Insights: Article

Unclaimed Property and Financial Institutions

August 03, 2015

Several Midwestern states have reinvigorated their efforts to investigate financial institutions for unclaimed property compliance. Even though unclaimed property reporting is not a new requirement, states are discovering significant underreporting, especially by financial institutions.  

To that end, the states (including Minnesota and Wisconsin) have contracted with third-party auditors to conduct contingency fee audits of financial institutions as well as other industries. The third-party auditors, who are usually CPAs and are versed in unclaimed property law, are obviously highly motivated to find noncompliance issues as a result of these arrangements with the states.

Definition of Unclaimed Property
Unclaimed property can be defined as any financial asset that has been abandoned or unclaimed by the rightful owner for a specific period of time. Some examples of unclaimed property are:

  • Bank accounts and contents of safe deposit boxes
  • Dividend, payroll or cashier's checks
  • Stocks, mutual fund accounts, bonds
  • Mineral interest or royalty payments
  • Court deposits, trust funds, escrow accounts

Some states see unclaimed property as a revenue source, even though unclaimed property is not technically a tax. Other states, such as Minnesota and Wisconsin, approach unclaimed property from a consumer protection perspective. This is helpful, as it should result in a state’s collaboration with a company, instead of fostering a confrontational review.

There are a number of important differences between unclaimed property rules and tax procedure:

  • A company can be subject to a state’s unclaimed property rules without having nexus—in  other words, no presence in the state.
  • The statute of limitations for unclaimed property generally does not toll. Audits can look back 10–20 years, and Delaware has been known to look back more than 30 years.
  • As mentioned above, audits can go back 10–30 years. Most businesses don’t keep records for that long, so the auditors resort to using statistical extrapolation for older years. Again, the property holder has the burden to prove these estimates are wrong. With no rebuttable records for early years like 1981, the business will find providing proof a very difficult and onerous task.
  • Third-party auditors often hold simultaneous contracts with multiple states, which can often lead to very aggressive and expensive audits and can take as long as 3-5 years to complete.
  • Generally, there are no administrative appeal procedures in unclaimed property audits. A business must pay the tax, interest and penalties or litigate.
  • Interest and non-compliance penalties can potentially reach amounts that are close to the value of the unclaimed property itself.

The Right Conditions
Several factors have come together to create an environment ripe for a new wave of unclaimed property audits.

First, during the economic downturn, states were exploring ways to replenish their coffers. One such strategy was to shorten the dormancy periods (period that account is idle), and force a quicker escheat (legal term for handing the property over) to the state. Another strategy was to expand the categories of escheatable property. Specifically, financial institutions are now responsible for monitoring more than 30 categories of property types.

Second, the modern world is smaller and more interconnected than ever before. The workforce is much more mobile and transient. Additionally, modern business is global thanks to the Internet. These factors can create difficulty and complexity in conducting unclaimed property due diligence such as tracking transactions, identifying property owners, and their current locations. 

Third, there has been significant merger and acquisition activity (consolidation) within the industry. Consolidation raises complexities relating to the integration of computer and reporting systems, record keeping procedures, and lapses in the escheat process. In our experience, there are several common areas driving escheatable accounts to be misreported or overlooked:

  • Computer conversion/upgrades
  • Branch mergers
  • Removal of old information from the computer system, including outdated account notes (these notes can contain pertinent information that can help in conducting due diligence)

Beside systems-related issues, there are always the traditional issues that surround unclaimed property reporting and escheat. Examples can include:

  • The improper assumption that sending a letter that does not return to sender is evidence of valid owner “contact”
  • Continuing to charge fees after the reporting year cutoff
  • Failure to send the required notification to account owner’s last known address (unless company has evidence that address is incorrect)
  • Failure to identify and open past due safe-deposit boxes, causing late reporting to the proper jurisdiction(s)
  • Accounts not being reported to the proper jurisdiction(s)
  • Continued updating of inactive accounts, contrary to company policy

Keeping Track Can Be a Challenge
Many financial institutions are decentralized and offer a variety of products and services that transcend various business lines. Keeping track of all this activity can present a challenge, especially in institutions with commercial operations. Specifically, commercial banking business lines that involve security deposits, club accounts, certificates of deposit, unidentified deposits and suspense accounts, and credit balances arising from loans, may have reporting and escheat issues resulting from unclear assignment of “ownership” or account maintenance responsibility at the clients business. Some other items that may cause escheat issues:

  • Stock and liquidating dividends
  • Bond interest and principal
  • Fiduciary checks
  • Cash dividends
  • Warrants

We mentioned customer “contact” above. It’s not always easy to identify when last “contact” occurred, and what constitutes acceptable “contact.” Contact can be evidenced by the property owner’s explicit or implicit acknowledgement of the existence of the account and their wish for the account to remain current and open. Particularly, this can be a problem for decentralized financial institutions that have customers with multiple accounts and/or in numerous locations? These issues need to be resolved, and one way to do that is to put a plan in place for tracking and remitting unclaimed property.

Another area of scrutiny revolves around inactivity fees, interest charges, and other service charges on inactive accounts which are presumed abandoned. In order for these fees to be deemed valid, the contract needs to address the various charges and fees with specific reference to inactive accounts. Again, the question of customer contact through other accounts must be considered.

IRAs and Educational Savings Plans
Individual Retirement Accounts (IRAs) and Keogh plans can also present unclaimed property reporting issues. These accounts might be reportable if the account owner does not claim their distribution as required by contract or law. Generally, the owner of a retirement account (or beneficiary) must begin taking distributions no later than the year after turning age 70½, or as a death benefit.

Similarly, special tax-advantaged educational savings plan accounts are required to distribute 30 days after the beneficiary’s 30th birthday. If the account balance is not distributed, a three-year dormancy period will generally apply. Financial institutions should report these accounts to the appropriate states if there has been no contact with the beneficiary once they reach the age of 33.

A Daunting Task
Navigating the unclaimed property compliance and the escheat process can be a daunting task, not to mention the complexity involved with identifying the appropriate dormancy periods and jurisdictions which have claim to the escheatable property. As states are picking up their audit activity of the financial industry, and are using third-party contingency fee auditors, financial institutions should ask themselves—are you comfortable with your company’s unclaimed property compliance process?

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