Mar 23, 2023
Written By: Kendall Houghton and Josh Labat from Alston & Bird LLP, © 2023
For NACM members, unclaimed property (“UP”) and UP compliance may be a foreign concept. Afterall, UP does not fit neatly within members’ accounting, finance, and legal departments, and adding a UP compliance program may appear like an unnecessary use of resources. However, if members take the time to implement a UP compliance program, its benefits will greatly outweigh the costs of not having such a program given states’ aggressive enforcement of their UP laws through audits.
Overview of UP Law
What is UP?
UP is property held by a business, known as a “holder,” which has not been claimed and belongs to a third-party, known as an “owner.” After a statutorily defined holding period, generally three to five years, the holder has an obligation to attempt to return the property to its owner. If the holder is unsuccessful, then the holder is required to remit the property to the appropriate state so that the state can hold the property until the state can contact the owner.
UP takes many forms including: (1) money, checks, drafts, deposits, and interest or dividends; and (2) credit balances, overpayments, credit memos, and unapplied funds. Every NACM member is a potential UP holder, because UP commonly originates from accounts receivable (“AR”), which include credit balances, overpayments, credit memos, and unapplied funds.
States’ UP Laws
Since NACM members’ AR may become UP, it is vital to understand state UP laws. Each state has enacted its own UP laws, which include statutes and regulations addressing the following:
- Time periods (a “dormancy period”) after which an unsatisfied obligation or funds in a holder’s possession become presumed-abandoned;
- Performance of due diligence outreach by holders to attempt to locate owners of UP;
- Reporting and payment instructions for UP when an owner cannot be located;
- The state’s processes to maintain custody of UP and how the state will return UP to an owner who comes forward to claim it;
- Interest and penalty provisions for a holder’s failure to report UP or a holder’s late reporting of UP; and
- Applicable exemptions to UP laws – for example, some states’ UP laws exempt business-to-business (“B2B”) property from being deemed UP.
Which State Gets the UP?
After reviewing the basics of UP and states’ UP laws, NACM members may look at their AR and ask the question: how do we know which state may escheat (that is, take possession of) the AR property when the owners of the property are located in numerous states?
The US Supreme Court has provided two rules to help holders make this determination. Under the Primary Rule, the state of the UP owner’s last known address as shown in the holder’s books and records may escheat the UP. Under the Secondary Rule, if no last known address for the UP owner is indicated in the holder’s books and records, or if the state of the owner’s last known address does not have applicable UP legislation, then the holder’s state of incorporation may escheat the UP.
Why Should NACM Members Care About UP Laws and Compliance?
Keeping accurate books and records plays a large role in complying with UP laws. Therefore, NACM members should not only maintain accurate books and records for internal accounting purposes, but should also do so to stay compliant with UP laws. Failing to comply with UP laws invites both (1) UP audits conducted by both states and on behalf of states by hired third-party auditors; and (2) the imposition of interest and penalties for failure to comply with UP laws. Third-party audits are typically multistate exams which require holders to simultaneously defend their UP compliance in 10+ states. Practically speaking, defending a UP audit is an expensive proposition because holders must dedicate resources and money to mounting a strategic audit defense. In addition, NACM members should be aware of interest and penalties that states impose on holders that fail to report (or timely report) UP. While interest and penalty rates vary across each state, they are imposed on the value of the UP from the date that the UP should have been reported, paid, or delivered to the state. In certain circumstances, the penalties and interest can exceed the value of the UP itself, and these expenses are borne directly by a member.
How Can NACM Members Manage the UP Impact on Accounts Receivable Credit Balances?
When implementing a UP compliance program or reviewing and potentially expanding a UP compliance program to address AR credits, NACM members should take the following concepts into consideration:
- General ledger accounts, where AR credit balances and write-off practices are on record, will be closely reviewed by any auditor.
- AR credits are subject to UP laws, and cannot be reversed simply because (i) your clients have not applied the AR credit to their AR account balances for some period of time (e.g., 6 months), and/or (ii) an AR credit balance is “de minimis” per your determination (e.g., less than $50 or $100). State unclaimed property laws expressly enumerate credits and credit memos as an escheatable property type.
- AR credits are only escheatable where there is a net credit balance – so, NACM members should utilize the practice of offsetting AR debits against AR credits to evaluate whether there are AR credit balances that have aged long enough to be presumed abandoned. NACM members can undertake this practice on an ongoing basis or as an audit defense technique to demonstrate that there are not aged AR credit balances.
- B2B exemption UP statutes generally apply to AR credits, but many are predicated on an “ongoing relationship” between businesses. NACM members should carefully review each state’s UP B2B exemption before determining that AR credits are exempt.
- NACM members should actively engage with clients to maintain active accounts and to apply, refund, or offset AR credit balances.
Kendall Houghton is a partner with Alston & Bird LLP in the firm’s Washington, DC office.
Joshua Labat is a senior associate with Alston & Bird LLP in the firm’s New York, NY office.
Both attorneys are in Alston & Bird LLP’s state and local tax group where both attorneys maintain an active unclaimed property practice.