Unclaimed Property – History, Audit Trends and Legislative Developments - Mike Stehly, US Foods,...

Unclaimed PropertyPresented by

Mike Stehly, VP of TaxUS Foods IncUS Foods, Inc.

1FOOD. FOOD PEOPLE. EASY.

Objectives• Overview of Unclaimed Property

• Key Concepts & Terms• Types of Unclaimed PropertyTypes of Unclaimed Property• State Jurisdiction – Priority Rules• Differentiation from a Tax

• Audit Trends – Delaware Spotlight• Unclaimed Property Feeding Frenzy• Potential Audit Triggers• Third Party Auditors• Audit Process & Challenges• Use of Extrapolation Methods

• Recent Legislation & Litigation in Delaware


Overview of Unclaimed Property

• All 50 states, DC, Puerto Rico, the U.S. Virgin Islands & Guam have unclaimed property lawsp p y

• There are four Uniform Act Versions: 1954, 1966, 1981 & 1995

• No two jurisdictions laws are exactly the same

• Theoretically states hold the property in custodial capacity until• Theoretically, states hold the property in custodial capacity until the rightful owner claims

• Estimation of liability is allowed under most state unclaimedEstimation of liability is allowed under most state unclaimed property laws when records are not available

• There is no statute of limitations in most state laws


There is no statute of limitations in most state laws

Key Concepts & Terms

• What is Unclaimed Property?Property held or owing in the ordinary course of business which has not been claimed by the owner for a specific amount of time

• Key Terms:y• Holder• Owner• Dormancy Period• Dormancy Period• Due Diligence• Escheat


Types of Unclaimed Property

• Uncashed payroll & vendor checks• Unapplied accounts receivable credit balances• Unapplied accounts receivable credit balances• Customer refunds and rebates• Benefit plan payments• Unredeemed gift certificates & gift cards• Publicly traded securities • Dormant bank and brokerage accounts• Dormant bank and brokerage accounts• Life insurance policies• Contents of safe deposit boxes


State Jurisdiction – Priority Rules

Companies are required to report unclaimed property pursuant to the jurisdictional priority rules established by the US Supreme Court in Texas v New Jersey (379 U S 674 (1965))Supreme Court in Texas v. New Jersey (379 U.S. 674 (1965)) and its progeny cases.

P i it R lPriority Rules:First-Priority Rule: Property is reported to the state of the last known address of the owner/payee/creditor as reflected on the h ld ’ b k d dholder’s books and records.

Second Priority Rule: If owner is unknown, or if owner’s dd i k if th l t k dd i i t taddress is unknown, or if the last-known address is in a state

that does not provide for the escheat of the property, property is reported to the holder’s state of incorporation (domicile).


Differentiation from a Tax

Taxes• State holds direct legal authority to

Unclaimed Property• States authority to receive and• State holds direct legal authority to

collect, retain and spend tax revenue• Nexus is required• Independent Administrative Appeals

States authority to receive and retain is derived from the owner’s rights and exists solely to protect those rights in a custodial capacity.

• Nexus is not a factor – priority rules• Independent Administrative Appeals Process for Holders

• Statute of limitations• Limited use of contract auditors

• Nexus is not a factor – priority rules govern

• Independent administrative appeals process typically unavailable – only recourse is to sue in court• Limited use of contract auditors recourse is to sue in court

• Most states do not have a statute of limitations

• Contract auditors conduct majority j yof unclaimed property audits

Although unclaimed property is not a tax, corporate tax departments are often


tasked with compliance and audit responsibility

Unclaimed Property Feeding Frenzy

• Unclaimed Property Generates Big Revenues for States• Unclaimed property has become a revenue source for statesp p y• States are prioritizing their bottom lines ahead of the historic goal of unclaimed

property which is to reunite property with the rightful owner• Unclaimed property has been the third-largest source of revenue for Delaware for

fi l 2013 d 2014 b i i i $566 5M d $474 9M ti lfiscal year 2013 and 2014 bringing in $566.5M and $474.9M, respectively• Delaware deposits all unclaimed property collections directly into the state’s

general fund

• Impact of Revenue Generation• States are aggressive in their audit practices• States are shortening the dormancy periods• States are targeting new types of property (e.g., stored value cards, promotional

incentives)If the purpose of the law is…to reunite owners with their lost or forgotten property, its ultimate goal should be to generate little or no revenue at all for the state ” Taylor v Chiang


ultimate goal should be to generate little or no revenue at all for the state.” Taylor v. Chiang, No. Civ. S012407 WBS GGH (E.D. Cal. June 1, 2007).

What’s the Big Deal?

Company has been filing reports and believes it is in compliance, BUT . . . Audits can go back as far as 1981• Audits can go back as far as 1981

• Does the company have copies of the filed reports and supporting documentation (down to the transaction detail) all the way back to 1981?

N t t t f li it ti (i D l ) f t fil d i t 2002• No statute of limitations (in Delaware) for reports filed prior to 2002• 3 year statute of limitations for reports filed after July 2002 • 6 year statute of limitations if “materially” under reported (25% or more)

• Use of extrapolation to estimate liability• High penalty and interest

• Delaware has stepped up audit enforcement activitiesDelaware has stepped up audit enforcement activities• Began mailing out audit notices in February 2013• Focus appears to be financial services industry, with retail, distribution,

entertainment and consumer products manufacturing industries also


entertainment and consumer products manufacturing industries also targeted

Potential Audit Triggers

• Holder is incorporated in the state or has presence in the state but has not filed reports

• Gaps in reporting history• Amounts reported by Holder appear small compared to the size of

the Holder• There was no reach back on the initial reporting by the Holder• Holder is large so as to draw attention from the state of

incorporationincorporation• History of mergers, acquisitions, reorganizations, liquidations,

dissolutions, incorporationsHi h l f fi i l t ti ( t il di t ib t )• High volume of financial transactions (e.g., retailers or distributors)

• Failure to report some property types that are common to the industry


Third Party Auditors

• The number of states engaging contract audit firms has increased drastically over just the past year

• from a handful to over 20from a handful to over 20• while not all states currently use contract auditors, most have the statutory

authority to do so• contract auditors perform virtually all of Delaware’s unclaimed property

auditsaudits

• Contract auditors are compensated by contingent fee which encourages auditors to:

• be overly aggressive;• interpret state laws to their own advantage;• ignore holder errors that would result in lower assessment; and

i k d h dit t t• pick and choose audit targets

• A number of states may participate in the same audit• focus remains on Delaware as the lead state (state of incorporation)


• focus remains on Delaware as the lead state (state of incorporation)

Third Party Auditors (con’t)

• Extended “reach back” periods • Delaware can audit as far back as 1981 (over 30 years!)

• Sampling and Extrapolations• Delaware’s laws allow the state and its contract auditors to estimate aDelaware s laws allow the state and its contract auditors to estimate a

holder’s liability where no records are available• The Delaware statute offers no guidance on what estimation

method(s) to usemethod(s) to use• Because no name and address information is available, the estimated

unclaimed property liability falls under the second-priority rule (escheats to the state of incorporation)( p )


Unclaimed Property Headlines

• “Attorneys find ‘formidable’ opponent in Kelmar “ – Legal Newsline Legal Journal 9/4/13

• “Delaware’s Unclaimed Property Racket: John Gotti Would be Proud” – The American Spectator 5/16/13

• “Are State’s Addicted to Revenue From Unclaimed Property?” Forbes• Are State s Addicted to Revenue From Unclaimed Property? – Forbes 10/18/13

• “Unclaimed Property Audit Lawsuit Filed Against Kelmar: You Do the Math” –The National La Re ie 6/9/14The National Law Review 6/9/14

• “Estimating Unclaimed Property Liability: The Wild West of Accounting” – Tax Executives Institute, Inc. 11/15/2012

• “Once a Friendly Locale to Business, The Modern State of Delaware is a Bully” – Forbes.com 5/19/2013


Chronological Audit Components

1. Notice2. Confidentiality & Non-Disclosure Agreement3. Opening Meeting4. Information/Document Requests5 Sampling and Extrapolation5. Sampling and Extrapolation6. Remediation7. Interim Status Report (ISR)8. Report of Examination (ROE)9. Statement of Findings and Request for Payment10 N ti ti / A l10. Negotiation / Appeal


Overview of Kelmar Audit Process

• Notice of intent to audit is received directly from the state(s) and lists Kelmar as auditor

• Kelmar contacts the company:• Complete a Confidentiality & Non-Disclosure Agreement (NDA)Complete a Confidentiality & Non Disclosure Agreement (NDA)

• Limit to participating states

• Have opening conference to kick off audit and complete the first• Have opening conference to kick off audit and complete the first information request

• Kelmar Uses a Four Phase Audit Approach• Kelmar Uses a Four Phase Audit Approach


Kelmar Four Phase Audit Process

• Phase I: Entity and Property Type Scopingy y y g• Public Information• Organizational Chart• Federal Tax Return 1120 (state apportionment schedules)Kelmar identifies the entities to be the primary focus of theKelmar identifies the entities to be the primary focus of the examination – then requests general ledgers

• Analysis of General Ledgers (by In-Scope Entity)Kelmar identifies the GL accounts it believes may hold unclaimed property and requests more detail on these particular accounts



• Phase II: Quantification of Potential Unclaimed Property• Kelmar Requests Source Data (bank account detail, A/R aged trial

balances, etc.)• Transaction Level Detail (aged outstanding checks, A/R credit

write-offs, etc.)

Challenges for Holder to Respond• Availability of records (record retention policies)Availability of records (record retention policies)• Accounting system changes• Staff changes• Mergers acquisitions reorganizations liquidations dissolutions• Mergers, acquisitions, reorganizations, liquidations, dissolutions,

incorporations

Kelmar uses the information to sample and extrapolate


Kelmar uses the information to sample and extrapolate


• Phase III: Research, Remediation and Due Diligence Adjustments• Actuals Presented to Holder (provided by individual property category)

Kelmar provides Holder with its initial findings of the populations of presumptively due transactions

• Research, Remediation, Due Diligence (errors, filed, due diligence letters, refunds, addresses)

• Holder performs research, due diligence to remediate the presumptively due transactions asserted by Kelmartransactions asserted by Kelmar

• Remediation – Holder had burden to prove that the property is not abandoned

• Phase IV: Unclaimed Property Reporting• Phase IV: Unclaimed Property Reporting• Report of Examination Findings• Final Assessment


Issues with Kelmar

• Long Drawn Out Audits• Holder accounting system changes

• Data archived at summary levelf /• Request huge amounts of data/documents

• Request all reports filed in all states for all years (go back as far as furthest state – Delaware back to 1981)

• No statute of limitations (record retention policies often just 7 years)• Kelmar monthly TMR (Task Management Report) track to show how many days requests are “past• Kelmar monthly TMR (Task Management Report) – track to show how many days requests are past

due”• Kelmar standard is to provide 30 days for responses – not reasonable considering amount of detail

being requested (ability to negotiate more time)• Acquisitions – limited access or no access to software systems/records, but have liability• Require all past reports, but Delaware says don’t have copies of all previous filings, holder

responsibility to retain copies• Cost of external advisors• Cost of internal staff hours to gather information

Ti i t l l f lti l f ti l (t t bl t• Tie up internal personnel from multiple functional areas (treasury, accounts payable, accounts receivable, payroll, shareholder services, tax, etc.)

• Failure by Kelmar to recognize some basic tax and recordkeeping principles (e.g., disregarded entities)

• Estimation/Extrapolation techniques a huge issue


Use of Extrapolation Methods

• Auditor selects base period covering several years for which records are available

• Using the base period, auditor calculates an “escheat percentage” (error rate)( )

• Example of an auditor’s extrapolation formula:

Escheat Percentage = [Determined Liability for Base Year(s) with Records]

[Revenue for Base Year(s)]

Projected Liability = [Escheat Percentage] x [Revenue for Years withInsufficient or No Records]


Use of Extrapolation Methods (con’t)

• Importantly, Determined Liability for Base Year(s) with Records includes:

• All the unremediated items for the base year(s)• All property escheated to any State during the base year(s)• Items discovered during the audit and considered abandoned that are g

reportable to any State and returned to the rightful owner• Items that could be abandoned property reportable to any State, but

for an applicable exemption provided by the State to which the property otherwise would be reportable.

• Impact of Extrapolation Can be Very Material!Impact of Extrapolation Can be Very Material!• Interest/penalty can equal or exceed the amount of the actual liability


Impact of Extrapolation Can be Material!

The Temple-Inland case highlights several of the weaknesses of the Kelmar extrapolation methodology. The complaint lists several specific examples, which practitioners have all seen before:p

• Using a B2B check in a continuing relationship state as the basis for unclaimed property, even though the check is not yet reportable to the state. A $1,312.72 h k bl t d i T t d i t D l t fcheck payable to a vendor in Tennessee turned into a Delaware assessment of

$101,463.27.

• A vendor check that was voided because it was issued in error and where noA vendor check that was voided because it was issued in error and where no liability exists turned the original $3,050.49 check issued in error into $144,028.97 under the extrapolation.

• A series of four vendor checks of $4,335.19 that were voided and reissued (and subsequently cleared within the dormancy period) turned into $237,339.18 of liability under the extrapolation.


Impact of Extrapolation Can Be Material! (con’t)

Temple-Inland case examples of extrapolation methodology weaknesses (con’t):

• A $100 uncashed check that was escheated to another state was used in the extrapolation.

• A voided check that was issued to an employee for vacation time already compensated was extrapolated to $87,386.75 in liability.

• Payroll checks that were reissued to employees in states other than Delaware for $8,355.94 turned into $174,223.29 in the extrapolation.

A h k h i i ll i d d ll h i d d• A check that was originally issued under payroll, then reissued under accounts payable, turned $1,641.50 into $95,090.73.


Key Recommendations

• Educate management team regarding Kelmar’s practices and what is in store with the audit

• CFO, Controller, General Counsel• Consider hiring outside assistance who has dealt extensively with

these audits• Legal counsel (attorney-client privilege)• Accountants if needed for the legwork (hire through legal counsel to

establish attorney client privilege)y p g )• All communications and submissions to Kelmar should be done

through the legal counsel as the point contact• Establish an internal mandate to not let anything out the doorEstablish an internal mandate to not let anything out the door

without understanding what it is and what its ramifications may be. • Anticipate resources needed – it will be more than you think!


Recent Legislative Changes in Delaware

• Senate Bill 228 (signed 6/30/2014)• Penalty for failing to file an unclaimed property report changed from 5% per month

to the lesser of 5% per month or $100 per dayto the lesser of 5% per month or $100 per day• Maximum penalty for failing to file a report changed from 50% of the amount

required to be shown on the report to $5,000.• Eliminated the assessment of interest on unpaid amountsated t e assess e t o te est o u pa d a ou ts• Extended enrollment period for the Voluntary Disclosure Agreement (VDA)

program administered by the Secretary of State to September 30, 2014

• Senate Bill 215 (did not pass)• Would have prohibited the state from paying contract auditors by commission and

require contracts with auditors to not extend beyond three years• Bill also recited existing law restricting state employees from assisting any private

enterprise on any matter involving the State for a period of 2 years after employment (directed at Delaware’s former State Escheator Mark Udinski who joined Kelmar)


joined Kelmar)

Recent Litigation in Delaware

• Select Medical Corporation v. Cook, et. al. U.S. District Court, District of Delaware No. 1:13-cv-00694, 1/21/2014)

• After Select Medical made a payment of more than $17,000 under a VDA, p yDelaware performed an unclaimed property audit and issued an assessment of $300,000

• Select Medical filed suit against Delaware arguing that Delaware’s li i i b d th f ll ipolicies were improper based on the following:• Delaware’s three year statute of limitations bars the assessment• Delaware Section 1155 does not provide authority for retroactive estimation

techniques during the time period in questiontechniques during the time period in question• Texas v. New Jersey, 379 US 674 does not give common law authority for

estimation techniques since records were available during the time period in question

• The estimation methodology was unconstitutional, violating the Commerce Clause, Full Faith Clause, Credit Clause and the Takings and Substantive Due Process Clause because it does not recognize exemptions, and was arbitrary and capricious


y p

• The parties settled the case

Recent Litigation in Delaware

• Temple-Inland v. Cook et. al., 1:14-cv-00654-SLR (D.Del. 5/21/14) • Temple-Inland alleges that Delaware illegally estimated unclaimed checks

dating back to 1986 for years that the company could not produce recordsdating back to 1986, for years that the company could not produce records.• A six-year audit of the books produced just a single $147.50 payroll check due to

Delaware for unreported unclaimed property liability • The $147.50 in unreported payroll for the six-year period alone resulted in anThe $147.50 in unreported payroll for the six year period alone resulted in an

estimated $952,066.36 due to Delaware for the seven prior years without records• Under Kelmar’s estimation and extrapolation methodology, Delaware assessed a

total liability of nearly $1.4M for the seven years without records

• Temple-Inland argues the calculation is flawed in several fundamental ways:• There is no relationship between revenues and the amount of unreported property• The adjustment of revenues by removing ACH payments from the denominator in

the escheat percentage calculation incorrectly inflates the final assessment because no similar adjustment for ACH payments was made during the estimation years.


• First case in which Kelmar Associates was directly named as a defendant

Date post:	04-Jul-2015
Category:	Business
Upload:	marcus-evans
View:	244 times
Download:	0 times