States bite into broken gift cards: understanding the impact of state escheat laws.
* Escheatment of gift cards creates challenges for both businesses and regulators. Reporting and compliance requirements can be consequential and can place businesses at risk because requirements are not uniform across states and some potential conflicts remain untested, and thus, unresolved.
* The first step in compliance to escheat laws is to identify which among the 50 state (and District of Columbia and Virgin Islands) escheat laws apply. For businesses operating in multiple states, the precedent for determining which state has priority in receiving unclaimed property is established in the rules set forth by the U.S. Supreme Court in State of Texas v. State of New Jersey (1965).
* Companies are required to file an annual report stating the amount to be escheated to the applicable state(s). Required reports can be obtained on the NAUPA Web site (www.unclaimed.org).
* Many state laws exempt businesses from conducting "due diligence" with respect to gift cards and other abandoned property below certain amounts. But in response to pressure from state attorneys general, some national retailers have changed their policies about replacing lost or stolen gift cards.
* In some states, such as Washington and California, businesses have successfully negotiated to be relieved from the obligation of reporting gift cards and gift certificates to the state as unclaimed property. In return, the states forbid businesses from charging service fees, dormancy fees or enforcing expiration dates on gift cards.
* Recently, a few gift card issuers have begun to manage breakage by encouraging customers to register their gift cards on the company's Web site. In return for registering the gift card, the issuing company promises to replace lost, stolen or destroyed cards, track card balances and provide card verification in the event that customers experience any complications arising from their card transactions.
At the peak of the 2008 holiday shopping season, gift card sales are expected to again have a material impact on the financial reports of many retailers. Gift card "breakage," or the portion of gift card balances that consumers fail to redeem for merchandise, can boost a retailer's short-term cash flows. In the long term, gift card breakage can enhance the bottom line of the retailer--or state treasuries--depending on how the retailer's gift card program is structured and the escheat laws of the states in which it operates. Escheatment of gift cards creates challenges for both businesses and regulators. Reporting and compliance requirements can be consequential and can place businesses at risk. Stephen Larson, Iowa deputy treasurer and president of the National Association of Unclaimed Property Administrators (NAUPA), warns that there is "a tremendous amount of misinformation out there." As a result, he says, "many [businesses] fail to adequately understand the reporting obligations that they have under various state provisions." That's because requirements are not uniform across states and some potential conflicts remain untested, and thus unresolved. Based upon extrapolations of available information, Larson believes that his state, Iowa, could easily be due as much as 10 times the amount that it actually collects. Estimates such as these, he says, are driving states to "take a fresh look at how to provide clarity to firms with regard to how they can comply with applicable state laws."
The stated purpose of escheat laws is to unite lost or abandoned property with its rightful owner. But when it comes to unclaimed gift cards, the money paid for the card is seldom united with the gift card owner, given that owner information is rarely recorded, ownership is easily transferable, and it is highly unlikely that a gift card owner who fails to redeem his or her card will, in turn, take the necessary steps to trace funds to a given state and initiate a claim for reimbursement. Instead, most escheated gift card money reverts to the state's general fund.
According to an NAUPA survey in 2006, states controlled roughly $33 billion of various unclaimed property, managed more than 117 million accounts, and returned more than $1.7 billion in property But obtaining accurate figures on how much of these amounts are attributable to gift card escheatment is difficult because reporting requirements in most states lump unclaimed gift cards with other categories of abandoned property, such as dividends, payroll checks and utility refunds. However, interviews with the directors of unclaimed property of several states suggest that the amounts escheated from gift cards are substantial. Moreover, while states seemingly are forever adjusting escheat laws, businesses are also adjusting their practices in response to those laws. As a result, companies often find themselves contending with multiple states over the same dollars.
IDENTIFYING WHICH STATE LAWS APPLY
According to Larson, the first, and perhaps most critical, step in compliance with escheat laws is to identify which among the 50 state (and District of Columbia and Virgin Islands) escheat laws apply to a given business. For businesses operating in multiple states, the precedent for determining which state has priority in receiving unclaimed property is established in the rules set forth by the U.S. Supreme Court in State of Texas v. State of New Jersey (1965).
In summary, if the holder of unclaimed property can determine the state of the property owner's residence using registration address data, then the holder escheats the property to that state (see Exhibit 1). (With respect to gift cards, the "holder" would be the business obligated to redeem the gift card). In such cases in which this information is unavailable, the holder would escheat the property to the state of the holder's domicile. Notice that the state of the holder's domicile is considered to be the place of incorporation, and not the state of its principal place of business.
Although the above consideration summarizes the general precedent to follow, actual applications may vary. For example, if the state that has priority (the state of the owner's residence) exempts businesses from escheating gift cards, then the state of the business's incorporation has a basis for stepping in as a surrogate to safeguard the owner's assets. Further, the state in which a gift card purchase occurred may lay similar escheat claims in instances where neither of the previously mentioned states have made a claim. Larson warns that "states may push the envelope if the recordkeeping systems are not quite to par, or if the business implies that the laws of that state are not germane to the state's regulatory oversight authority Consequently, businesses should focus on staying in compliance with those laws that are the most germane."
SUMMARIZING STATE ESCHEAT LAWS
Exhibit 2 presents a general summary classification of state escheat laws. Of the 20 jurisdictions classified here, 14 escheat at the rate of the card value, and six escheat at 60% value. The 60% policy is intended to allow businesses to earn a reasonable profit, as though the card had been redeemed, while maintaining the state's mission of preserving unclaimed assets. The dormancy period represents the period of time a gift card can go unused until it escheats to the state. Dormancy periods range from an aggressive two years (Maine) to five years.
Exhibit 3 presents a summary classification of jurisdictions that generally do not escheat. These classifications represent only a general, quick-reference guide because many states make exceptions that create what are, in essence, hybrid laws. Therefore, in determining if and how much to file, businesses must review the many stipulations within each law Some of the more notable, but not all, exceptions are provided in the table. Three of the more common exceptions arise as follows:
Fees and expiration dates. Although it is becoming less popular to do so, many businesses place expiration dates on their cards or charge fees. Both practices, in effect, erase unused balances in time. Not surprisingly, expiration dates and fees have been a source of conflict and the target of several state legislative initiatives to require clear disclosure of such practices, place limitations upon such practices, or outright ban them. States may also amend escheat laws to exempt cards provided that they do not expire and/or enforce a fee. These states are included in Exhibit 3. Note Idaho as an exception--the state only exempts cards that have clearly defined expiration dates.
Definition of a gift card/certificate. Several states exempt only specifically defined cards, such as those used by a single or affiliated group of merchants, or exclude certain general usage type cards, such as preloaded bank or generic phone cards. For example, in Colorado gift certificates that are redeemable for cash escheat to the state, whereas those that are redeemable for tangible goods or services do not. Thus, compliance with escheat laws requires careful attention to the definition given by the state for a gift card.
Amendments to state laws. As legislatures actively amend escheat laws in an attempt to make the law more consumer-friendly, or in reaction to certain business practices, they, in essence, create hybrid systems that exempt cards before, or after, the date that the amendment goes into effect. Exhibit 2 gives the current law as the general case, but businesses must be aware of any previous provisions on the books that still cover older cards.
Each year, companies are required to file a report stating the amount to be escheated to the applicable state(s). Required reports can be obtained online. NAUPA provides a common link to access each state's Web site. A company operating in multiple states is not required to file with every state, although a few states require reports, even when money is not being escheated to that state. Reporting requirements and procedures vary by state, so the filer must pay careful attention to the details in the report and the laws of a given state. As previously mentioned, receipts from unclaimed gift cards are lumped together with other property, but some states, such as Iowa, are moving toward separate reporting.
Once funds from unclaimed gift cards are escheated to the state, they generally remain with the state indefinitely However, current technology allows businesses to track balances and usage by each individual card (account). If a customer redeems a card whose balance has previously been escheated to the state, the business has a means of tracking that information, and thus has a legitimate basis for reclaiming those funds from the state. For simplicity, reclaimed funds are generally netted out of the amount due with the ensuing filing.
ISSUERS AGREE TO HONOR LOST AND STOLEN GIFT CARDS
Many state laws contain provisions that exempt businesses from conducting "due diligence" with respect to gift cards and other abandoned property below certain amounts (due diligence would require the business to make efforts to locate the owner). However, a recent event highlights that businesses are expected to assume a certain degree of responsibility over gift cards that they sell, even in instances in which the customer does not physically possess the card.
In 2002, the New York Attorney General's Office conducted an investigation against The Home Depot when the retailer refused to honor a customer's misplaced gift card. In response to the investigation, Home Depot agreed to revise its corporate policy to "reissue gift cards for those customers who can provide reasonable evidence" that they purchased a card that was later lost or stolen. Evidence can be a receipt, canceled check, or even a transaction register from the customer's credit card company.
In summary, this event offers one more indication that, in the public's mind, what the business is selling is the obligation to provide a good or service, rather than just the card itself, and that businesses bear a responsibility to view prepaid funds as belonging to the card owners, and not to the holders.
Needless to say, confusion from nonuniform reporting obligations, costs of compliance and the amount of money at stake all combine to motivate firms to devise ways to attempt to mitigate the effects of escheat laws. One approach that businesses have adopted is to lobby states to relax laws. In some states, such as Washington and California, businesses have successfully negotiated to be relieved from the obligation of reporting gift cards and gift certificates to the state as unclaimed property In return, legislators require businesses to relinquish their ability to charge service fees, dormancy fees or enforce any expiration dates on gift cards. Such negotiated outcomes have generally been hailed as an example of business and government working together to reach workable solutions for the benefit of the consumer.
Another approach that businesses have adopted is to alter the business's structure so as to also alter who the holder of the unclaimed gift card is and, consequently, the applicable state agency. The general approach is to establish a separate limited liability corporation in a state in which the escheat laws concerning gift cards exist, but are less aggressive. (Recall that if a state does not escheat gift cards, another state can step in and claim escheatment of the property.)
The LLC would primarily exist to manage the gift card program. Diane Green-Kelly, a partner in the Chicago office of Reed Smith, advises clients in escheatment, franchise and antitrust matters. She cautioned that while such a strategy can be advisable, any such arrangement must serve business purposes. In other words, she specifically notes that the subsidiary must have its own management, capital, financial transactions, accounting, fully dedicated board of directors and anything else necessary to create adequate "separation" and "avoid being treated as a sham."
REGISTERING GIFT CARDS ONLINE
Recently, a few gift card issuers, such as Crate & Barrel and Buca di Beppo, have started programs that encourage customers to register their gift cards on the company's Web site. In return for registering the gift card, the issuing company promises to replace lost, stolen or destroyed cards, track card balances and provide card verification in the event that customers experience any complications arising from their card transactions.
Starbucks even offers incentives such as personalized designer cards, free drinks, refills and drink options and the free use of in-store Wi-Fi service. Customers can also sign up to have cards automatically reload when their balance drops below a specified amount.
Paula Borhauer, who manages the escheat reporting requirements for Starbucks, believes that such initiatives offer several advantages, including the potential to reduce breakage. "From my perspective, I would rather have owners be able to use their card balances," says Borhauer. "Registration offers a way for them to do that, even when cards are misplaced."
However, the owner information provided from registration also likely introduces additional complications to determining escheat obligations. For example, having possession of owner information could imply that the issuing company should establish a basis for escheating to the state of the owner's residence, rather than the company's state of incorporation, since, as previously noted, priority over abandoned property goes to the state in which the owner claims residence.
On the other hand, given the transferability of gift cards (the person who registered the gift card may not necessarily be the current owner), the issuer's state of incorporation could also lay claim to such funds on the basis that the company has no method of proving that the registered individual is, in fact, the current owner. Moreover, Borhauer notes that this issue is further complicated by the fact that some states either don't want or don't accept owner detail because most balances fall under aggregate limits.
Another consideration involves the feature that allows customers to reload balances. State laws generally view the escheat period as stemming from the date that the customer initially purchased the card. However, reloading makes a determination of when a card has been abandoned, and therefore due to be escheated to the state, a lot less straightforward. To date, these issues have yet to be tested, and therefore, remain unresolved. Borhauer admits that issues such as these may make reporting even more challenging "considering the volume of card activity and the many considerations that feed into the escheat requirements."
The continued growth in the sale of gift cards has made breakage no longer just a byproduct of gift cards, but a potentially material contributor to profit in its own right. Funds from unredeemed cards are at the center of a legal tug of war between states, which have historically taken control of unclaimed assets, and businesses, which face ambiguous reporting and are reluctant to forgo the cash from their gift card transactions. Maybe the fundamental question for society to answer is, "Who better holds the interests of the consumer with regard to prepaid, but unclaimed, gift card balances?" Previous court decisions have viewed the state as custodian of the consumer's general welfare. However, some recent events and trends indicate that businesses also face incentives to devise methods for assuming control over the consumer's interest when the right to receive goods or services goes unclaimed.
* "Accounting for Gift Cards," Nov. 07, page 38
* "Unclaimed Property," Feb. 04, page 49
"Prepaid Cards and State Unclaimed Property Laws," by Phillip Bohl, Kathryn Bergstrom and Kevin Moran, Franchise Law Journal, Summer 200?
State of Texas v. State of New Jersey, 379 U.S. 674 (1965)
Unclaimed Property: A Reporting Process and Audit Survival Guide, by Tracey L. Reid, John Wiley & Sons, 2008
National Conference of State Legislatures, www.ncsl.org/programs/banking/ GiftCardsandCerts.htm
Charles Owen Kile Jr., Ph.D., is an assistant professor of accounting, and Patricia S. Wall, .I.D., CPA, MBA, Ed.D, is an assistant professor of business law, both at Middle Tennessee State University. Their e-mail addresses are, respectively, firstname.lastname@example.org and email@example.com.
Exhibit 1 A Typical Gift Card Transaction A B C State State where Holder's state purchase occurred owner resides of domicile A customer purchases Customer gives gift The holder's a gift card. card to a recipient, domicile is which results in a considered to transfer of be the state of ownership. Recipient incorporation. The is now the owner. holder may not be the same business that sold the card.
* If the owner has registered the card, the registration information may provide a basis for escheating any remaining unclaimed balance to the state of the owner's residence (State B).
* If no owner information exists or if owner information is challenged, then the holder's state of incorporation (State C) may have a basis for escheating unclaimed balances.
* Alternatively, if the state of the owner's residence (State B) does not escheat unused gift card balances, then the holder's state of incorporation (State C) may have a basis for escheating unclaimed balances.
* If neither State B nor State C escheats unused gift card balances, then State A may have a basis for escheating any unclaimed balances.
Exhibit 2 Jurisdictions That Generally Include Gift Cards in Escheat Laws Jurisdiction Escheat Rate Escheats After Alaska 100% 3 years Delaware * 100% 5 years District of Columbia 100% 5 years Georgia 100% 5 years Hawaii 100% 5 years Idaho ** 100% 5 years Iowa 100% 3 years Louisiana 100% 3 years Main 60% 2 years Michigan 100% 5 years Mississippi 100% 5 years Missouri 60% 5 years Montana 60% 3 years Nevada 60% 3 years New Mexico 60% 3 years New York 100% 5 years South Dakota 100% 5 years Texas 100% 3 years Virgin Islands 100% 5 years West Virginia 60% 3 years * Delaware exempts cards with values less than $5 and holders with aggregate values under $5,000. ** Idaho exempts cards with expiration dates that are clearly displayed and communicated. Exhibit 3 States That Generally Exempt Gift Cards From Escheat Laws Jurisdiction Special Conditions Alabama if for tangible merchandise Arizona if after 2005 Arkansas if not for general usage California if no fees or expiration and after 1997 Colorado if for tangible merchandise Connecticut if not a prepaid phone card Florida Illinois if no fees or expiration and after 2004 Indiana Kansas if not for general usage Kentucky Maryland Massachusetts if no expiration Minnesota if not for general usage Nebraska if no fees or expiration New Hampshire if less than $100; otherwise 100% after five years New Jersey North Carolina if no expiration and not for general use North Dakota if not for general usage Ohio Oklahoma if not for general usage Oregon if not for general usage Pennsylvania if no expiration and not for general use Rhode Island South Carolina Tennessee if no fees or expiration, after 1998 and not for general usage Utah if less than $25; otherwise 100% after five years Vermont Virginia if for tangible merchandise Washington Wisconsin Wyoming if less than$100 otherwise 60% after three years
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|Author:||Kile, Charles Owen, Jr.; Wall, Patricia S.|
|Publication:||Journal of Accountancy|
|Date:||Dec 1, 2008|
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