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Unclaimed Property: When Does the Auditing Go Too Far?

Money and lockYou know those gift cards you never got around to using? It’s possible they are now being counted as revenue by the state. Same goes for uncashed payroll checks and other financial instruments that were never claimed or used. States’ interest in unclaimed property as a source of revenue continues to grow. CPAs need to be extremely alert to state abandoned and unclaimed property (AUP) laws (which continue to evolve) and AUP reporting requirements to limit surprises related to an audit.

How does the process work? After the dormancy period expires, holders typically are required to turn over AUP to the state. AUP is property held or owed in the ordinary course of business that the owner has not claimed for a certain period of time and includes:
  • uncashed payroll and vendor checks
  • unapplied accounts receivable credits
  • dormant bank and brokerage accounts
  • unredeemed gift certificates and cards
  • life insurance policies
  • publicly traded securities with lost owners
  • customer refunds and rebates
  • benefit plan payments
  • contents of safe deposit boxes

Many states treat unclaimed AUP as a source of revenue. All states, as well as Puerto Rico, the U.S. Virgin Islands, and Guam, have AUP laws.

Favorable court decision and implications

Historically, Delaware is one state that aggressively audits AUP. Using contract firms to audit companies incorporated in the state, Delaware has estimated AUP liabilities as far back as 30 years. Delaware’s specious theory was that the entire estimate was “no-address property” subject to claim by the holder’s state of incorporation.

In June 2016, a federal district court held in Temple-Inland, Inc. v. Cook et al that Delaware’s method of estimating AUP liabilities violated due process, stating that Delaware “…engaged in a game of ‘gotcha’ that shocks the conscience.” In issuing its decision, the court noted that Delaware waited 22 years to initiate the audit and tried to exploit loopholes in the state’s statute of limitations. The state also failed to notify holders that unclaimed property records should be retained and had no legitimate state interest in retroactively enacting an estimation statute other than raising revenue.

The court’s ruling ostensibly reined in Delaware’s egregious audit methods. That’s the good news. The bad news is the court also concluded that: 1) estimating an AUP liability is permissible; 2) raising revenue is not a prohibited purpose for enacting AUP laws as long as it’s not the only purpose; and 3) apparently, any state can estimate a liability for any holder regardless of the holder’s state of incorporation. As a result, expect to see other states jump on the AUP audit-and-estimate-a-liability train as a way to generate revenue.

The Downside

Running counter to the fact that many businesses underreport AUP are the risks associated with overreporting certain types of property, in particular, appreciated stock, brokerage accounts, certificates of deposits, individual retirement accounts, and health savings accounts. Not surprisingly, states are eager to monetize equity property when it’s received, which stops the clock on future appreciation. Owners have sued – and continue to sue – holders and states for allegedly mishandling the AUP treatment of these types of property.

Adding to the uncertainty is the lack of reporting guidance – statutory or otherwise – for retirement-type accounts. State AUP laws haven’t kept pace with the development of new investment and retirement vehicles, and what little guidance is available often differs from state to state.

Imagine an individual who attempts to withdraw funds from an IRA account only to find that the funds were turned over to the state as AUP 25 years earlier, and, moreover, tax penalties are due because the money was reported before the individual reached retirement age. Failing to follow AUP due diligence procedures can be a costly mistake for holders, especially for property with a growth or appreciation component.

The AUP compliance environment is dynamic, with increasing litigation and constantly changing state laws. The pace of statutory change is expected to increase as states begin to evaluate the provisions of the Revised Uniform Unclaimed Property Act, which was approved by the Uniform Law Commission (National Conference of Commissioners on Uniform State Laws) in July 2016. Staying abreast of developments and understanding the rules – which, of course, vary by state – is critical not only to steer clear of expensive state audits, but also to avoid the potentially high cost of overreporting certain property types.

Chris Hopkins, CPA, is a tax partner with Crowe Horwath LLP based in New York City. He has been at the forefront of unclaimed property as the area has evolved into a significant source of state revenue, and contributes to The Tax Adviser. A significant part of Chris’ practice is devoted to consulting with companies on unclaimed property matters.

Money and lock courtesy of Shutterstock.


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