Minimizing Your Companys Escheatment Exposure: Three Questions to Ask When Developing Procedures to Minimize Your Unclaimed Property Liabilities

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Minimizing Your Company's Escheatment Exposure: Three Questions to Ask When Developing Procedures to Minimize Your Unclaimed Property Liabilities

By Karen Anderson

Is your credit department next? You may not realize it, but increasingly, A/R portfolios are the targets of "unclaimed property" audits by states seeking to find out if you have old, unused credit memos on the books. Recent news reports have detailed astonishing liabilities owed as a result of these audits.

These increasingly likely audits should serve as a wake-up call for corporate credit professionals. While state unclaimed property officials and their third-party audit agents may have overlooked accounts receivable in the past, the money they can find in A/R portfolios has gotten their attention, and they are now actively pursuing customer credits as reportable unclaimed property.

In addition, since customer credits have been a neglected item in the past, the liability for penalties and interest for failure to timely report and remit this property may be significant, as penalties and interest are most often calculated based on the time between when the funds should have been reported and when they are actually reported.

Ultimately, the liability for past-due escheatable credits and corresponding penalties could cause an understatement of liabilities that is material enough to trigger Sarbanes Oxley Act (SOX) consequences.

Which Credit Transactions Qualify?
Not sure whether your company would have a liability for unclaimed property? Consider the following scenarios:

Scenario A:
Your company delivers products to customer XYZ, who later notifies you that some of the products are defective or spoiled. You instruct the customer to destroy the defective or spoiled product and issue the customer a credit for the value of the spoiled goods. Further, you notify customer XYZ that they must take the credit on future orders and the credit is only valid for 90 days.

If the customer does not take the credit or does not take the credit within the specified period, could the credit be reportable unclaimed property subject to state escheat law?

Scenario B:
Your company has a discount policy for prompt payment, whereby a credit memo equal to a percentage of the current invoice is created for use against future orders.

If the customer pays promptly on a current order but does not take the credit on a future order, could the credit be reportable unclaimed property subject to state escheat laws?

The answers to the questions posed in both scenarios A and B are yes - these credits may be considered reportable unclaimed property subject to the due diligence and reporting and remitting requirements of state unclaimed property laws.

Four Most Common Causes
The most common causes of unclaimed property found in accounts receivable are credits that occur when there are:

duplicate payments
credits issued for returns or other reasons
payments received for which no receivable can be identified (unapplied cash or cash on account)
rebates issued as a part of a company rebate program

State Unclaimed Property Law Requirements
Every state, as well as several jurisdictions, such as Guam and Puerto Rico, has an unclaimed property law. Most of these laws require that you make a last ditch attempt to contact the unclaimed property's owner (this is known as "statutory due diligence") and then that the property be reported and remitted to the state after the running of a specified period of time called a "dormancy period". (The common dormancy period for customer credits is three years or five years from the date of issue, depending upon the particular state to which it must be reported.)

Which State Gets the Money?
In 1965, the United States Supreme Court (Texas v. New Jersey) decided that unclaimed property obligations must be reported and remitted to the state of the last known address of the owner (the entity to which the credit is owed) in your records. This means that due diligence and reporting obligations are NOT dependent upon whether or not your company does business or is licensed to do business in a particular state. It is the last known address of your customer ("the owner") that controls where and how unclaimed property is reported and remitted.

Unclaimed Property Resources
A solid Unclaimed Property (Escheatment) Policy is essential for credit execs today, as states are increasingly seeking alternative methods to bridge their revenue gaps.

Check out Credit Today's articles, resources, and templates to help you put together an Unclaimed Property Policy customized for your company.
Credit Today's Unclaimed Property Portal

Minimizing or Mitigating Liability: Three Questions
Successfully complying with state escheatment laws requires both current information and thoughtful policies and procedures. Because state laws change frequently, information about the requirements of state escheatment laws and reporting specifications is key. Having a credible source for this information is important to maintaining compliance.

And it's even more important to create a procedure whereby credits are reviewed if they are not taken after a specified period of time (i.e., 60 days) as such a procedure may significantly reduce the number of outstanding credits. Three levels of analysis should be made a part of this procedure:

Is the credit really owed?
Is the owner really "lost"?
Is the credit exempt from reporting?

Credit Owed?
You don't want to send state governments money if its not required. So it's important to determine if outstanding credits are really owed. As part of that exercise, you should be able to answer the following questions:

Is the credit valid?
Has the credit already been taken by a customer?
Does the credit represent a true obligation? For example, was the credit offered for promotional/marketing reasons or for goodwill purposes?
Is there an offset that can be made?

Sometimes, a credit is recorded as a result of inaccurate record keeping. In other instances the customer may have taken the credit but it was applied improperly, leaving the original credit on the books. If the credit in question is a duplicate or was actually used by the customer, it is not reportable. Evidence of the duplicate credit or use of the credit should be kept in order to prove that it was an accounting error in case of a future state unclaimed property audit.

In addition, some credits are issued to customers for marketing or promotional/goodwill purposes and do not result from the exchange of goods or services. These purely gratuitous credits are usually not considered to be unclaimed property and would not be reportable. Again, evidence of the nature of this credit should be kept so that it does not become an issue during a future state unclaimed property audit.

Finally, you may be able to offset the credit balances against an open invoice. This may prevent the credit balance or memo from being reportable unclaimed property. You should ask the following questions when considering the possibility of offset:

Does the customer have invoices outstanding to which the credit can be applied?
Have we previously written off invoices to which the credit can apply?
Is the customer with the credit also a vendor with a debit balance in accounts payable?

Because it may be very labor intensive to perform the research necessary to determine the validity of a credit, you should, of course, consider the materiality of the credit(s) and the relationship your company has with the customer before initiating the research.

Owner Lost?
With regard to the second level of analysis, whether or not the owner is really "lost", it is important to consider if there has been recent contact with the customer that would indicate if the customer or client has knowledge of the credit. There may be situations when mailings to the customer ("owner") have been sent, but have not been returned by the post office as undeliverable.

One might argue that the owner has received notice about the credit but has chosen not to take any action. Unfortunately, most state unclaimed property officials do not interpret unclaimed property laws in this manner; therefore, they do not consider non-return of mail as contact that would forestall the running of a dormancy period.

To be proactive, if you have unused credits, you should incorporate a procedure for establishing "contact" with the customer or client to which a credit is owed. Correspondence can be sent or a telephone call made to the client, customer or vendor, informing them of the credit and requesting that they respond to acknowledge the credit. If they acknowledge the credit and this acknowledgement is in writing, the state unclaimed property laws would not be applicable. However, if, after your notification, your customer fails to use the credit for a period equal to the applicable dormancy period, it again becomes subject to the reporting and remitting requirements of the state unclaimed property laws.

Most likely, the correspondence or telephone call will cause the customer to take the credit or request that a check be issued. The customer may also indicate that the credit is not owed. In any of those scenarios, as long as there is documented evidence of their response or use of the credit, the item would no longer be considered unclaimed property subject to the reporting and remitting requirements of state unclaimed property laws.

B2B Exemption?
Some state's unclaimed property laws exempt particular credit-related items from reporting and remitting. In general, these laws apply to credit memos. Some also apply to credit balances and a few apply to vendor checks as well. Commonly, these exemptions are called the "Business-to-Business" or "B2B" exemptions.

Unfortunately, the criteria for applying the exemptions are not uniform from state to state. In some states, you must have an ongoing business relationship with the customer that has a credit. A few of the exemptions are retroactive while others are prospective from a particular date. Some of the exemptions require you to keep the credit on your books indefinitely. Finally, note that these exemptions generally do not apply to financial institutions or insurance companies.

Conclusion
Careful planning that includes thoughtful policies and procedures can significantly reduce the number of credits that become escheatable unclaimed property. Minimizing the number of unclaimed property isssues also builds stronger customer relationships through better communication and may forestall state-imposed penalties and interest and possible SOX consequences.

Karen Anderson was vice president at Unclaimed Property Recovery and Reporting (UPRR) when she initially wrote this. She is currently Senior Compliance Advisor with Abandoned Property Services, LLC, and can be reached at 317-577-9530 or via email at Kanderson@apsescheat.net.