Audit alert

Just as businesses today are looking for ways to generate revenue, states are also considering how to fill budget deficit “cavities” and raise dollars in this down economy. The fastest-growing source of revenue for states is not income tax or sales tax. It’s unclaimed property, and every company has it.

States are currently in possession of approximately $20 billion in unclaimed property dollars. Auditors will actively seek out businesses that did not report and turn over this property to the state. Unclaimed property is a compliance issue that all businesses should understand and address this year and going forward.

“Businesses don’t often hear about unclaimed property policy because it falls under property law, not under tax law,” says Tim Dudek, a director in the tax strategies group at Kreischer Miller, Horsham, Pa. “Unclaimed property is important to businesses today because the end result is typically a cash outlay to the state.”

Smart Business spoke to Dudek about what constitutes unclaimed property and how noncompliant businesses can mitigate penalties and interest by taking action before an audit occurs.

What is unclaimed property?

Also called abandoned property, unclaimed property is any type of tangible financial asset held for a party that cannot be found. Unclaimed property is not real estate or ‘lost and found’ items. It represents the debt of one party and the asset of another. For instance, a company mails a paycheck to an employee who leaves the company. The company cannot locate the former employee so the check is never cashed by its rightful owner. After several failed attempts to find the individual, the uncashed paycheck is considered ‘abandoned property.’ The business then cancels the check and that money goes back into the company bank account. The problem: That money now belongs to the state as ‘unclaimed property.’ The cash should have been turned over to the state, but instead has been infused back into the business.

Other examples of unclaimed property include uncashed checks to vendors, accounts receivable credit balances, expense reimbursement checks, ‘expired’ gift cards (which should never expire, actually) and safe deposit boxes. The list of what qualifies as unclaimed property is pages long and includes industry-specific property.

How much unclaimed property do companies identify? What sort of revenue do states expect to collect by enforcing this tax law?

States believe that only 10 to 15 percent of companies comply and turn unclaimed property dollars over to them. Delaware (the second-smallest state) expects to collect $400 million this year just from companies remitting payment for reported unclaimed property. Assuming that less than 15 percent of companies are compliant, auditors who exercise this property law will, more often than not, turn up dollars for the state.

How will states collect unclaimed property dollars?

The states will search for unclaimed property through compliance efforts and audit proceedings. Every company must be registered with a state in order to conduct business, and because all registered businesses must file tax returns it’s very easy for the unclaimed property bureau to match these returns to abandoned property reports.

What penalties and interest could noncompliant companies face?

The state has discretion to look back an unlimited number of years for unclaimed property and charge penalties and interest for each year that unclaimed property was not remitted to the state. Some states set no penalty limits, but in Pennsylvania, the cap is $10,000.

What can companies do if they recognize they have unclaimed property recorded on their books?

The good news is that opportunities exist for companies that recognize their own noncompliance. Businesses that perform their own due diligence and determine the dollar magnitude of property they should have remitted to the state should contact their tax accountant, who can begin negotiations with the state and help the company enter into a Voluntary Disclosure Program. This program involves a contract between the company and the state. The company admits to deficiency and asks for ‘forgiveness.’ As a result, companies can save dollars and reduce administrative look-back periods. In other words, the state may agree to limit the reporting period to 10 years or less, with minimal interest and no penalties. This scenario is far better than risking the possibility of an unclaimed property audit by the state. If no reports were ever filed, a state may go back and audit for an unlimited number of years, imposing full interest and penalties on any deficiency with no chance of abatement.

The key is to understand what qualifies as unclaimed property and discuss the rules and opportunities with your accountant. Determine if your company owes money to the state, and do not assume your company will go unnoticed. The state is always looking for untapped revenue sources. Every business that is noncompliant is a target.

Tim Dudek is director of the tax strategies group at Kreischer Miller, Horsham, Pa. Contact him at (216) 441-4600 or [email protected].

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