It was not intended for their clients.  Because of the potential for specialized statutes, regulations, or contractual provisions bearing on your clients’ retention obligations, I do not recommend that accountants assume the role of advising their clients on those issues.  It is better to direct the clients to their corporate or personal lawyers.  And, as tax preparers are aware, tax years may not be deemed closed after three years if certain circumstances exist, as when the client is found to have materially understated income.  If a tax preparer is inclined to give clients guidance on this point, I would recommend advising clients to retain original supporting documents for as long as possible.

Can you clarify what should be kept in hard copy vs. electronically. I understand client originals should be kept and original signed engagement letters. Is this it?

I recommend returning original client records as soon as possible, and definitely by the end of the engagement.  Do not become a warehouse for client records.  I think it is wise to retain important document with original signatures (engagement letters, client representation letters, lawyers letters) in paper form even after scanning them.

We keep audit statements and reports permanently but we only keep the work papers for seven years. Is this a good policy?

A seven-year retention period for work papers is generally considered to be sufficient, as long as it is part of a documented policy that the firm follows consistently.  If, however, the firm becomes aware of existing or threatened litigation or investigations concerning a client, it should remove its files concerning that client from the destruction process until it is clear that the matter is over.

We have finally implemented mandatory 1040 engagement letters, and I just learned that our admin person is offering clients the option of faxing/e-mail them to us when she finds that the client has not returned originals to us.  We have still required an original signed letter for all other engagements, and I want to make sure a fax or e-mail engagement letter would be suitable in the event of a future suit.

Receiving a copy of the client’s signature on the 1040 engagement letter, whether by fax or email attachment, is acceptable for most purposes, and is certainly better than no signature at all.  I would recommend sending the 1040 letters to the clients as part of the organizer, and including in the letter a paragraph that provides something along the following lines:

“If, after full consideration and consultation with counsel if so desired, you agree to authorize us to prepare your personal income tax returns pursuant to the terms set forth above, please execute this letter on the line below designated for your signature, and return the original of this executed letter to this office along with a completed copy of the enclosed tax organizer and the supporting documentation requested therein.  You should keep a copy of this fully executed letter for your records.  If you choose to instead return a copy of the signed letter by facsimile or email attachment, you agree that such copy may be construed as an original for all purposes.  If this firm does not receive from you the original of this letter, in fully executed form, but receives from you a completed copy of the enclosed tax organizer and/or supporting documentation requested therein, then such receipt by this office shall be deemed to evidence your acceptance of all of the terms set forth above.  If, however, this office receives from you no response to this letter, then this office will not proceed to provide you with any professional services, and will not prepare your income tax returns.”