Unclaimed property: What is it, and what are the risks?

Proper policies and procedures can help CPAs reduce the potential of state audits and steep penalties for employers and clients.
By Luke A. Sims, CPA

Unclaimed property: What is it, and what are the risks?
Image by zmeel/iStock

Given the ongoing fiscal strains on many states, even prior to COVID-19, it is likely that unclaimed property will continue to be an important source of nontax revenue for them. As such, CPAs and other professionals charged with an organization's risk management and compliance should ensure the company is in unclaimed property compliance.

This article provides an overview of unclaimed property, the risks a company faces if it is not in compliance with applicable laws and regulations, the options available to a company that is out of compliance, and recommendations on processes for staying in compliance.

UNCLAIMED PROPERTY BASICS

All 50 states, together with the District of Columbia, Guam, Puerto Rico, and the Virgin Islands, have unclaimed or abandoned property laws. These laws govern the disposition of unclaimed property, which eventually can become property of the state (typically referred to as escheatment). Unclaimed property can be tangible (safe deposit box contents) or intangible property (securities-related property and general ledger property) due and owing to a third party (the owner) where there has been no contact with the owner for a specific period (dormancy period). The dormancy period is the time during which property remains unclaimed before becoming escheatable; for a payroll check, the dormancy period can be one, two, three, or five years, depending on the owner's address.

When the dormancy period has passed, the entity legally responsible for the obligation to the owner (the holder) is required to perform due diligence and make an attempt to locate the owner of the abandoned property prior to escheatment. The holder is required to:

  1. Confirm the owner's interest in property that meets state thresholds by sending the owner notice via a due diligence letter or email. Certain jurisdictions also have advertising requirements, such as publishing a notice in a local newspaper.
  2. If the owner fails to respond to the notice, the holder must escheat the property to the appropriate jurisdiction.

The requirement to provide notice can vary by state depending on the amount due to the owner and what information the holder has on its books and records. For example, as long as a valid U.S. or international postal service address is kept, New York requires due diligence mailings to owners regardless of the amount of the property owed to the owner, while Texas requires due diligence mailings to owners if the value of the property is greater than $250. Further, certain states have adopted the 2016 Revised Uniform Unclaimed Property Act, allowing for, or in some cases requiring, the use of email as an option for contacting owners.

The priority rules established in a 1965 Supreme Court case, Texas v. New Jersey, 379 U.S. 674 (1965), are used to determine the appropriate jurisdiction where the property escheats. In this case, two priority rules were established to facilitate where the property or cash that represents the property is escheated.

  • First priority rule: Property escheats to the state of the owner/payee's last known address.
  • Second priority rule: Property escheats to the state of domicile/incorporation for the company holding the property, where the holder's records have no last known address associated with that property.

UNIFORM UNCLAIMED PROPERTY ACTS

The Revised Uniform Unclaimed Property Act (RUUPA) is the latest version of the Uniform Unclaimed Property Act originally enacted in 1954 by the Uniform Law Commission and most recently amended in 2016. States have generally adopted a version of the various uniform acts to create their unclaimed property laws or written legislation specific to their states' needs.

The trend over time has been for the unclaimed property acts to increase the types of property covered by the acts, while reducing the general dormancy period. As an example, in the 1954 act, the general dormancy period was seven years. Today, the RUUPA specifies a general dormancy period of three years.

With each state adopting its own unclaimed property act, companies are left with a complex administrative burden to ensure they remain in compliance with all state requirements. Varying state laws may affect the way a company handles unclaimed property.

Thorough internal policies and procedures can assist with appropriately navigating these state law variations.

WHAT IS THE RISK OF NONCOMPLIANCE?

Unclaimed property compliance is an atypical risk that accountants may encounter for which they have not been trained. Nearly every company has the potential to generate unclaimed property through its standard business operations (e.g., accounts payable, accounts receivable through customer overpayments, and payroll). In addition, other types of liabilities such as securities for public companies, certain retirement accounts for financial service providers, stored value (gift) cards for retailers, customer rebates for manufacturers, or mineral proceeds for oil and gas companies may also create unclaimed property risk.

A variety of situations can cause a company to become an audit target; some of the most common are:

  • Lack of reporting history;
  • Inconsistent reporting history;
  • Fluctuations in amounts or types of property being reported; or
  • Not reporting property types common to an industry.

Of course, states use other factors to determine audit candidates, and even a company with a consistent reporting history may be audited. States are employing new technology created by third-party firms to analyze datasets to help expand criteria for identifying audit candidates. These criteria may include, but are not limited to:

  • Industry;
  • Company size;
  • State(s) of incorporation;
  • Acquisition history; and
  • Comparison of filing histories with similar entities.

Once a state has determined it will audit a company, it is very likely that multiple states will join the audit. As many state agencies do not have the resources to perform an audit, third-party firms commonly are employed to do so. These firms often have agreements with multiple states. They may also be aggressive in reviewing a company's books and records because, in many instances, the third-party auditor is paid on a contingency fee basis.

Under audit, detailed financial records will be requested by the auditor for the period covered by the audit, which could extend to 15 or more years. However, most record retention policies align with IRS or FASB rules or standards, which generally means a company retains seven years of records.

In unclaimed property law, state statutes typically span beyond seven years. Companies should be aware of this disparity because states can apply estimation techniques for years where records may not be available.

What does this mean for your organization?

  • Determine if unclaimed property is being reported in accordance with state law and at the appropriate time, as filing deadlines vary by state.
  • Ensure all aged liabilities that may be covered by unclaimed property law are being considered for reporting.
  • Establish unclaimed property policies and procedures.

If a company does not report, or its reporting appears inconsistent to the states, it runs the risk of being audited and assessed steep penalties and interest. All states have statutes that allow for the assessment of penalties and/or interest.

VOLUNTARY DISCLOSURE IS AN OPTION

Audits can be exhausting for internal personnel and typically span several years. Thankfully, the majority of states allow companies to report past due property through voluntary disclosure programs (aka amnesty programs or voluntary disclosure agreement (VDA) programs). A VDA is an important tool in a business's unclaimed property risk mitigation toolbox, allowing organizations to become compliant, limiting the risk of an audit, and generally eliminating interest and penalties associated with late properties.

While states have differing protocols, most require the review of the last 10 report years (i.e., 10 transaction years plus the dormancy period of property type(s) reviewed) and include guidelines regarding the timing for completion of the VDA. Some key factors to consider when trying to determine whether to enter a state's VDA program are:

  • The type of program (formal or informal) offered by the state;
  • The amount of the liability found to be due and owing;
  • The likelihood of penalties and interest being assessed;
  • The state(s) of the company's domicile/incorporation; and
  • The state(s) where the company has substantial business operations (e.g., operational facilities, large customer base, etc.).

Before entering into a VDA, companies should be aware of specific state VDA requirements. Generally, a company should expect the following phases during the VDA process:

Scoping

  • Analyze the company's organization structure;
  • Review the merger-and-acquisition history;
  • Determine the relevant entities for inclusion;
  • Analyze the accounting processes;
  • Determine the accounting functions/transaction flows that may generate unclaimed property; and
  • Analyze accounting records and system(s) capabilities to determine the availability of transactional data.

Quantification

  • Gather source information for in-scope entities;
  • Validate the accuracy of the source information gathered against financial records;
  • Create research populations based on the VDA criteria;
  • Consider state-specific exemptions (i.e., property identified by a state as not subject to escheatment);
  • Research and remediate items selected for testing;
  • Quantify exposure by state and determine the need for VDA(s); and
  • Enroll in applicable state voluntary programs.

Submission to state

  • Finalize the testing methodology report and workpapers to support the testing performed;
  • Submit materials to the state/state agent in conformity with state voluntary program requirements;
  • Answer state/state agent questions on source documentation, methodology, or testing processes performed; and
  • Provide an updated methodology report and workpapers, if necessary.

Closing

  • Obtain the closing agreement;
  • Verify the closing agreement includes all in-scope entities, types of property, and years reviewed;
  • Execute the closing agreement; and
  • Create a retention package of documents.

Once a holder has completed the VDA process, it is important to create a retention package that includes the supporting documentation for the completed VDA(s). The supporting documentation should include but is not limited to scoping analysis; testing workpapers; estimation models; testing narratives; methodology report; state reporting documents and supporting data detail; and VDA enrollment and closing agreements.

Whether under audit or performing a VDA, companies may also consider the use of internal or external counsel in order to take advantage of attorney-client privilege protections.

ONGOING COMPLIANCE

Coming into unclaimed property compliance, whether through an audit or a VDA, will likely be a multiyear endeavor. After taking the time and energy to become compliant, it is essential that a company solidify its internal policies and procedures so it can remain in compliance. Policies and procedures should:

  • List the key contacts within each operational entity where unclaimed property may be generated;
  • Identify the property types that are subject to various state unclaimed property laws;
  • Specify best practices and provide guidelines for each type of property generated;
  • Outline a cadence by which data is received and reviewed for operational entities or functional groups that generate unclaimed property;
  • Address the integration of procedures for mergers and acquisitions;
  • Describe the due diligence process;
  • Detail the reporting process; and
  • Document record retention requirements.

The responsibility of unclaimed property compliance varies from company to company (i.e., compliance may reside with tax, accounting, financial reporting, or risk management). Wherever the responsibility resides, maintaining compliance involves coordination across multiple departments, divisions, and, in many cases, entities. Internal audit departments should also include unclaimed property as an area of review when testing the company's processes and procedures.

Personnel involved in the unclaimed property process should have a basic understanding of what unclaimed property is and how their area impacts the company's compliance efforts. Additionally, the personnel handling unclaimed property should stay educated about unclaimed property to assist in limiting noncompliance.

JUST RIGHT COMPLIANCE

Maintaining compliance with unclaimed property laws is no small feat. While unclaimed property may never rise to the top of a company's risk radar, coming into and staying in compliance with unclaimed property laws may save a company from financial or reputational damage.

With respect to financial risk, in the mid-2010s, the life insurance industry came under scrutiny by states regarding their unclaimed property practices. As a result of audit settlements between life insurance companies and states, billions of dollars were returned to owners and escheated to the states by various companies. In addition to financial risk, an unclaimed property audit may also lead to reputational risk if a company is found to have not properly attempted to reunite obligations with customers, employees, or vendors.

With world, federal, and state economies in disorder, companies should recognize that compliance is more important than ever. To obtain more information on state reporting requirements or to search for unclaimed property, readers can visit unclaimed.org.


About the author

Luke A. Sims, CPA, is the advisory practice leader at MarketSphere Consulting in Overland Park, Kan. MarketSphere Group LLC is not an accounting or law firm, and the information provided within this article should not be viewed as accounting or legal advice.

To comment on this article or to suggest an idea for another article, contact Ken Tysiac, the JofA's editorial director, at Kenneth.Tysiac@aicpa-cima.com.


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