Case Problem Analysis: Accountant's Liability

Marlena Hailey owed Fidelity Bank of Idaho approximately $250,000 for loans she had taken out to start up a business that had failed. Because she did not have the cash, she negotiated with the bank to transfer property she owned worth approximately $200,000 to the bank to reduce the debt. Before signing any paperwork, Hailey hired Smitty, Smitty, and James, an accounting firm, to review the transaction. She was concerned that transferring the property would create a tax liability for her when she would not be getting any cash out of the transfer to cover such a tax liability. Kostas Smitty, a partner in the firm, reviewed the details of the potential contract and advised Hailey that the transaction would not create a significant tax liability for anyone.

Smitty did not do a thorough analysis of Haileys financial situation to assess how the contract would relate to her other financial activities. Based on this information and advice, Hailey signed the paperwork and transferred the property. Early the next year, Hailey received an IRS Form 1099 from the bank reporting the transfer of the property as a sale that had to be reported on Haileys tax return for the year. Because of other items in her financial status, this did create a significant tax liability for Hailey. She sued the firm for breach of contract and negligence. Does she win? Question:

Smitty was hired (to conduct an analysis of a particular deal/to verify the payment of taxes/to certify Hailey's financial statements). There (is/is no) evidence that Smitty did not complete the analysis within the stated time period. There (is/is no) evidence that Smitty did not provide Hailey with a complete report as required in the contract. Smitty likely (is/is not) liable to Hailey for breach of contract.

Smitty had a duty of (perfection/care/tax awareness) to Hailey. This duty required Smitty to act as (a reasonable client/an ordinarily prudent accountant/a fair judge) would act. A reasonable accountant (would be/Would not be) familiar with tax rules and regulations when asked to perform an analysis on a deal to determine if it would result in tax liability. A reasonable accountant (would/Would not) explore a clients entire financial situation when asked to assess whether a transaction would result in a tax liability.

Smitty (did/did not) include an analysis of this transaction in relation to Haileys overall financial situation. Smitty likely (did/did not) breach his duty. This action (did/did not) cause harm to Hailey in the form of a tax liability. Smittys action (did/did not) cost Hailey money. Smitty likely (did/did not) commit negligence.

What If the Facts Were Different?

Assume that Smitty did a thorough investigation of Haileys financial situation, including an interview of Hailey about her assets and financial transactions. Smitty then assessed the contract in light of this information. The next year, Hailey had a tax liability, but it was based on the fact that she forgot to mention to Smitty that she had also sold three pieces of land to private buyers earlier in the year. Is the firm liable to Hailey for negligence?

In this situation, Smitty (did/did not) assess the transaction and (did/did not) conduct a thorough investigation of Haileys financial situation.

In this situation, Smitty (did/did not) have all of the information he needed to offer the best advice to Hailey and (was/was not) missing information about prior land sales. The fault for the error lies with (Hailey/Smitty). If sued for negligence, Smittys best defense would be that the (client was/client was not/purchaser of the land was) negligent.