November 30, 2017 EY Webcast addressing the shifting unclaimed property compliance landscape, including significant Illinois legislative changes, available for replay Unclaimed property laws across the country have been going through rapid change in the past few years, with the latest significant changes coming in Illinois. In 2017, Illinois adopted the Revised Uniform Unclaimed Property Act (IL RUUPA) bringing with it substantial and potentially material statutory changes affecting holders of unclaimed property operating, or transacting business with customers and other businesses located, in Illinois. These statutory changes include the retroactive repeal of the business-to-business (B2B) exemption and the related requirement to report additional unclaimed property by the May or November 2018 reporting deadlines. Ernst & Young LLP (EY) recently hosted a webcast where the panelists discussed this ever-changing unclaimed property landscape and provided an overview of the major changes occurring nationwide. The webcast is now available for replay. Shifting unclaimed property landscape throughout the United States Unclaimed property represents a financial asset held by someone other than the owner that has gone unclaimed by the owner beyond a set period of time (i.e., the dormancy period).1 It is a property right rather than a tax, so there are no nexus or rate considerations, and where to file unclaimed property is based on priority rules established by US Supreme Court rulings and federal and state statutes rather than based solely upon a business's location or nexus. Property that remains unclaimed by its rightful owner after a period of time called the "dormancy period" becomes escheatable to a state by law. Under the US Supreme Court's priority rules, unclaimed property is reported first to the state of the last known address of the owner as set forth on the business's own books and records (known as the "first priority rule"). If the owner's last known address is unknown or if the address is located in a foreign country (generally), the priority rules hold that the unclaimed property is reported to the corporation's state of incorporation (second priority rule).2 "This is very impactful for the state of incorporation under a look back, because of this notion of estimation in periods where you might not have accounting records under an extensive look-back period," said Sarah Toi, EY Senior Manager based in Stamford, Connecticut. All 50 states, the District of Columbia, Puerto Rico, the Virgin Islands, and Guam have enacted their own unclaimed property statutes, and companies are required to file unclaimed property annually with each applicable jurisdiction. "This is an area where the states do enforce compliance through the use of third-party contingent-paid, fairly aggressive audit firms," Toi said. Costs of both compliance and non-compliance can be significant. "With respect to the overall unclaimed property landscape, both litigation and legislation have come together to create an environment of change, increased awareness, and robust audit activity," Toi said. For example, in 2016, a federal district court judge in Delaware found that the state's aggressive audit practices violated substantive due process ("shocked the conscience" in the words of the court), causing Delaware to enact legislation (SB 13) substantially overhauling its unclaimed property law and system.3 Through this legislation, Delaware largely adopted the recently Revised Uniform Unclaimed Property Act (RUUPA). Toi said this resulted in some holder wins, such as shortened lookback periods, records retention, and improvements and clarification of the applicable statutes of limitation, but extrapolation for unclaimed property purposes and how it is calculated has not changed. The implications of Delaware's developments extend to other states. For example, New York's unclaimed property administration announced in January 2017 that all voluntary disclosure agreements (VDAs) going forward would carry a 10-year lookback plus the applicable dormancy period (cutting off 10 years from the prior lookback). There also has been an uptick in third-party audit activity with the growth of third-party audit firms. "Many holders are facing audit even with a robust and well-documented filing history," Toi said. RUUPA is the basis of the unclaimed property laws of many states. After nearly 20 years, RUUPA was updated in 2016. The updated provisions: (1) clarify the property subject to the RUUPA; (2) offer guidance on when property is presumed abandoned and when states can escheat; (3) provide annual reporting requirements; (4) establish statutes of limitations; and (5) clarify audit procedures. The purpose of the update is to clarify property that is subject to the RUUPA, or more specifically to clarify exemptions, said Dave Bourgoin, EY Manager based in Dallas. Clarifications include: (1) express exemptions for game-related digital content, loyalty cards and 529A tuition plans; and (2) optional exemptions for gift cards and merchandise credits. It also clarifies that RUUPA does not propose a broad B2B exemption. RUUPA further clarifies that foreign property is not fully exempt. Foreign property is subject to the state of incorporation/second priority rule when the foreign country does not specifically exempt the property from its own unclaimed property law. "As you can imagine, this places a greater burden on the holder to keep apprised of the unclaimed property requirements, in not only US jurisdictions, but in other countries as well," Bourgoin said. In terms of annual reporting, RUUPA requires companies to retain the information included in the report and any information regarding the circumstances giving rise to the property right for 10 years. The aggregate reporting is suggested at an option of $50 and requires that owners be notified of potential escheatment (i.e., due diligence) at least 60-180 days before escheatment by first-class US mail. Illinois's modified enactment of this provision allows for notification to be made by email in certain circumstances. Illinois's enactment of RUUPA standardizes the statute of limitations to five years after the holder filed a non-fraudulent report or 10 years after the holder was required to file a report (if no report was filed or a fraudulent report was filed). Finally, from an audit perspective, Illinois's version of RUUPA allows state agencies to use contingent fee auditors, with restrictions on fees, and requires the state to promulgate rules for the method of exam, including a reasonable method of estimation allowed. Illinois's adoption of much of RUUPA makes it one of the first states to do so, setting the stage for other states to follow.4 Illinois's B2B exemption repeal and retroactive application States with B2B exemptions (there are about 15) allow businesses to settle contractual rights between each other, while states without B2B exemptions take custody of unclaimed property between businesses and hold it for the rightful owner to claim it. The application of a B2B exemption is state-specific based upon the address of the apparent owner/business, and these exemptions can significantly reduce a holder's unclaimed property liability. "At its core, it is an exemption from reporting, so there is no determination of whether an item is unclaimed property or is not unclaimed property, but merely that it does not need to be reported to the state if that state has a B2B exemption," said Aurianne Lopatka, an EY Senior Manager based in Boston. The exemptions can take several forms, including a blanket exemption from reporting any property transacted between businesses in the ordinary course of business, credit balance exemptions, or current business relationship exemptions. Illinois's RUUPA (IL RUUPA) is the first comprehensive rewrite of Illinois's unclaimed property statute since 1961 and takes effect on January 1, 2018. It was enacted this summer over the governor's veto as part of the state's budget, and it is largely based on the RUUPA with some modifications. The retroactive repeal of the B2B exemption means that B2B property will be reported and remitted for the first time in 2018 under the following 2018 filing deadlines: 1) May 1, 2018 for certain businesses, utilities and life insurance; and 2) November 1, 2018 for financial institutions, banks and other insurance companies. B2B property refers to property due to businesses with an Illinois address, not businesses simply located in Illinois. Illinois is imposing a five-year retroactivity period, plus the revised three-year dormancy period for accounts payable and accounts receivable property types — essentially an eight-year lookback for the retroactive B2B exemption repeal. Due diligence is required for previously exempt property and, under IL RUUPA, the state is only allowed to use estimation in an examination as a penalty for failure to maintain records. Proposed rules are expected to be filed before January 1, 2018. "This [Illinois's retroactive repeal of its B2B exemption] is an area of concern for a lot of corporations," Lopatka said. Change in dormancy period and the resulting "catch-up" reporting requirement The dormancy period change from five years to three years for most Illinois property types means that the 2018 report will include three total years of property as a "catch up" for the change in dormancy period versus a typical one-year filing. For governmental agencies required to report unclaimed property under IL RUUPA, the dormancy period changed from seven years to three years (a five-year "catch up"). However, the following dormancy periods have not changed: payroll (one year), traveler's checks (15 years), money orders (seven years), tangible property in a safe deposit box (five years) and stored value cards (five years). Due diligence requirements IL RUUPA requires holders to notify apparent owners of unclaimed property no less than 60 days and no more than one year before a report is filed, and in some situations allows due diligence notices to be transmitted to the owners by email. The general threshold triggering due diligence mailing requirements increased to $50 (from $10). For securities, holders must notify owners of property with a value of $1,000 or more, and the due diligence notice must be provided 60 days or more before filing a report. Leading due diligence practices include: (1) designating key contacts to lead research efforts within each applicable business unit; (2) identifying, researching, and resolving large dollar items before compliance requirements; (3) tracking evidence of customer contact across the organization to avoid escheating active customer funds; (4) sending correspondence to payees in advance of state-mandated due diligence letters; (5) using third-party resources to assist with locating owners; and (6) tracking and processing owner responses. "Leading practices usually begin much earlier in the process than when the property actually becomes dormant," Bourgoin said. Practical application of Illinois law changes Toi said that, in a technical bill trailer (S.B. 868, which has passed both houses of the Illinois legislature as of November 8 and is expected to be signed by the governor), the Illinois legislature would clarify and correct the definitions of "gift card" and "stored value card" as set forth in the IL RUUPA. Consistent with prior Illinois law, gift cards (including certificates) are exempt from Illinois reporting, provided that they do not charge dormancy or service fees, do not expire, and cannot be monetized except where required by law, and they do not make reference to being redeemable at an affiliated group of merchants. However, if any of the required characteristics of a gift card are absent, the card would be considered a stored value card, which is a general purpose reloadable card the funds of which are escheatable after five years. Other highlights include the record retention requirement and clarification of the statute of limitations, which are 10 years plus dormancy. Additionally, IL RUUPA updates provisions for "indication of interest" in property that includes an oral communication by the apparent owner to the holder if the holder contemporaneously makes and preserves a record of oral communication. "As you might imagine, the level of accounting records maintained in that case is of utmost importance, and is a best practice for audit preparedness," Toi said. For more information on this legislation, see Tax Alert 2017-1971. For compliance with the new provisions, Lopatka said the identification and quantification of previously exempt amounts possibly taken into income under the B2B exemption is going to be the challenge — especially regarding what detail is still available and how far back it is available. Completing due diligence mailings on that property will also be important. "As states continue to adopt the Uniform Law Commission's RUUPA in whole or in part, holders should be attentive to these changes in filing methods, such as exemptions dormancy periods, dormancy triggers and due diligence requirements," Lopatka said. "We expect contract auditors to look for timely compliance with these law changes when they're completing unclaimed property audits." For May filers, January and February will be the time to assess records, identify prior B2B exemptions taken in Illinois, quantify those exemptions, and research or send due diligence letters. All due diligence letters must be sent by February to meet the 60-day minimum guidelines. In preparation for sending due diligence correspondence by March 1, 2018 and filing by May 1, 2018, holders should collect and review all records that may have been potentially removed from reporting due to the B2B exemption with a look-back of eight years. Sources to review and analyze include: previous years' unclaimed property obligations and changes; transactional general ledger data, journal entries and potential write-offs; and different sources generating unclaimed property, including Enterprise Resource Planning systems, databases, and subaccounts. Conclusion The panelists offered holders guidance for considerations based on where they are in the compliance life cycle. Those who have never filed should consider what types of unclaimed property exist in their organizations and where the states of incorporation are, and they should assess potential unclaimed property exposure before filing and developing a remediation plan. Those who are partially in compliance should assess their current policies and procedures and consider possible voluntary disclosure agreements, where applicable, and enhance their processes. Finally, holders that are fully compliant could consider how they are keeping up with legislative changes, dormancy changes, and due diligence letter requirements, and how their compliance processes can be further automated. "It [the annual compliance process] really does start and end with accounting procedures, and creating that audit trail," Toi said. ———————————————
——————————————— 1 It often includes items such as uncashed payroll checks; uncashed vendor, supplier, and accounts payable checks; aged accounts receivable credit balances; unredeemed matured life insurance policies; unredeemed gift cards; uncashed dividend checks; and lost shareholders or shares, among other property. 2 Texas v. New Jersey, 379 U.S. 674 (1965); Delaware v. New York, 507 U.S. 490 (1993). 3 Temple Inland, Inc. v. Cook, 192 F. Supp. 3d 527 (D. Del. June 28, 2016). 4 Delaware, Illinois, Tennessee, and Utah have adopted significant parts of RUUPA so far. Several other states proposed, but did not enact, RUUPA provisions during the 2017 legislative sessions. | |||||||||
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