It’s a common problem faced by businesses that build a good-sized customer base over time. A customer leaves a deposit, uses your services for a few years then moves on. They forget to ask for the deposit back and you are focused on getting new business, so returning that deposit doesn’t exactly keep you up at night. When certain conditions are met, property like this deposit can no longer be held by your business. It must be turned over to the state government. Failure to do so can result in penalties and interest due immediately and in some cases, it could even lead to criminal charges. Welcome to the world of unclaimed and abandoned property.
What is Escheat
Escheat refers to the power of the state to acquire title to property for which there is no owner. With respect to your business, there is unclaimed or abandoned property escheat which is governed by state law. It extends to over 100 different types of property including:
- Abandoned bank accounts
- Securities including shares of stock and related dividends
- Deposits left with utility companies
- Unused gift certificates and stored value cards
- Unpaid wages
- Insurance payouts to unknown beneficiaries
- Unclaimed money retained by employers
- Rain checks
- And more
With regards to unclaimed or abandoned property, the state cannot simply take it. The unclaimed or abandoned property does not belong to the state. But more importantly, it also doesn’t belong to your company! The $500 deposit left by a former customer that is in your possession still belongs to that former customer. There is a process in place whereby businesses holding turn the property over to state for “safekeeping” until the true owner claims it. According to the National Association of Unclaimed Property Administrators, nearly $33 billion in unclaimed property is currently held by state treasuries and other agencies.
How to Handle Unclaimed or Abandoned Property?
Companies that have unclaimed or abandoned property in the possession are known as the “holder.” Depending on the type of asset and the state that has jurisdiction, the property can only be held for a certain amount of time known as the dormancy period. Upon completion of that period, the property must be turned over to the state. States also require the filing of unclaimed property reports with specific deadlines each year.
How is it Getting More Aggressive
Each state has its own set of regulations and more states are adopting the regulations usually associated with aggressive enforcement. These include:
- Shortened dormancy periods – this reduces the length of time a holder may keep the unclaimed or abandoned property and increases the likelihood that your company may inadvertently open itself to penalties and interest for not handing over the property in time.
- More auditing – state governments are increasing the number of audits conducted over unclaimed and abandoned property as well as lowering the threshold to be considered auditable. While before only the largest companies had to worry about this, smaller companies are now realistic targets in some cases.
- Negative reporting – Many states require reports to be filed even if you have no unclaimed or abandoned property to turn over. Of course failure to comply can lead to penalties.
- Limited or no appeals process – If your company is audited, some states do not provide an appeals process. In fact if the state finds that you do owe them, they will send you the bill and require almost immediate payment.
- Far reaching auditing periods – While many companies keep their financial records for seven years as required by the IRS, an unclaimed property audit can go back for many years.
Why States are Getting More Aggressive
I recently wrote about how state governments are suffering from massive budget deficits and are turning to new taxes and regulations on businesses to help plug the hole. Aggressive enforcement and expansion of escheat laws is now growing to raise even more funds for state governments. Once property is turned over, the state usually maintains a percentage in a reserve fund for payouts against future claims from owners. This is in case someone who is owed money finally tracks it down to the state. But in reality most of the funds go unclaimed. This gives state governments additional sources of revenue for their ailing budgets without having to raise taxes. Unclaimed property laws provide the benefits of “tax increases” without the political costs or the risks of the legislative process.
Delaware, for example, is able to generate a significant portion of its state revenues through this process. According to the Delaware Department of State, Division of Corporations, more than 850,000 businesses are legally constituted in Delaware, including over half of all publicly-traded companies and 63 percent of the Fortune 500. Most unclaimed and abandoned property regulations require that after the dormancy period, holders turn it over to the state of the last known address of the owner according to the company’s records. If that cannot be determined, then the default is to turn it over to the state of incorporation for the company.
Delaware audits companies aggressively to ensure compliance with unclaimed and abandoned property laws. According to the Delaware Economic and Financial Advisory Council, revenues from abandoned property are estimated at $400 million for FY2010 and $380 million for FY 2011. In 2009 they were $392 million. This represents over 12 percent of the state’s sources of funds. In recent years it has ranked as the third largest source of funds for the state behind personal income tax and incorporation revenue.
Given the complexity of unclaimed and abandoned property compliance, it may be worth outsourcing it to specialized vendors. Your company may derive additional benefits as well.
According to James O. Santivanez, a nationally recognized expert on unclaimed property matters and President of JMS Advisory Group, a firm offering unclaimed property compliance solutions, the handling of unclaimed and abandoned property usually gets addressed only when a problem such as an audit arises. Companies rarely look at how to derive value through the escheatment process. "At times it may seem like a process that is entirely favorable to the states. However, there are very real benefits to managing compliance in this area with a high degree of accuracy - it's meaningful for companies both currently in compliance, and those seeking to be compliant. This also means reporting the correct amount as efficiently as possible. Surprisingly, many companies don't realize that over-compliance can be as costly as under-compliance."
Mike Periu is the founder of EcoFin Media, LLC an independent producer of financial, economic and entrepreneurial content for television, radio, print and the internet. Over the past ten years he has started three companies and advised over 50 companies on financial strategies including fundraising. Mike also hosts regular small business webinars on a range of topics relevant to business owners.