Gift cards can be an attractive option for restaurants and customers alike. For customers, they provide an easy, yet thoughtful, gift idea. And for restaurants, they help increase revenue, attract new customers and build customer loyalty.

Another potential benefit is that many gift cards go unused or are only partially used — a phenomenon known as “breakage” — which may provide a financial windfall for the issuer. According to Audit Analytics, gift card breakage rates — that is, the percentage of gift card values that is never redeemed — typically fall between two and four percent, although they can be substantially higher for some businesses. Note that this statistic is based on an analysis of SEC filings by public companies. Arguably, breakage rates would be higher for smaller, local businesses. According to anecdotal evidence, breakage rates for restaurants often reach as high as 10 to 15 percent.

Unredeemed gift cards may seem like found money, but before you get too excited about it, be sure to assess the impact of unclaimed property laws. These laws vary from state to state, but in many cases, they require you to remit unused gift card values to the state.

Related Read: Playing Your Cards Right: Can You Defer Taxes on Gift Card Sales?

What is unclaimed property?

Unclaimed property laws — also known as “escheat laws” — originated in medieval England, where the right to abandoned land would revert — or escheat — to the king. Fast forward to today, when every state requires holders of certain unclaimed property to report it and remit it (or its value) to the state, which holds the property until it is claimed by its rightful owner. Some states also require holders of unclaimed property to send a notice to the owner’s last known address (if available).

Property is considered unclaimed after a dormancy period — typically, three to five years, but sometimes longer. Most states apply different dormancy periods to different types of property.

How Are Gift Cards Treated?

The types of property that are subject to unclaimed property laws vary from state to state. Most (but not all) states provide a full or partial exemption for gift cards. In some states, including Illinois, gift cards are exempt only if they meet certain requirements.

In Illinois, gift cards are exempt from the state’s unclaimed property law, provided: (1) Their value does not expire; (2) They are not subject to dormancy, inactivity or post-sale service fees; and (3) They may not be redeemed for cash or otherwise monetized by the issuer (unless required by law). Non-exempt gift cards (“stored value” cards) that have been abandoned must be reported and their value remitted to the state. A card’s balance is presumed to be abandoned five years after the latest of: (1) December 31 of the year the card is issued or funds are added to it; (2) The most recent indication of interest in the card by the apparent owner; or (3) A verification or review of the balance by or on behalf of the apparent owner.

Which State’s Law Applies?

The variations in state unclaimed property laws can make it difficult to determine whether gift cards are exempt and, if not, which state is entitled to the property. Fortunately, the Supreme Court has provided some guidance. Generally, the state where the gift card owner’s last known address is located has first priority to the abandoned funds. However, if the card issuer does not have access to that information or if the owner is located in a state whose unclaimed property law does not apply to gift cards, then second priority goes to the state in which the card issuer is incorporated or otherwise domiciled.

Typically, restaurants do not retain the names and addresses of customers who purchase gift cards, so in most cases, the treatment of abandoned cards will be dictated by the state of incorporation or domicile. What if that state’s unclaimed property law applies to gift cards? One potential solution that many businesses are exploring is to have gift cards issued by a subsidiary incorporated in a state where they are exempt.

Complying with unclaimed property laws can be a challenge, especially for restaurants that do business in several states, so be sure to consult with an ORBA professional for assistance.

For more information about unclaimed property laws, please contact Rob Swenson at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Restaurant Group.