Strapped for cash, most state governments are turning to unconventional means to increase revenue—and they are finding unclaimed property audits to be an easy target.
“The states’ unclaimed audit activity is at an all-time high, because they are searching for ways to meet their budgets,” says Laura Lane, vice president of the unclaimed property services division at consulting firm The Keane Organization. “They see unclaimed property as a really fluid source for revenue, because it doesn’t involve raising taxes.”
According to the National Association of Unclaimed Property Administrators, U.S. states collectively hold more than $33 billion in unclaimed property—a figure that grows by millions of dollars annually, Lane says, since less than 20 percent of owners ever claim that property.
In addition, more and more states use third-party audit firms to track down the owners of “UCP” and pay them a contingency fee based on what they find. (Other states have dedicated staff to handle audits.) For corporations, that can mean more scrutiny and surprise bills if a state suddenly decides your business is responsible for UCP you might not even know you owned.
More than 110 different types of UCP exist, Lane says. A few of the major categories:
Uncashed payroll checks and wages;
Accounts payable checks, such as refunds;
Accounts receivable credit balances;
Unredeemed rebates;
Unused gift cards;
Unredeemed vendor credits;
Interest and dividend payments; and
Stock and other securities.
Michelle Andre, a principal in KPMG’s state and local tax practice, says a company could also have items that appear to be UCP but actually aren’t: a check that was voided and then reissued but not recorded, for example, or errors made in a vendor name.
Andre
Some industries (like the financial services sector) have a better handle on their UCP than others, because they haven’t had much choice, Andre says. For others, it’s fairly new territory. Thomson Reuters, for instance, recently polled 82 energy executives and found that only 56 percent file unclaimed property reports. Additionally, 32 percent said they have been or are currently being audited.
“Most companies don’t have policies and procedures in place for handling unclaimed property until they’re subject to an audit and are forced to develop them.”
—Laura Lane,
VP of Unclaimed Property Services Division,
The Keane Organization
The biggest challenge for companies about UCP is knowing how and when to report amid myriad state laws. UCP isn’t like a tax, where the company only needs to pay state or local tax if it has some clear legal nexus compelling it to do so. Rather, UCP reverts to the state of the property owner’s last known address, or the state of incorporation if that address is unknown. That means companies can have reporting obligations to numerous states simultaneously, and doesn’t necessarily need to have a business presence or employees in those states for the obligation to exist.
Complicating matters: Many states change their UCP laws frequently, especially provisions about how long property must be dormant before it becomes unclaimed. In most states, the dormancy period is three to five years, depending on the type of asset. No single database compiles all those rules, so whoever is in charge of UCP compliance at a company must comb through state requirements individually. (And that assumes your compliance department knows about UCP in the first place.)
Getting Ahead of UCP
The risk of UCP should be treated like any other. Namely, companies should have policies and procedures in place to identify UCP, and they should serve as a guide for internal auditors when the time comes to assess UCP risk, Andre says.
Lane
Lane, however, sounds a sourer note. “Most companies don’t have policies and procedures in place for handling unclaimed property until they’re subject to an audit and are forced to develop them,” she says. “It’s just a matter of being proactive with customers, employees, and vendors and making sure they manage the financial balances that are on their accounting books and records.”
Valerie Jundt, director of the Unclaimed Property Group at Thomson Reuters and a former state unclaimed property administrator, can vouch for that. Typically when a company is selected for an audit, they request two things: copies of unclaimed property reports they had been filing to the state and copies of their written policies and procedures. “Many companies do not have a both,” she says.
TO AVOID AN AUDIT …
Michelle Andre, state and local tax principal with KPMG, recommends a checklist of questions companies should ask themselves to reduce their chance of an audit:
What is your company’s potential unclaimed property liability in the next one, two, and three years?
Do you have a process to assess potential targets’ unclaimed property exposure?
How do you assess the unclaimed property implications of new products or services?
Do you have a process to address states’ compliance requirements?
Do you have a process to identify key unclaimed property risks?
Are your unclaimed property liabilities appropriately reflected on your financial statements?
What are the controls related to your unclaimed property obligations?
—Michelle Andre
UCP risks can also surface in the wake of a merger or acquisition. In that case, Lane says, compliance officers should ask the acquired company about its filing history and ask to see copies of any UCP reports. If the acquired company hasn’t been in compliance, the purchasing company should include a provision in the contract that somehow accounts for the risk of unclaimed property, such as setting aside money in escrow in the event of an audit.
In general, to stay in compliance, companies have a duty to try to find the property owner before filing a report and remitting the funds to the state. Assuming you can’t find that owner, compliance typically consists of filing UCP reports to the proper state authorities annually and remitting property in a prompt fashion. Most states’ UCP filing season is in the fall, although some (Delaware, New York, and Pennsylvania, for example) require additional reports filed in the spring.
Not knowing the laws of each state can expose a company to potentially significant interest and penalties. For example, companies that fail to file a timely report in Colorado face an annual interest rate of 18 percent. In particularly egregious situations, such as fraudulent acts, states may also add criminal penalties on top of interest.
As far as what department should be responsible for UCP records, that depends on the company. “There is no real easy answer,” says Jundt.
As far as who should be responsible for UCP records, Lane recommends designating a senior-level executive either from the legal, tax, accounting, or controller’s office. Auditors will be looking at accounting records, “so you need someone who is going to coordinate the production of documents that the auditor is going to request,” she says.
Because of the potential sensitive information contained in such documents, “it’s imperative that they get a confidentiality agreement executed before the audit starts,” Lane adds.
Another best practice: Hold onto your records perpetually, “because that is your only form of defense in the case of an audit,” says Jundt. There is no statute of limitations in an unclaimed property audit (Delaware, for instance, goes as far back as 1981).
“So if you have a strong reporting history and you can support that with documentation that shows you are in compliance and do have good procedures in place to address this, most of the time you can bypass a very lengthy and costly audit,” Jundt adds.
Communication is also important. For example, if the auditor is demanding a deadline that’s not feasible because the company has other priorities, such as a financial close, “they need to be upfront with the auditor,” Lane says.
“An audit definitely can be a time-consuming and resource-consuming process for companies,” says Andre. Taking the initiative to identify and address potential risks will help companies reduce their overall chance of an audit.
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