While the states generally will not disclose how they choose the targets of upcoming unclaimed property audits, experience shows us certain trends that increase the likelihood of audits.
Incomplete Filing History: For one, companies with incomplete filing histories will often trigger audits. This could include filing in some years, while not in others. It could also involve filing only certain kinds of properties, but not others. For example, publicly traded corporations often have transfer agents to handle the maintenance of their stock records and handle dividends. Transfer agents often file abandoned dividends and shares on behalf of their client corporations, while the corporation ignores general ledger liabilities. As a result, states may initiate an audit of general ledger property.
Hint: States may also initiate audits if the situation is reversed, so it is important to discuss unclaimed property reporting with your transfer agent.
In addition to looking at unclaimed property filings, states will cross-reference sales and use, property, payroll, and income tax filings to determine companies that are not in full compliance. Even though unclaimed property liability is not determined by traditional nexus rules, those companies that have operations in a state are more likely to have unclaimed property in the state. Michigan recently sent letters to companies doing business in the state that have not filed unclaimed property reports, asking that they begin a compliance program. Presumably, if a company fails to respond to the letter, Michigan will initiate an unclaimed property audit in the near future.
State of Incorporation: Delaware reviews incorporation records to determine companies that are incorporated in Delaware but have not filed unclaimed property reports. If your company, including any subsidiaries or related companies, is incorporated in Delaware, your company is at a higher risk for unclaimed property audits. Delaware also uses contract audit firms, notably Kelmar Associates, which will leverage audit lists generated by Delaware to encourage other states to sign on to the audit.
Mergers and Acquisitions: A history of mergers and acquisitions often means a lack of records. As companies are absorbed into your company, often detail of accounts receivable balances and historic payroll and accounts payable ledgers are lost in the transition. Incomplete records are a boon to the state of incorporation, as they will use the absence to estimate the liability based on various extrapolation methods.
Industry: Certain industries are at a higher risk for audit than others. Recently, there have been large and public audits against life insurance companies, resulting in large unclaimed property liabilities and eventual settlements. Due to the recent regulatory actions, MetLife is also the subject of a new class action lawsuit by shareholders for improper disclosures and material misstatements on financial reports. In addition to life insurance companies, there has been an increase in audits against property and casualty insurance companies and continued action against rebate processors.
Some companies believe that accounts receivable credits are not reportable as unclaimed property. State auditors are aware of this position and will often target companies, such as manufacturers and distributors, that are likely to have large accounts receivable balances.
Media and Public Events: Has your company been in the news lately, whether for good or bad? Layoffs can mean that you lose track of former employees, many of which may miss cashing their last payroll checks. Financial restatements will lead to questions on the accuracy of other reports. Revenue and income windfalls or unexpected increases may lead to an audit to determine whether companies are obtaining the windfalls in impermissible ways. New programs, such as gift card or rebate programs, can lead to unclaimed property liabilities and thus audits.
Company Size: The larger your company, in revenue, employees, and customers, the greater the risk of audit. Simple economic factors contribute to this: an auditor has to spend a certain amount of time to audit a company, and particularly the contingency fee third party auditors have all the incentive to go after large companies first. These companies represent the low hanging fruit for auditors.