How to Build an Unclaimed Property Audit Defense

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Jun 4th 2015
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Unclaimed property is a challenge for organizations that may pose a number of financial and operational risks. But how often does an organization evaluate and remediate unclaimed property liabilities? Probably not often enough. However, in an era marked by state revenue deficits, state and local authorities have turned to unclaimed property audits as a source of capital. Many companies would be wise to proactively mitigate their exposure to costly audits.

Reporting is key to managing a company’s unclaimed property risk. As a requirement, organizations must turn over to the state “intangible property,” such as uncashed checks, credits, gift cards, merchandise credits, and rebates. Organizations have a legal obligation to turn over all qualified property that they hold on behalf of the payee (“apparent owner”) after a prescribed statutory dormancy period has elapsed.

Generally speaking, the unclaimed property needs to be remitted to the last known payee by using the name and address on file with the company. In the event that the information is not available, then the unclaimed property is sourced to the state of incorporation of the corporate holder, or the commercial domicile in the case of unincorporated entities.

In approximately seven states, organizations are required to file annual returns that report unclaimed property during spring filings, with due dates that range between March 1 and July 1. In all other states, corporate holders need to file during Oct. 31 and Nov. 1. Some states also have “negative reporting” compliance requirements, mandating that the corporate holder needs to file $0 returns where the organization owes nothing to the state after a review of its books and records.

Because of the frequent – and perhaps flagrant – lack of compliance with state unclaimed property laws, state authorities have become proactive in carrying out unclaimed property audits, with look-back periods extending as far back as 25-plus years in some states. The result of being found noncompliant carries financial weight. Organizations may find themselves subject to stiff penalties and interest charges.

As part of the increased scrutiny and proactive audit environment, states have stepped up enforcement efforts in recent years. Perhaps not surprisingly, Delaware, for more than a decade, has been strategically focused on unclaimed property compliance violations. However, many other states, including California, New York, Pennsylvania, and Texas, are now auditing as well. As a result of increased activity, there’s been a notable increase in unclaimed property audits and a shift toward more states hiring commission-based, third-party auditing firms to conduct the audits on behalf of the states.

Third-party auditors typically receive compensation on a contingent fee basis – meaning they are heavily incentivized to succeed in finding noncompliant organizations. In some cases, third-party auditors will receive up to as much as 12 percent of the assessment imposed on the company. In other cases, some of them are paid on an hourly basis; the hourly compensation is then deducted against the contingent fee. Corporate-holder lobbyists have and continue to argue that the compensation structure for third-party state auditors has created a conflict of interest and directly contributed to a rise in assessments.

Best Practices to Reduce Risks
While each situation is unique, there are standard best practices that, if implemented, could help reduce the financial and operational risks associated with an unclaimed property audit, including:

  • Executing nondisclosure agreements with the auditor (which should eliminate additional states piggybacking on the audit).
  • Forming a steering committee comprising IT, accounting, tax, and legal professionals.
  • Assigning a project leader.
  • Managing information flow through SharePoint portals.
  • Defining active review procedures and protocol for dealing with auditors.

For corporate holders not currently involved in an audit, there is time yet to proactively mitigate your risk by creating an infrastructure and culture of compliance through launching voluntary disclosure programs, implementing policies and procedures, and maintaining an ongoing compliance process.

There is no doubt that the compounded effects of a lack of resources – money, time, human capital – with the increasingly demanding regulatory and compliance environment has put a strain on companies. However, there is a strong financial – and reputational – argument to be made for the benefits of investing in mitigating risk and fostering transparency.

Material discussed is meant to provide general information and should not be acted upon without first obtaining professional advice appropriately tailored to your individual circumstances.

About the author:
Joe Carr is a partner in the state and local tax practice of BDO USA LLP. He leads the firm’s national unclaimed property practice. His email address is [email protected].

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