States are increasingly pursuing unclaimed property that companies may be sitting on unwittingly. Delaware—among the most aggressive—is conducting deep audits of companies incorporated there to determine if they are turning over the unclaimed assets.
Unclaimed property, which can include everything from uncashed checks, abandoned pension or 401(k) balances, unspent gift cards, and forgotten deposits or layaways, can represent a large risk for many companies and a narrowing window of opportunity to mitigate it, as well as compliance headaches. States have held authority over abandoned or unclaimed property since the 1960s, collecting it from corporations or other institutions when it is left unclaimed by its rightful owners. Many states count on the revenue stream that such property can provide, since much of it is never claimed.
With a growing reputation as a ruthless collector of unclaimed property, Delaware has stepped up its enforcement of companies incorporated in the state to report and remit unclaimed property. State officials have estimated nearly 300,000 companies might be required to report unclaimed property to the state, yet only a small fraction of those required to report have done so.
With an eye on increasing enforcement and collections, state officials launched a voluntary disclosure program in July 2012 that a year later had reined in only 450 companies, says Bob Peters, managing director at Duff & Phelps and head of the firm's unclaimed property and tax risk advisory. The carrot, he says, is a limited look-back period (to only 1993 instead of 1981) and a waiver of interest and penalties.
The stick, says Peters, is a frightening audit, with state auditors empowered by case law to go back deep into a company's history and estimate liabilities where companies lack records to substantiate their unclaimed property holdings. “The state audit division has stepped up audits of companies for unclaimed property and made it very clear through this process that they will aggressively pursue those that have not come into compliance,” he says.
A recent survey by Duff & Phelps and Financial Executive Research Foundation of 100 companies found that 75 percent have no plans to investigate Delaware's voluntary disclosure options because they are already under audit or are in the program. According to Peters, many other companies falsely believe they are in compliance or that they have no obligation to report to Delaware. The reality is the risk is much greater, he says. “Even if you are the most sophisticated company in the world that has been filing reports, on audit virtually all companies have a liability,” he says.
Valerie Jundt, managing director at unclaimed property services firm Keane, says she routinely sees companies with an overconfident sense of their unclaimed property status. “They often think they have good internal procedures in place,” she says. “Just because you're reporting doesn't mean you're in compliance.” Companies often fail to remember unclaimed property reporting requirements when they change product or service lines, acquire business units, or transition to new information systems. “Valuable data gets lost,” she says.
“I'm still amazed at the large corporations that have never reported a single dollar. In today's environment, it's hard for a company not to know about the subject, but some companies tend to bury their heads in sand.”
—Noel Hall,
Principal,
Ryan
As the Duff & Phelps survey reveals, many companies believe they are only required to report unclaimed property based on the state of residence for the holder of the unclaimed property or based on where they do business. Not so, says Marc Musyl, a shareholder at law firm Greenberg Traurig. In priority rules established by the Supreme Court to clarify state authority over unclaimed property, the first place to report unclaimed property is the state of last known residence for the lost owner. If that can't be determined, however, the second obligation is to report it to the state of incorporation, explaining why Delaware has such a big stake in the claim over abandoned property. “If the second priority rule applies, you're typically talking about a very large sum of money,” he says.
Delaware's voluntary disclosure program closes to new entrants in June 2014, and companies have to complete the process by June 2015, leaving a small window of time for companies to assess their potential liability and consider their options, says Peters. Other states with large populations, and therefore a substantial stake in unclaimed property reporting, also are operating voluntary disclosure procedures, he says, but Delaware's is among the most liberal. “Delaware lets you come forward even if you've been filing in the past,” he says.
Where the Risks Are
WHAT IS UNCLAIMED PROPERTY?
Below, Duff & Phelps explains what constitutes unclaimed property.
Unclaimed property can result from both tangible and intangible property. The current unclaimed property laws impacting most U.S. businesses relate primarily to intangible property. The types of unclaimed property subject to reporting by the states has expanded over the years, and with new business practices such as internet sales, gift cards, rewards, and consumer daily deal programs is likely to continue into the future. Common reportable unclaimed property currently includes:
Unclaimed wages and vendor checks
Uncashed dividend or interest checks
Unredeemed rebates and unused gift cards/certificates
Unlocated owners of stocks and bonds
Unredeemed vendor credits
Credit balances or accounts receivable
Unclaimed deposits or lay-aways
Third-party payments in the form of employee benefit or payroll plans
Source: Duff & Phelps.
Companies can examine a number of risk factors to determine if they might benefit from a voluntary disclosure option, says Jundt. Decentralized companies tend to have a heightened risk of non-compliance, she says, especially if they leave reporting duties to various business units or divisions. “Every company has a tax division, but fewer have a comprehensive area dedicated to unclaimed property,” she says. In addition, companies that rely on third-party outsourcing for things like payroll, issuing bonds or debt securities, gift cards or numerous other financial functions are ultimately responsible for unclaimed property compliance. “Companies think, ‘I've outsourced it, so it's not my problem,'” she says. “But the obligation is between the company and the consumer or the shareholder, not the third party that you've outsourced to.”
Another risk factor, says Noel Hall, a principal at tax consulting firm Ryan can stem from a company's acquisition history. If a company acquires business units with little or no reporting history, they typically acquire some unclaimed property risk in the process. “A company may not know enough in the due diligence process to ask, 'are you in compliance?'” he says.
With the advent of Sarbanes-Oxley, public companies have made some progress in improving their unclaimed property compliance, Hall says, but it's far from perfect. “I'm still amazed at the large corporations that have never reported a single dollar,” he says. “In today's environment, it's hard for a company not to know about the subject, but some companies tend to bury their heads in sand.”
RECOMMENDATIONS
Below, are recommendations from Duff & Phelps for managing unclaimed propoerty.
Perform a full internal assessment of your books and records
Consider all legal entities (subsidiaries, merged or acquired entities);
Determine what property types (other than payroll and accounts payable) have the potential to generate unclaimed property;
Determine the accuracy of previously submitted unclaimed property reports, is any, including those years in which no or nominal amounts were remitted as unclaimed property;
Review business practices to determine if liabilities have and/or are written off or taken back to income (stale date checks; accounts receivable credits; suspense items);
Perform due diligence to reunite the owner with the lost property;
Understand the specific voluntary compliance program rules of the applicable states to which liabilities are owed, and;
Seek the advice of an outside advocate who is well versed in the unclaimed property practices and has extensive experience in unclaimed property audits and VDA submissions.
Source: Duff & Phelps.
Marlys Bergstrom, a lawyer with law firm Sutherland Asbill & Brennan, says companies tend to treat unclaimed property as a “back office function” until they are faced with an audit. “Then it can be a huge priority because it can have such a dramatic impact,” she says. “Are you reporting all of your property types? Are you reporting to the right states? In the 20 years I've been doing this I've never seen a company in full compliance.”
When it comes to public companies that are required to submit to an external audit and report where they may have uncertain future obligations, there still tend to be gaps, Bergstrom says. “Unclaimed property just doesn't get the same attention,” she says. “They may look at it for a year or two or may not look at it at all because it's not material. But state auditors can go back over 30 years and extrapolate results. Then it becomes a material issue.”
Tracy McBride, vice president of research and accounting policy at FERF, says companies have time if they start now to assess their situation and consider Delaware's voluntary disclosure program. “This is part of good balance sheet due diligence for any company,” she says.
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