The everyday functions of a company’s operations result in the generation of legal obligations that can become “unclaimed property.” With state budget deficits continuing to grow, companies should not count on unclaimed property compliance and related audits to go away anytime soon. Today, more and more businesses and financial institutions are reporting large accounts and dollars representing unclaimed property, much of which will go directly to the state instead of the customer or the rightful owner.
Tax professionals may not think that unclaimed property compliance falls within their department’s jurisdiction. Such thinking, however, is usually not the case. Even though unclaimed property laws are not tax laws, they are close cousins. The law looks like a tax because there is an annual filing requirement governed by state law. It feels like a tax because compliance requires ongoing monitoring of changes in laws and regulations. Because of these similarities, the tax department is actively involved in, and ultimately responsible for, unclaimed property compliance.
This is occurring more and more in businesses and corporations around the country because the tax department commonly has a structured compliance calendar to ensure the timely completion of periodic tax filing deadlines. Moreover, this calendar is easily adapted to unclaimed property reporting deadlines. In addition, because tax professionals are most familiar with the process of state and federal tax audits, they are often left with managing an unclaimed property audit if it occurs. This is why it is important for tax professionals to become conversant with state abandoned property requirements.
What is Unclaimed Property?
Each of the 50 states, the District of Columbia, Puerto Rico, the U.S. Virgin Islands, Guam, and some foreign countries, including three provinces in Canada, have unclaimed property laws. Within the United Sates, unclaimed property laws require companies, both public and private, including not-for-profit entities, to annually report and remit all unpaid/unfulfilled liabilities owed to third parties — such as patients, vendors, employees, customers, clients, shareholders, bondholders, and policyholders —once the prescribed statutory number of years, known as the “dormancy period,” has expired.
Obligations that remain outstanding once the dormancy period has expired are required to be reported and remitted to the state of the last known address of the owner of record. One thing that tax professionals are surprised to learn is that there is no “nexus” requirement for unclaimed property. The business holding the liability due to the owner (a “holder”) can have no business contact with or presence in a state and still have a filing obligation because it owes a debt (such as an uncashed check or customer credit) to an owner whose last known address is in that state. Generally, the trigger for dormancy is three to five years, with the exception of payroll, which is generally one year. It’s important to note, however, that dormancy periods vary by state and property type and the states are amending their laws to shorten dormancy periods as means of bringing much needed cash into their coffers.
State Audit Intensity
Given the fiscal crises in many states, unclaimed property audits are occurring more frequently. The states have recognized unclaimed property as a way to raise revenue without imposing tax increases on residents. This practice has become so widespread that unclaimed property has quickly become one of the more important sources of state revenues across the country. Nationwide, the total value of unclaimed property in states’ custody is approximately $35-$40 billion. Significantly, it is estimated that less than half will ever be reunited with its rightful owner. It is for these reasons (among others) that tax professionals must understand the complexities of unclaimed property compliance. This will enable them to educate management to recognize where the risks exist, implement the necessary policies and procedures to achieve compliance, and establish adequate reserves to negate the effect to financial statements if audited.
Experience teaches that a surprisingly low percentage of businesses are in full compliance with the laws — less than 20 percent. Even those that think they are “technically” in compliance may be under-reporting because they are not reporting all property types, fail to take into consideration property that may be outsourced to a third party (such as securities or payroll), or are applying the wrong dormancy period. By recognizing where the risks exist, tax professionals will be able to implement the necessary policies and procedures (or utilize existing processes) to achieve compliance and establish the adequate reserves needed to negate the impact to financial statements if an audit should occur.
Another area of exposure is the level of merger and acquisition activity that a business has had. Mergers and acquisitions can lead to potential exposure stemming from the acquired entity’s historical accounting practices and lack of compliance.
How Tax Professionals Can Provide Guidance and Support to Ensure Compliance
There are several best practices that tax departments can adopt to enhance their company’s compliance level.
Identify potential Outstanding Liabilities
Encourage management to assess and analyze the various sources within your organization that may produce unclaimed property liabilities. Review existing policies, including unwritten practices, for how liabilities are resolved for each of these areas. An important consideration is that unclaimed property liability has a cumulative effect. Instead of having an effect for one year, it can extend back 10 or 20 years or even to the date of the company’s formation. While unclaimed property might not appear to be material in the context of an annual review, it could become material when the cumulative effect of historical non-conformity is calculated, particularly when potential interest and penalties (which can double the underlying liability assessment) are factored in. understand Why unclaimed property s Being Generated Management should devote the time and effort to understand why individuals or businesses have failed to take action with regard to the obligations the company owes them. Customers often relocate or get acquired, or their businesses simply fail. Recipients of health benefit checks can easily become confused between amounts owed to them versus their insurance providers. Duplicate or alternate modes of payment can go unidentified if not properly reconciled. Are there miscellaneous income entries without adequate explanation? Are comprehensive and written unclaimed property policies and procedures in place? Are the policies followed consistently throughout the organization?
Management Can Preemptively Resolve Outstanding Liabilities
The primary threat presented by past due obligations is a state or multistate initiated audit. A majority of states now use third party, generally contingent fee auditors to conduct unclaimed property audits. The tax department should discuss with management the need to undergo a rigorous self-audit or third-party evaluation to make sure that historical practices and reporting are sound. If risks are identified in the process (or compliance history), corrective action should be taken as soon as possible. There are still opportunities in many states to enter into voluntary compliance programs that provide incentives with respect to delinquent reporting and, in some cases, include the waiver of interest and penalties.
Assist Management in Developing a Corporate Policy Regarding Due Diligence
The best defense is good offense. In the unclaimed property world, due diligence is the practice of mitigating unclaimed property liability at its source, specifically, by finding missing owners and helping them take action to reconcile their accounts. Rather than waiting until statutory due diligence is required, companies should reach out to customers six to nine months after a check goes stale or a credit remains unused. This approach will create a better opportunity to find them. In addition, companies should address the undeliverable mail population by suggesting research alternatives for locating accurate addresses.
Reconcile Accounts to Prevent Overpayment
Management should review practices to identify areas of duplicate payments and other costly accounting errors. Reducing these factors can minimize risks.
Document an Annual Compliance Roadmap
The tax department should recommend that management formalize all compliance goals and expectations of professionals who play a role in unclaimed property compliance. The goal should be to establish a working environment where compliant behaviors are standard and executives are committed to, and encourage transparency. The tax department should suggest that management maintain electronic and hard copy documentation of all previous unclaimed property reports for at least 10 years so that the company can quickly and easily demonstrate compliance in the event of an audit. This will help to facilitate internal audits, contribute to long-term compliance efforts, and serve to demonstrate that controls are in place in the event the company is selected for an audit.
Monitor and Track Regulatory Changes
The laws are continually evolving. States frequently add property types, reduce dormancy periods, and change process requirements. A range of unclaimed property software systems and outsourcing options exist to help with planning and execution. If efforts are coordinated in-house, document the workflow, staff responsibilities and informational needs at each step in the process.
Conclusion
The ultimate objective of the tax department is to ensure compliance with unclaimed property laws. Tax professionals should be knowledgeable and vigilant in their efforts. Whether or not this “cousin” to a tax is a welcome addition to the department’s responsibilities, there is a significant likelihood that the tax department will be involved in establishing or maintaining the compliance initiatives discussed in this article. With preparation and integration into the company’s annual tax and compliance processes, unclaimed property can be a manageable responsibility.
Laura Lane is Vice President, Unclaimed Property Services Division for Keane Unclaimed Property Consulting and Advisory Services, with three decades of experience. Based in Cleveland, she joined Keane after spending five years as Senior Manager and Area Leader of the unclaimed funds client services practice at Ernst & Young LLP. A graduate of the University of Pittsburgh School of Law, she may be reached at llane@KeaneUp.com.