Unclaimed property: current issues and trends.

• Author: McGahan, Sarah
• Position: Tax issues

Even as the economy is slowly crawling back from its recent downturn, states continue to scramble for dollars. In the face of tight budgets, states increasingly are turning to their abandoned or unclaimed property (AUP) laws to generate revenue. Compliance with AUP reporting requirements has become a critical issue for many businesses in recent years, particularly as states have enforced their laws through far-reaching audits resulting in costly liability assessments. Delaware, the state of incorporation for thousands of U.S. companies, has been particularly aggressive in its pursuit of AUP assessments. To reduce the odds of an unwelcome surprise in the form of a hefty AUP assessment, companies need to stay on top of the latest AUP issues, including court challenges and legislative developments.

What Is AUP?

Unclaimed (or abandoned) property generally is defined as property held or owing in the ordinary course of business that the owner has not claimed for a certain period of time (the dormancy period). AUF' can include uncashed payroll and vendor checks, unapplied accounts receivable credit balances, dormant bank and brokerage accounts, unredeemed gift certificates and gift cards, life insurance policies, publicly traded securities with "lost" owners, customer refunds and rebates, benefit plan payments, and the contents of safe deposit boxes.

The AUP Laws

All 50 states, the District of Columbia, Puerto Rico, the U.S. Virgin Islands, Guam, and a few foreign countries have AUP laws. Under the laws, businesses holding AUP (holders) must turn the property over to the state after the dormancy period expires. States typically hold AUP in a custodial capacity until the rightful owner claims it.

The U.S. Supreme Court has established jurisdictional rules for states' claims to AUP. Under the primary-priority rule, the holder must report AUP to the state of the rightful owner's last known address as reflected in the holder's books and records. If the owner is unknown or the holder lacks the owner's address records (no-address property), the holder must remit the AUP to the state of the holder's legal domicile (state of incorporation) under the second-priority rule. (1) The Court also established that the state of incorporation can claim property held by entities legally domiciled in the state and not subject to custodial taking in the state of the owner's last known address.

Most of the AUP laws--including state AUP laws based on the Uniform Unclaimed Property Act of 1981 or the Uniform Unclaimed Property Act of 1995 (2) --have provisions that generally allow a state to estimate a liability for AUP that the holder failed to report if the holder has not complied with statutory recordkeeping requirements.

AUP vs. Taxation

AUP has its own lexicon that might be unfamiliar to many CPAs. Unique terms include:

* Escheat. To report and remit AUP to the state. Technically, it is the process by which the state takes legal ownership of presumed abandoned property. However, as commonly used, the term refers to a state's custodial taking and holding of AUP.

* Holder. The obligor or party that holds AUP.

* Owner or apparent owner. The party that has a legal claim of ownership to an item of AUP.

* Dormancy period. The period of time that must lapse before an item becomes AUP. The dormancy period varies by state and property type.

* Due diligence. The procedures by which a holder attempts to contact an AUP owner before property is reported to the state. Virtually every state requires due diligence. (3)

* Aggregation limit. A holder can combine and report AUP items under the aggregation limit to the state as a single amount. (Because there is no owner name or other identification, AUP reported on an aggregated basis cannot be returned to the property owner. Although it is "free money" to the state, it obviously defeats the primary purpose of unclaimed property laws, which is to reunite lost property with owners.)

* Reciprocity. An informal agreement under which one state will accept AUP otherwise reportable to another state.

Collecting AUP is not technically taxation--but a tax by any other name is still a tax. AUP essentially gives state governments a politically neutral way of raising revenues from corporations and other holders without using the dreaded "T" word. As with taxes, though, state revenue departments usually enforce the AUP rules, and the funds received eventually are treated as revenue in state budgets (even though the states themselves do not own the collected AUP). In Delaware, in fact, collected AUP goes directly into the general fund and is removed only when an owner makes a claim. But there are some differences between AUP laws and taxation that can make the former the more troublesome to deal with.

The use of contract auditors is one such difference. States typically use their own employees to conduct tax audits, but third-party auditors conduct the majority of AUP audits. These auditors often make no money unless they find AUP, and then they are paid a percentage of revenues the states would not otherwise reap. From the states' perspective, there's little downside in AUP audits. After all, it does not cost them anything if no AUP is found.

Most AUP laws also are not restricted by statutes of limitation. The IRS generally is prohibited from going back more than three years in an audit (in the absence of a material misstatement or fraud), but few states limit the period that an AUP audit can reach back.

Finally, AUP laws are not subject to the equitable apportionment rules that apply to state taxes. Under federal law, state taxes must be fairly apportioned. (4) In other words, a state generally cannot subject a company to taxation out of proportion to the company's activity in the state. Because AUP technically is not a tax, these rules do not apply to AUP assessments. (5) In fact, Delaware will claim 100% of estimated AUP liability for any company incorporated there, regardless of whether the company had any employees, customers, vendors, or property in the state (see example in next section).

AUP as a Revenue Generator

Certain states view AUP as a significant source of revenue. In Delaware, for example, "abandoned...