STATE & LOCAL
Unclaimed Property Can Be a Hidden Liability

Over the past several years, the number of states conducting unclaimed property audits of businesses and other entities that hold such assets has been on the rise, sparking a need for companies to pay greater attention to their potential liability in this area. States view unclaimed property as a substantial source of non-tax revenue, especially during economically challenging periods.

While there is a common misconception that unclaimed property is an issue of concern only to banks and dividend-paying corporations, this is incorrect. Any company, that finds itself in possession of intangible property that rightfully belongs to another is subject to unclaimed property laws. Companies must be aware of their obligations related to unclaimed property under the various laws of the states in which they conduct business, as well as some financial reporting issues that can arise from unclaimed property.

What Qualifies as Unclaimed Property?
Four elements must be present for property to qualify as unclaimed property under most states’ laws:

• It must be intangible, i.e., representative of the right to hold or receive something of value (uncashed checks, unclaimed stock certificates, dormant bank accounts, etc.)
• The location of the apparent owner must be unknown
• The property must remain unclaimed for an abandonment or dormancy period stipulated in state law—anywhere from one year (for unclaimed wages in most states) to 15 years (for travelers checks), but averaging three to five years.
• The legal obligation of the property holder to the owner must be fixed and certain.

States’ Escheat Laws
All 50 states and the District of Columbia currently have statutes dealing with unclaimed property. Sometimes referred to as escheat laws, most are based on a uniform unclaimed property statute formulated half a century ago and recently revised about 10 years ago. Most unclaimed property statutes are custodial, with the state taking possession of the unclaimed property and holding it on behalf of the rightful owner. However, even though states generally do not assume title to such property—often uncashed payroll or dividend checks or payments to vendors—they are entitled to hold unclaimed funds and to use them for the general benefit of the state.

The amounts involved are substantial, and given the increasingly mobile nature of our society, they are on the rise. According to the Office of the New York State Comptroller, New York is currently holding some $7.2 billion in unclaimed funds from banks, corporations, broker/dealers, insurance companies, state court funds and other sources. On average, about 20% of funds are claimed by their rightful owners every year, leaving a sizeable nest egg to help prop up the state’s coffers.

The U.S. Supreme Court has established and reaffirmed a priority scheme for unclaimed property that is reflected in the most recent version of the Uniform Unclaimed Property Act and can be helpful to companies trying to determine which state’s laws apply in a given case. In general, the rules give the first priority right to take and hold unclaimed property to the state shown on the holder’s books as the state of the property owner’s last known address, and that state’s escheat laws apply. In the common case of anonymous unclaimed property, the escheat laws of the state in which the property holder is incorporated or domiciled take precedence.

Enforcing Compliance and Consequences
In recent years, many states have increased the size of their unclaimed property offices, added more auditors, boosted the number of audits they conduct each year and stepped up efforts to encourage greater compliance with escheat laws. The stakes are high for businesses that fail to comply. Most states allow auditors to look back at least 10 years before the expiration of the dormancy period, and some allow look-back periods of 15 or 20 years in certain cases. Unreported unclaimed property may be subject to steep interest charges, penalties as high as $500 per day for noncompliance and punitive assessments amounting to 25% of the value of the unclaimed property. Though rarely imposed, criminal penalties are included in the escheat laws of several states and may be sought in cases of willful noncompliance.

Some businesses write off unclaimed property obligations to income in their financial statements, rather than reporting and turning over the funds to the appropriate states as required by their escheat laws. That practice can result in misleading financial statements. Failure to comply with unclaimed property laws can also increase a company’s exposure to litigation risks, and “whistle-blower” statutes in some states are providing incentives for employees to turn in their employers for violations.

How to Reclaim Funds
While each state has its own procedure for restoring unclaimed funds to individuals, New York’s is typical of most states. New York pays interest on unclaimed interest-bearing accounts such as savings accounts and certificates of deposit for the first five years it holds the funds; the current interest rate is 4%. Individuals can contact the Comptroller’s office directly at 1-800-221-9311 (within New York state) or 1-518-270-2200 (outside New York state), Monday to Friday, 7 a.m. to 5 p.m.

Searches can also be conducted through the Comptroller’s Web site (www.osc.state.ny.us), and 62% of all claims paid are the result of Web site searches. There is no fee for an individual to reclaim funds. Private companies are allowed to charge claimants up to a 15% finder’s fee, but they do not have any faster access to funds than individuals who contact the Comptroller’s office directly.

For more information, please contact Carolyn Makuen at cmakuen@gellerco.com.

CORPORATE
Avoiding Conflicts Under FAS 109

The closing paragraph of a recent article in The Tax Adviser, the journal of the American Institute of Certified Public Accounts, states the issue succinctly: “An auditor’s use of the ‘tax specialist’ for tax matters is more important than ever before,” author Katherine D. Morris, CPA, writes in the May 2005 issue. “Clear guidance on tax services is needed to satisfy audit firms, CEOs, CFOs and audit committees.”

Prompting Morris’ avowal regarding the need for audit firms to tap the expertise of tax specialists is the accounting industry’s ongoing discussion regarding the impact of the Sarbanes-Oxley Act of 2002 on audit firms’ responsibilities under Financial Accounting Standards Board Statement (FAS) No. 109 and the potential conflicts of interest it can create for both auditing firms and their clients.

A Closer Look at FAS 109
Issued in February 1992, FAS 109’s stated purpose is to recognize the amount of taxes payable or refundable for the current year and the deferred tax liabilities and assets for the future tax consequences of events that have been recognized in a corporation’s financial statements or tax returns. In short, FAS 109 requires public companies to disclose a reconciliation of the reported amount of income tax expense that would result from applying domestic federal statutory rates to pretax financial income.

The focus of FAS 109, which applies only to publicly owned companies, is the treatment of deferred tax assets and liabilities, which arise when the tax treatment of an item is temporarily or permanently different from its financial accounting treatment. For example, generally accepted accounting principles (GAAP) might allow a $20,000 expense for a particular item where the Internal Revenue Code allows just a $9,000 deduction. The temporary difference arises if the Code also allows for the remaining $11,000 to be deducted in subsequent years.

Sarbanes-Oxley Brings FAS 109 Into Focus
With the passage of Sarbanes-Oxley three years ago, FAS 109 went from being a thorny and sometimes subjective accounting issue to one that also involves issues of corporate ethics, accountability and potential conflicts of interest. A key question concerns which types of tax services auditing firms can provide to public clients without compromising their independence and, as a result, the viability of those companies’ audit statements.

The lack of a “bright line” rule governing tax planning and advice has been a source of concern to many audit firms, but proposed guidance identifying tax services that pose and do not pose unacceptable threats to auditor independence may help clarify the situation. In December 2004, the Public Company Accounting Oversight Board (PCAOB) voted unanimously to propose rules that would prohibit registered public accounting firms from providing certain tax services to public company audit clients, providing any tax services to officers in a financial reporting oversight position, and receiving contingent fees for such tax services from public company audit clients.

Ensuring Accuracy
The issue of verifiable auditor independence is particularly important as it relates to FAS 109 because deferred tax liabilities can offer significant advantages to companies. A big one is the time-value of money that results from a deferral in paying taxes. arbanes-Oxley requires public companies to have adequate, auditable internal controls in place for accounting decisions of this type, and it requires auditors to attest to the accuracy of those reports. Since the PCAOB standards clearly indicate that an audit firm cannot function as part of a client company’s system of internal controls, there is increasing demand for the services of independent tax specialists such as Geller & Company to perform various services including FAS 109 accounting.

For more information, please contact Lynn Ellenberg at lellenberg@gellerco.com.

INDIVIDUAL
Basic Estate Planning Techniques
Part 3 in a Series

The vast majority of estates—about 98%, according to IRS estimates—are not subject to federal estate tax under current regulations, and changes to the tax code may push that percentage even higher. But for those estates that do face the possibility of taxation, the unified credit can be a useful tool for minimizing or even eliminating estate tax liability. To be used most effectively from an estate planning perspective, the unified credit should be utilized in conjunction with the annual gift tax exclusion.

The unified credit is a federal tax credit that offsets gift and estate tax liability. For estate tax purposes, the unified credit is being gradually increased from $555,800 this year to $1,455,800 in 2009. Those figures are equivalent to applicable exclusions from estate tax of $1.5 million and $3.5 million, respectively.

Using the Unified Credit
A unified credit applies to both the gift tax and the estate tax. Taxpayers must subtract the unified credit from any gift tax they owe in a given year, and any unified credit used against the gift tax in one year reduces the amount of credit that can be used against the gift tax in a later year. The total amount used against gift tax during the taxpayer’s lifetime reduces the credit available for use against the estate tax.

Under prior tax law, the same unified credit amount applied to both the gift tax and the estate tax, but recent changes in the law have altered that treatment. Beginning in 2004 and extending at least through 2009, the unified credit amount for gift tax purposes holds steady at $345,000. This figure is equivalent to the applicable exclusion from gift tax of $1 million. However, the unified credit and applicable exclusion amounts for estate tax purposes increase, as mentioned above.

Gift Tax Rule Exceptions
According to IRS Publication 950, the general rule is that any gift is a taxable gift unless it falls under one of the many exceptions to the gift tax rule, such as:

• Gifts totaling less than the annual exclusion amount for the calendar year.
• Tuition or medical expenses paid directly to a medical or educational institution for someone.
• Gifts to the taxpayer’s spouse.
• Gifts to a political organization for its use.
• Gifts to charities.

A separate annual exclusion ($11,000 in 2005, which may be increased due to a cost-of-living adjustment in subsequent years) applies to each person to whom the taxpayer makes a gift. The spouse of a married taxpayer may also give up to $11,000 to the same recipient in the same tax year. Gift splitting allows a married couple to claim the full $22,000 exclusion for a gift to an individual, even if one spouse provides most, or all, of the gift.

Similarly, in order to make maximum use of the unified credit from an estate-planning perspective, married couples who may be subject to estate tax are often advised to divide or “balance” their assets between husband and wife. Another strategy is to establish a Bypass Trust, also known as a Credit Shelter Trust. This trust is created in the testator’s will to utilize the testator’s exemption equivalent amount. Its purpose usually is to hold assets for the benefits of a testator’s surviving spouse during the survivor’s lifetime and then to pass to the testator’s children without the trust assets being included in the survivor’s estate. This strategy also allows each of the spouses to claim the maximum allowable exclusion at the time of their deaths.

Determining the Taxable Estate
For estate tax purposes, the taxpayer’s taxable estate is determined by subtracting allowable deductions from the gross estate, which consists of the value of all property in which the taxpayer had an interest at the time of death. Some examples of items generally included in the gross estate include, among others, cash, securities, real estate, life insurance proceeds payable to the estate or heirs, and the value of certain annuities payable to the estate or heirs. Some examples of allowable deductions used in determining the taxable estate include funeral expenses paid out of the estate, charitable bequests, debts owed by the taxpayer at the time of death and the marital deduction, which generally consists of the value of the property that passes from the taxpayer’s estate to the surviving spouse.

In most cases, any unified credit not used to eliminate gift tax during the taxpayer’s lifetime can be used to reduce or eliminate estate tax. In light of recent changes to the tax code in this area and the strong possibility of additional changes in the near future, high-net-worth individuals in particular should consult their tax advisers to make sure they use the unified credit to their maximum advantage.

For more information, please contact Charlie Pomo at cpomo@gellerco.com.

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The information contained in TaxView is for general purposes only and is not intended, and should not be construed, as legal, accounting, or tax advice or opinion provided by Geller & Company to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs. Therefore, the information should not be used as a substitute for consultation with professional accounting, tax, or other competent advisors.