Case Name: INTERNATIONAL ENGINE PARTS, INC., et al., Plaintiffs and Appellants, v. FEDDERSEN AND COMPANY, Defendant and Respondent
Court: Supreme Court of California
Jurisdiction: California
Decision Date: 1995-03-02
Citations: 9 Cal. 4th 606
Docket Number: No. S037753
Parties: INTERNATIONAL ENGINE PARTS, INC., et al., Plaintiffs and Appellants, v. FEDDERSEN AND COMPANY, Defendant and Respondent.
Judges: 
Reporter: California Reports
Volume: 9
Pages: 606–633

Head Matter:
[No. S037753.
Mar. 2, 1995.]
INTERNATIONAL ENGINE PARTS, INC., et al., Plaintiffs and Appellants, v. FEDDERSEN AND COMPANY, Defendant and Respondent.
Counsel
Thomas Kallay for Plaintiffs and Appellants.
Garrett & Tully, Stephen J. Tully and Kevin S. Lacey for Defendant and Respondent.
Pettit & Martin and Robert L. Maines as Amici Curiae on behalf of Defendant and Respondent.

Opinion:
Opinion
LUCAS, C. J.
We granted review to resolve a narrow, but recurring, issue as to when actual injury, caused by an accountant's negligent filing of tax returns, occurs so as to commence the running of the two-year statute of limitations period of Code of Civil Procedure section 339, subdivision 1 (hereafter section 339, subdivision 1). A cause of action for accountant malpractice under section 339, subdivision 1, specifically accrues "on discovery of the loss or damage suffered by the aggrieved party," but until the client suffers damage or actual injury from the negligence, a cause of action for professional negligence cannot be established. (Schrader v. Scott (1992) 8 Cal.App.4th 1679, 1684 [11 Cal.Rptr.2d 433] [hereafter Schrader].) Some Court of Appeal decisions hold that actual injury in accountant malpractice cases occurs on final tax deficiency assessment. (See e.g., Moonie v. Lynch (1967) 256 Cal.App.2d 361 [64 Cal.Rptr. 55] [hereafter Moonie].) The Court of Appeal herein employed a different measure, holding that actual harm occurs when the client learns, on receipt of a preliminary Internal Revenue Service (IRS) audit report, that the accountant's negligence may lead to imposition of tax deficiencies.
As we explain, IRS procedures support a rule commencing the limitations period of section 339, subdivision 1, at the time the IRS actually assesses the tax deficiency. (Moonie, supra, 256 Cal.App.2d at p. 364.) Prior to the penalty assessment, the preliminary findings of the auditor as noted in the audit report are merely proposed findings, subject to review and negotiation. We are persuaded by decisions of the Court of Appeal, the majority of sister state jurisdictions, and the federal circuit courts, that actual harm occurs on the date the tax deficiency is assessed. Accordingly, we will reverse the Court of Appeal's judgment herein.
Facts
The relevant facts are not in dispute. Plaintiff International Engine Parts, Inc. (IEP), hired defendant Feddersen and Company (Feddersen) to perform accounting services in 1969 or 1970 for IEP. After IEP's subsidiary, plaintiff I.E.P.O., Inc. (IEPO), was incorporated in 1974, Feddersen prepared IEPO's 1983 and 1984 income tax returns. IEPO relied on Feddersen's advice in signing and filing those returns.
IEPO, an export company, was incorporated as a "domestic international stock corporation" (DISC). IEPO's DISC status gave the company certain tax benefits in the form of deferred income so long as it satisfied the requisite requirements of the Internal Revenue Code. (Int.Rev. Code, § 991 et seq.) Among the requirements for maintenance of DISC status were the proper documentation of loans made by the exporter IEPO to the producer IEP ("producer loans"), and intercompany pricing agreements. Feddersen failed to provide the necessary documentation for the 1983 and 1984 tax returns.
In 1984, the IRS audited IEP's income tax returns. Sometime prior to May 1985, IRS Agent Carol Dinner audited the DISC status of IEPO. In connection with the audit, Feddersen informed IEPO President Elmo Iadevaia, that his firm "just forgot or missed" the required document filing and Feddersen agreed to continue representing IEP and IEPO in the hope that it could mitigate the extent of its alleged oversight.
In 1986, Dinner advised Iadevaia that because Feddersen failed to provide the proper documentation relating to "producer loans" for 1983 and 1984, it would be disqualified by the IRS as a DISC. Several people involved in IEP, IEPO, and related entities, including plaintiffs' controller and tax expert, Russ Piti, also advised Iadevaia that they believed Feddersen was responsible for the missed filing, and that Feddersen was directly responsible for the disqualification of DISC status during the course of the IRS audit. Iadevaia discussed these comments with company attorneys.
Soon thereafter, Feddersen informed IEPO that the company's federal tax liability for the years 1983 and 1984 could be in the range of $300,000. In response to this information, Iadevaia authorized a company attorney to write a letter, dated July 14, 1986, withdrawing a settlement offer in unconnected litigation then pending against IEPO. The pertinent portion of that letter stated: "I have just been advised by Elmo Iadevaia that he is compelled to withdraw his offer of settlement set forth in my letter to you of June 16, 1986. He has now learned that the Internal Revenue Service, as a result of [its] audit, has decided to disqualify IEPO as a DISC corporation for the tax year 1983. The effect of this is the loss of the forgiveness of the accumulated earnings and creates a tax liability for IEPO in excess of $300,000." At the same time, the bank in charge of handling the company's accounts reduced its line of credit from $600,000 to $400,000 so that if a tax assessment was made against IEPO, the company could meet its liability to the IRS.
The IRS issued a preliminary audit report to Feddersen in June 1987. The report indicated the IRS planned to disqualify IEPO as a DISC and impose tax deficiencies, interest, and penalties against IEP and IEPO for the years 1983 and 1984. The amounts were calculated and set forth in the report, which was then forwarded to Iadevaia. Feddersen, on behalf of IEP and IEPO, requested and was granted "Special Consent to Extend Time to Assess Tax" relating to the finalization of the audit because another related entity, ASCO, recently had been audited and was expecting a refund of $250,000. IEP and IEPO needed this refund to help meet the anticipated IRS assessment. The audit was finalized on May 16, 1988, when the deficiency was assessed and taxes and penalties were imposed.
IEP, IEPO, and the Iadevaias filed the present action against Feddersen for accountant malpractice on May 15, 1990. This filing occurred four years after the companies were first advised by IRS agent Dinner that IEPO probably would be disqualified as a DISC for failure to file the proper documentation relating to producer loans, nearly three years after the preliminary audit report was prepared, and one day short of two years after the tax deficiency was assessed. Feddersen sought summary judgment on the ground that the action was barred by the two-year limitations period of section 339, subdivision 1, because actual injury due to Feddersen's malpractice occurred no later than 1986, when IEPO was forced to withdraw its settlement offer in the unrelated lawsuit based on the disqualification of DISC status, and when the company's bank reduced its line of credit by $200,000 as a direct result of the predicted tax liability. Feddersen also claimed that IEP's and IEPO's payment of attorney fees for representation throughout the audit amounted to actual injury that commenced the running of the statute of limitations under section 339, subdivision 1.
IEP and IEPO opposed summary judgment, arguing that actual harm occurred, and the limitations period of section 339, subdivision 1, should commence, when the deficiency was assessed on May 16, 1988, because the IRS could not have assessed tax deficiencies before that time. IEP and IEPO asserted that any estimate of taxes due prior to that date was purely speculative and subject to modification.
The trial court granted summary judgment for Feddersen and the Court of Appeal affirmed, concluding that the fact that federal tax law would not allow the IRS to issue a binding tax assessment to IEP and IEPO until the deficiency was assessed had no legal effect in determining when the corporations first suffered the actual injury resulting from Feddersen's alleged malpractice. The court held that plaintiffs suffered actual harm in 1986, when their line of credit was cut by $200,000, or, at the latest, in June 1987, when the IRS issued the preliminary audit report. Either way, the court concluded, the action was time-barred by section 339, subdivision 1.
The dispositive issue in this appeal, therefore, is whether actual harm occurred prior to June 1987, when IEP and IEPO had sufficient information to put the companies on notice that Feddersen's negligence in failing to file proper DISC documentation in preparing IEPO's 1983 and 1984 tax returns would probably disqualify the company for DISC status, or on May 16, 1988, when the IRS assessed the deficiency and penalties in the form of additional taxes and interest levied on the companies. Feddersen claims that in addition to notice of its alleged negligence, the fees paid to it for work on the audit, the "nominal fees" paid to IEP and IEPO attorneys, and the impairment to cash flow from the reduction of IEPO's credit line together constituted actual injury which arose well before May 16, 1988. By contrast, IEP and IEPO assert that until the tax deficiency was assessed in 1988, no actual harm occurred because the IRS could not assess or collect any taxes or penalties prior to that date. IEP and IEPO readily admit they knew the IRS was auditing their returns for tax deficiencies, but they observe that before a deficiency is assessed, there can be no finding that the costs associated with the audit are due to the accountant's alleged malpractice; those costs may be incurred for the purpose of responding to a routine audit by the IRS.
Discussion
We consider the issues following the grant of a summary judgment motion. Because the relevant facts are not in dispute, the application of the statute of limitations may be decided as a question of law. (McKeown v. First Interstate Bank (1987) 194 Cal.App.3d 1225, 1228 [240 Cal.Rptr. 127] [hereafter McKeown].)
1. IRS Deficiency Assessment Procedures
In order to better understand why the limitations period necessarily commences no earlier than the date of deficiency assessment in cases involving the negligent filing of tax returns, it is helpful to review IRS procedures for examination of tax returns and assessment of tax deficiencies.
Once a federal tax return is selected for audit, the examination is performed by an IRS examiner. At the conclusion of the examination, the taxpayer is sent a report of the examiner's findings, indicating any proposed deficiency assessments. If the taxpayer agrees with the findings of the examiner, he or she will sign the appropriate forms (form No. 4549 and/or form No. 870) acknowledging the tax liability. (Holland v. C.I.R. (4th Cir. 1980) 622 F.2d 95, 96.) If the taxpayer signs the agreement form, he or she immediately (1) waives the required statutory notice of deficiency pursuant to Internal Revenue Code section 6212 (the 90-day letter), (2) waives the corresponding prohibition on collection for 90 days under Internal Revenue Code section 6213, and (3) is thereafter precluded from litigating the proposed deficiency in tax court. (Int.Rev. Code, § 6212, 6213; Mills v. Garlow (Wyo. 1989) 768 P.2d 554, 556 [hereafter Mills]', see also Robinson v. United States (3d Cir. 1990) 920 F.2d 1157, 1158 [explaining that notice is pivotal in IRS assessment procedures because it serves as prerequisite to valid tax assessment].) If the taxpayer does not agree with the examiner's proposed findings, the findings will be reviewed in the district office, and the taxpayer will be sent a "30-day letter" instructing that the taxpayer has 30 days to file a protest. (Mills, supra, 768 P.2d at p. 557.) "If the taxpayer fails to respond within the thirty days, a notice of deficiency will be issued. [Citation.] If the taxpayer timely files a protest, he [or she] will be accorded an appeals office conference. . If a settlement is reached, the taxpayer will again be requested to sign the agreement form . A determination by the appeals office, however, is final insofar as the taxpayer's appeal rights within the IRS [are concerned], and if the taxpayer continues to disagree, the statutory notice of deficiency will be sent giving the taxpayer ninety days to file a petition in the Tax Court before collection actions are begun." (Ibid.)
Thus, the preliminary findings of the tax examiner are proposed findings that are subject to negotiation prior to any determination of tax deficiency. (Mills, supra, 786 P.2d at p. 557.) Once a deficiency is assessed, however, either by the taxpayer's consent to deficiency assessment, or by receipt of a final deficiency notice pursuant to Internal Revenue Code section 6212 et seq., the matter is final as to the IRS and subject to legal appeal in federal tax court. (Ibid.)
In the present case, the IRS assessed the deficiency on May 16, 1988. On this same day, IBP and IEPO signed forms No. 4549 and No. 870, acknowledging the deficiency assessment and agreeing to pay the taxes and penalties due. Issuance of a statutory notice of deficiency pursuant to Internal Revenue Code section 6212 was therefore not required. Against this background, we consider the issue raised by the parties.
2. Commencement of Statute of Limitations
Section 339, subdivision 1, provides that "[a]n action upon a contract, obligation or liability not founded upon an instrument in writing, except as provided in Section 2725 of the Commercial Code or subdivision 2 of Section 337 of this code; or an action founded upon a contract, obligation or liability, evidenced by a certificate, or abstract or guaranty of title of real property, or by a policy of title insurance; provided, that the cause of action upon a contract, obligation or liability evidenced by a certificate, ór abstract or guaranty of title of real property or policy of title insurance shall not be deemed to have accrued until the discovery of the loss or damage suffered by the aggrieved party thereunder." Although the statute does not specifically require actual injury to commence its limitations period, cases interpreting the statute have inferred such a requirement in professional malpractice actions. The actual injury requirement for accountant malpractice cases was foreshadowed in Moonie, supra, 256 Cal.App.2d 361, in which the plaintiff sued his accountant for negligence following a deficiency assessment by the IRS.
The Moonie court phrased the issue as whether "the statute of limitations in an action for alleged malpractice by an accountant start[ed] to run from the alleged negligent act, from discovery of the negligence, or from the date when defendant was notified of the income tax penalty assessment" following receipt of the notice of final deficiency assessment from the IRS. (Moonie, supra, 256 Cal.App.2d at p. 361.) The court concluded that "[the taxpayer] at all times was liable for the deficiency but the deficiency in itself did not cause injury for which he could recover against [the accountant]. It was the assessment of the penalty due to [the accountant's] alleged negligence which gave [the taxpayer] a cause of action against [the accountant]." (Id., at p. 364.)
The express requirement of actual injury, in addition to discovery of negligence, to commence the running of the limitations period under section 339, subdivision 1, was not adopted by the courts until four years after Moonie was decided. The rule was first imposed in 1971 in companion cases discussing the statute of limitations in attorney malpractice actions, which were then governed by section 339, subdivision 1. (Neel v. Magana, Olney, Levy,Cathcart & Gelfand (1971) 6 Cal.3d 176 [98 Cal.Rptr. 837, 491 P.2d 421] [hereafter Neel]; Buddy. Nixen (1971) 6 Cal.3d 195 [98 Cal.Rptr. 849, 491 P.2d 433] [hereafter Budd].)
The Neel court held that the statute of limitations for professional malpractice under section 339, subdivision 1, commences on discovery of the cause of action. (Neel, supra, 6 Cal.3d at pp. 187-188.) The Budd court reviewed the statute of limitations for professional malpractice in the context of a client suing his attorney for the failure to assert an important defense in an answer to a breach of contract action. The court held that in addition to discovery of the negligent conduct, a client must prove he or she was actually damaged by the negligence in order to assert a cause of action for negligence. (6 Cal.3d at p. 201.) The Budd court's requirement of damage in addition to discovery of the malpractice was based on the reasoning that "[i]f the allegedly negligent conduct does not cause damage, it generates no cause of action in tort. (See Developments in the Law—Statute of Limitations (1950) 63 Harv.L.Rev. 1177, 1201.) The mere breach of a professional duty, causing only nominal damages, speculative harm, or the threat of future harm—not yet realized—does not suffice to create a cause of action for negligence. [Citations.] Hence, until the client suffers appreciable harm as a consequence of his attorney's negligence, the client cannot establish a cause of action for malpractice." (Budd, supra, 6 Cal.3d at p. 200, fn. omitted.) The Budd court emphasized, therefore, that the focus of the limitations period for legal malpractice actions should be on the fact of damage giving rise to the professional liability, not the amount of inchoate monetary damages that may have been incurred after the initial discovery of the malpractice. (Budd, supra, 6 Cal.3d at pp. 200-201.)
After determining that both discovery and appreciable harm are required to commence the statute of limitations in a professional malpractice action, the Budd court remanded the case for a determination of whether the plaintiff suffered appreciable damage when he incurred attorney fees at the time of the trial in the contract action, or not until the date of formal entry of judgment in that action. The Budd court observed: "[The] plaintiff maintains that he did not suffer damage until the formal entry of judgment in the [contract] suit against him. In that event, since judgment was not entered until November 4, 1965, plaintiff's action in the present case would not be barred by the statute of limitations. If plaintiff's action in tort had not earlier accrued, it at least matured on entry of judgment because he clearly then became obligated to pay a considerable sum to the broker or to post a bond on appeal." (6 Cal.3d at p. 202.)
Following the Budd decision, the Legislature codified the "discovery plus actual injury" rule in Code of Civil Procedure section 340.6, the statute of limitations that governs attorney malpractice actions. Thereafter, in Laird v. Blacker (1992) 2 Cal.4th 606, 612 [7 Cal.Rptr.2d 550, 828 P.2d 691] (hereafter Laird), we resolved a conflict in the Courts of Appeal over whether the statute of limitations in attorney malpractice actions commences on final judgment in the underlying action on which the malpractice action is based, or whether the limitations period is tolled until the appeal of right is resolved.
In agreeing with Feddersen's assertion that actual injury occurred when IEP and IEPO were first notified by the IRS that IEPO might be disqualified as a DISC, the Court of Appeal reasoned that IEP and IEPO ignored the discovery and actual injury rule imposed by the above case law interpreting section 339, subdivision 1, and sought, by implication, to revive the law of "irremediable damage," whereby a cause of action would not accrue until a final disposition or judgment had been rendered. The Court of Appeal specifically noted that we recently rejected the "irremediable damage" rule in Laird, supra, 2 Cal.4th 606. Both Feddersen and the Court of Appeal, however, misread Laird and its progeny and confuse final notice of deficiency assessment with "irremediability."
In Laird, the plaintiff's claim against her former attorney was based on dismissal of her underlying action for failure to timely prosecute the action. The plaintiff argued that the statute of limitations for attorney malpractice (Code Civ. Proc., § 340.6) should not commence on final judgment of the underlying action, but should be tolled until all appellate review has been exhausted and the result "irremediable." A majority of this court disagreed, and held that the applicable statute of limitations commenced when the plaintiffs had knowledge of the "fact" of damage—i.e., when the underlying action was dismissed as a result of the attorney's negligence, and not, as plaintiff argued, on finality of a subsequent appeal. (Laird, supra, 2 Cal.4th at p. 615.)
In rejecting the plaintiff's assertion that actual injury did not occur until completion of the appeal, or the time the malpractice became "irremediable," we observed in Laird that such an interpretation of the statute would mean that the requisite limitations period would be tolled until the negligent attorney's error could be remedied or when the appellate process had been exhausted. We pointed out that the discovery and actual injury rule implicitly rejected "irremediable damage" as the point to commence the limitations period because actual injury usually occurred before the harm became irremediable in the sense that an appeal or other appellate process was finalized. (Laird, supra, 2 Cal.4th at pp. 615-617.) Thus we clearly distinguished between the concepts of actual injury and irremediable harm.
Our rejection in Laird of the "irremediable damage" rule was recently followed in Schrader, supra, 8 Cal.App.4th 1679, in which the defendant accountants argued the plaintiffs' cause of action for professional negligence accrued no later than the day the plaintiffs received the statutory notice of deficiency assessment from the IRS. The Schrader plaintiffs asserted the statute was tolled while they pursued administrative appellate remedies. (Id., at p. 1681.)
The Schrader court rejected the plaintiffs' contention and instead applied Laird's reasoning to conclude section 339, subdivision 1, is not tolled while the taxpayer pursues administrative appellate remedies. (Schrader, supra, 8 Cal.App.4th at pp. 1686-1687.) In so doing, the Schrader court observed that the plaintiffs' argument had been "fatally undercut by the holding in Laird v. Blacker" (Schrader, supra, 8 Cal.App.4th at p. 1685.) The court pointed out that Laird specifically disapproved the line of cases holding that the commencement of the statute of limitations was tolled until the appellate process had been exhausted, or when a plaintiff's damages became "irremediable." (Schrader, supra, 8 Cal.App.4th at p.1684; Laird, supra, 2 Cal.4th at pp. 616-617.)
The focus of the Schrader case, therefore, was on rejection of "irremediable damage" as the point to commence the statute of limitations. Feddersen and the Court of Appeal, however, read Schrader as supporting their assertion that equating the date of deficiency assessment with the date of actual injury erroneously focuses on the point when actual injury is "irremediable," whereas the focus of determining when actual injury occurred should be on the date the client received notice of the injury.
Schrader, however, is of no assistance to Feddersen. The court did not discuss whether actual injury was sustained prior to the notice of deficiency as a result of the costs incurred in hiring other professionals to assist in the audit, or at the time the deficiency was assessed by the IRS. Although the Schrader court noted that the plaintiffs discovered their cause of action in 1986 when they "concluded that the defendants had been negligent" in their tax advice (8 Cal.App.4th at p. 1682), the court did not discuss the point of actual injury except to note that defendants had argued that actual injury occurred no later than the date the plaintiffs received a notice of final adjustment and deficiency assessment from the IRS. (Ibid.)
It appears that Feddersen and the Court of Appeal confused the determination of tax liability with finalization of the audit process, at which point the tax deficiency is actually assessed. The deficiency assessment serves as a finalization of the audit process and the commencement of actual injury because it is the trigger that allows the IRS to collect amounts due and the point at which the accountant's alleged negligence has caused harm to the taxpayer. Contrary to both Feddersen and the Court of Appeal, the date of deficiency assessment is not the point of "irremediability" in the Laird sense because it is not the equivalent to a final judgment. Indeed, the taxpayer has 90 days from receipt of the notice of deficiency to file a petition for redetermination of the deficiency. (Int.Rev. Code, § 6213(a).)
Alternatively, Feddersen and the Court of Appeal also rely on McKeown, supra, 194 Cal.App.3d 1225, as authority to conclude that plaintiff's payment of professional fees to Feddersen and company lawyers throughout the audit process amounted to actual injury under section 339, subdivision 1. Our reading of McKeown compels a different interpretation.
In McKeown, supra, 194 Cal.App.3d 1225, the taxpayer plaintiffs received a statutory notice of deficiency for taxes owed following an audit of the plaintiffs' corporation. One month later, the plaintiffs paid the defendant, their attorney, a $1,000 retainer to represent them in a tax court appeal challenging the deficiency notice. The plaintiffs did not file their lawsuit against their accountant until 1982, nearly five years after receipt of the deficiency notice. (Id., at p. 1228.)
The trial court in McKeown granted the defendant's summary judgment motion on statute of limitations grounds and the Court of Appeal affirmed, concluding that the plaintiffs had suffered actual injury at least as early as January 1977 when they paid attorney fees for representation in the tax court appeal following notice of deficiency assessment. (McKeown, supra, 194 Cal.App.3d at p. 1230.) The McKeown court rejected the McKeowns' argument that they had not suffered actual injury until the tax court judgment became final. (See Schrader, supra, 8 Cal.App.4th at p. 1686.) As observed in Schrader, supra, 8 Cal.App.4th 1686, "[although the court in McKeown did not disapprove of the 'irremediable injury' test, its holding that the plaintiffs suffered 'irremediable injury' once they acted on the erroneous tax advice is fully in keeping with the holding in Laird v. Blacker . to the extent that the McKeown court concluded that the possibility of seeking administrative review from an unfavorable IRS ruling and even challenging an adverse administrative decision in a proper judicial forum, i.e., Tax Court or United States District Court, did not negate the fact of actual (and irremediable) injury to plaintiffs caused by their acting on such faulty advice."
"The court in McKeown distinguished the McKeowns' situation from cases in which attorney errors during the course of litigation conceivably could be corrected by subsequent motion or appeal, in which cases the error became irremediable only when the adverse determination had become final, or the remedial motion had been denied. [Citation.] [The McKeown court] noted that in the McKeowns' case, the bank's allegedly erroneous advice could not be remedied by the tax court litigation. [Citation.] This portion of the McKeown case, of course, is now no longer good law, given the holding in Laird v. Blacker [citation]." (Schrader, supra, 8 Cal.App.4th at p. 1687, fn. omitted.)
Thus, contrary to the Court of Appeal and Feddersen, McKeown simply held that section 339, subdivision 1, was not tolled until the tax court judgment became final. Indeed, as plaintiffs point out, the McKeown court impliedly held that the action for accountant malpractice accrued when the plaintiffs were notified of the tax deficiency by the IRS. As the court reasoned: "The taxpayer to whom a notice of deficiency is sent is put to the choice of paying the deficiency, incurring the expense of petitioning for redetermination, or facing collection by the government. (Int. Rev. Code, § 6213(a) & (c).) [The plaintiffs] had at that point suffered [actual] harm." (McKeown, supra, 194 Cal.App.3d at p. 1229, fn. omitted.)
Feddersen also relies on Yandell v. Baker (1968) 258 Cal.App.2d 308 [65 Cal.Rptr. 606], in support of its assertion that the statute of limitations commenced either in 1983 and 1984, when Feddersen filed the tax returns in question, in 1986, when IRS Agent Dinner first informed IEPO that it might be subject to a deficiency assessment based on the negligent preparation of its 1983 and 1984 returns, or, at the latest, in June 1987, when the proposed audit report was sent to IEP and IEPO.
Indeed, the Yandell court held that the statute of limitations under former section 339, subdivision 1, commenced "from the time of the negligent act rather than from the time of discovery of the injury." (Yandell v. Baker, supra, 258 Cal.App.2d at p. 311.) Thus, the court held: "Once . . . [the] assets were distributed, the liability for payment of ordinary income rates, rather than capital gains rates, arose and the damage was done—even though the amount of damage or liability could not be determined until the [IRS] acted later." (Id., at p. 314.)
Yandell, however, was decided before this court determined that a cause of action for professional malpractice does not accrue until discovery of the negligent act. In fact, we specifically disapproved its holding. (Neel, supra, 6 Cal.3d at p. 190, fn. 29.) As the Schrader court observed, Yandell "was decided before the California Supreme Court held that a cause of action for malpractice does not accrue until the plaintiff knows, or should know, of the negligent act. [Citation]. Therefore, the emphasis in Yandell on the date of the negligent act. . . is now, after Neel, simply irrelevant; what is relevant is the date by which the plaintiff should know or have known of the injury caused by the negligent act and when he or she had sustained appreciable and actual damage." (Schrader, supra, 8 Cal.App.4th at p. 1686, fn. 2.)
We have recently held that it is the disposition of a case that triggers the running of the statute of limitations in professional negligence suits. (ITT Small Business Finance Corp. v. Niles (1994) 9 Cal.4th 245 [36 Cal.Rptr.2d 552, 885 P.2d 965] [hereafter 777].) Although neither Budd nor Laird addressed the limitations question in the context of a second, underlying action pending at the time the statute of limitations period expired for professional malpractice, we applied the reasoning of Budd and Laird to transactional legal malpractice cases in which litigation is frequently the result of the legal malpractice. In ITT, we held that until bankruptcy litigation concerning the effectiveness of loan documents is settled, the question whether the attorney has actually committed malpractice has not been resolved. (ITT, supra, 9 Cal.4th at pp. 257-258.) The court observed in ITT that the question whether the plaintiff suffered actual injury as a result of the attorney's preparation of the loan documents is contingent on the outcome of the adversary proceeding. (Id., at p. 258.) Therefore, ITT concluded, the statute of limitations starts to run once the adversary proceeding is complete. (Ibid.) Here, the assessment of the tax deficiency is the equivalent of the settlement in ITT, because the question whether the taxpayer suffered actual injury as a result of the accountant's allegedly negligent preparation of the tax returns is contingent on the outcome of the audit.
Thus, the reasoning of Laird and ITT apply with equal force in cases involving the negligent filing of tax returns, where the alleged malpractice is not discovered until the time of the audit, and the malpractice tort is not complete until the audit is finalized. The taxpayer's tax returns may have been selected for audit for a number of reasons, some unrelated to the alleged accountant malpractice. Indeed, "actual injury" represents a legal term of art which recognizes that an inchoate or potential injury cannot give rise to a professional malpractice action until there has been an actual determination that the accountant's alleged negligence is related to the deficiency assessment. Once the audit process is finalized, however, the harm caused by the accountant's negligence is no longer contingent and the taxpayer's cause of action in tort for alleged malpractice against the accountant accrues under section 339, subdivision 1.
Therefore, in the present case, actual injury occurred when the IRS issued its penalty tax assessment on May 16,1988, rather than when IEP0 withdrew its settlement offer in an unrelated lawsuit, or when the company's bank reduced its line of credit by $200,000 in anticipation of lEPO's potential tax liability. Although these two latter events may represent palpable harm caused by the malpractice of the accountant, they are based on a tentative assessment of potential liability only. Although Feddersen's alleged negligence may have been "discovered" during the audit, such potential liability could not amount to actual harm until the date of the deficiency tax assessment or finality of the audit process.
The foregoing rule both conserves judicial resources and avoids forcing the client to sue the allegedly negligent accountant for malpractice while the audit is pending. It also avoids requiring the client to allege facts in the negligence action that could be used against him or her in the audit, without first allowing the accountant to correct the error (or mitigate the consequences thereof) during the audit process. (See Ackerman v. Price Water-house (1992) 156 Misc.2d 865 [591 N.Y.S.2d 936, 941], affd., 198 A.D.2d 1 [604 N.Y.S.2d 721] ["general rule that statute of limitations for accountant malpractice does not begin to run until a tax deficiency is assessed protects federal tax preparers from the prejudice of needless litigation expense on suits which must later be abandoned because no damage ensued, after occasioning an entirely wasted investment of court resources"].)
3. Other-state Cases
Authority from other jurisdictions favors a rule whereby the limitations period for the tort of accountant malpractice regarding tax advice does not commence until the taxing authority assesses a deficiency. (See e.g., Mills, supra, 768 P.2d at p. 556; Thomas v. Cleary (Alaska 1989) 768 P.2d 1090, 1093-1094; Strieb v. Viegel (1985) 109 Idaho 174 [706 P.2d 63, 67]; Chisholm v. Scoff (1974) 86 N.M. 707 [526 P.2d 1300, 1301-1302]; Sladky v. Lomax (1988) 43 Ohio App.3d 4 [538 N.E.2d 1089, 1090]; Atkins v. Crosland (Tex. 1967) 417 S.W.2d 150, 153 [26 A.L.R.3d 1431].) The general rule in these cases is that "the statute [of limitations for accountant malpractice] does not begin to run until a tax deficiency is assessed because there is no injury to the plaintiff prior to that time; i.e., there is not a completed tort until the IRS assesses a deficiency." (Mills, supra, 768 P.2d at p. 556.)
As Feddersen observes, some authority from other jurisdictions holds that the statute of limitations starts to run on the first indication that the accountant's mistake in preparing the tax return may lead to adverse action by the IRS. (See, e.g., Ackerman v. Price Waterhouse (1994) 84 N.Y.2d 535 [620 N.Y.S.2d 318] [accountant malpractice action accrues upon client's receipt of accountant's skill and advice]; Klosure v. Johnson, Grant & Co. (1988) 229 Neb. 369 [427 N.W.2d 44] [two-year statute of limitations for accountant malpractice commences when plaintiff told by accountant that company did not qualify for DISC status under Internal Revenue Code]; Harvey v. Dixie Graphics (La. 1991) 580 So.2d 518 [taxpayer sustained actual injury under accountant malpractice statute of limitations when he learned during IRS audit that IRS disagreed with taxpayer's accountants].)
We are not persuaded. These cases would commence the limitations period when actual injury is still speculative and deficiency assessment uncertain, defeating the purpose of California's "discovery plus actual injury rule." Moreover, as the Mills court observed, the goal of a statute of limitations is to prevent stale claims. By using the date of deficiency assessment or notice of deficiency assessment, as the date of actual injury, we further this goal. As set forth above, the IRS must assess a tax deficiency within three years from the date of the tax return, unless the parties agree to extend the assessment period. Most taxpayers are likely to contact the accountant who prepared the returns in question for assistance in the audit process. If the taxpayer were required to file suit against the accountant at this time, the effort to clarify any mistakes in filing would be frustrated. (Mills, supra, 768 P.2d at pp. 557, 558.)
The use of the date of deficiency assessment to mark the date of actual injury in accountant malpractice cases provides the parties with a bright line that, once crossed, commences the limitations period under section 339, subdivision 1, and therefore provides certainty in terms of the statute's application. Obviously, in some cases injury will be clear before the notice of deficiency is given to the taxpayer. But uniformity in application serves a more important function when interpreting statutes of limitation than does the identification of the precise point at which some harm might be said to have occurred, even if negative collateral consequences might arise from the tentative assessment of additional tax liability.
Conclusion
We conclude that the statute of limitations in an accountant malpractice case alleging the negligent preparation of tax returns commences when the tax deficiency is assessed by the IRS. In the present case, the IRS presented IEP and IEPO with its final deficiency assessment on May 16, 1988. Accordingly, the two-year statute of limitations provided in section 339, subdivision 1, began to run at that time, and this suit, filed on May 15, 1990, was timely. We conclude, therefore, that the Court of Appeal judgment should be reversed and remanded for further proceedings consistent with this holding.
Because we determine that the statute of limitations commences on the date of deficiency assessment, we do not address IEP's alternative argument that the statute should be tolled during the "continuous representation" of the accountant. We believe any broadening of the continuous representation rule should come from the Legislature. We also deny Feddersen's request to strike IEP's reply brief and have chosen instead to exercise our discretion to disregard any defects and consider the brief to the extent it was properly prepared. (See Cal. Rules of Court, rule 18.)
The judgment of the Court of Appeal is reversed.
Arabian, J., Baxter, J., George, J., and Werdegar, J., concurred.
More recent cases applying the "discovery plus actual injury" rule in accountant malpractice cases, where the accountant has negligently filed a tax return, have explained the Moonie holding: "The client's cause of action accrued when he learned of the accountant's negligence through the notice that a penalty was to be assessed against him. [Citation.] The client suffered . . . 'appreciable harm,' when he became liable for a tax penalty . . . ." (Schrader, supra, 8 Cal.App.4th at p. 1687, italics added.)