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Unclaimed Property Audit Strategies: Responding to Latest DevelopmentsSharpening Compliance and Planning as States Aggressively Pursue Additional Revenue

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

THURSDAY, JANUARY 12, 2012

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

Jennifer Zimmerman Horwood Marcus & Berk ChicagoJennifer Zimmerman, Horwood Marcus & Berk, Chicago

Sonia Walwyn, Vice President, Unclaimed Property, Duff & Phelps, Chicago

David Hopkinson, CEO, Abandoned Property Experts, East Lansing, Mich.

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Unclaimed Property Audit Strategies: R di t L t t D l t Responding to Latest Developments Seminar

Jan. 12, 2012

Sonia Walwyn, Duff & [email protected]

Jennifer Zimmerman, Horwood Marcus & [email protected]

David Hopkinson, Abandoned Property Experts [email protected]

Today’s Program

K B kg d C t Slid 7 Slid 23Key Background Concepts[Jennifer Zimmerman]

Current Developments Of Note[Sonia Walwyn]

Slide 7 – Slide 23

Slide 24 – Slide 33[ y ]

Common Taxpayer Mistakes With Unclaimed Property[David Hopkinson]

Common Red Flags Drawing A State's Attention


Slide 40 – Slide 46Common Red Flags Drawing A State s Attention[David Hopkinson and Sonia Walwyn]

Auditor Tactics To Expect In Unclaimed Property Exams[Sonia Walwyn, Jennifer Zimmerman and David Hopkinson]

Sl de 0 Sl de 6


Best Practices For Taxpayers During The Audit[Jennifer Zimmerman]

Documentation Improvements To Consider Going Forward


Slide 70 – Slide 72Documentation Improvements To Consider Going Forward[David Hopkinson]

Slide 70 Slide 72

KEY BACKGROUND CONCEPTSJennifer Zimmerman, Horwood Marcus & Berk

KEY BACKGROUND CONCEPTS

Introduction

• Unclaimed property or escheat is currently one of the “hot topics.”

• Not really a tax• Not really a tax

• Difficult to distinguish from a tax when facing auditors who issue dl d t d lti t l d d i ifi t fendless record requests and ultimately demand significant sums of

money

The Pinnacle is Always Small 8

Introduction (Cont )Introduction (Cont.)• States have dramatically increased their audit activity.

– For fiscal 2012, the combined deficit for 42 states with budget , gshortfalls and the District of Columbia is expected to be $103 billion.

• Often, audits are conducted by contract auditors that will represent 20 to 30 states.

• Significant source of revenue without going to the well– State treasuries holding nearly $33 billion in 117 million accounts


Introduction (Cont )Introduction (Cont.)• Often, amounts claimed by states do not represent abandoned property.

• Credit balances arise as a result or errors or failure to reconcile accounts.

• Too often, companies are paying over amounts that have already been remitted to third parties but have been improperly reflected on the companies’ bookscompanies books.


Introduction (Cont )Introduction (Cont.)• Most states estimate that only 15 to 35% of companies are in full

licompliance .– Experts see the most vulnerable companies as those in the Fortune

1000 and those incorporated in or doing substantial business in the i h D l d C lif imost aggressive states, such as Delaware and California.

• Trend emerging that companies in full compliance on securities side, but not the general ledger side

• As a result of increase in audit activity, asking for more records y, gincluding shareholder records


Introduction (Cont )Introduction (Cont.)• Companies that are in the bad habit of writing off outstanding checks

di b l h ld d dor credit balances should adopt some new procedures.

• Get arms around all possible sources of unclaimed property, assess procedures and determine if a voluntary disclosure program might be a good option

• With unclaimed property subject to no statute of limitations, and states showing interest in estimating and extrapolating, the liabilities can become daunting.


Issues: DelawareIssues: Delaware• Third-largest revenue source for Delaware; brings in almost $500

million annuallymillion annually

• SB 272 amended 12 Del. Code Sect. 1155 to expressly authorize Delaware to use “reasonable” estimation techniques to determine theDelaware to use reasonable estimation techniques to determine the existence and amount of unclaimed property when the holder’s records are “insufficient” to permit preparation of a report.– May still challenge on constitutional grounds of manner used to– May still challenge on constitutional grounds of manner used to

estimate


Issues: Nexus??Issues: Nexus??• Nexus under Commerce Clause and Due Process Clause

– Again, not a tax

• Litigation?

• Who is the holder?

F d l i• Federal pre-emption – “National banks”– Bankruptcy– ERISA– Interstate transportation


Issues: Appeals

• No formal appeals process in most states– No mention in model acts

Litigation only recourse in many states– Litigation only recourse in many states– Delaware: Formal administrative appeals process, effective July

23, 2010 (12 Del. C. § 1158(b)-(k)


Issues: Uniformity

• 54 reporting jurisdictions (including District of Columbia, Puerto Rico, U.S. Virgin Islands and Guam)– No two jurisdictions sharing the exact same lawsNo two jurisdictions sharing the exact same laws– Presents challenges when it comes to reporting correctly,

especially with emerging law changes


Issues: Exemptions

• Most common exemptions– Business-to-business

De minimis– De minimis– Gift certificate or card– Industry specific


Business-To-Business Exemption

• Only 12 states have some type of B2B exemption.– Both holder’s and owner’s last known addresses must be

jurisdiction with B2B exemptionjurisdiction with B2B exemption– Applies to only certain types of property– Applies to only certain types of relationships

B f d t t hi h ti li– Be aware of dates to which exemption applies


De Minimis Exemption• Few states have de minimis exemptions. Examples include:

– KY, MI and OH: Payroll items valued at $50 or less– CO: Allows deduction of 2% of the property’s value or $25 per

item, depending upon the property type, p g p p p y yp– FL: Credit balance exemption having a value of less than $10


Gift Card Or Certificate ExemptionGift Card Or Certificate Exemption

• More than half of the states provide for this type of exemption, though slowly being eliminated – Exemptions vary dramatically; some apply to the entire value,

while others apply only to a portion.– Some exemptions apply only to cards or certificates with no

expiration dates.– Some exemptions only apply if issued by certain entities or after a p y pp y y

certain date.


Industry Specific ExemptionsIndustry Specific Exemptions

• Another common exemption, which is also slowly being eliminated. Some current exemptions: – KY: Money funds or other property held by certain 501(c)(3)

organizations– KY: Mineral royalties– NV: Unredeemed gaming chips and tokens


Issues: Emerging Trends• New property types

• Shortening dormancy periods

• Reporting deadlines becoming less uniform

i i d ll i h i d b i i i h• Earning interest on dollars in their custody, but not paying it without putting up a fight

• Increasing audit activity

• Increasing legislative activityg g y


Issues: Increased Audit ActivityIssues: Increased Audit Activity• Increases in number and in scope, as well as in the number of audit

firms conducting audits on behalf of the states

• Where most of the new property types are coming from

• With belt-tightening, states that have been historically lenient are now pursing interest and penalties for non-compliance.

• Increased activity for certain industries, securities and insurance companies


CURRENT DEVELOPMENTS OF Sonia Walwyn, Duff & Phelps

CURRENT DEVELOPMENTS OF NOTE

Pending LawsuitsDelaware• McKesson Corp. v. Thomas Cook (2009)

McKesson challenged GRIR as unclaimed property.– Dismissed August 2010Dismissed August 2010

• Staples Inc. v. Cook (2010)– Delaware demanded $3.1 million and interest of approximately $800,000.– State cites the lack of an appeal or refund process in Delaware as a basis for not payingState cites the lack of an appeal or refund process in Delaware as a basis for not paying

the assessment.– Challenges Delaware estimation techniques

» Presumes any check outstanding > 90 days to be unclaimed» Includes property not reportable to Delawarep p y p

– Case is ongoing.

New Jersey• American Express et al. v. Sidamon-Eristoff (2010)p ( )• (Third Circuit Court of Appeals Decision – Jan. 5, 2012)

– Retroactive enforcement– Place-of-purchase presumption– Data collection provisionp– Two-year abandonment period

25

Delaware’s Legislative Update• Delaware SB 272 (signed into Law in July 2010)

– Eliminates “GR/IR” or goods received not invoiced, from the definition unclaimed property.u c a ed p ope ty

– Statutorily authorizes Delaware’s use of estimation techniques– Establishes an administrative appeal process

• Delaware HB 229B (pending)– Statute of limitation for audits to be moved from 1981 to 1995 and for

VDA ( f 1991 t 2002)VDAs ( from 1991 to 2002)– Holders’ ultimate goal: A lookback period of 10 reporting years, as

opposed to the existing 30-plus years exercised by Delaware

26

Promotional Coupons Or Gift Certificates???p

• Groupon and LivingSocial– Discounted promotional coupon or gift certificate?– Application of the Gift Card Act– Application of states’ unclaimed property lawsApplication of states unclaimed property laws

» Who is the holder?» What is the reportable amount, if any?Class action suits– Class action suits

– States’ continual challenge to fit new property types, not previously contemplated by the acts, into the rules for abandonment

27

Insurance IndustryInsurance Industry• Verus Financial, LLC

– Authorized by 35-plus states to audit the industry– Audit methodology– Market conduct examinationsMarket conduct examinations

• Audit targets– Life and annuity companies, and

Property and casualty– Property and casualty• Property types targeted in these audits

– Annuities– Life policies and death claims– Retained asset accounts

28

Insurance Industry (Cont )Insurance Industry (Cont.)• John Hancock Insurance Co.

– California and Florida settlements in excess of $20 million

• Audit IssuesAudit Issues– Use of the Social Security Death Master File (SSDMF)– Life vs. annuity products by insurers

• Unclaimed property laws– Limiting age– Policy claims– Maturity date

29

Insurance Industry (Cont )Insurance Industry (Cont.)• New York administrator subpoena

• New York State Insurance Department: 308 letters

• Knowledge of death– Industry practice (notice and proof provided by claimant)

Is there a “new” standard looming for life and annuity property?– Is there a new” standard looming for life and annuity property?

30

Security-Related PropertySecurity-Related Property• Initially, states performed only securities-related audits (1980s).

– Transfer agents (TAs) were deemed compliant (1990s and early 2000s).

• Due to misdeeds of a few TAs, securities are once again included in state audit plans specifically from the state of Delawarestate audit plans, specifically from the state of Delaware.– Note: Prior Delaware VDA settlements excluded security-related

property.– Kelmar (Delaware third-party auditor) hired an expert in this area– Kelmar (Delaware third-party auditor) hired an expert in this area.

• Costs of defending a securities-related audit include:– Excessive fees charged by TAs to provide copies of reports and

other documentation to disprove a presumption of abandonmentother documentation to disprove a presumption of abandonment• Ensure that agreements with TAs expressly provide for copies of reports

annually, as well as indemnification for failure to fully comply with states unclaimed property laws

31

Security Related Property (Cont )Security-Related Property (Cont.)Debt- and securities-related property• Bond principal (matured/called)/bond interest• Cash for fractional shares• WarrantsWarrants• Dividends (cash, stock and liquidating), ADRs• Underlying shares

Un exchanged shares• Un-exchanged shares• Physical issue mutual fund shares• Dividend reinvestment plans• Employee stock purchase plans

32

Security-Related Property (Cont )Security-Related Property (Cont.)• Ensure that securities are defined in the scope of your audit at the

beginning. They should not be added at the end, once all other field work is concluded.

• Be knowledgeable of the unclaimed property policies, procedures and filing history of all TAs and other third-party administrators pertaining to debt and securities-related property.

33

COMMON TAXPAYER David Hopkinson, Abandoned Property Experts

MISTAKES WITH UNCLAIMED PROPERTYPROPERTY

Common Mistakes WithUnclaimed PropertyUnclaimed Property

A Id tif ll t tA. Identify all property types• Any type of payment still outstanding; e.g, paycheck,

vendor payment, refund• A t ith dit b l t• Any account with a credit balance; e.g., customer or

vendor account, deposits

B. Identify all proper jurisdictions that apply• Domicile and physical presence of parent company,

subsidiaries and affiliates• Domicile of employees and sales agents• Domicile and physical presence of vendors• Domicile of shareholders/owners (if applicable)

35APEXAbandoned Property Experts, LLC

Common Mistakes WithUnclaimed Property (Cont )Unclaimed Property (Cont.)

A T ki l i d t t iA.Taking unclaimed property to income

• All outstanding payment and account balance types are covered by statutescovered by statutes.

• Any property written off to income is proscribed.

• Considered “private escheat” by states and jurisdictions• Considered private escheat by states and jurisdictions

• Errors in accounting must be determined by due diligence mailing.g g

• Documentation of the mailing should be retained as support.



A.Obligations from third-party agents

• Created when you “fund” their account, and they issue “your” payments

• Payroll processor• Payroll processor

• Transfer agent (if applicable)

R f d b t f lfill t• Refund or rebate fulfillment processor

• Coupon fulfillment processor

• All varieties of payment processor

➡ You are the “holder.”



A.Inappropriate dormancy triggers

• Everything about unclaimed property varies by state.y g p p y y

• Dormancy also varies by property type.

• Dormancies are subject to changeDormancies are subject to change.

• Time frames for due diligence mailing relative to reporting are often defined.



A.Other common mistakes

• An absence of records ≠ absence of obligation to report.

• A non-cashed reissue payment does not re-set the meter.

• Due diligence must be in writing and by mail.

• Due diligence letter not RPO does not constitute contact

• No response to due diligence letter does not mean the money is not owed.

• Reporting all property to your state of domicile is not always p g p p y y yacceptable.

• B2B exemption is not a broadly defined panacea.


David Hopkinson, Abandoned Property Experts

COMMON RED FLAGS

David Hopkinson, Abandoned Property ExpertsSonia Walwyn, Duff & Phelps

DRAWING A STATE’S ATTENTIONATTENTION

Audit Triggers

• State of incorporation• Specific Industry or Issue• Mergers and acquisitions (successor liability)• Media event and publicityMedia event and publicity• Public company (debt- and security-related property)• Incomplete filing history

Transfer agent filing security related property but no filing of general• Transfer agent filing security-related property, but no filing of general ledger property

• Filing with state where the company is headquartered, in lieu of adherence to the priority rulesadherence to the priority rules

• Foreign-owned companies

41

Common Red Flags For StatesCommon Red Flags For States

A Where the company has physical or legalA. Where the company has physical or legal presence

• Domestic non-reporting entity (including negative report, p g y ( g g p ,if required)

• Any physical presence in state of an out-of-state entity

• Widely held, publicly traded entity

• Change of ownership or change of incorporation of domestic entity


C R d Fl F S (C )Common Red Flags For States (Cont.)

A Decentralized accounting or recordkeepingA. Decentralized accounting or recordkeeping

• Entity in industry known for decentralized accounting

• Pros and cons for audit selection

• Pros and cons for reporting process


Common Red Flags For States (Cont.)

A. Conducting business in many states, reporting to few

• Do states coordinate?

• How dependable is reciprocity?

• P d f ti• Pros and cons for reporting process


Common Red Flags For States (Cont.)A. Property types that generate large unclaimed

volumes

• Large transaction volumes generate large unclaimed volumes.

• Bad incentives generate large unclaimed volumes.

• Physical forms of payment generate large unclaimed volumes.

• High employee turnover generates large unclaimed volumes.

• Low-quality accounting generates large unclaimed volumes.

• OPM generates large unclaimed volumes.


Issues That ‘May’ Give Rise ToSignificant Audit FindingsSignificant Audit Findings

• Decentralization of a company’s books and records• System conversions• Practices of writing liabilities off to income, or reversing expenses• Failure to document and maintain documentation sufficient to disprove aFailure to document and maintain documentation sufficient to disprove a

presumption of abandonment• Failure to conduct due diligence and reserve for predecessor liabilities

associated with merged or acquired companiesassociated with merged or acquired companies• Failure to adequately determine in advance of an audit the years for

which researchable records are available• Failure to apply statutory exemptions and exclusions such as ERISA• Failure to apply statutory exemptions and exclusions such as ERISA.

46

Sonia Walwyn, Duff & PhelpsJennifer Zimmerman, Horwood Marcus & Berk

AUDITOR TACTICS TO EXPECT

JDavid Hopkinson, Abandoned Property Experts

IN UNCLAIMED PROPERTY EXAMSEXAMS

What Can Auditors Review?

• Only abandoned property compliance

• Only years within statute• Only years within statute

• Only what they (including other audit firms working for the same t t ( )) h ’t l k d t i lstate(s)) haven’t looked at previously

• Only what exists in your records

• Only what the auditors request specifically


What Must Auditors Review?

• Addresses

• Any documents that establish defenses• Any documents that establish defenses

• Demonstration of compliance and effective policies and procedures


Types Of Auditors

• Third-party contingent fee auditors

• State auditors• State auditors

• Other state auditors, regulators, a.k.a. indirect auditors– Sales and use tax auditors– Other industry regulators; e.g., insurance, energy


Third-Party Auditors

N i id hi d di fi• Nationwide third-party audit firms– Specialty Audit Services (SAS)– Kelmar Associates, LLC (Kelmar)– ACS Unclaimed Property Clearinghouse (ACS)– Revenue Discovery Services (RDS)– Verus Financial LLC (Verus)Verus Financial, LLC (Verus)

• Some third-party audit firms offer voluntary disclosure services on behalf of the holder.


Third-Party Auditors (Cont.)

• Most states use third-party firms to audit unclaimed property compliance.

• Third-party firms typically perform an audit for a contingency fee, based on a percentage of the assessment.

• Incentive to make assessments as high as possible and to use aggressive estimation techniques



• Problems with contingent fee arrangements• Seen as violating due process and public policy• Encourages third party to “cherry pick” audit targets• Encourages third party to cherry pick audit targets• Ignore holder errors that would result in lower assessment• Excessive payments to auditors will reduce funds available to

d t l f downers and to general revenue fund.



• Even if state agreed to audit by third party, state may be “convinced” to change its mind.• Example: Taxpayer underwent two prior unclaimed property auditsExample: Taxpayer underwent two prior unclaimed property audits

by different a third-party firm. Both audits resulted in few adjustments.

• Contact states that participated in one or both prior auditsContact states that participated in one or both prior audits• Request them to reconsider participating in third “new audit”


State AuditorsState Auditors• Generally audit only on behalf of a single state• Not as aggressive as third-party auditors• More amenable to settle and resolve issues amicably• Objective is usually more educational in nature, with a goal of ensuring j y , g g

that the holder has the knowledge and process to comply prospectively.• More amenable to have the holder complete the review of its records

and provide findings to the auditor for reviewp g• Usually, budget is constrained, so not much time is spent on-site unless

the auditor uses the holder’s facility as an office.

55

Confidentiality Agreements• Should be considered for use in ALL audits• Should address each of the following:

– Scope of the audit (years and property types)– Limitation to the authorizing states as of the execution of the

agreement (participating states should be listed in an appendix)– Define what constitutes confidential information– Include express provisions for damages as a result of breach– Identify who is liable for breach (auditor state(s) or all)Identify who is liable for breach (auditor, state(s) or all)– Include industry specific limitations (HIPPA, etc.)

• Be knowledgeable of state limitations for contingent fee auditors (Illinois’ for example)(Illinois , for example) – Ask about fee arrangements with state(s) and request copy of the

auditor’s contract with the state(s) to verify their ability to audit in conformance with state specific prohibitionsconformance with state-specific prohibitions

56

BEST PRACTICES FOR Jennifer Zimmerman, Horwood Marcus & Berk

TAXPAYERS DURING THE AUDITAUDIT

Best Practices

• Standard of proof– Standard of proof on holder: Equivalent to criminal standard of

“beyond a reasonable doubt”beyond a reasonable doubt – Much higher standard than that of most litigated cases

(preponderance of the evidence)• Staples Inc v Delaware Department of Finance et al May 5• Staples Inc. v. Delaware Department of Finance et al., May 5,

2010; suit filed in Delaware Chancery Court against the Delaware Department of Finance, Division of Revenue


Best Practices (Cont.)

No prior reporting history– Perform an initial, high-level review of all potential unclaimed

property– Initiate voluntary disclosure agreements in jurisdictions where the

potential liability is high, in order to help abate interest and penaltiesE bli h li i d d f h li f i– Establish policies and procedures for the compliance function

– Begin annual compliance reporting



Prior reporting history– Review all current and prior reports to ensure items were not over-

reported– Build or buy system that enables organization to track property

from period it becomes outstanding until it is remitted to the states, or eliminated as reportable propertyE bli h li i d d f h li f i– Establish policies and procedures for the compliance function



Preparing for an audit– Determine the jurisdictional basis for the audit– Negotiate confidentiality agreement and establish scope of the g y g p

audit– Establish responsible parties in the company to assist with the audit– Perform your own high-level review of all potential unclaimed

property– Assess impact of systems conversions, acquisitions, availability to

adequately research prior years



Handling an audit– Set up a pre-audit interview between the auditor and the person

responsible for the audit – Manage the audit; communicate with the auditor on a regular basis– Discuss lack of records before commencement of the audit and

agree that any reasonable estimation techniques are to be agreed g y q gupon prior to their use in the audit



Handling an audit (Cont.)– Proactive use of statistical sampling– Be prepared to negotiateBe prepared to negotiate– Conduct an exit interview; obtain copies of all audit workpapers– Insist on a closing agreement; know what is and isn’t covered by

the agreement and save the document You may need it again inthe agreement, and save the document. You may need it again in the future.

– Most importantly, learn from the audit



• Understanding auditor’s expectations Auditors expect owner confirmations that an item of property is

not owed, in order for the property to be non-reportable.not owed, in order for the property to be non reportable.– What are your company’s systems capabilities for tracking

reasons for voids, duplicate credits, etc.?– Record retention policies ≠ research capabilitiesp ≠ p



• Understanding auditor’s expectations (cont.) Auditors expect significant records (i.e, bank reconciliations, A/R

aging reports, outstanding checklists). Holders are forced into an untenable position of proving the

negative.



• Audit mitigation strategies: Audit controversy can be minimized by: Clarifying “lookback” period as affected by past M&A activitiesClarifying lookback period as affected by past M&A activities

and prior VDAs Agreeing on a “base period” for each of the property types Agreeing to a sampling methodology by property type Agreeing to a sampling methodology by property type



• Audit mitigation strategies: Audit controversy can be minimized by: Agreeing on adequate remediation for potential items of reportableAgreeing on adequate remediation for potential items of reportable

property, including:• Voided checks• Stale dated tax payments or utility payments• Stale, dated tax payments or utility payments• Unapplied customer credits• Customer deposits• Consumer rebates



• Post-audit considerations – Get policies in place

Assign leaders in A/R A/P and credit departments– Assign leaders in A/R, A/P and credit departments– Tax function vs. bookkeeping – Stay informed– Participation in VDA or amnesty programs


Why Seek Voluntary Compliance?

• If accepted, the benefits include:– Limited look-back periods

Limited audit scope– Limited audit scope– Waiver of penalty in most cases– Waiver of interest in some cases– Closing letter security


DOCUMENTATION David Hopkinson, Abandoned Property Experts

IMPROVEMENTS TO CONSIDER GOING FORWARDCONSIDER GOING FORWARD

Improvements Going ForwardA. Accounting practicesg p

• Identify relevant property types and processes that generate them

• Review outstanding items at 9 months old

• Attempt to resolve at 12 months old

• Transition to electronic payments, to extent possible

• Avoid third-party paying agents, to extent practicalp y p y g g p

• Raise awareness among accounting/finance personnel


Improvements Going Forward (Cont.)A. Documentation improvementsp

• Develop internal policies and procedures document (central or by department)

• Develop and maintain a relevant dormancy matrix (central or by department)

• Develop and maintain a matrix of relevant states

• Retain documentation of due diligence mailings performedperformed

• Retain copies of reports filed and payments remitted


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