Perhaps no area of compliance gives businesses more trouble than that of escheat, commonly known as unclaimed property (“UP”). I’ve termed it “The Un-Tax” since it is not a tax imposed on a business.
Rather it is an obligation placed on businesses to give certain money or other escheatable items that they are in possession of that rightfully belong to another. Frankly, in modern America, strict enforcement of state UP laws is a very politically correct way for the states to generate additional revenue since a large portion of UP is never claimed by its rightful owners. While the states generally must hold UP in perpetuity for its rightful owners, in reality many of them use UP as part of their general funds when needed, only returning it to its owners when a substantiated claim is made.
Many companies, small, medium and large, have no formal program in place to enable them to comply with the various state laws dealing with UP. Companies that fail to follow the strict escheat guidelines set forth in state statutes do so at their own peril since the respective states have become keenly aware of UP audits as an untapped revenue source. As a result, they have ramped up their focus on them and have benefitted significantly by doing so. In total, the states are now holding about $50 billion of UP, with New York State leading the pack at $13 billion.
What Is UP?
Unclaimed property (“UP”) is tangible or intangible property that has been abandoned or lost by its rightful owner for an extended period of time. Common forms of UP include: stocks, uncashed payroll and dividend checks, unredeemed money orders, uncashed traveler’s checks, insurance payments or refunds, unredeemed credit balances, uncashed vendor checks, savings or checking accounts, and gift certificates (in certain states). A company in possession of UP is known as a “holder.”
Basic UP Guidelines
The concept of UP is a holdover from the British feudal system, under which land was granted by the monarch to certain of his or her subjects, and if the land owner died without an heir, that land escheated back to the monarch. The theory behind state UP laws is that a company should not be unjustly enriched by the loss incurred by the payees of the UP as a result of them not claiming their property.
Under rules set forth by the United States Supreme Court, a holder must escheat (turn over) UP to the state in which the last known address of rightful owner is located. If that state is unknown, then the UP must be escheated to the state in which the holder was incorporated or organized.
Each state, as well as the District of Columbia, Puerto Rico and the Virgin Islands, has its own escheatment procedures, including the length of the periods with respect to which specific types of UP must be abandoned to be subject to escheat. Consequently, great care must be taken by holder companies in establishing UP compliance programs to avoid the costly penalties and interest that some states apply for late remissions.
States use a variety of methods to carry out their UP audits. One method that is becoming more common is the use of third-party UP “bounty hunting” firms, whereby the auditing firm’s fee is a percentage of the unclaimed property liability it identifies for the state. As you can imagine, such an arrangement leads to very aggressive audits by the third-party firms. Often such firms are retained by a number of states to carry out audits of holders on behalf of such states at the same time. Since there is generally not an applicable statute of limitations in play to protect holder companies that have not been regularly reporting UP, audits can extend back for a significant number of years. In many cases, holder companies do not have records available for the complete audit period. Under those circumstances, states like Delaware (where a great many companies are incorporated or organized) will compute an escheatment percentage regarding the years for which records exist and use it to project UP amounts due for those years for which records do not exist. Such projections can be very costly to holder companies.
What Can Be Done
For holders that are not currently in compliance regarding their UP obligations, many states offer UP voluntary disclosure programs. Such programs may be formal or informal in nature. Generally, as long as a holder agrees to escheat all of the UP due to a subject state under a voluntary disclosure program, all penalties will be waived, and in many cases interest will be waived as well. New York State has such a program that, unlike many states, allows holders to enter it even if the state has approached them first as to potential UP obligations.
Ignorance is definitely not bliss when it comes to UP. Do not allow your business to fall victim to a costly UP audit because of a failure to comply with the necessary reporting procedures. Education is the first step in the UP process. Determine what types of UP your company may have and with what states its obligations may lie. Establish UP information gathering processes. Seek assistance where necessary. Help is available. Don’t let the Un-Tax overwhelm you!
If you have any questions with regard to UP, please reach out to the author at firstname.lastname@example.org, or Christian Burgos, Co-Leader of Friedman’s State and Local Tax Practice, at email@example.com