Missing Something The Other Side of Unclaimed Property

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					Missing Something? The Other Side of Unclaimed Property
Diann L. Smith and Marlys A. Bergstrom




     Diann L. Smith              Marlys A. Bergstrom




Escheat: Most of us did not learn this word in law school, but it is the historic concept that has evolved into modern
unclaimed property law. Unfortunately, unclaimed property laws are as unfamiliar to businesses as the word
“escheat” is to most lawyers. Such unfamiliarity can result in significant and unexpected financial liabilities.

State unclaimed property laws are largely concerned with intangible property such as uncashed payroll and vendor
checks, unredeemed gift cards, uncashed dividend checks, and accounts receivable credit balances. Unclaimed
property is property, held or owed by a business to someone else, for which the actual owner has not, during a
certain period specified by law, taken some action that indicates an awareness of an ownership interest in the
property. When this “abandonment” occurs, it becomes the obligation of the party holding the property to report
and pay over such property to the state. The rationale behind unclaimed property laws is that the state can best
protect the interest of the owner. The state becomes the custodian of the property and steps into the shoes of the
owner.

Application of the Unclaimed Property Laws

In 1965, the United States Supreme Court set out the following rules for determining which state is entitled to take
custody of property when the owner could not be located: (1) where the last known address of the creditor (i.e.,
owner of the intangible personal property) is known, the state in which that address is located has the right to escheat
(“primary rule”); and (2) where the last known address of the owner is unknown, or in a state that “does not provide
for escheat of the property owned,” the state in which the debtor is incorporated is awarded the right to escheat
subject to the “superior” right of the creditor’s home state should that state submit proof of the owner’s address (the
secondary rule).

Unclaimed Property Laws as a State Revenue Raiser

While unclaimed property statutes have been a part of state law for decades, use of the laws for the benefit of state
coffers is of more recent vintage. Most of the funds collected by states as unclaimed property will never be claimed
by an owner, so the funds remain available for the states’ use. During the last decade, states began to rely on
unclaimed property remittances as a magic bullet for escalating budget deficits. To increase the flow of funds from
unclaimed property, states are enacting material legislative changes to the laws and increasing enforcement of the
existing laws.

Legislative Changes

Originally, dormancy periods—the time during which the owner’s inactivity results in the property being deemed
abandoned—were commonly as long as 15 years. However, within the last five years almost all states have reduced
the dormancy period for uncashed payroll checks to one year and for all other property types to three years. The
immediate financial benefit to a state of shortening the dormancy period is significant. For example, Illinois
recently shortened the dormancy period for uncashed payroll checks from five years to one year. As a result, Illinois
will receive the dollar value of an additional four years of uncashed payroll checks for the current budget period.
Another legislative tactic states employ is to repeal existing exemptions for certain property types or identify
additional property types as subject to remittance as unclaimed property. For example, Nevada has pending
legislation that would require casinos to remit uncashed payments from a cashless wagering system. In other words,
those slips of paper that are printed out of slot machines will now be reportable as unclaimed property after one year
of inactivity.

Increased Enforcement: The Unclaimed Property Audit

The states also employ aggressive enforcement of the unclaimed property laws to improve their financial situation
by increasing the scope and number of unclaimed property audits. Unclaimed property laws do not represent a tax;
the laws protect existing property rights, something the people of the United States hold in deep reverence.
Therefore, enforcement of unclaimed property laws is quite different from enforcement of tax statutes.

The most significant difference is the lack of a statute of limitations. As a result, an unclaimed property audit period
may start from the date the holder was incorporated or the date the state’s unclaimed property statute was enacted.
Generally speaking, most unclaimed property audits cover a period of 10 to 20 years. Another important distinction
between unclaimed property and tax is the procedural remedy available if a company disagrees with an assessment.
For an unclaimed property assessment, the only remedy is in civil court; there is no administrative protest process.

Unclaimed property compliance is typically administered by a state’s department of revenue or treasurer’s office and
most unclaimed property departments are severely understaffed. As a result, third-party contract auditors conduct
most audits on behalf of the states. Third-party auditors typically have contracts with multiple states and are usually
paid on a contingency basis of 10-12 percent of the final liability.

Are You a Target?

Here is a checklist of red flags that increase the chance of being chosen for an unclaimed property audit. If any of
these scenarios apply to your company, it may mean an audit is arriving sooner rather than later:

         (1) A well-known name: A large company with a well-known name or a manufacturer of a common
         household product is on an audit list.

         (2) People come, people go: Companies with a transient work force or a significant number of hourly
         employees are often audit targets because of issues associated with uncashed payroll checks.

         (3) It is so obvious: Are “obvious” property types missing from an unclaimed property report? Based on a
         company’s particular industry, certain property types are expected to be reported. If that property type is
         absent, a state is likely to ask: what else is missing?

         (4) Nothing in this world is free: Before a company makes a claim for property owed to it, consider
         whether the company is (or should be) reporting unclaimed property as a holder to the appropriate state.

         (5) You are being watched: States benchmark unclaimed property reports and audit the results of various
         industries. If a state notes that a company within a specific industry is remitting significantly less than
         other companies in the same industry, an audit is likely.

         (6) Your state of incorporation is (almost) everything: Under the jurisdictional rules of unclaimed
         property, if the last known address of a payee is unknown or incomplete, the property is reportable to the
         holder’s state of incorporation. Since the majority of public companies are incorporated in Delaware,
         well...we think you get the idea.

         (7) If you have nothing to say, say nothing: One of the biggest and most obvious audit triggers is
         underreporting unclaimed property. Based on the size of a company or the industry in which the company
         is involved, it may be obvious that the company should have significantly more unclaimed property than
         what it has reported. Many companies decide they need to “get in compliance” so they just file negative or



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         zero reports with all states. After all, “There is no way people don’t cash their checks!” Taking this
         approach routinely results in an unclaimed property audit.

As state deficits continue to expand, so will states’ creativity in using the unclaimed property laws to generate
revenue. What can companies and counsel do to prepare and mitigate the potential financial impact? The best
defense is a good offense. Have government affairs monitor state unclaimed property legislation, participate in
relevant industry groups, and educate legislators on unclaimed property issues. Ensure that processes and
procedures are in place for properly reporting unclaimed property to the states. If there are periods of
noncompliance, seek experienced unclaimed property counsel to assist with a self-review. Unfortunately, at least
for the foreseeable future, “escheat” is here to stay and should become a familiar concept for all companies and their
counsel.

Diann Smith, an attorney with Sutherland in Washington, D.C., advises clients on the full spectrum of unclaimed
property law matters such as multi-state unclaimed property compliance and voluntary disclosure opportunities.
Formerly General Counsel for the Council On State Taxation, Diann spearheaded the COST Unclaimed Property
Task Force where she was involved in drafting the COST “Model Unclaimed Property Act.” Diann can be reached
at diann.smith@sutherland.com or 202.383.0884.

Marlys Bergstrom, an attorney with Sutherland Asbill & Brennan in Atlanta, has more than 14 years of experience
advising clients on complex unclaimed property policy, compliance, planning, and audit issues. Marlys can be
reached at marlys.bergstrom@sutherland.com or 404.853.8177.




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