An item that states have been increasingly looking at is unclaimed property. While not a tax, it is a major revenue source for states, often administered by the state treasurer’s office.
Unclaimed property can be many things, with one of the most common examples being uncashed checks. However, over recent times, states have become increasingly creative in expanding the concept of “unclaimed property.” Many states require the escheatment (the payment of the unclaimed property to the state after a period of dormancy) of such items including outstanding credit balances in accounts receivable. Often, businesses write items such as these off into income after a certain period, but write-offs to income are the first thing state auditors (and firms the states contract to audit for them) examine during an unclaimed property audit.
The right of a state to require unclaimed property to be escheated dates back to Europe when kings often held such property until such time the proper owner could be found. Many states have names such as “cash dash” for their programs, which encourage residents to search online databases to find property that the state may be holding on their behalf. However, the truth is that only about 20 percent of escheated property is ever claimed by the “owner” of the property (e.g., the payee on an uncashed check, etc.), thus creating a revenue windfall for states.
Here’s an example of how unclaimed property can be created. Company A, a clothing manufacturer, needs material and contracts Company B to supply a textile of a specific content, weight and color. When Company A receives the material, it notes that the contracted specifications were not met, and demands that Company B reduce the related invoice from $1,200,000 to $800,000. Company B refuses, but offers to reduce the invoice to $1,000,000. This negotiation goes on for nearly two years, at which time Company B goes bankrupt. The dormancy period for a payable item has passed, but the bankruptcy trustee never attempts to collect the unpaid balance, or even inquire about the dispute with Company A. Although Company A’s controller would like to take the disputed amount into income, to do so would raise a red flag for any state auditor.
There are potential issues in this situation, such as does Company A now have knowledge as to who the current owner of the property is and where the party is located? What would be the proper amount to escheat? To which state is the property escheatable? The danger in situations like this is that while federal guidelines exist, they are vague enough that more than one state may try to collect the same unclaimed property, potentially putting the company in a “double escheatment” situation. In addition, states often impose different penalties on property that has not been properly escheated which, in some instances, can exceed 100 percent of the property’s value.
In addition, while many states have similar rules governing this area of law, many have different specific requirements, such as how long the dormancy period is for various types of property. In addition, various “due diligence” procedures are required by the states (usually involving mailings, etc.) prior to escheatment of property. State rules can be very specific, even detailing such matters as the specific font to be used in due diligence letters.
Many of the concepts in state taxation such as nexus, statute of limitations, etc., often do not apply to unclaimed property. For example, a company might be liable for escheating unclaimed property to a state in which it has no operations!
To discuss unclaimed property, or to determine if your business has any potential liability for it, please call Larry Ewing at 312.648.6674.