Why Unclaimed Property Risk Management Is on the Menu in 2022: For certain states, unclaimed property represents a significant revenue source.

• Author: Houghton, Kendall L.

Every state has adopted an unclaimed property (or escheat) law, which generally provides that a holder of unclaimed property must escheat the property to the state after it has remained unclaimed by its owner for a certain period (usually three or five years). The unclaimed property is the legal obligation or debt that is owed to the owner of the property, and the holder is the party that is obligated to pay or deliver the property to the owner. Common examples of unclaimed property include uncashed vendor and payroll checks, failed ACH or direct deposits, dormant bank and shareholder or investment accounts, unredeemed prepaid cards, aged customer credit balances, and, more recently, virtual currency.

Companies do not need physical presence in or material revenue sourced to a given state to be subject to its unclaimed property laws. Because the property owner's state has first claim to the property (rather than the state where it was found or where the holder is based), (1) a company could have annual reporting and remittance obligations in up to fifty states, the District of Columbia, and US territories.

The importance of knowing and understanding unclaimed property laws has grown in recent years, because unclaimed property is now a significant revenue source for certain states, even though unclaimed property is not a tax. (2) The New York Times recently estimated that state government agencies have tens of billions of dollars' worth of unclaimed property. (3) It is the fifth-largest general fund revenue source for California (4) and was Delaware's third-largest source of revenue during the 2019 fiscal year. (5) As a result, states now actively enforce these laws to capture unclaimed property in audits, voluntary disclosure programs, and litigation or through legislation (for example, through shortened dormancy periods, enumeration of "new" property types, etc.).

As a panel discussed during the recent TEI Annual Conference, (6) tax personnel are often called upon to advise the C-suite on unclaimed property risk management and to defend audits. Among other things, the correct application of unclaimed property laws is critical to maintaining accurate balance sheets. For example, financial statements and company reserves can be materially impacted if a company incorrectly determines that certain assets are (or are not) unclaimed property. The overreporting of property that is exempted by certain unclaimed property statutes (for example, property that is outside the statute of limitations, property exchanged between two businesses, de minimis property, and so forth) can depress a company's annual profits. By the same token, the underreporting of unclaimed property can have potentially adverse implications beyond the liabilities assessed--for example, in a worst-case scenario, a company might be required to re-report earnings. Inaccurate unclaimed property records may also affect mergers and acquisitions. In a stock deal, the purchaser of a company assumes any preexisting successor liability, including unreported unclaimed property in the target's possession or on its books, so it is critical that these records are correct and clearly maintained. But unclaimed property statutes are notoriously tricky and may not always clarify whether a company's business model produces, or its accounting practices memorialize, unclaimed property.

Tax executives should familiarize themselves with these statutes and understand their nuances to maintain the accuracy of balance sheets. Millions of dollars may quite literally depend on the tax executive's understanding of unclaimed property compliance regimes and the tailoring of the company's reporting practices and positions. Holder companies, and their tax executives, should also proactively monitor proposed and enacted changes in state unclaimed property laws as well as administrative guidance to ensure operational resilience in meeting compliance obligations, including pandemic and remote-working disruptions such as changing filing deadlines. (7)

Compliance Continuum Audits: VDAs, Private Enforcement

So, what happens if your company receives an audit notice--which could pertain to a single state or, more frequently, to multiple states that jointly employ a contract audit firm? Or state "self-audit" directives? Or "invitations" to voluntarily disclose liability? Or questionnaires and reminders to file reports? Or all of the above?

Audits. Every state today employs audits as a principal enforcement tool, and most states have contracts with numerous third-party audit firms. Although a handful of states have published formal audit manuals or guidelines, most provide scant guidance to companies on how a compliance examination will be conducted and what standards pertain. What's more, unclaimed property administrators are not often directly accessible if a holder has questions or concerns with the audit process or with the theories of liability propounded by a contract auditor.

Compounding the risk associated with audits is the fact that most audit firms treat companies differently if they have retained advocates to represent themselves during an exam. The tax executive's staff will likely be assigned audit management tasks. Ensuring that your company's CEO, CFO, and controller know the enforcement landscape and that a voluntary disclosure agreement (VDA) program "invitation," if not responded to promptly, may initiate an audit is critical to securing the opportunity to control the process and, to some degree at least, the outcomes of one or more states' outreach. The impacts of noncompliance with state unclaimed...