Unclaimed property laws protect owners vulnerable to the loss of their property. For this reason, many states have specific reporting requirements for life insurance companies, financial institutions, and other entities that act as fiduciaries. The laws are based on the policy that these entities should not benefit financially from the vulnerability of the individuals they serve.
Some states take the position that businesses, unlike individuals, do not need the protections afforded by unclaimed property laws, and therefore business holders are exempt from reporting unclaimed property owned by other businesses (business-to-business, or B2B, exemptions). States with B2B exemptions have determined that businesses are capable of ensuring that their property interests are secured and that taxpayer dollars should not be spent to protect them. States with B2B exemptions choose not to interfere with business relationships and instead allow businesses to settle their contractual rights between each other.
While the concept of a B2B exemption to unclaimed property reporting seems simple on its face, the intricacies of state-specific laws greatly complicate the matter. B2B exemptions can vary considerably among states but generally fall within three broad categories: (1) complete exemption, (2) limited exemption, and (3) ongoing-business-relationship exemption. It is important for CPAs and other professionals who may deal with unclaimed property to understand the different exemptions.
The Three Types of B2B Exemptions
A complete B2B exemption is the most holder-friendly exemption. Consider, for instance, Ohio's B2B exemption, which establishes that unclaimed property does not include:
Any payment or credit received by a business association from a business association for tangible goods sold, or services performed, in the course of business, including, but not limited to, checks or memoranda, overpayments, unidentified remittances, nonrefunded overcharges, discounts, refunds, and rebates. [Ohio Rev. Code §169.01(B)(2)(c)]
Ohio's B2B exemption is broad and all-encompassing. While holders are still required to attempt to return the property to the owners through due-diligence procedures, any unreturnable property becomes the property of the holder. Illinois, Kansas, Maryland, and Virginia have similar complete B2B exemptions (765 Ill. Comp. Stat. 1025/2a(b); Kan. Stat. §58-3935(g); Md. Code, Com. Law §17-101(m); and Va. Code §55-210.8:1(B)).
States with limited B2B exemptions exempt some, but not all, types of property from escheatment. Consider Michigan's limited B2B exemption:
[T]his act does not apply to any credit balances, overpayments, deposits, refunds, discounts, rebates, credit memos, or unidentified remittances created on or after April 1, 2009 and issued, held, due, or owing in any transactions between 2 or more associations. This exemption does not apply to outstanding checks, drafts, or other similar instruments. [Mich. Comp. Laws §567.257(a)]
Indiana, Iowa, Massachusetts, North Carolina, and Wisconsin also have limited B2B exemptions, each of which must be analyzed to determine which types of property are exempt from escheatment (Ind. Code §32-34-1-1(e); Iowa Code §556.1(12); Mass. Gen. Laws ch. 200A, §5; N.C. Gen. Stat. §116B-54(e); Wis. Stat. §177.01(10)(b)). For instance, Iowa's limited B2B exemption does not exclude deposits from escheatment and does not apply to banks and financial institutions:
"Property" does not include credits, advance payments, overpayments, refunds, or credit memoranda shown on the books and records of a business association with respect to another business association unless the balance is property described in section 556.2 held by a banking organization or financial organization. [Iowa Code §556.1(12)]
Limited B2B exemptions are state-specific and should be read carefully.
Finally, Arizona and Tennessee offer an ongoing-business-relationship B2B exemption, which merely acts as a deferral of unclaimed property reporting until the business relationship ends, at which point the property's dormancy period begins to toll. Tennessee's B2B exemption states:
[A]ny outstanding check, draft, credit balance, customer's overpayment or unidentified remittance issued to a business entity or association as part of a commercial transaction in the ordinary course of a holder's business shall not be presumed abandoned if the holder and such business entity or association have an ongoing business relationship. An ongoing business relationship shall be deemed to exist if the holder has engaged in a commercial, business or professional transaction involving the sale, lease, license, or purchase of goods or services with the business entity or association. . . . [Tenn. Code. §66-29-104(3)(C)]
Texas and New York, states without statutory B2B exemptions, have administrative B2B exemptions as a result of issued guidance (see Texas Comptroller of Public Accounts, Unclaimed Property Reporting Instructions, and New York State Office of the State Comptroller, Handbook for Reporters of Unclaimed Funds). Because this guidance is not law, holders cannot cite it as precedent, but they can generally rely on it for application to each state's unclaimed property reporting laws. Both of these administrative B2B exemptions generally only act as reporting deferrals rather than full exemptions from reporting.
B2B Exemptions Under Examination
In Texas v. New Jersey, 379 U.S. 674 (1965), the Supreme Court established that unclaimed property first escheats to the state of the owner's address according to the holder's records, i.e., the primary state. If the holder's records do not contain an address, unclaimed property then escheats to the holder's state of incorporation, i.e., the secondary state. Upon examination, a secondary state's unclaimed property auditor may attempt to escheat funds exempt from escheatment by the primary state. While courts have not expressly addressed this issue, the Third Circuit's rationale in New Jersey Retail Merchants Association v. Sidamon-Eristoff, 669 F.3d 374 (3d Cir. 2012), supports the proposition that property that falls under a primary state's B2B exemption cannot escheat to the secondary state.
In that case, New Jersey had codified the so-called place-of-purchase presumption, under which stored-value cards purchased in New Jersey would escheat to New Jersey even if the primary state exempted that property from escheatment. The Third Circuit struck down the place-of-purchase presumption and noted that one state cannot infringe on the sovereignty of another state:
The ability to escheat necessarily entails the ability not to escheat. To say otherwise would force a state to escheat against its will, leading to a result inconsistent with the basic principle of sovereignty. Various considerations might motivate states not to exercise custodial escheat. For example, because companies might find the absence of state custodial escheat attractive, states may want to incentivize companies to incorporate in their jurisdiction by choosing not to escheat abandoned property. In reaffirming the Texas rule, the Supreme Court "detect[ed] no inequity in rewarding a State whose laws prove[d] more attractive to firms that wish to incorporate." Accordingly, the Court intended that a state's decision, regarding the exercise of custodial escheat under the secondary rule, would be respected under the principle of sovereignty. [New Jersey Retail Merchants, 669 F.3d at 395, quoting Delaware v. New York, 507 U.S. 490, 507 (1993)]
B2B exemptions can significantly reduce a holder's unclaimed property liability. Unfortunately, many holders are either unaware of B2B exemptions or are unfamiliar with the specifics. States will not ensure a B2B exemption is properly applied and may even take aggressive positions that diminish property subject to a B2B exemption. For these reasons, it is the holder's duty to fully understand and apply B2B exemptions to ensure the holder receives the full benefit of these exemptions.
Mark Heroux is a principal with the Tax Services Group at Baker Tilly Virchow Krause LLP in Chicago.
For additional information about these items, contact Mr. Heroux at 312-729-8005 or email@example.com.
Unless otherwise noted, contributors are members of or associated with Baker Tilly Virchow Krause LLP.