Unclaimed property audits.

Editor's note: Ms. Boucher chairs the AICPA Tax Division's State and Local Taxation Committee.

If you would like more information about this article, contact Mr. Hall at [phone].

Ten years ago, the hottest area in the state and local arena was sales and use taxes. As tax practitioners began to develop planning opportunities within the then existing laws, states also became more sophisticated. As a result, sales and use tax planning has become a mature and developed area of practice. Today, the laws involving unclaimed property (escheat) have become the new hot area in state and local planning. State unclaimed property laws apply to almost every type of property, whether real or personal, tangible or intangible. While the escheat laws were of concern primarily only to banks, insurance companies and brokerage firms at one time, today industries as diverse as entertainment, health care, retail/distribution, airlines, transportation and oil and gas can come under the scrutiny of states' unclaimed property administrators.

Escheat Laws

Today's escheat laws began as a way for the king to claim ownership of real property whose owner had died without heirs. Under today's typical escheat laws, the state "steps into the shoes" of the true owner and claims the same rights as the true owner, no more and no less. Although the state takes possession of property presumed abandoned on behalf of the owner, should the true owners be located or come forward to make a claim, the state is obligated to return the property to them.

The underlying policy is that, if the true owner cannot be found, unclaimed property should benefit the general public rather than the holder of the property. The states felt that allowing corporations, banks and other business enterprises to hold this property would lead to their undue enrichment at the expense of their customers and creditors.

Unclaimed Property

Dormant bank accounts, uncashed dividend checks, untendered shares and outstanding insurance drafts used to be the only property subject to the escheat laws. Today, gift certificates, payroll checks, electronic gift cards, customer credits and security deposits may also be affected (depending on the state). It was once the standard practice of industry to reverse (i.e., either to expense or income)stale checks, unredeemed gift certificates, customer credit balances, etc. Financial officers, controllers and corporate treasurers now find that these past practices are affecting today's bottom line, as states make demands or assessments for property presumed abandoned that was erroneously taken into income or reversed to expense in earlier periods.

Varying State Laws

Unclaimed property laws were written on a state-by-state basis, with each state having its own interest and the interest of its citizens as primary concerns. However, because each state's interests vary, the state laws often led to competing and conflicting results.

Priority of claims. The Uniform Disposition of Unclaimed Property Act of 1954 (the Act) (with subsequent revisions in 1966, 1981 and 1995) attempted to establish a uniform unclaimed property law and to provide a model statute that states could adopt or incorporate into their existing statutes. However, even with the Act, there was still no single authority to resolve state disputes. The Supreme Court ultimately established a much-needed bright-line test to determine the priority of conflicting state claims of unclaimed property.

In Texas v. New Jersey, 379 US 674 (1964), the Court decided that, as the first rule of priority, the property will be awarded to the state of the last known address of the owner as shown on the holder's books and records. The Court also established a secondary priority rule: When an owner's address is unknown, the state in which the holder is incorporated is entitled to the funds.

Dormancy period. While the Supreme Court established a bright-line test for primary and secondary priority, the states have retained control over the other areas of unclaimed property law; the dormancy period is one such area. The dormancy period is the time that must pass for property to be deemed abandoned. Because each state established its own laws, the period varies depending on the state that has jurisdiction over the property and the type of property in question. The dormancy period begins to run from the time the true owner last exercised control or expressed an interest in the property. If, within the statutorily imposed period, the owner does not reestablish contact or exercise control over the property, the property becomes subject to escheat in the state with jurisdiction over the property. Generally, the shortest dormancy periods involve uncashed vendor and payroll checks (those types of property that would normally be cashed within a few months). The longest dormancy periods involve traveler's checks and money orders (which can be used as cash equivalents in many transactions), with most other types of property falling somewhere in the middle.

Current Environment

As noted, a state does not own the property that escheats to it; it merely holds it until the true owner can be found or comes forward to claim the property. The states feet that they are in a better position than the holder to locate the rightful owners of abandoned property. Before most property is subject to escheat, the holder of the property is required to perform "due diligence' by attempting to locate the true owner using the appropriate methods as provided in the statutes. If they fail, the property is remitted to the states. The states feel that, absent an affirmative duty on the part of the holders to try and locate the true owner and the obligation to turn the property over to the state if they fail, the holders would have little incentive to try and locate the owners on their own. When the state is unsuccessful in reuniting the owner with his property, the property will usually revert to the state's general fund. In an era in which additional tax increases are unpopular and the states are in need of additional funds, tapping into unclaimed property can provide a popular solution for underfunded state governments.

The difficulty in complying with escheat laws today is that there is no consistency. The 53 jurisdictions (50 states, the District of Columbia, Guam and Puerto Rico) all have different unclaimed property laws. Additionally, most corporations are unfamiliar with unclaimed property laws in their own state, not to mention other jurisdictions. It is not uncommon for both large and small companies to overlook unclaimed property issues. Over the last five years, a large number of Fortune 1000 companies have been audit targets for the states. Although these companies' corporate tax departments are generally sophisticated and aware of various state and local tax issues, an unclaimed property audit is still a major challenge; as astute as these tax practitioners may be, outside consultants and attorneys must often be used. While various state and local tax audits typically encompass look-back periods of three to five years, unclaimed property audits can often span 10 to 20 years and yield assessments in the tens of millions of dollars.

Although the various statutes can make understanding and complying with unclaimed property laws a heavy burden, they can also provide practitioners with the tools needed for proactive escheat planning and future compliance. A corporation unfamiliar with the law or caught unprepared will often unwittingly turn over property to a state that is not truly subject to escheat. In many cases, a corporation's actual escheat liability is much smaller than it initially may have calculated or been assessed. This, combined with many states now offering amnesty programs (periods during which the state will waive penalties and interest on unclaimed property reported and paid over to the state) (see S&L Alert, "Amnesty Program Broadens as States Join Unclaimed Property Voluntary Compliance Program" TTA, August 1999, p. 595), makes proactive escheat planning now more important than ever. By reducing an outstanding escheat liability to its proper level and taking advantage of these amnesty program, a corporation can remove a presumed liability from its books and free up cash erroneously earmarked as unclaimed. Additionally proactive escheat planning allows a corporation to use the lack of uniformity in the state escheat statutes to minimize (or even eliminate) some future escheat liabilities by making sure the appropriate structures are in place before furore liabilities even arise.

Advocacy groups have been organized to help the holders of unclaimed property understand and keep current with new developments in unclaimed property laws so that proactive planning and compliance are possible. The Unclaimed Property Holder's Liaison Council (UPHLC) was formed to foster the interests and education of corporate holders. UPHLC keeps track of developments in state unclaimed property laws and advocates the unclaimed property holders' positions with state unclaimed property administrators.

Additionally, the Committee On State Taxation, a trade association that represents the interests of multistate taxpayers, has also begun to focus on unclaimed property issues, most specifically on the states' use of contract auditors to perform unclaimed property audits.

Future Directions

While no one can ever truly predict the future path of legislation, certain trends have emerged. Probably the most noticeable is the advent of aggressive lobbying efforts protecting the interests of specific industries. While lobbying efforts have a long history of influencing tax legislation, their appearance in the unclaimed property area is relatively new. As a result, many large corporations have been able to lobby state legislatures to obtain favorable treatment for specific types of property. Under one successful lobbying effort, Florida now exempts unused theme park admissions from escheat. While this would seem to benefit everyone from the major parks to local carnivals, "theme park" is defined such that only parks with vast numbers of visitors a year and that encompass enormous and contiguous acreage are eligible for the exemption.

Another example involves a fast food chain that was successful in having gift certificates in the amounts of $5.00 and under exempt from escheat in Delaware (the company's state of incorporation). The chain only issues gift certificates under $5.00, and the names and addresses of purchasers are never recorded. In general, successful lobbying efforts are usually not quite so narrow and specific. Retailers in the past decade have successfully lobbied many states to either completely exempt gift certificates from escheat or create thresholds under which a certificate below a set dollar value is exempt.

The Internet also provides challenges; existing laws may not cover the evolving technology. In the area of escheat, most states just fall back on their "catch-all" provisions, which provide that any tangible or intangible property not specifically enumerated elsewhere in the statute escheats to the state in a set period. While these may have worked well in the past to cover property that otherwise would have been outside the unclaimed property statutes, holders and practitioners are becoming more sophisticated. Soon it will become necessary for states to adopt laws that address and respond to the new issues. As companies expand into new markets and develop new types of property via the Internet and e-commerce, the role lobbyists play in influencing the drafting of new statutes will continue to grow in importance.

Co-Editors: Karen J. Boucher, CPA Arthur Andersen LLP Milwaukee, WI

Noel E. Hall, Jr., CPA Matthew B. Chenowth, J.D., LL.M. Arthur Andersen LLP Los Angeles, CA