What to Expect During an Unclaimed Property Audit

May 14, 2024   |   Luke Sims, Joshua Moldrup

In MarketSphere’s previous Unclaimed Property Audit Series blog posts, we examined the current unclaimed property audit environment and how to respond to an audit letter. Part three of this four-part series explores the audit process and provides an overview the typical audit assessment is calculated.

Phase 1: Initiation

The audit process begins when a company (i.e., “holder”) receives an audit letter alerting the business it is facing an unclaimed property examination. The letter may specify the immediate next steps, including who will conduct the audit – a state auditor or a third-party audit firm. The designated auditor will often follow the letter with a communication to establish contact with the holder. This communication will typically include an initial information request. Some auditors schedule a kickoff call to discuss the process and ask initial questions. During the initiation stage, a non-disclosure agreement (NDA) should be executed with the audit firm conducting the exam. A detailed discussion on NDAs is beyond the scope of this blog, however a few important things should be said:

  • Legal counsel should be consulted to ensure the appropriate protections for the holder are included in the NDA.
  • A holder should not provide information to the auditors or participate in the kick-off call until the NDA is in place.

Prior to moving out of the initiation phase the holder should ensure they are aware and in agreement with the significant details of the audit. These typically include but are not limited to the following.

  1. Type or focus of the audit (general ledger, securities, etc.).
  2. Target of the audit (parent company, subsidiary, all operational entities, etc.).
  3. Party conducting the exam.
  4. Periods under review.
  5. Records destruction notices.

In most cases these details are straightforward, however facts about the holder may change these details and should be fully understood prior to moving into the next phase of the audit.

Phase 2: Scoping

After the preliminary initiation steps are complete, the auditor will request records to help determine the audit scope, including the entities, property types and years of available records. Specific requests may vary by industry but typically include tax filings, state apportionment schedules, merger and acquisition history, trial balances, shared service information, as applicable, unclaimed property policies and procedures, and record retention policies.

Phase 3: Testing and Remediation

Next, the auditor will conduct a detailed record review. This phase is often the bulk of the exam and is intended to identify the holder’s unclaimed property liability for the jurisdiction(s) and years covered in the audit. As with information requests during the scoping phase, source data requests vary by industry. However, such requests typically include bank records, check registers, aging reports, account listings, suspense account balances, GL detail, and administrative and claim system data.

The auditor will analyze the source data and organize checks, credit balances, suspense balances, accounts and policies into populations for review. Population examples include:

  • Disbursements: Outstanding checks aged beyond 90 days and voided checks aged beyond 30 days before being voided.
  • Accounts Receivable: Credits aged beyond 30 days that no longer appear on customers’ accounts.
  • Accounts: Savings, checking, retirement, investment and other accounts that haven’t had activity within the designated dormancy period.

When adequate records are unavailable, the auditor may include estimation populations, which will be discussed in detail shortly. For some industries, the auditor may attempt to use outside databases, such as the Social Security Administration’s Death Master File or National Change of Address database, to help identify potential unclaimed property.

After establishing populations, the auditor asks the holder to review them and provide supporting documentation to show that the included items are not unclaimed property. This is often the longest and most laborious part of the audit. Populations can include thousands of items that require research. Once research efforts are exhausted, the holder needs to send due diligence mailings in accordance with state statutes for any property that will be reported through the audit.

Items that the holder cannot resolve during this phase will be used to determine the audit liability. These items may include actual property to be reported and property that contributes to estimation calculations. It is important to understand that the audit methodologies utilized by many states will often result in items being identified as unclaimed property in that audit, that may not actually be unclaimed. This occurs when the holder does not have the ability to research transactions and provide sufficient support to demonstrate that the liability was resolved in the ordinary course of business (e.g., proof a check cleared or was voided for cause).

Phase 4: Closing and Settlement

During the final phase, the holder works with the auditing states and auditor to establish the settlement amounts, remit unclaimed property to the states and close the audit. Negotiation may occur during the settlement process to calculate the total audit liability. The holder may also negotiate closing and settlement agreements to include penalty and interest waivers, protections against being audited for prior periods and other considerations that weren’t negotiated at the beginning of the audit and included in an audit resolution agreement. The auditor may provide a closing letter summarizing the audit’s scope and confirming its completion.

Audit Exposure

A holder’s overall audit exposure derives from audit liability and internal resources needed to complete the audit. Liability includes unremediated property identified during the audit and owed to the states, as well as estimated liability for property lacking adequate records.

Estimation typically applies when the holder’s state of incorporation is involved, and records are unavailable for a portion of the audit lookback period. Using available years’ records, the auditor applies estimation methodologies to calculate liability for the years where records are unavailable. These estimations are treated as “unknown owner” property to be escheated to the holder’s state of incorporation. In most cases the estimation is inclusive of transactions for all jurisdictions, not just the audit states or the holders state of incorporation. This results in the state of incorporation receiving the full amount of estimation for the periods where records do not exist.

During the testing and remediation phase, the auditor creates a population of records for the years when records are available. The holder then researches the population to demonstrate that the items were resolved. Unresolved items determine an error rate or escheat percentage that is applied to the total sales for the years when records are unavailable. The auditor may include items properly reported as unclaimed property as errors in the calculation. This can result in a large, estimated liability calculation even when findings of actual unreported unclaimed property are minimal.

While all U.S. jurisdictions have unclaimed property statutes, some do not assess penalties and interest. In those jurisdictions that do, the liability can be significant and may exceed the value of the past-due property. For example, in Nevada, the interest is 18% per annum plus a $5,000 penalty for any property that is reported late. Learn more about penalties and interest.

In addition to the holder’s liability, internal resources represent substantial audit costs. Audits are highly detailed and require large amounts of records and significant research from several departments, including IT, accounting, tax, and legal. The process requires staff to shift their time and focus away from the holder’s core business throughout the audit, which can span many years.

Navigating the intricacies of unclaimed property compliance can be challenging. Watch for our next Audit Series blog post, which will discuss key audit defense strategies holders can employ to help minimize the exposure and impact of an unclaimed property audit.

For help with your unclaimed property needs, contact us so we may assist you in considering your available options and determining your next steps.

*Content contained in this article is considered accurate as of the publish date.

Categories: Audit & Consulting
Featured Blog: Unclaimed Property Audit Series - Audit Letter
Read The Article