In unclaimed property circles, a popular hard-knocks story to share is the result of a state’s extrapolation of unclaimed property liabilities. Many holder personnel who have gone through the process of estimation during an audit or Voluntary Disclosure Agreement feel that the total assessment of past due amounts using extrapolation formulas has not been fair. Some holders have taken this question to court.
How does extrapolation work? Can holders avoid over-assessments resulting from extrapolation? Informed holders realize any unclaimed property team must be aware of estimation methods and potential related assessments in the event their company is audited.
Estimation is the general process used to determine a holder’s liability when actual amounts of unclaimed property are not available. The 1981 and 1995 Uniform Unclaimed Property Acts, adopted to varying degrees by most U.S. unclaimed property jurisdictions, allow for estimation, but do not describe what methodologies may be used. Delaware has its own statute, and in 2010 amended its law to allow for estimations.
Extrapolation is the mathematical protocol or methodology used to apply error rates from periods when data is available to periods when data is not available. In other words, the process tests available records for a base period of time, noting errors in the company’s reporting of unclaimed property. The auditor then applies the same error rate to a historical benchmark representing previous periods of time for which records are not available. Prior filings for the base period are included in the error rate, and the holder is credited for past filings, so there is no double counting. The result is an estimated amount of unclaimed property owed for years where records do not exist.
This process has been used for many years, and through its longtime use has been accepted as the best way to determine unclaimed property liability for periods when records are not available.
From a company’s point of view, it is problematic that these methodologies can be used to create arbitrary estimates of amounts due. In a recent lawsuit brought against the state of Delaware by Temple-Inland, the company claims credit wasn’t given for differing state statutes. A number of constitutional breaches also have been claimed, and the case is still pending.
In general, from the state’s point of view, if estimation wasn’t permitted, this might allow companies to destroy records and make it impossible for states to determine historical compliance with unclaimed property statutes and hold companies accountable to the law.
At first glance, it may seem as though it’s unfair to extrapolate amounts for the past based on more recent levels of unclaimed property. Most companies have more income and associated unclaimed property in later years. Is it fair to use current records and processes to estimate amounts many years in the past when a company probably did less business and had less unclaimed property?
Actually, it may be in the company’s best advantage to use current years as the basis of extrapolation. A company will typically have more readily available records for these current years, and this will generally allow the holder to refute the presumption of abandonment for more current items selected by the auditor, resulting in smaller levels of unclaimed property in the basis for extrapolation.
Estimation and extrapolation are complex processes, and legal precedents are changing. There are many ways to reduce a holder company’s liability in this area, in some cases significantly reducing estimated amounts calculated by an auditor.
For example, when auditors create extrapolations, they may use model and error rate calculations most advantageous to them. Holders might not realize an auditor’s chosen model and error rate isn’t the only one available. An experienced unclaimed property advocate can work with auditors to adjust the model/error rate to create a more reasonable result.
Stay tuned in coming months for more about the Temple-Inland lawsuit, as well as another in-progress lawsuit against Delaware brought by Plains All America. These cases could significantly change the use of estimation and extrapolation. In the meantime, if your company needs assistance facing this aspect of an audit, contact Mike Hughes at 814-235-9301 or Heather Steffans at 816-559-0619.
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