Why Law Firms Should Not Ignore Unclaimed Property Regulations

Law firms across the United States are confronting a surge in state audit notices concerning unclaimed property (UP) and heightened scrutiny on record retention. This issue has swiftly vaulted to the forefront of business compliance as states intensify their efforts to uncover unclaimed assets. While states cannot use the actual funds, they can use the investment returns in a bid to bolster revenues amidst fiscal constraints.

Businesses are often unaware that they have UP or are unsure what qualifies. Some important concepts to understand include:

• UP includes property or accounts within financial institutions in which no activity has been generated, or no contact has been made with the owner regarding the property for a specified period of time based upon each state’s requirements.
• UP is not a tax, nor is it managed by taxing authorities; thus, rules such as the IRS’s seven-year document retention mandate are not applicable; hence, there is no statute of limitations, per se.
• When the no contact or dormancy period is reached, the UP must be remitted as the first priority to the state of the owner’s last known address or, if unknown, to the state of the business’s incorporation.
• Annual compliance filings and due diligence requirements vary by state, with most states necessitating a report even if no property is required to be remitted.
• Failing to comply with UP mandates can result in penalties, interest and administrative assessments, and examinations covering many years, which can be expensive and extremely disruptive for the business. Additionally, reputational damage can ensue as some states, including New York, have public disclosure policies.

The most prevalent forms of UP include uncashed payroll checks, accounts payable checks, and accounts receivable credits. However, the spectrum of UP varies depending on the industry and ranges from store gift cards to valuables in safety deposit boxes.

For law firms, the stakes are even higher. Client trust accounts, unclaimed settlement funds, and uncashed client checks are particularly vulnerable to unclaimed property audits and many State Bar Associations have specific ethics rules relating to escrow and interest on lawyers’ trust account (IOLTA) funds. Maintaining rigorous tracking and communication protocols is essential to ensure compliance with state regulations and to protect funds.

Historically, UP laws faced lax enforcement. The landscape shifted as third-party audit firms began conducting audits on states’ behalf for contingency fees, leading to the current environment in which multiple auditors target companies of all sizes for non-compliance. Consequently, companies are must address their UP obligations to avoid an audit notice. Failing to file or ignoring UP requirements will further escalate the likelihood of an audit, which may scrutinize the entity named and any related entities within its corporate structure. These audits can have devastating consequences for the unprepared. Some states require companies to provide historical UP records going back up to 15 years, a requirement that catches many businesses off guard. If filings were not made, no statute of limitations would apply to those records. Companies are delving deep into their financial archives to unearth any traces of UP, often with unexpected outcomes.

To mitigate risk, businesses must engage experienced UP experts to develop policies and procedures regarding compliance and extended document retention to comply with UP rules. Additionally, internal teams should actively reach out to vendors, customers, and employees to resolve outstanding credits promptly and accurately.

Though UP audits can be daunting, proactive adherence to robust processes can shield companies from significant exposures. Additionally, some states offer Voluntary Compliance Programs (VCPs) to come forward. To learn more about the risks of an UP examination and how to formulate a comprehensive compliance policy for your law firm, please contact Alan Goldenberg, Principal and Leader of the State and Local Tax and Tax Controversy Groups, Steven Lando, Tax Partner and Co-Leader of the Law Firm Group, Deborah de Vries, Partner and Co-Leader of the Law Firm and Compensation & Benefits Groups, or your Anchin Relationship Partner.