The 2019-20 Budget: Increasing Compliance With Unclaimed Property Law

The 2019-20 Budget: Increasing Compliance With Unclaimed Property Law GABRIEL PETEK LEGISLATIVE ANALYST MARCH 15, 2019 Summary Unclaimed Property in California. California law requires banks, insurance companies, and many other businesses (known as “holders”) to transfer to the California State Controller’s Office (SCO) personal property considered abandoned by owners. Most of this “unclaimed property” is cash, like uncashed checks. The state takes temporary title in these properties and maintains an indefinite obligation to reunite the property with its owners. Both holders and the state are required to notify owners about their property and attempt to reunite them with it. Funds remitted to the state but not reunited with owners provide a source of General Fund revenue, currently around $400 million per year. Holder Compliance With Unclaimed Property Law Is Very Low. Most businesses in California fail to report unclaimed property—SCO estimates the compliance rate is about 2 percent. There are two reasons for this: (1) they are unaware of the law or (2) they are willfully noncompliant, largely to avoid the high interest penalty (12 percent annually) associated with failing to properly report. Increasing Holder Compliance Has Merit. To increase holder compliance, the Governor proposes allocating resources to SCO for more audits of potential holders. We agree with the Governor’s goal to increase holder compliance. However, the scale of SCO’s audits cannot address the significant lack of compliance. With only a couple of dozen audits conducted each year, SCO cannot change the behavior of hundreds of thousands of California businesses. Two Options to Address Holder Compliance. This report contains two options to try to substantially increase holder compliance with unclaimed property law. In particular we suggest the Legislature consider: • Including an Unclaimed Property Question on Businesses’ Tax Forms. The Legislature could amend tax law to require businesses to respond to a question about unclaimed property as part of their tax filings. This question would be purely informational (it would not have tax implications for the business) and likely would significantly increase businesses’ awareness of the law. • Providing One-Time Amnesty for Noncompliant Holders. The Legislature also could provide one-time amnesty for holders who voluntarily report past-due unclaimed property by temporarily waiving the penalty associated with delinquent reports. This could be an effective way to address the problem of willful noncompliance. The Legislature might want to consider pursuing both of these options. This would be even more effective at increasing holder compliance than either of these options alone and would avoid placing undue financial hardship on businesses. Effectively increasing holder compliance would mean more property reunited with its rightful owners and could result in hundreds of millions of dollars in General Fund benefit. analysis full gutter 2019-20 BUDGET BACKGROUND Unclaimed Property Program the next paragraph. These notices contain specific information, including details about the property, What Is Unclaimed Property? California a statement that the property will escheat to the law requires banks, insurance companies, and state, and a form that owners can use to contact many other types of entities (known as holders) the holder to keep the property active. The reasons to transfer to SCO personal property considered owners have unclaimed property vary. Sometimes abandoned by owners. Nearly all “unclaimed” owners are deceased or simply unware that the properties are cash assets, like uncashed checks, property exists. bank accounts, payments from insurance policies, Holders of Unclaimed Property Required to and the value of liquidated stocks and other Report Annually to SCO. By November 1st of each securities. In rare cases, unclaimed property year, holders are required to submit a holder notice includes tangible items, like the contents of safe report to SCO. This report details the property deposit boxes. Property is considered unclaimed that has exceeded its dormancy period. SCO if owners have had no contact with holders for a uses these reports to send pre-escheat notices to specified period of time, in many cases three years. owners, advising them to reestablish contact with This period without contact is called the “dormancy the property. In 2016, SCO received 16,555 holder period” (see Figure 1). The state “escheats,” or notice reports. takes temporary title in, these properties and Property Escheats to State About Seven maintains an indefinite obligation to reunite the Months After Holder Report. If efforts by holders property with owners (including heirs), should they and SCO to prevent escheat have failed, holders come forward and make a claim. must deliver unclaimed property to SCO between Holders Must Notify Owners of Impending June 1 and June 15 (submitted with another report, Escheat. State law requires holders (businesses) called the holder remit report). State law requires to notify owners their property will escheat to the holders that willfully fail to report, pay, or deliver state if they do not contact the holder. Holders unclaimed property to SCO to pay 12 percent must notify owners between six months and one annual interest on the value of the property from year prior to the reporting deadlines described in the date it should have been reported, paid, or delivered. Figure 1 SCO Works to Reunite Dormancy Period Is Three Years for Property With Owners. Before Most Property Types and after property escheats to the state, SCO conducts a variety of One Year activities to try to reunite owners Wages and salaries, such as uncashed paychecks with their property. In addition to Three Yearsa the notices referenced earlier, SCO Checking and savings accounts maintains a website for owners Matured CDs and other time deposits to search for their property, runs Payable individual retirement accounts (IRAs) advertisements, and works with Stocks, bonds, dividends, and mutual funds the Department of Veterans Affairs Seven Years to send notices to veterans who Sums payable on money orders appear to have unclaimed property. SCO also has a property owner Fifteen Years advocate’s office that assists Sums payable on travelers’ checks a individuals in making claims. Includes only a selection of example property types. Most other property types also fall into this category. State law also allows individuals 2 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET or businesses—known as investigators—to assist like paychecks. While the dollar value of owners in recovering their unclaimed property and a single unclaimed property might be low, charge a fee of up to 10 percent of the value of the in aggregate, the value of this unreported claim. (Our report from 2015, Unclaimed Property: unclaimed property could be substantial. Rethinking the State’s Lost and Found Program, • Individual Retirement Accounts (IRAs). recommended a variety of options to improve the Even though major financial institutions state’s success in reuniting unclaimed property with tend to submit holder reports to SCO, owners.) audits have revealed that these institutions still under-report IRAs. Like other forms of Holder Compliance Is Very Low property, IRAs are considered unclaimed Only a Small Portion of California Businesses property if an owner has not made contact Are in Compliance With Holder Reports. with the account for three years. However, According to SCO, only 16,555 out of about other conditions must also apply, namely that 900,000 California businesses submitted a holder the owner must be over the age of 70.5 or the report in 2016. This represents a compliance property is payable or distributable. rate of about 2 percent. (SCO’s estimate of total • “Pay-Per-Click” Revenue. An audit of a businesses excludes self-employed individuals major California-based technology company and small businesses.) While this might be an found that while the business was remitting imperfect measure of the number of business with holder reports to SCO, it failed to identify unclaimed property, it strongly suggests that the pay-per-click revenue. This is money paid to vast majority of California businesses are out of individuals for allowing advertising content on compliance with unclaimed property law. Based on their websites. For example, one company’s this, SCO has estimated that the total amount of policy was to only issue a check once outstanding unclaimed property that has not been revenues reached a certain threshold. For properly reported by holders to the state is in the some individuals, reaching that threshold may billions of dollars. Moreover, although the number of take a long time and the owner may no longer active California businesses has increased, holder be involved with account. reporting has declined—from nearly 23,000 holder • Other. SCO reports that many other forms of reports received in 2011-12 to 16,555 in 2016-17. unclaimed property are under-reported, some Many Types of Holders and Properties Are specific to a particular industry. Automobile Out of Compliance. The types of holders that do dealerships tend to under-report customers’ commonly submit holder reports include banks deposits and Department of Motor Vehicle and other financial institutions, major multinational fees. Casinos under-report uncollected corporations, and real estate agencies. Given jackpots and bonuses and expired chips. the very low compliance rate, there are examples Professional sports teams often fail to report of nearly all types of businesses that are out of ticket refunds. compliance with unclaimed property law. This Two Main Reasons Holders Are Out of includes hospitals, retailers, utility companies, Compliance. SCO reports that there are two manufacturers, and insurance companies. Even main reasons that businesses tend to be out of institutions that do remit reports fail to report compliance. (“Out of compliance” can mean the certain kinds of property. Some forms of unclaimed business fails to remit a holder report entirely or property that is under-reported includes: fails to report a complete holder report.) In general, • Uncashed Checks. Other than sole when holders are out of compliance it is because proprietorships, most businesses have they either are: employees. As such, they are likely to • Unaware of the Law. Many businesses have some form of unclaimed property, for are simply unaware of the law regarding example, in the form of uncashed checks, unclaimed property. These businesses do www.lao.ca.gov 3 analysis full gutter 2019-20 BUDGET not to submit holder reports at all. Relatedly, Department of Fee and Tax Administration and businesses also may lack adequate internal the Secretary of State to provide information procedures to remain in compliance with the about the law to new businesses. SCO law. For example, holders must track when currently has six authorized positions and owners are in contact with their properties $630,000 in expenditure authority for the either through a technological solution holder compliance unit. to automate monitoring or—for smaller • Audits. Second, SCO performs audits of businesses—manually. California businesses to ensure they are • Willfully Noncompliant. Some businesses are in compliance with unclaimed property aware of the law, but still either fail to submit law. Through the course of an audit, when holder reports or submit incomplete reports. SCO discovers a business has unreported A key reason some businesses might choose unclaimed property, the business must first not to comply with the law is the relatively high notify the owners about it. If an owner does interest rate that must be paid on properties not reestablish contact with the account, that have not been reported. the holder must remit the property to SCO. In either case, the holder must pay penalty SCO’s Efforts to interest to the state on the unreported property. SCO also checks the businesses’ Improve Holder Compliance internal policies and procedures to ensure SCO Has Two Primary Ways to Increase they are able to perform the necessary Holder Compliance. SCO recognizes the holder functions to comply with the law. SCO compliance rate is very low and has made efforts currently has 17 authorized positions and to increase it. SCO has resources for two major $2.7 million in expenditure authority to activities related to holder compliance: conduct these audits. • Holder Outreach and Compliance. First, SCO Conducts About 20 Audits Per Year. SCO established its holder outreach and Since 2013-14, SCO has released 119 holder compliance unit in the 2012-13 budget to audit reports, an average of about 20 audits per increase businesses’ awareness of and year. Audits result in more property reunited with compliance with the law. This unit conducts owners, property remitted to the state, and penalty a variety of activities, including: speaking interest revenue to the state. Figure 2 shows a at conferences, conducting training and recent history of the results of SCO’s holder audits. workshops, and sending informational letters. As the figure shows, audits result in somewhat SCO also works with both the California more property being returned directly to owners by Figure 2 Property Returned to Owners and Remitted to State From Recent Audits (Dollars in Thousands) 2013-14 2014-15 2015-16 2016-14 2017-18 2018-19 Audit reports issued 29 21 10 20 19 20 State Interest revenue $3,761 $2,073 $1,849 $2,980 $1,547 $1,400 Property remitted to statea 2,146 3,941 3,195 2,654 5,326 4,480 Totals $5,907 $6,014 $5,044 $5,634 $6,873 $5,880 Owners Property returned to owners $9,392 $2,082 $95 $112 $863 $1,120 a A portion of the property remitted to the state is eventually returned to owners. 4 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET holders. In addition, the amount the state spends decades, even declining slightly in recent years. on audits each year—$2.6 million—is less than the (The significant spike in revenues in the mid-2000s annual amount received by the state as a result reflects a decision to accelerate the schedule for of the audits—$5.9 million (a portion of this is selling securities.) The fact that unclaimed property eventually returned by the state to owners). revenue has been largely flat in recent years is Since 2013-14, Holder Compliance Unit Has consistent with declining rates of holder reporting. Brought Thousands of Holders Into Compliance. State Maintains an Indefinite Liability for SCO estimates that, since 2015-16, the holder Unclaimed Property. The cumulative amount of compliance unit has brought an average of past unclaimed property that was not reunited 2,200 new businesses to remit holder reports with its owners constitutes a liability for the state. for the first time each year. SCO estimates this With hundreds of millions of dollars flowing to the has resulted in an average of $57 million in cash state annually, this liability grows each year—and property reunited with owners (directly by holders) the cumulative total now stands at $9.4 billion. and $70 million in unclaimed property remitted to The state maintains an indefinite liability to reunite the state each year. property with owners—meaning owners could one day come forward to claim any piece of this Unclaimed Property Provides a total amount. That said, the vast majority of this Net Benefit to State Budget property will never be reunited with owners for a variety of reasons. For one, some records contain Amount Escheated Always Exceeds Amount very little to no information about owners, rendering Reunited With Owners. Each year, the state reunification with owners virtually impossible. Also, receives unclaimed property from holders and owners of properties that the state escheated long reunites some portion of this property with its ago may have died or moved to another state, rightful owners. However, the value of property greatly diminishing the chances of reunification. remitted to the state always exceeds the value Actual Liability Much Smaller. The state’s of property reunited with owners. This difference Comprehensive Annual Financial Report (CAFR)—a provides a monetary benefit to the state, which display of the state’s finances in compliance with first is deposited into the Unclaimed Property generally accepted accounting principles—includes Fund and then transferred to the General Fund. an alternative estimate of the state’s unclaimed The state uses the unclaimed property fund to finance SCO’s administrative costs to operate Figure 3 the program. The remainder—the General Fund Revenue From Unclaimed Property amount that is not reunited with (In Millions) owners or used for unclaimed property administration—provides $1,000 a source of General Fund revenue. 900 This money is spent on programs 800 throughout the General Fund 700 budget. 600 Unclaimed Property Revenue 500 Has Remained Flat in Recent 400 Years. Figure 3 shows the 300 annual amount of unclaimed 200 property revenue to the state 100 adjusted for inflation. As the figure 1984-85 1989-90 1994-95 1999-00 2004-05 2009-10 2014-15 2019-20 shows, General Fund revenue from unclaimed property has remained largely flat for a few www.lao.ca.gov 5 analysis full gutter 2019-20 BUDGET property liability. Specifically, the CAFR includes experience in reuniting property with owners. The an estimate of the amount that owners will actually 2016-17 CAFR reflects an unclaimed property claim in the future based on the state’s historical liability of nearly $1 billion. GOVERNOR’S PROPOSAL AND ASSESSMENT This section summarizes the Governor’s proposal • Slightly More Unclaimed Property Remitted to increase unclaimed property holder compliance to the State. As Figure 2 showed, since and provides our assessment of the proposal. 2013-14, SCO’s holder audits resulted in an Governor Requests $1.6 Million (Unclaimed average of $3.6 million in unclaimed property Property Fund) for 11 Positions. The Governor’s remitted to the state and nearly $2 million in Budget proposes funding to improve holder related interest payments. (A portion of the compliance with unclaimed property law. In total, property remitted to the state as a result of the Governor requests 11 positions and $1.6 million audits is eventually reunited with owners.) ongoing (Unclaimed Property Fund) to continue That said, compared to existing unclaimed activities related to auditing holders for compliance. property revenues (nearly $400 million in (This proposal would make permanent a similar 2018-19), audit revenue of a few million 2016-17 budget request plus one additional dollars is very low. Overall, the General Fund position for administration.) revenue that results from the audits is low, but exceeds the cost of the audits. Increasing Holder Compliance Increases Benefit to Owners and the State. We agree with Audits Can Only Address a Small Share the Governor’s goal to increase holder compliance. of Holders Out of Compliance. The threat of As discussed previously, compliance with a potential audit is an important incentive for unclaimed property law is very low. The state has businesses to comply with unclaimed property the incentive to increase holder compliance for two law. That said, while there are benefits to auditing main reasons. Increasing holder compliance would holders—and the General Fund benefit of the audits (1) result in more property being reunited with exceeds the cost of conducting them—there also owners (both directly by holders as well as by the are clear limitations. Namely, the scale of audits state) and (2) increase a source of state revenue. cannot address the vast holder under-compliance Measured against these goals, audits result in: rate. With only a couple of dozen audits conducted each year, SCO cannot change the behavior of the • Slightly More Property Reunited With hundreds of thousands of California businesses Owners. As Figure 2 showed, since 2013-14, that are not complying with unclaimed property law. SCO’s holder audits have resulted in an As such, this approach is unlikely to result in much average of nearly $1 million in unclaimed additional compliance relative to current trends. property being reunited with owners directly To address this problem, the following section by holders. That said, the magnitude of presents some additional policy options to try to these increases is very low in the context of significantly increase holder compliance. the overall amount of property that holders and the state reunite with owners each year. For comparison, through the course of the program’s normal operations, the state reunites a couple hundreds of millions of dollars with owners each year. 6 LEGISLATIVE ANALYST’S OFFICE analysis full gutter 2019-20 BUDGET OPTIONS TO INCREASE HOLDER COMPLIANCE This section presents some options to address Resources Required. Implementing this option the goal of substantially increasing holder would require additional resources for both FTB compliance with unclaimed property law. As and SCO. FTB would require additional resources discussed earlier, there are two major reasons primarily to handle questions from businesses holders tend to be noncompliant. They are either: generated by this new line on the form. SCO (1) unaware of the law or (2) willfully noncompliant, would require additional resources to process and mainly to avoid interest penalties. Each of the two evaluate additional holder reports and process options in this section addresses one of these two more claims by owners. That said, the cost of different causes of noncompliance. As such, the these activities likely is much lower than the Legislature could purse either or both of these benefit, both in terms of the unclaimed property options. returned to owners and the amount of unclaimed property revenue remitted to the state. As a result, Include an Unclaimed Property such a proposal likely would have a net benefit to Question on Businesses’ Tax Forms the state, possibly in the hundreds of millions of dollars over time. (If this question were included Most California businesses file income tax on businesses’ tax forms for the 2019 tax year, returns with the Franchise Tax Board (FTB) each increased reporting would likely begin in late 2020.) year. Under one option, the Legislature could amend tax law to require businesses to respond Provide a One-Time Amnesty for to a question about unclaimed property as part Noncompliant Holders of their tax filings. This addition to tax forms could be relatively simple with a single question. Another option is to provide a one-time amnesty For example, the tax form could ask: “Did your for holders who voluntarily report past-due business submit a holder notice report to the unclaimed property. Under current law, these California State Controller’s Office last year?” holders owe an interest penalty of 12 percent per and indicate that the business could be out of year for past-due unclaimed property. This may compliance with existing law if it responds “no.” deter some holders from becoming fully compliant, Alternatively, the tax form could include a few particularly because the probability of being audited different questions that ask about different property is relatively low. The Legislature could temporarily types and length of time since owner contact. The waive this penalty for a certain period for holders adoption of this question in tax software would be who voluntarily report past-due unclaimed property. critical to its effectiveness in improving compliance State Has Conducted a Holder Amnesty because so many businesses file their taxes Program in the Past. The state has conducted electronically. an amnesty program for holders before. Option Would Address Holders’ Awareness Chapter 267 of 2000 (AB 1888, Dutra), authorized of Unclaimed Property Law. This question a one-year amnesty program beginning in would be purely informational—it would not January 2001. (The program was extended for have tax implications for the business. The main a second year—through December 2002—by advantage of this option is that it is likely to Chapter 22 of 2002 [AB 227, Dutra].) During significantly increase holders’ awareness of the the amnesty period, SCO conducted outreach law. Incorporating such a question into tax filings efforts, including advertisements in national is likely to be much more effective at increasing newspapers. The program resulted in 4,927 holder compliance than notices or letters because it reports detailing 145,903 properties valued at incorporates information about the program into a $196 million (in nominal terms)—$113 million in formal process that businesses participate in every cash and $83 million in securities. Of these reports, year. 1,567 were made by holders that had never www.lao.ca.gov 7 analysis full gutter 2019-20 BUDGET previously filed. For comparison, this represented would be much lower than the benefit of unclaimed about a quarter of property escheated in 2000-01 property returned to owners and remitted to the and 2001-02. state. Consequently, there likely would be no net Option Would Address Willful Noncompliance. cost to the state. The state’s experience with an Conducting audits—as the Governor proposes— amnesty program in the past suggests this option is one way to address the problem of willful alone would result in at least a couple hundred noncompliance, but it is a narrow solution to a millions of dollars in additional revenue. wide-ranging problem. Because the state only Both Options conducts a couple of dozen audits each year, businesses know that the probability of receiving Pursuing either of the options described above an audit is relatively low. Giving businesses a in isolation may be less effective than if they temporary amnesty period to report past-due were implemented simultaneously. In particular, unclaimed property could be a different—and more a change to tax filings might make many more effective—way to address the problem of willful businesses aware of the unclaimed property law, noncompliance, particularly among businesses that but they also might be reticent to participate if it are already reporting to SCO. means reporting years- or decades-old property, Resources Required. Implementing this carrying a very high interest penalty. Complying option would require resources for SCO—mostly with these interest penalties could even result in on a temporary basis—to process and evaluate a financial hardship for some smaller businesses. additional holder reports that occurred during the Conversely, pursuing an amnesty program without amnesty period. Some more resources also would an effective way to increase businesses’ awareness be required on an ongoing basis to address higher of the law would not bring many new holders compliance rates and more claims by owners. One into compliance. As such, the Legislature might way to limit the resources required would be to want to consider pursuing both of these options roll out the amnesty period at different times for together—coupling an amnesty program with a different industries (say, one year for the service new reporting requirement to FTB—to increase industry, a second year for the financial industry, holder compliance, reunite property with its rightful and so on). That said, even if an amnesty period owners, and result in additional General Fund were pursued simultaneously for all industries, the benefit. temporary increased cost of these activities likely LAO PUBLICATIONS This report was prepared by Ann Hollingshead and reviewed by Carolyn Chu. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. To request publications call (916) 445-4656. This report and others, as well as an e-mail subscription service, are available on the LAO’s website at www.lao.ca.gov. The LAO is located at 925 L Street, Suite 1000, Sacramento, CA 95814. 8 LEGISLATIVE ANALYST’S OFFICE