Radical Changes Coming to Illinois Unclaimed Property Reporting

This article was originally published in Tax Notes on November 27, 2017.
 
Accounting, tax, and legal professionals historically have paid little attention to unclaimed property matters for Illinois-based companies given the broad business-to-business (B2B) exemptions and lenient enforcement practices. With the enactment of S.B. 9 on July 6, corporate America faces a significant challenge potentially rivaling that historically presented by Delaware. The new law, which goes into effect January 1, 2018, makes many changes designed to increase escheat revenues, including:

• reducing dormancy periods;
• increasing statute of limitation and record retention requirements;
• permitting specified exemptions while eliminating B2B exemptions;
• a five-year transitional provision requiring retroactive application;
• estimation and extrapolation of liabilities;
• a new penalty and interest regime;
• new administrative procedures; and
• contingent fee auditor provisions.

These changes raise significant accounting and legal questions and exposure for holders to consider. Illinois-based holders and those conducting significant business in the state must prepare to ensure historical and prospective compliance.

 

Unclaimed Property Basics

All states have laws regulating the reporting and remittance of unclaimed property. Also referred to as abandoned property or escheat, unclaimed property concerns the requirement that a company holding such property (the holder or debtor) report it to the appropriate state after a statutory dormancy period has passed. The purpose of unclaimed property laws is to ensure that property is returned to its rightful owner — rather than retained by the debtor — and to permit the public to benefit from the use of those funds until the true owner can be found.

Unclaimed property may include some types of intangible property, as well as some tangible personal property, depending on state law. Common types of intangible unclaimed property include uncashed checks for obligations, such as payroll, commissions, voided checks (for example, 90-day cutoff period), non-ERISA self-funded benefit plans, and purchases, as well as unredeemed gift certificates and gift cards, customer credits, layaways, deposits, refunds, rebates, and accounts receivable credits, regardless whether they remain on a company’s books or were written off to income or expense, such as bad debt. See Table 1 below for Illinois property types and related dormancy periods.

 

Unclaimed Property Dormancy Periods

Property Type	Dormancy Period (years)	Comments
Accounts receivable credit	3
Payroll	1
Accounts payable	3
Securities	N/A	See section addressing securities.
Traveler’s check	15
Money order	7
State or municipal bearer or original issue discount bond	3	Years after the earliest of the date the bond matures, is called, or the obligation to pay the principle arises.
Debt of a business association	3	Years after obligation to pay arises.
Demand, savings, or time deposit	3	Years after the later of maturity or the date of last indication of interest in property by the apparent owner, except for a deposit that is automatically renewable, or after the initial date of maturity unless apparent owner consented in a record on file with the holder to renewal at or about the time of renewal.
Safe deposit box	5	Years after the expiration of the lease or rental period of the box.
Deposit or refund owed by a utility	1	Year after the deposit or refund becomes payable.
All other property	3	Years after the owner first has a right to demand the property or the obligation to pay or distribute the property arises.

 

Unclaimed property laws in the United States are custodial statutes — that is, the state takes custody of the property, but title remains with the owner. The determination of which state has jurisdiction over unclaimed property is dictated by priority rules established by the U.S. Supreme Court in Texas v. New Jersey,¹ and affirmed and explained in Delaware v. New York.² The escheat analysis is a three-step process beginning with a determination of the precise debtor/creditor relationship. Once that is done, the state of the rightful owner’s last known address as shown on the debtor’s books and records is given first priority. If the debtor’s records do not contain an owner’s address, the state of the debtor’s incorporation or the state of commercial domicile for an unincorporated entity has jurisdiction over the unclaimed property.

Over the past decade, states have actively enforced their unclaimed property laws through audits conducted by either state representatives or, more commonly, through third-party auditors that are paid on a contingent fee basis and audit for multiple states at once. Making matters worse, the audit lookback period often times are 15 years. The combination of the length of the audit period, a lack of available records, and a lack of what an auditor may deem “sufficient support” often leads to an unexpected estimated assessment well in excess of what a company believes it owes and has reserved for accounting purposes. As a result, some holders have filed suit seeking relief from state unclaimed property enforcement. Is similar litigation inevitable in Illinois as a result of the new law?

 

Shortened Dormancy Periods

Generally, the Illinois Revised Uniform Unclaimed Property Act (IRUUPA) changes the dormancy periods from five years to three years for most property types. See Table 1 above.

 

When Securities Are Dormant

Under the new law, securities will generally incorporate a returned post office (RPO) and inactivity standard. An RPO standard means that mail is returned by the U.S. Postal Service as nondeliverable. Securities are now presumed abandoned at the earliest of three years after the first RPO or five years after the owner’s last indication of interest in the security. There are two general exceptions to this rule.

First, if the holder does not send annual communications to the apparent owner by mail to confirm his interest in a security, then the holder must send an e-mail within three years after last indication of interest in the property. If a holder does not have the apparent owner’s email, or receives notification that the e-mail was not received by the apparent owner, or receives no response to an e-mail within 30 days after it was sent, then the holder must reach out via first-class U.S. mail and the security is presumed abandoned five years after the owner’s last indication of interest in it.

Second, a holder that receives notification that the owner of a security has died is required to attempt to confirm within 90 days of learning of the death whether the owner is in fact deceased. If the death is confirmed, the security is presumed abandoned two years after the date of the owner’s death.
Indication of an apparent owner’s interest generally includes:

• written record sent by the apparent owner to the holder or its agent;
• verbal record of owner communication contemporaneously memorialized by the holder or agent;
• check presentment, or claimed dividend, interest payment or other distribution;
• account activity;
• account deposit or withdrawal; or
• insurance policy premium payment.

 

Revised Statute of Limitations and Record Retention Requirement

The new law lengthens the statute of limitations for enforcement of the act. Prior to the change, the law stated that “the State Treasurer shall issue a Notice of Deficiency to a holder or direct the commencement of an examination of a holder with respect to a report required under this Act within 5 years after the report is filed.”³ Thus the statute of limitations is triggered only by the filing of a report. The new statute of limitations bars an “action or proceeding” to enforce the act “more than 10 years after the holder specifically identified the property in a report filed . . . or gave express notice to the administrator of a dispute regarding the property.”⁴ Therefore, the new limitations period is 10 years, but only as to property specifically identified in a report. The new law provides that “in the absence of such a report or other express notice, the period of limitation is tolled.”⁵

The record retention requirement, however, has the effect of creating a limitations period for holders that did not file a report. Under the new law, a holder must retain “records for 10 years after the later of the date the report was filed or the last date a timely report was due to be filed.”⁶ Adding the three-year dormancy period to the 10 years of retention results in a 13-year document retention requirement that effectively acts as a statute of limitations. This is shorter than under current law, which provides that “property records for the period required for presumptive abandonment plus the 9 years immediately preceding the beginning of that period shall be retained for 5 years after the property was reportable.”⁷ Because the dormancy period previously was five years, the effective record retention period was 19 years (5 + 9 + 5). This is true even though administratively the state generally imposed a 14-year lookback period on audits and voluntary disclosure filings. The new law provides guidance on what records are to be retained, including:

• the date, place, and nature of the circumstances that gave rise to the property right;
• the amount or value of the property;
• the last address of the apparent owner, if known;
• sufficient records of items that were not reported as unclaimed, to allow examination to determine whether the holder has complied with the act; and
• if the holder sells, issues, or provides to others for sale or issue in this state traveler’s checks, money orders, or similar instruments, other than third-party bank checks, on which the holder is directly liable, a record of the instruments while they remain outstanding indicating the state and date of issue.⁸

In short, holders must retain bank statements, bank reconciliations, outstanding check lists, void/stop lists, accounts receivable agings, check registers, unclaimed property reports, settlement agreements, email support, and virtually every record used to record or write off an amount owed to a vendor or customer.

 

Unclaimed Property Audit Trap — Accounts Payable Example

The most significant risk for Illinois holders is that by complying with Illinois’s new 13-year record retention requirement, the holder may be able to avoid penalty extrapolation only to be stuck with high multistate liability instead, as outlined in the following hypothetical accounts payable example.

Assume that the unclaimed property holder is a C corporation incorporated in Illinois in 2000 and headquartered there. The holder has never filed any unclaimed property returns in any state and maintains accounting records for an average of seven years. In 2018 the holder is audited by Illinois and the auditor piggybacks 20 other states onto the audit. Finally, assume that the holder has accounts payable checks totaling $13 million — representing $1 million per year for the last 13 years — that are outstanding or voided after 90 days. The holder has a check register that maintains all this information, including payee name and addresses.

 

Accounts Payable Audit Analysis

Assume further that the Illinois auditor requests 13 years of accounts payable records (check registers, voids listings, etc.) and the holder provides a 13-year check register with full addresses.

• First Seven Years Complete and Researchable Address Property Books and Records Maintained — For the most recent seven years, for which the holder has complete records, the holder has a 95 percent remediation rate. For these years, the holder has unremediated items totaling $350,000 owed to various states ($1 million x 7 years x 5 percent = $350,000).
• Last Six Years Incomplete or Non-Researchable Address Property Books and Records Exist — However, the holder has a 30 percent remediation rate on transactions for the oldest six years. That results in $4.2 million in unclaimed property liability for those years ($1 million x 6 years x 70 percent = $4.2 million).

Total Escheat Liability – Liability in this hypothetical example should be based on address property records only (no extrapolation) as full records were provided for the entire 13-year lookback period. This would result in $350,000 (first 7 years) plus $4,200,000 (last 6 years) equaling a total exposure to all states of $4,550,000.

The large exposure is mostly due to 30 percent remediation rate, which is most likely evidence that the holder lacks the researchable records needed to remediate items and which are required by section 15-404 — that is, “sufficient records of items which were not reported unclaimed, to allow the examination to determine whether the holder has complied with the Act.” The holder then faces a dilemma: (1) argue that it should be subject to the estimation penalty for those years, rather than rely on those records to determine a liability (see discussion below); or (2) rely on those incomplete records and pay a $4.5 million liability, which likely is significantly overstated. The answer will depend on the methodology the administrators adopt to calculate an estimation penalty. Either way, under the new law, large multistate assessments may be inevitable.

 

Exemptions Permitted

The new law exempts gift cards, game-related digital content, loyalty cards, and in-store credits for returned merchandise.⁹ Gift cards are defined as prepaid commercial mobile radio services and stored value cards that meet various conditions, including that they may be increased in value and are only redeemable for merchandise, goods, or services upon presentation at a single merchant or an affiliated group of merchants. Given the specificity of the definition, the gift card exemption appears to include “closed loop” gift cards, but not “open loop” gift cards. Generally, an open loop card includes a credit card, debit card, or gift card that a consumer can use to make purchases anywhere that a card is generally accepted. An open loop card carries a major credit card company’s logo, such as Visa or American Express. A closed loop card includes store gift cards and store credit cards that can only be used at a single store or a small group of stores owned by the same company. Given the broad exemption under the old law, it is hopeful Illinois will apply the law to exempt both open loop and closed loop cards.¹⁰

 

Elimination of B2B Exemption

Prior to the new law, Illinois had the broadest form of B2B exemption. It exempted from the reporting requirement all unclaimed payments to a business association made in the ordinary course of business, as well as credits owed to customers that are business associations. The new law repealed the B2B exemption. Moreover, as discussed below, the repeal is retroactive.

The elimination of the B2B exemption is a drastic change. Unclaimed property laws were not created to protect businesses. The early unclaimed property statutes governed only banks and insurance companies, and were designed to protect and preserve property owned by individuals, such as bank deposits and life insurance proceeds. Because businesses usually engage in ongoing relationships with customers and vendors, and because they are motivated by profit, they are unlikely to overlook amounts owed to them. Further, businesses are unlikely to invest time and resources in tracking small credits or obligations, and thus abandon those amounts voluntarily. These amounts are not unclaimed, but rather willingly abandoned. It is inconsistent with unclaimed property rationale and policy for a state to take custody of these amounts with the purported purpose of reuniting the property with owners who willingly abandoned it and have no interest in reclaiming it.

 

Five-Year Transitional Rule

Section 15-1503(a) of the new Illinois law provides:

• An initial report filed under this Act for property that was not required to be reported before the effective date of this Act, but that is required to be reported under this Act, must include all items of property that would have been presumed abandoned during the 5-year period preceding the effective date of this Act as if this Act had been in effect during that period.

Therefore, even though property arising from, for example, a B2B transaction was not subject to reporting five years ago, a holder is now required to submit a report and turn that property over to Illinois. Presumably, the state believes the underlying obligation owed to the apparent owner (the customer or vendor) was never extinguished but rather only exempted from escheat reporting under the B2B exemption. Thus, the debt is still owed to the apparent owner unless some other defense would preclude the operation of escheatment. Even if there was such a defense, such as a contract statute of limitations, the state may invoke its anti-limitation provisions or the holding of no private escheat in Marshall Field as a defense against the same.

In addition, the new law was made part of a revenue-raising bill. Funds from remitted unclaimed property are required to be paid to fund Illinois’s materially underfunded pension obligations. Clearly, the intent of the B2B exemption repeal is to raise monies to pay down pension obligations and not to return property to its owners. As such, there is a question whether the retroactive application of the exemption repeal for property that already reached its dormancy period is even lawful.

 

Estimation and Extrapolation

The IRUUPA, like the current Illinois law, allows for estimation if a holder fails to retain the records for the period, in the form and with the content required. In these circumstances, the state treasurer is permitted to use a “reasonable method of estimation . . . including extrapolation and use of statistical sampling.”¹¹ However, while the prior statute purported to permit the state to estimate liability for unreported unclaimed property, new section 15-1006 provides that “a payment made based on estimation under this Section is a penalty for failure to maintain the records required by Section 15-404 and does not relieve a person from an obligation to report and deliver property to a State in which the holder is domiciled.”

This is significant for two reasons. First, because the estimate is a penalty, Illinois does not have to return any portion of the amount to any owners and can apply the funds towards Illinois’s pension fund shortfall. Therefore, this provision is strictly a revenue-generating provision without any intent to reunite property with its owners — the alleged purpose of unclaimed property laws. Second, the language indicates that holders incorporated outside Illinois may be subject to estimated liabilities from both Illinois and the holder’s state of incorporation. For example, if a holder incorporated in Delaware lacks records for 15 years, Delaware is authorized to estimate a liability for the years for which records do not exist.¹² Under Delaware regulations, that estimate may be calculated by extrapolating unclaimed property owed to all states combined regardless of the fact that much of it is escheatable to other states under the Supreme Court’s primary rule.13 Under Illinois law, an estimated liability is a penalty that can be assessed in addition to Delaware’s estimated liability. This results in multiple liability. The priority rules were established to avoid multiple liability because it violates constitutional due process, and as a result, Illinois’s new law could create a serious constitutional issue.

 

Penalties and Interest

The IRUUPA enacts various penalties and interest for failure to file, pay, or deliver unclaimed property, and for evasion and fraud as shown in Table 2 below.

Given the table and that the extrapolation penalty is for failure to hold records, it is unclear if the penalty would be waived in a voluntary disclosure setting. This could be an enormous benefit of the voluntary disclosure program if it does waive this penalty for holders. Most important is the question of whether these enhanced penalties can be lawfully applied retroactively without violating due process.

 

Unclaimed Property Penalties and Interest

Type of Interest/Penalty	Details	Discretionary Waiver	Citation
Interest for failure to report, pay, or deliver property	1% per month on the amount or value of the property, calculated from the date the property should have been reported	Yes, if the holder acted in good faith and without negligence	765 Ill. Comp. Stat. section 15-1204 (a) (interest) 765 Ill. Comp. Stat. section 15-1206 (a) (waiver)
Penalty for failure to report, pay, or deliver property	$200 per day for each day the failure occurred; maximum of $5,000	Yes, if the holder acted in good faith and without negligence	765 Ill. Comp. Stat. section 15-1204 (b) (penalty) 765 Ill. Comp. Stat. section 15-1206 (a) (waiver)
Penalty for failure to retain required records	State is permitted to use “reasonable method of estimation”	No	765 Ill. Comp. Stat. section 15-1006 (penalty)
Penalty for evasion of unclaimed property law	$1,000 per day that obligation is evaded or duty not performed, maximum of $25,000 plus 25% of the property that should have been reported	No	765 Ill. Comp. Stat. section 15-1205 (a) (penalty)
Fraudulent filing penalty	$1,000 per day from date of original report until corrected, maximum of $25,000 plus 25% of the property that should have been reported or was underreported	No	765 Ill. Comp. Stat. section 15-1205 (b) (penalty)

 

Administrative Procedures

The IRUUPA enacts administrative appeals procedures for challenging unclaimed property assessments.¹⁴ Generally, holders have two options to contest an escheat assessment or a notice of deficiency (NOD).

 

Option 1: Informal Conference¹⁵

Protest audit assessment to an Informal Conference Board (ICB). In the first step in option 1, a holder has 30 days after receiving a notice of determination of a liability to request an informal conference with the state treasurer. The administrator (state treasurer or his designee) schedules a conference within 30 days of the request. The administrator (state treasurer or his designee) is then required to issue a decision in a record within 30 days of the conference date. Interest and penalties continue to accrue during the pendency of the informal conference. The conference is not an administrative remedy and is not subject to the Illinois Administrative Procedures Act. Rather, it is informal and there is no testimony under oath and the rules of evidence do not apply.

Appeal the ICB decision to an administrative law judge hearing. In step 2, if the holder wants to appeal an informal conference decision, it has 90 days after receiving the ICB notice of decision or notice of determination of liability to pay on appeal. The appeal is treated as a contested case under the Illinois Administrative Procedure Act. A final decision in an administrative appeal proceeding is subject to judicial review.¹⁶

Appeal the ALJ case to the state circuit court. In step 3, a holder must file an appeal within 30 days of issuance of a final ALJ order. Any additional appeals would be to a state appellate court.

Option 2: Bypass Informal Conference

Protest the audit assessment under the Protest Monies Act. If the holder wants to appeal an audit NOD directly and forgo the ICB process, the holder has 90 days or whatever timing is designated in the NOD after receiving an NOD to appeal the determination and pay the liability under protest. This is an alternative to requesting a contested case to review the administrator’s decision.

File a complaint in circuit court. In step 2 of option 2, a holder must file a complaint within 30 days of payment under protest with the circuit court to get an injunction against the transfer of Monies Out of Protest Act. A complaint seeks to obtain an injunction to protect the payment of monies from transfer to another fund. This is a de novo proceeding. The payment stops the accrual of interest and earns interest until a final order is entered resolving the dispute. Any additional appeals would be to a state court of appeals.

 

Contingent Fee Auditors

The IRUUPA expressly authorizes the state treasurer to contract with third parties to perform audit examinations. The auditor may be paid on fixed fee, hourly fee, or a contingent fee basis. If a contingent fee arrangement is agreed to, the fee charged by the third party cannot exceed¹⁵ percent “of the amount or value of property paid or delivered as a result of the examination.”¹⁷ The use of a contingent fee auditor raises the question of whether the administrator’s decision to waive interest will be influenced by the desire to recoup fees being paid to the auditor. This effectively charges the holder for the auditor’s fees.

Regulations and Administrative Guidance - SB9 Section 15-1003 requires the Treasurer to promulgate rules and regulations governing procedures and standards for an examination. The rules may reference any standards concerning unclaimed property examinations promulgated by the National Association of Unclaimed Property Administrators and shall make provisions for multistate examinations. It is expected that these regulations will be published either later this year or into calendar 2018.

 

Conclusion

Unclaimed property affects all companies and audits are being aggressively pursued by states in their quest for additional revenue. Unclaimed property, in effect, is now viewed as similar to a tax because it generates revenue for the state, while lawmakers can avoid being blamed for raising taxes — something Illinois has been doing a lot lately. The abundance of third-party audit firms that work on a contingent fee basis allows states to expend little time and few resources in the pursuit of unclaimed property and makes unclaimed property even more appealing to states. While most companies will generate some type of unclaimed property, those located or incorporated in Illinois are potentially at a unique disadvantage given the new law. Accounting, tax, and legal professionals should be mindful of unclaimed property in their day-to-day activities and in their policies for record retention. Those with potential deficiencies in their monitoring of unclaimed property should consider a voluntary disclosure and other compliance options.

 

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¹379 U.S. 675 (1965).
²507 U.S. 490 (1993).
³765 ILCS section 1025/23.5(a).
⁴765 Ill. Comp. Stat. section 15-610(b).
⁵765 Ill. Comp. Stat. section 15-610(b).
⁶765 Ill. Comp. Stat. section 15-404.
⁷765 Ill. Comp. Stat. section 1025/11(h)(2).
⁸765 Ill. Comp. Stat. section 15-404.
⁹765 Ill. Comp. Stat. section 15-102(24)(C); 15-201(7).
¹⁰See generally House Amendment #2 to S.B. 868 (filed 11/1/2017). This is a technical corrections bill pending at the time of this writing that is expected to pass in the near future. The bill generally modifies certain definitions amongst other technical correction changes including deleting definition of “affiliated group of merchants,” adding “escheat fee”, removing “store value card” language and reference from definition of “gift card” and separately redefines “store value card”, addressing funeral policy benefits, payment of interest on saving deposits, time deposits, etc. As a result, it appears the technical corrections bill seeks to include open loop cards in the gift card exemption effective January 1, 2018.
¹¹See 765 Ill. Comp. Stat. section 1025/11.5 (repealed as of Jan. 1, 2018). Compare to 765 Ill. Comp. Stat. section 15-1006 (effective Jan. 1, 2018), which refers to estimation as a penalty.
¹²See 12 Del. Laws section 1176(a).
¹³See 1 Del. Reg. 10 01 1 Final, section 2.19.1. But see Temple-Inland Inc. v. Cook, 192 F. Supp.3d 527, 549 (D. Del. 2016) (holding that estimating a liability by extrapolating amounts owed to other states produces “significantly misleading results” based on an interpretation of the priority rules that goes to “troubling lengths”). Considering the Temple- Inland decision, it is questionable whether Delaware can lawfully assess an estimated liability based on extrapolation of amounts over which Delaware lacks escheat authority. Indeed, the court held that estimating a liability based on amounts escheatable to other states was an improper use of estimation. As such, that opinion also places into question whether an estimated penalty by Illinois would be upheld as a valid use of estimation if it is based on extrapolations of the same property.
¹⁴765 Ill. Comp. Stat. section 15-1101; 1102.
¹⁵765 Ill. Comp. Stat. section 15-1101.
¹⁶765 Ill. Comp. Stat. section 15-1102.
¹⁷765 Ill. Comp. Stat. section 15-1009.