PBC List for Taxes, Legal Matters and Related Parties: Request Guide

These three areas are where management knows facts the books do not show. A tax notice, a demand letter or a loan to the owner might never reach the ledger unless someone asks. Put these requests early on the list and ask for a signed statement that nothing else exists. The other sections of the list are in the PBC list overview.

Taxes

• Federal and state income tax returns for the last three years, with extensions and payment confirmations.
• All IRS and state notices, audits and correspondence received since the start of the prior year.
• Payroll tax returns (Forms 941 and 940) and deposit records for the year, agreed to the payroll register.
• Sales and use tax returns for the year and any nexus studies.
• The tax provision workpaper if the client records income taxes, with temporary differences listed.
• For pass-through entities: the K-1 schedule and any state composite or pass-through entity tax filings.

How long the client must keep tax records

IRS guidance on record retention helps set the request window. The periods are:

• 3 years from filing, the general rule.
• 3 years from filing or 2 years from payment, whichever is later, if the client filed a claim for credit or refund.
• 6 years if the client left out income of more than 25 percent of the gross income shown on the return.
• 7 years for a claim involving a loss from worthless securities or a bad debt deduction.
• At least 4 years after the tax is due or paid, whichever is later, for employment tax records.
• Indefinitely if no return was filed or the return was fraudulent.

The IRS also says to keep records that support income, deductions or credits until the period of limitations for that return runs out. A client that cannot produce returns and payment records inside these windows has a documentation gap the auditor will note.

Legal

• A list of all pending and threatened claims, with counsel's name and contact.
• Names of every law firm the company used in the year.
• Insurance policies and claims correspondence.
• Settlement agreements and demand letters.
• Regulatory correspondence and licenses.

The auditor sends inquiries to the attorneys. See legal letters.

Related parties

• A complete list of owners, officers, directors, family members and affiliates with ownership percentages.
• Loans to and from owners, with agreements, interest terms and repayment records.
• Leases with entities the owners control, with market rent support.
• Management fees, shared costs and sales to or purchases from affiliates.
• Guarantees given on behalf of the company or by it.

See related-party transactions and ASC 850 disclosures.

What the auditor does with the list

Under the related party standard (AU-C 550, with ISA 550 as the international counterpart), the auditor inquires of management about the identity of the entity's related parties, including changes from the prior period, the nature of the relationships, and whether any transactions occurred during the period and why. The auditor also inquires about the controls management has to identify, approve and disclose these transactions.

The auditor then looks for what management did not mention. ISA 550 requires inspecting bank and legal confirmations and the minutes of shareholder and governance meetings for signs of related parties or transactions not previously disclosed. If something turns up, the auditor asks management to identify all transactions with the newly found party, asks why the controls missed it, performs substantive procedures, and considers whether other related parties exist. If the non-disclosure looks intentional, the auditor evaluates the effect as a fraud risk.

For significant transactions outside the normal course of business, the auditor inspects the contracts, evaluates the business rationale, checks whether the terms match management's explanation and obtains evidence of authorization. Management gives written representations that it has disclosed all related parties and transactions it knows of. A complete list sent at the start shortens each of these steps.

Worked example 1: owner loan roll-forward

The balance sheet shows a loan from the owner of $212,000. The client's schedule:

• Opening balance: $150,000.
• Advances in the year: $80,000.
• Repayments: $25,000.
• Interest at 6 percent on an average balance of about $200,000, accrued and unpaid: $12,000.
• Ending: $150,000 plus $80,000 minus $25,000 plus $12,000, or $217,000.

The ledger shows $212,000, so $5,000 is unexplained. The schedule caught a missing accrual entry or a miscounted repayment before the auditor did.

Worked example 2: income tax provision tie-out

A C corporation has pre-tax book income of $600,000. Tax depreciation exceeds book depreciation by $90,000 for the year, the only difference between book and taxable income. The federal rate is 21 percent of taxable income.

• Taxable income: $600,000 minus $90,000, or $510,000.
• Current tax: $510,000 times 21 percent, or $107,100.
• Deferred tax liability increase: $90,000 times 21 percent, or $18,900.
• Total provision: $107,100 plus $18,900, or $126,000.
• Check: $600,000 times 21 percent, or $126,000.

The two methods agree because there are no permanent differences. The client sends the schedule with the return, the book-to-tax reconciliation and the fixed asset schedule behind the $90,000. State taxes add a layer that the client lists separately.

Common errors

• Returns provided without the extension request or proof of payment.
• A notice from a state agency filed in the owner's email and never forwarded.
• Payroll tax forms that agree to the payroll register in total but not by quarter.
• Owner loans with no written agreement and no stated interest.
• A related party list that omits family members and entities the owner holds through a spouse.
• Law firms used in the year left off the list because the matter has settled.

Sources

• Internal Revenue Service, How long should I keep records: https://www.irs.gov/businesses/small-businesses-self-employed/how-long-should-i-keep-records
• International Auditing and Assurance Standards Board, ISA 550 Related Parties (paragraphs 13 to 15, 21 to 23, 26 and 28; AU-C 550 is the US counterpart): https://www.ifac.org/_flysystem/azure-private/publications/files/A029%202013%20IAASB%20Handbook%20ISA%20550.pdf
• Cornell Law School Legal Information Institute, 26 U.S.C. 11 (corporate tax rate of 21 percent): https://www.law.cornell.edu/uscode/text/26/11
• American Institute of CPAs, AICPA Professional Standards (AU-C 501, AU-C 550): https://www.aicpa-cima.com/resources/landing/aicpa-professional-standards

CORAA prepares ready-to-review audit files for US CPA firms from QuickBooks books; you review and sign. See /us.

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error