Compliance

Unclaimed Property: Why Should I Give Escheat?

FEI interviews Chris Hopkins, Crowe Horwath LLP Tax Partner and unclaimed property luminary, who explains how unclaimed property risks and costs can be minimized with a little foresight and planning.

Exploiting their unclaimed property – or escheat – laws is a way some states generate significant revenue without actually imposing a tax. An unclaimed property audit can be exhausting and often concludes with an egregious assessment. The following article provides answers to some common questions about unclaimed property and highlights how a bit of advanced planning can help to minimize related risks and costs.   

What exactly is unclaimed property?

Unclaimed property rules generally apply to intangible property held in the ordinary course of business that is owed to another party, the “owner.” After a period of time has expired, which varies by property type, the “holder” must turn the property over to the state. Some examples of unclaimed property include uncashed payroll and vendor checks, unapplied customer credit balances, unredeemed gift cards, dormant bank accounts, and owner-unknown shares of stock.

All 50 states, along with the District of Columbia, Puerto Rico, Guam and the U.S. Virgin Islands, have unclaimed property laws. Unclaimed property mostly is a U.S. phenomenon, and executives of non-U.S. companies often are aghast when they first encounter these rules.

What state has jurisdiction over unclaimed property?

Generally, the state of last known address of the owner as shown in the records of the holder has a priority claim to unclaimed property. However, if there is no address for the owner or the owner’s address is in a foreign country, the unclaimed property is reportable to the holder’s state of incorporation. These jurisdictional rules were established by the U.S. Supreme Court in a series of cases involving disputes between states. The rules are still in play, though, as 22 states recently sued Delaware over its alleged claim to money order-type property.

How is unclaimed property different from a tax?

Unclaimed property is not a tax but a property right, and tax rules such as nexus and statutes of limitations often don’t apply. More significantly, many companies aren’t even aware that unclaimed property laws exist, and a state inquiry or audit notice can be a big surprise. That said, given the manner in which some states audit and estimate liabilities, an unclaimed property assessment really amounts to nothing more than a tax, and arguably an unconstitutional one at that.

Why are unclaimed property audits so challenging?

Most unclaimed property audits are conducted by contract audit firms. These firms typically are paid on a contingency fee basis. There are few rules that dictate how an audit should be performed, so auditors are left to their own devices to determine the best approach. Obviously, given the contingency fee nature of most arrangements with contract audit firms, audits are designed to create the largest purported unclaimed property liability possible.

Unclaimed property audits can touch every part of an organization’s balance sheet. I contend that most so-called unclaimed property identified during an audit consists of accounting transactions that can’t be reconciled eight or nine years after the fact. But try telling that to a contingency-fee auditor.

Over the past two decades, Delaware, which ironically holds itself out as the “business friendly” state, has been notoriously aggressive in sponsoring unclaimed property audits that have generated billions of dollars of revenue for the state – and Delaware does refer to unclaimed property proceeds as revenue. On a positive note, last year a federal court ruled that Delaware’s approach to audits and estimating liabilities was unconstitutional, and found that Delaware “engaged in a game of ‘gotcha’ that shocks the conscience.” In February 2017, Delaware enacted legislation that overhauled the state’s unclaimed property laws in an attempt to keep the unclaimed property revenue stream flowing. But it may be too little, too late.

As a financial executive, what can I do to protect my company from a costly audit?

The first step is get a handle on your company’s unclaimed property profile. What types of unclaimed property might it hold, and does the company have unclaimed property policies and procedures and a history of reporting unclaimed property to states?

Almost all states have programs that allow a company to enter an agreement to voluntarily report past-due property. Under such an arrangement, penalties and most interest usually are waived and the reach-back period is reduced. Probably the biggest benefit is that prior years usually won’t be audited. California is one of the few exceptions.

In addition to addressing past-due property, a company should establish compliance policies and procedures – and then follow them. A reasonably robust compliance process can reduce significantly or eliminate a contract auditor’s motivation to turn an unclaimed property audit into a treasure hunt.

As a final note, some companies find it advantageous to reincorporate into a state with favorable unclaimed property laws. Virginia, for example, exempts gift cards and similar items, as well as virtually all transactions that arise from transactions between businesses. Reincorporation can be particularly attractive to companies with a significant amount of no-address property like gift cards or with a large number of non-U.S. business customers or vendors.

Register today for the FEI and Crowe Horwath webinar: “Practical Approaches to Unclaimed Property Compliance.”