Managing unclaimed property: Understanding dormancy periods, due diligence and escheatment

Dealing with unclaimed property can become an afterthought for companies whose focus on profits leads to decreasing prioritization of regulatory and customer-protection responsibilities.

As a result, the burden of managing unclaimed property often falls on tax professionals with little to no training in the role. Their task becomes to identify escheatable property and follow through on their organization’s duties under state laws to attempt to reunite that property with its owners. After performing required due diligence as the holder of unclaimed property, companies must “escheat” that property into the custody of the appropriate jurisdiction if it cannot be reunited with its lawful owner.

Determining how to accomplish this seemingly simple final obligation could become more complex with the United States Supreme Court preparing to open the 2022 Fall term by hearing its first unclaimed property case in 30 years. Laws regarding unclaimed property have changed often in recent years, and they could be altered dramatically by the end of the year.

Companies that fail to keep up to date or even avoid regulatory requirements can find themselves in deep trouble. Not meeting statutory demands for unclaimed property could result in significant fines and legal exposure. Who will face the blame when a stiff penalty is imposed? That can be a frightening thought for well-intentioned tax professionals thrown into the fray without even a simple understanding of unclaimed property basics, such as what exactly does it mean to escheat and what is escheatable property?

Understanding the basics

To escheat means to revert property to the state on the owner’s dying without legal inheritors. The term has its roots in medieval times with the transfer of property following the deaths of royal subjects with no heirs. In those cases, ownership of lands and other property would go to the king.  Today, escheat occurs when the lawful owner can not be found by the holder of the property.

The rules following the escheatment of unclaimed property differ from those related to the collection and remittance of sales tax. Once remitted, the state becomes the custodian for unclaimed property rather than the owner. Some states will attempt to return the property to its owner. Others will find ways to use the unclaimed property, including filling holes in budgets, despite maintaining responsibility for repayment should an owner eventually come forward with a claim.

But before states can take control, companies in possession of escheatable property have due-diligence responsibilities that can vary based on the rules of each state and the type of abandoned property in their possession.

How property becomes “unclaimed”

The National Association of Unclaimed Property Administrators defines abandoned property as “property or accounts within financial institutions or companies in which there has been no activity generated (or contact with the owner) regarding the property for one year or a longer period.” Typically, that activity must be owner-initiated.

A bank can have abandoned property in the form of old checking accounts, savings accounts, or physical items left in safety deposit boxes. An investment firm can have long-forgotten stocks or bonds. A store or restaurant could have unused gift cards or uncashed employee paychecks. Doctor offices might end up with overpayments due to their patients, and utility companies could have security deposits that were never returned to long-lost former customers.

Determining dormancy periods

In each case, these abandoned properties are considered unclaimed and therefore escheatable after a designated period, called a dormancy period. The timing can differ for different types of property. For example, an employee’s paycheck might be considered dormant just one year after the date payable. Employees are expected to cash their paychecks soon after they are issued, but it is not unusual for a savings account to be inactive for more extended periods of time. Those accounts might not be designated dormant for five or seven years. Dormant periods for vendor payments are predominately three or five years, although some states consider these exempt from escheatment. Similarly, dividends usually become dormant after three or five years.

A valuable resource for determining dormancy periods by state and type is available at the National Association of Unclaimed Property Administrators website.

According to a December 2020 report by Sovos, it is becoming increasingly difficult to keep track of dormancy periods as state laws are changing at a rapid pace:

A growing trend in recent years has been the reduction of unclaimed property dormancy periods. Many states have reduced their dormancy periods for a variety of property types, most are reducing their dormancy period from five years to three years on selected property types. Over a 16-year period, 17 jurisdictions reduced their dormancy periods for banking properties to three years, from either five or seven years.

These ever-changing laws make compliance a moving target for even the most conscientious companies. The 2020 Sovos report demonstrates how a holder’s failure to fulfill its duty to keep up with state laws can lead to a variety of consequences:

Reporting a property too early may result in an upset customer, employee, shareholder, or investor. It can also result in asset liquidation by the state and the holder’s loss of indemnification by the state. Reporting IRA accounts too early can significantly impact a persons’ retirement planning. On the opposite end of the spectrum, reporting unclaimed property too late will likely result in costly fines and penalties from the state. In addition to passing reporting deadlines, it may also land your company on the state’s radar for an audit.

Companies without systems in place to identify escheatable property are most at risk for audit. To determine liability, it is essential to communicate with all departments to review outstanding checks for employees, customers, and vendors. Companies relying on third-party agents for functions such as payroll need to remember they are still responsible for unclaimed property in a vendor’s possession.

The process of due diligence

After identifying the property classification and associated dormancy period but before reporting and remitting unclaimed property to the state, consumer protection laws require companies to perform due diligence in an attempt to return the property to the owner. At a minimum, if the property’s value is $50 or more, this means sending a letter to the owner’s last known address between 120 and 60 days before reporting to the state. Some states make it mandatory to send the letter through certified mail, but most require only first-class mail.

During a 2018 presentation at Austin Peay University, Tennessee Unclaimed Property Director John Gabriel admitted states are far more likely to reunite owners with their long-lost property than companies are with mailings to old addresses listed in their files. Even if the shot-in-the-dark letter reaches its target, there’s still the chance it will be misidentified as junk mail and tossed into the bin.

States with a sincere interest in returning unclaimed property have more resources at their disposal, such as cross-referencing with databases of all of their agencies in an attempt to discover more accurate addresses.

Unclaimed property in the courts and the challenges of determining jurisdiction

Whether or not states are effective in dealing with unclaimed property, companies still have the responsibility to escheat once due diligence has been performed. For nearly 60 years since the Supreme Court’s ruling in Texas vs. New Jersey (379 U.S. 674 (1965)), companies could mostly rely on Priority Rule in determining to which state they should escheat. That means remitting to the state of the owner’s last known address, and, if no address is available, to the state where the holder is incorporated. That often means Delaware, considering more companies are incorporated in that state than any other, including 65 percent of all Fortune 500 companies.

Court battles between states to determine jurisdiction to source unclaimed property have become the norm in recent years. Delaware happens to be named in the two original jurisdiction cases (Delaware v. Pennsylvania and Wisconsin and Arkansas v. Delaware) scheduled to be heard by the U.S. Supreme Court on October 3, the first day of the 2022 Fall term.

As Marcia Coyle of Law.com reported on August 17, 2022, the first unclaimed property case to go before the Supreme Court in 30 years is unlikely to qualify for dinner-table discussions, “but for Delaware, the 30 states opposing it, and members of the financial community, the roughly $150 million at stake push it to the top of their list in terms of importance.”

Delaware is challenging the recommendations of Senior Judge Pierre N. Leval of the Second Circuit, a special master appointed by the Supreme Court in 2017, who found against the state’s claim to abandoned MoneyGram checks.

Coyle quotes attorney Michael Lurie of Reed Smith, who explains how the case demonstrates unclaimed property’s increased importance for states like Delaware and Connecticut since the Supreme Court last made a ruling on the topic in 1993 (Delaware v. New York, 507 U.S. 490 (1993))

“Since then, this has really grown,” Lurie told Coyle. “Now, for Delaware, it’s the state’s third-largest source of revenue,” and returning $150 million or more would be a significant blow to the state’s budget.

Jordan Goodman, a partner at HMB Legal Counsel’s State and Local Tax (SALT) Group, is quoted in a February 24, 2022 Law.com article by Maria Koklanaris as suggesting the Court should revisit the original 1965 Texas v. New Jersey case that established priority rules for unclaimed property. Goodman argued, “priority rules that place the funds with the holder’s state of incorporation in absence of a last known address are not enough when other information is known.”

With the cases set to be heard by the Court in October, “Pennsylvania says, wait a minute, we know because we deal with MoneyGram that they write X amount of money in MoneyGram checks, you can trace those and they were purchased in Pennsylvania,” Goodman told Law.com. “Can’t we use the place of purchase and we then get millions of dollars?”