Eschew escheat: unclaimed property--or the "hidden tax"--is an old topic with a renewed interest.

Though escheat, also known as abandoned/unclaimed property (AUP) or sometimes the "hidden tax," has been around since this country's inception, many practitioners and business executives have never heard of this oft-considered contentious state law.

Escheat is a process wherein the state takes possessory interest in an owner or apparent owner's property and holds the property into perpetuity on behalf of the owner or apparent owner until it is claimed by the owner or the owner's heirs. In essence, the state is only a custodian on behalf of the rightful owner and generally takes no ownership interest in the property.

For example, the escheat process from a Holder's perspective can be either annual compliance (for Holders that have previously filed and continue to file annually); a Voluntary Disclosure Agreement (VDA) or a Voluntary Remittance Letter (VRL), depending on the jurisdiction (whereby a Holder has never filed in the past and wants to be in compliance); or a formal audit initiated by a jurisdiction.

If a Holder's records go back seven years and the terms of the VDA, VRL or audit period is 20 years, the calculated amount of property for the difference of 13 years will arguably be "revenue" to the Holder's state of incorporation, as there is no Owner-specific identification for that property.

"Holders" are legal entities or individuals who hold property in their possession for another party and "Owners" are the parties with an ownership right in the property in question.

For example, a Holder would be XYZ Inc., a company incorporated in California, and an Owner, for abandoned payroll property, would be Jane Smith, a current or former employee of XYZ Inc.

MEET THE ISSUE

AUP has become a windfall for many jurisdictions and a nightmare for CEOs and CFOs.

With the passage of Sarbanes-Oxley, an increase in the sensitivity of all aspects of corporate reporting and governance has forced companies to meet head-on the many years of non-compliance in the escheat area. Many public companies and SEC registrants are faced with the challenge of having to identify and, in some cases, quantify decades of non-reporting of AUP.

The issue of noncompliance is continuing to surface through the external auditor's identification of this area as a material internal control weakness, which fails to adequately address a company's procedures for identifying, capturing and reporting AUP. The external auditors are uncovering these weaknesses while performing a financial statement audit or through a SOX 404 engagement. Moreover, the Holder's external auditors are precluded from assisting the Holder in an AUP advocacy role (which may include providing such services as exposure quantification, remediation and representation) due to SOX prohibition.

The weaknesses identified are considered material because of the Holder's potential liability from previous noncompliance and are identified in an auditor's or SOX 404 team's checklist.

DEALING WITH WEAKNESSES

Once weaknesses are identified and disclosed to management, the company can no longer ignore the problem. Prior to SOX, many companies preferred to play the audit lottery game, but they can no longer afford to take this wait and see approach.

Assessments in AUP examinations are reaching staggering amounts and may include interest and penalties that can exceed the value of the property assessed in the examination.

For example, let's assume Holder is incorporated in California and has never reported AUP in the past 10 years. Holder engages an advocate to identify, calculate and mitigate their exposure liability, which in this example amounts to $1 million. As seen in Figure 1, the total amount actually owed to California in abandoned property, interest and penalties is in excess of $1.8 million.

[ILLUSTRATION OMITTED]

NO STATUTE OF LIMITATIONS

CPAs are generally familiar with statute of limitation provisions, which preclude a taxing jurisdiction--be it state, local or federal governments--from auditing back beyond a certain period of time, such as three to five years, providing the taxpayer did not participate in any malfeasance or fraudulent activities relative to the reporting of their tax liability.

But the rules are different in the area of AUP. There is generally no statute of limitations defense for a Holder that has never filed and reported AUP.

Many Holders mistakenly believe that filing a report with the jurisdiction starts the clock for statute of limitation purposes. While there are statutes of limitation defenses that can be raised in an AUP examination, they are only to the extent the Holder has properly filed and reported all categories of AUP in their possession.

For example, if a Holder has only been reporting payroll for the last 15 years, the statute could potentially toll on this property type depending on the particular jurisdiction's rules governing the "look-back period" under an examination.

However, assuming other categories of AUP exist, such as unused customer credits or uncashed accounts payable disbursements that had not been previously reported, the statute of limitations would not toll and the jurisdiction could reach back under examination for an extended period of time for both customer credits and uncashed accounts payable disbursements.

The typical look-back period for non-filers in many jurisdictions is 1981.

There are a number of jurisdictions that are the least interested in whether the Holder has records covering the extended look-back period under an examination. A Hoder's failure to have detailed records back to 1981 (as most Holders don't have due to internal record retention policies or established policies by a government entity, such as the IRS) will bode well for the Holder's jurisdiction of incorporation.

CASE LAW

In 1965, 1972 and most recently 1992, the U.S. Supreme Court heard three cases related to AUP. The cases dealt with the issue of competing claims by several jurisdictions for AUP in the possession of a Holder--and which jurisdiction had a superior right to take custody of the property from the Holder.

In Texas v. New Jersey [379 U.S. 674, (1965)], the court ruled that for a jurisdiction to take custody of AUP in the possession of a Holder, the jurisdiction must establish that the last known address of the owner of the property, as reflected on the Holder's books and records, is within the respective jurisdiction's boundaries. This is known as the First Rule of Escheat.

In a situation where the Holder's books and records do not reflect the name and last known address of the owner, or the jurisdiction does not provide for the escheatment of the particular property type (in the case where the owner's information is available), the court concluded that the property must be relinquished to the Holder's jurisdiction of incorporation.

Collectively, these last two provisions are referred to as the Second Rule of Escheat.

In the subsequent two cases, Pennsylvania v. New York [407 U.S. 206 (1972)], and Delaware v. New York [507 U.S. 490, 507, (1993)], the Supreme Court reaffirmed its earlier rulings in Texas v. New Jersey. For all intents and purposes, there are only two rules governing the right of a jurisdiction to take custody of AUP in the possession of a Holder.

REPORTING POLICIES DIFFER

It is essential for CPAs and Holders to know that there are 53 reporting jurisdictions (the 50 states, plus the District of Columbia, Puerto Rico and the U.S. Virgin Islands)--and they all have their own distinct rules and reporting requirements.

Most frustrating of these rules to Holders is the dormancy period, the time in which a particular property must be continuously outstanding without any contact between the Owner and Holder, before a Holder is required to report and relinquish custody of the property to the jurisdiction.

Depending on the property type in question, the dormancy periods can be as short as one year (generally payroll) to as long as 15 years (in the case of traveler's checks).

Some of the more typical property types falling under the definition of AUP include, but are not limited to, uncashed payroll checks, vendor payments, rebate checks and unredeemed gift certificates.

Furthermore, every industry has certain property types specific to it, which a state auditor will identify and schedule out as a potential liability during an examination.

Jurisdictions are becoming increasingly aggressive in identifying Holders for examination. The use of third-party audit firms, commonly referred to as "bounty hunters," is on the rise.

These bounty hunters work on a contingent fee (usually 12 percent of the value of property identified and turned over, and may include interest and penalties) and it's common for these bounty hunters to represent in upwards of 20 to 30 jurisdictions at once in the same examination.

CPAs and Holders need to be proactive where the prior reporting history has been inconsistent or absent. Internally identifying and quantifying the exposure and settling the matter with the jurisdictions directly yields a far better result than the alternative--a long examination, which can often become contentious and, at times, lead to litigation as a result of the amounts assessed.

Holders should proceed cautiously in dealing directly with examiners. There are numerous situations where a Holder's rights have been compromised during an examination because the Holder or their representative did not fully understand the scope of the examination or rules of engagement.

When facing an impending examination, use common sense and obtain qualified representation in the form of an AUP specialist from the start the examination.

CONCLUSION

As a best practice, Holders should not wait to receive an examination notice, but proactively assess their exposure and settle the matters directly with the jurisdictions.

Depending on circumstances, the cost to defend a Holder in an AUP examination can be millions of dollars both in professional fees and calculated liability. The cost to retain competent AUP specialists to resolve a Holder's past liability through a self-examination, such as a VDA or VRL with multiple jurisdictions, is a fraction of the audit defense cost and generally yields more favorable terms, including a reduced look-back period mitigating the amount due.

Noel E. Hall Jr., CPA, is the managing director and national AUP practice leader at Los Angeles-based True Partners Consulting LLC. You can reach him at [e-mail].

John Samore III, CPA, CFE, MBA, is a manager at True Partners Consulting LLC and vice president of CalCPA's Los Angeles Chapter. You can reach him at [e-mail].

BY NOEL E. HALL JR., CPA AND JOHN SAMORE III, CPA

Figure 1 Example Unclaimed Property Examination

                            Amount of Unclaimed  Interest @
       Amount of Unclaimed  Property Identified  12% Per
Year   Property Identified  (Cumulative)         Annum (1)   Penalties

1990     100,000              100,000             12,000      10,000
1991      50,000              150,000             18,000      10,000
1992      75,000              225,000             27,000      10,000
1993     225,000              450,000             54,000      10,000
1994     125,000              575,000             69,000      10,000
1995     150,000              725,000             87,000      10,000
1996     125,000              850,000            102,000      10,000
1997      75,000              925,000            111,000      10,000
1998      50,000              975,000            117,000      10,000
1999      25,000            1,000,000            120,000      10,000
Total  1,000,000                                 717,000     100,000

(1) Interest is calculated on the total cumulative unclaimed property
identified and not reported.