Perils of Unclaimed Property

Failure to comply with state statutes can result in huge audit assessments, significant interest accumulations, and civil and criminal penalties. These ramifications are not limited to a single state if a company has vendors, customers, or shareholders in multiple states. It is estimated that only 10% to 20% of businesses currently comply with un-claimed property laws. The others are at substantial risk, because states facing revenue shortfalls recognize this as an easy source of untapped revenue.

Many states are facing budget crunches, and unclaimed property funds could represent a windfall. Because all jurisdictions already have unclaimed property laws on the books, they can pursue these funds without imposing new taxes or passing new legislation. Experts estimate that $2–3 billion is being collected by states annually from the small percentage of unclaimed property being reported. Identifying and auditing the large majority of noncompliant businesses holds great promise for states.

State tax revenues are on a sharp and widespread decline. Personal income tax revenue was down by 2.7% in the fourth quarter of 2001. Corporate income tax revenue suffered a staggering 31.8% decline in the same period, marking the fifth straight quarter of accelerating declines. Projections for fiscal 2002 revenue collections are not sufficient to pay for the current state commitments.

After unclaimed property funds are remitted to the state, in theory the state holds the property in perpetuity for the benefit of the rightful owner. The rightful owner may reclaim the property from the state, but only a small percentage of the property reported and remitted is actually reunited with the owner. As a result, the states are left with large sums of money that are effectively interest-free loans that may never have to be repaid.

The size of any settlement naturally varies by case, but such settlements could easily reach well into the millions for large corporations, even before computing interest and penalties for the noncompliant period. First-time audits of previously noncompliant businesses frequently reach back a minimum of 10 years, corresponding to the statute of limitations in a few states. Many states have no statute of limitations, and therefore an even longer look-back is possible.

Attempts at Uniform State Laws

Unclaimed property is property over which the owner has not taken any action to assert ownership or indicate interest in ownership during a period of time specified by law. Property is considered abandoned when the owner has voluntarily relinquished all right, title, claim, and possession with the intention of terminating ownership, but without vesting it in any other person. State unclaimed property laws cover both types of property. For the purpose of efficiency and consistency, the term “unclaimed property” will be used throughout to refer to both types.

Unclaimed property laws can be traced back to the development of escheat in medieval England, the process of forfeiture of property to a sovereign when an owner is unknown or considered to have abandoned the property. In England, escheat was only applicable to real property, but these principles were expanded by some of the original American colonies to include personal property. Eventually, all states enacted statutory provisions for escheat that included both real and personal property.

The early state statutes were not well organized, creating confusion and controversies among states over their relative claims to various unclaimed properties. By the 1950s, there was a clear need for a consolidated, unified statutory scheme addressing unclaimed property. The Uniform Disposition of Unclaimed Property Act was first promulgated by the National Conference of Commissioners on Uniform State Laws (NCCUSL) in 1954. The NCCUSL is a nonprofit, unincorporated organization composed of attorneys, judges, and law professors appointed by the states. Its purpose is to review state laws to determine areas where uniformity is desirable, and draft and propose the adoption of statutes in such areas. No uniform law is effective in any state, however, until it is adopted by that state’s legislature. The original uniform act of 1954 has since undergone revisions and has been superseded on several occasions. States have adopted different versions of the act over time and have individually modified the laws, meaning that a lack of uniformity among the states still exists.

Specific Uniform Laws

The 1954 Uniform Act revolved around the issue of multiple liabilities. This occurred when two or more states had statutes claiming jurisdiction over the same property held by a particular business. This act provided for the elimination of multiple liabilities for businesses that operated in more than one state, so the holder was not subject to more than one liability for a single property. The proposed uniform law was not widely adopted.

The Revised Uniform Disposition of Unclaimed Property Act was approved by the NCCUSL in 1966. This act dealt only with specific problems arising with money orders and traveler’s checks. This amendment also eliminated the holder’s requirement of reporting the name and address of owners of traveler’s checks and money orders and the state’s requirement of publication on a list. These changes were necessary due to the inability of an issuer to know who the ultimate holder of the instrument was.

The 1981 Uniform Unclaimed Property Act (UUPA) was a complete revision of the 1954 and 1966 acts in response to jurisdiction and priority issues that remained. The act did not completely resolve these issues, but two Supreme Court decisions, Texas v. New Jersey [379 U.S. 674 (1965)] and Delaware v. New York [507 U.S. 490 (1993)] established a bright-line test for primary and secondary priority among state claims. The first priority belongs to the state with jurisdiction over the owner’s last known address as shown by the holder’s books. The second priority is the state of the holder’s incorporation, as set out in Delaware v. New York.

The 1981 act was superseded by the 1995 Uniform Unclaimed Property Act. The 1995 UUPA was designed to clarify the issue of the identity of the debtor when payments by intermediaries such as banks, brokers, or depositories serving as the record owner of securities are at stake. This act also established a duty by holders to report unclaimed property to any state that the holder’s records identify as the owner’s last known address, regardless of whether the holder is otherwise subject to jurisdiction of that state. Different states have adopted different versions of the uniform act (see the Exhibit). Currently, four states have unclaimed property programs based on the 1954 act, with one of those including provisions from the 1981 act. The 1966 act has been adopted by 14 states, with eight of those states also including provisions from the 1981 act. The 1981 act has been substantially adopted by 17 states, with two of those including provisions of the 1995 act. The 1995 act has been adopted by 11 states. Finally, five states do not rely on any uniform act.

Current State of Enforcement

States are currently increasing their audit and enforcement efforts. Un-claimed property has become a significant revenue-generating program. In some states it exceeds lottery revenue.

Texas shifted the responsibility for its unclaimed property program from its treasury department to its comptroller in 1996. The comptroller’s office increased its unclaimed property audit staff and trained its sales and franchise tax auditors to include unclaimed property as part of their regular audit routine. The comptroller’s office also trained additional auditors. Other states have adopted similar methods. Texas has also retained outside audit firms in its enforcement efforts.

The increased enforcement trend is also seen in Delaware, where incorporated companies that have never filed an unclaimed property report are being targeted. Warning letters were sent out in the first phase of Delaware’s enforcement effort in March 2001. Recipients were given 60 days to respond and report on unclaimed property going back to 1990 in order to avoid penalties and interest.

In addition to increasing audit efforts, states are changing laws to shorten dormancy periods, the length of time that must pass for the presumption of abandonment to apply. This results in the requirement to report funds and turn them over to the states sooner. The states argue that if they receive the funds sooner, it is more likely the funds will ultimately be reunited with their owner, but the costs associated with enforcement and compliance still need to be evaluated.

Compliance Costs

If a company has properly accounted for unclaimed property, it will have a reserve on the books to cover liability for it. For companies without the proper reserve, however, these items will become a liability to the business. After a liability has been tabulated, a state will assess interest from the date the report was due until it was actually filed. For some companies, this might mean a 12% annual charge spanning 10 to 20 years.

The labor cost of compliance is a direct cost, and the reporting and research requirements are a time-consuming, labor-intensive task that requires substantial staff hours. This is particularly true for the initial design and implementation of a compliance process. Staff hours may be reduced by the use of available software solutions. Low-end packages can replace the manual task of filling out the various forms required by the state. A full-service package can handle the due diligence and reporting requirements.

Indirect costs are usually applicable to the noncompliant business. Those businesses are most likely to account for unclaimed items improperly. Common errors are to reverse the original disbursement entry or write off the amount to a miscellaneous income account. These entries may happen with many types of property, such as payroll, advance deposits, credit balances, gift certificates, insurance proceeds, and prepaid credit cards. Items should be moved to a general ledger account dedicated exclusively to accounting for unclaimed assets. This general ledger account should appear in the current liability section of the balance sheet. The reversal of these items would have both an income statement effect and a tax effect if the total is material. Their materiality would then dictate the financial statement ramifications. The cost to the company would depend upon the severity of the issue. The actual cost associated with restatement and amended returns can be significant, as can the cost of negative perceptions by the company’s stakeholders.

The magnitude of penalties for noncompliance is significant and varies widely from state to state. The penalty for inadvertent failure to file usually results in a $100- or $200-per-day fee with a maximum of $5,000, but this can be higher. In New York, the penalty for willful failure is not often evoked, but when it is, there is no maximum on the $100-per-day penalty. The penalties are even stiffer when fraud is involved. In November 1998, Bank of America agreed to pay $187 million for the mishandling of unclaimed interest and payments, double charging, and charging for services it did not perform. In another case, Bankers Trust Company pleaded guilty to federal criminal charges that its employees had illegally diverted $19.1 million in unclaimed checks and other credits owed to its customers. This suit was settled in March 1999 by paying fines of $60 million to the federal government and turning over $3.5 million to the state of New York. The employees were indicted and face up to 30 years in prison.

Compliance Challenges

Many noncompliant businesses are simply unaware of unclaimed property statutes. When a business chooses to comply, the magnitude of the burden may not be initially understood. The inconsistencies between jurisdictions create a considerable compliance burden.

Reporting due dates vary by state and type of business; for example, businesses in New York are required to file unclaimed property reports by March 10. Life insurance companies are an exception; they have varying due dates throughout the year that do not correspond with those for other businesses. The dormancy period also varies by jurisdiction and by type of unclaimed property. Dividends are considered dormant in New York after five years.

Property holders are required to perform due diligence. The holder must make a final attempt to locate the owner prior to reporting and remitting the property to the state. This is usually done in the form of a first class letter to the last known address. The unclaimed item must have some set minimum value for the due diligence process to be required. This value varies among states and ranges from $10 to $100. The required duration of due diligence ranges from 60 days to one year prior to turning over an item to the state.

The form of reporting also varies. For small quantities, the report may be completed manually on a paper form. After the quantity reaches a certain threshold (which varies by jurisdiction), a diskette or magnetic tape report is required. Some aggregate reporting is available in all states. The ceiling for aggregate reporting also varies by state, usually somewhere between $10 and $100. Some states require attachments containing owner information, while other states do not allow owner information to be sent on items that must be reported in aggregate. Aggregate reporting does serve to lessen the reporting burden for the holders, but there is then no means by which to reunite the transferred property with its rightful owner.

Finally, there are a few types of property that are exempt from un-claimed property laws, but only on a state-by-state basis. These can include the following:

Other potential exemptions not yet recognized by any state are IRA accounts and Keogh plans.

Benefits due to exemptions happen in few situations. If an item is exempt in the state with first priority, the state with second priority still requires the item’s remittance. The exemption must be available in both jurisdictions for a holder to receive the benefit.

Mitigating Compliance Challenges

The compliance challenges can be eased with the use of software. There are some simple free, downloadable software programs that can alleviate the manual process of compliance. New York, for example, provides a diskette program and instructions for its installation and use. Many states are now accepting reports created from free software available from providers like Wagers & Associates (www. wagers.net). These programs allow the holders to create records and put them into a format accepted by the state. This type of program accommodates only the disk reporting requirements. There are also complete software packages that can accurately and efficiently handle the burdens of both due diligence and reporting requirements for all jurisdictions, and be integrated into many accounting systems (e.g., Chesapeake System Solutions, www. chessys.com).

Outsourcing is another alternative. It can be accomplished through various agencies, such as National Abandoned Property Services.

All three options have costs associated with them. A cost–benefit analysis would allow a business to make an informed decision about which method would best suit its needs.

Mitigating the penalties and interest can provide substantial savings, especially for noncompliant businesses. The National Association of Un-claimed Property Administrators (NAUPA; www.unclaimed.org) developed a national voluntary compliance program in 1999. This amnesty program was developed to increase awareness of reporting requirements, encourage states to offer assistance to businesses that wanted to comply, and reunite owners with their property. The amnesty program provided holders that voluntarily reported overdue unclaimed property the opportunity to qualify for waivers of penalties and interest. Many states participated in the program, but most of the original amnesty periods have now expired. Some states continue to offer some form of amnesty program to encourage voluntary compliance. For others, a negotiated settlement of past obligations may be an option. Interested parties should contact the appropriate state tax administrator.

Implementing a Compliance Program

Implementing a plan to successfully negotiate the compliance maze should begin with an evaluation of the needs of the company. Education, awareness, and planning at the outset will minimize the magnitude of the project. In-house compliance, outsourcing, and software packages should be researched to select the best solution. Internal control and procedures must be established or improved. Procedures should be in place for internal identification, tracking, and early notification. These procedures will serve to identify and often reunite items of property to the rightful owners. Proper procedures will also provide sufficiently maintained records of owners. Ultimately, the records will be complete and accurate. Unclaimed property audits will often span 10 to 20 years, making adequate documentation and record retention policies essential.

Previously established exemptions can provide a planning tool. Publicly held companies may want to educate shareholders on the benefits of a dividend reinvestment program or the importance of cashing dividend checks, regardless of the size. When offering a product or benefit, appropriate structures can be put in place prior to the program’s implementation to eliminate or minimize any future liabilities.

Lobbying efforts are relatively new in the unclaimed property arena, although there have been a few successful efforts. In Florida, some unused theme park admissions are now exempt from escheat. Even though this exemption is limited in scope to large parks, it demonstrates how, under the right circumstances, lobbying can be effective.

The efforts of due diligence could produce additional positive results by informing a customer or employee of funds that are owed to them. This may strengthen or reestablish relationships, and it may also serve to enhance the public image of the company.

Lori Furguson-Kenney recently received her Master’s in Taxation and is currently employed as a tax accountant.