Practice and Procedure: Delaware Unclaimed Property Audits Present Significant Challenges for Businesses

Despite the enactment of Delaware S.B. 141 during the 2015 legislative session, which overhauled the state’s unclaimed property laws, audits in the state continue to present major issues for businesses, according to panelists at the 34th Institute on State and Local Taxation hosted by the NYU School of Professional Studies.

Under S.B. 141, the look-back period for unclaimed property audits was reduced to 22 years from 34 years, however, audit targets are still subject to substantial compliance costs and data production obligations. The amended law also prohibits the initiation of audits prior to an entity being offered the chance to enter into an unclaimed property voluntary disclosure agreement (VDA) with Delaware.

Under the Delaware VDA program, the look-back period is 1996 – a slightly shorter period than the new statutory mandate – and interest will not be assessed on late filed property provided the taxpayer works in good faith to complete the program.

Companies targeted prior to the change in law were not necessarily given the VDA option, and face a comprehensive, and possibly multi-state audit that is most likely being conducted by third-party vendor, Kelmar Associates, LLC.

There has been considerable discussion and debate over the years regarding whether contingency fee audits violate due process. However, to date, there has not been a successful challenge on that arrangement, said panelist Matthew P. Hedstom, senior associate with Alston and Bird LLP, New York, NY.

This could soon change, however, as several cases challenging Delaware’s contingency fee arrangement with auditors, the estimation methodology it uses to valuate unclaimed property, and other issues are pending in federal and state courts.

As panelist Kendall L. Houghton, partner with Alston and Bird LLP, Washington, DC, noted, multi-state audit arrangements where the audit firm “has the opportunity to decimate the audit target” are particularly concerning because “states are effectively outsourcing the function and the authority to make critical governmental decisions.”

While most companies facing audit agree to the audit and simply try to limit its scope despite legitimate questions concerning the constitutionality of the process, Plains All American Pipeline, L.P. sued Delaware in Plains All American Pipeline, L.P. v. Cook, et al., D. Del., No. 1:15-cv-00468, 6/5/15.

Plains is an energy company organized in Delaware and headquartered in Houston. The company’s complaint includes seven causes of action including unreasonable search and seizure, substantive due process and equal protection.

The unreasonable search and seizure claim addresses, in part, data production requests which Plains argues seek information that is outside the scope of any legitimate interest Delaware has. Plains further argues that the security and privacy of their data will be compromised if they are forced to comply with such requests.

The substantive due process claim challenges the legality of Delaware’s contingent fee audit arrangement since it leaves Kelmar with a substantial interest in the outcome of the audit. As Hedstom questioned during the panel discussion, “If an auditor individually makes more money by virtue of finding more property, does that create a conflict of interest?”

The equal protection claim accuses Delaware of targeting large, well-known companies for unclaimed property audits in violation of the fourteenth amendment, believing that audits of such companies will produce major dollars for state coffers.

Interestingly, according to Plains’ complaint, unclaimed property assessments account for approximately 15 percent of Delaware state revenue, which is more than the state lottery, and more than corporate income taxes, cigarette taxes, alcoholic beverage taxes and inheritance taxes combined.

Businesses and practitioners should closely monitor this case, as a result in favor of Plains could yield major changes to unclaimed property programs throughout the country.


Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: Is the Delaware unclaimed property audit process constitutional?

With a free trial to Premier State Tax Library, practitioners have a single trusted resource that provides all of the tools and information they need to develop and implement the right tax strategies.