Unclaimed, unreal property

Douglas Lindholm, president of the Council on State Taxation, wrote in Investor’s Business Daily to sound the alarm about the latest Orwellian scheme for shaking down business owners – ironically coming from Delaware, a state which has invested considerable effort in attracting corporate headquarters.

The scheme revolves around “unclaimed property” audits.  “Delaware originally enacted its unclaimed property laws as a consumer protection mechanism to reunite Delaware residents with dormant bank account balances, uncashed paychecks, and other unclaimed property,” writes Lindholm.  “And these laws are still valid.  But Delaware is now interpreting those laws against businesses to create a colossal revenue source for the state government.”

Today, unclaimed property is Delaware’s third-largest source of revenue after income taxes and franchise fees. Last year alone, Delaware seized $319.5 million from liquidated property while returning only $18.9 million of unclaimed property to its rightful owners.

Delaware does this through an unfair, onerous and expensive audit system that “looks back” to 1981, and contrives unclaimed property if the company doesn’t have records for all those years. This process often costs companies millions of dollars, mires them in years of audits, and forces them to deal with third-party auditors who are motivated by contingent fees to invent unclaimed property where none exists.

Kelmar, which conducts most of the audits for the Delaware Department of Finance and works on a contingent fee, was paid more than $30 million in the second half of 2012 alone.

The payout to this one auditor for six months was almost twice the unclaimed property returned to all owners all of last year.

So the state comes along and demands companies cough up 30 years of paperwork that they’re not actually required to keep, in order to document dormant accounts, paychecks that were never cashed, and so forth.  Under a 2010 statute, the state Department of Finance works a little accounting voodoo to “extrapolate” how much unclaimed property the company “probably” holds.  The company is summarily judged guilty of sitting on this loot, and required to hand it over… or fight a long, expensive legal battle if they refuse, racking up penalties for late “escheat” payments as they go.

No complaints from the proper owners of this unclaimed property are necessary to initiate the process.  In fact, since it’s all based on “extrapolation,” and human cloning technology has not yet advanced to the point where the government can extrapolate people to claim the money, about 95 percent of the money goes right into state coffers, after a sizable bounty is paid to third-party private auditing firms.  What a sweet racket!

According to Lindholm, companies are tumbling to the racket, the Council on State Taxation slapped a failing grade on the state’s worst-in-the-nation unclaimed property laws, and the Delaware Secretary of State is getting nervous:

There’s now a struggle between the Department of Finance’s desire to keep the money flowing until the unclaimed property well runs dry and the secretary of state’s attempt to protect Delaware’s long-term reputation as a good place to incorporate.

The secretary is running a voluntary disclosure process that lets companies report unclaimed property back to 1996, instead of the 1981 look-back used by the Department of Finance, and promises to treat businesses more fairly than the Department of Finance audits that pay Kelmar a percentage of any funds they can squeeze out of Delaware’s corporations.

But the voluntary disclosure process may not be available to companies already under audit, and these reforms have been too limited in scope to solve this immense problem.

Some companies do decide to resist these unclaimed property seizures.  Staples did battle against Delaware  back in 2010, filing a lawsuit after voluntarily disclosing $137,000 in past-due escheat payments… which prompted Delaware to run an audit and declare the amount due was more like $3.9 million, payable within 30 days, thank you very much.  The suit was settled in June 2012 for an undisclosed amount.

Another challenge came from a pharmaceutical and health care information-technology company called McKesson Corporation, which got zinged for $4.6 million in inventory certain suppliers delivered, but never billed.  This led to an exemption for “uninvoiced payables,” probably out of concern that companies would grow nervous about maintaining large inventories, disrupting business operations.

A new suit was filed in U.S. District Court by Select Medical Corporation in April 2013, citing violations of the Delaware Escheats Law, as well as the Takings Clause, Commerce Clause, and Full Faith and Credit Clause of the United States Constitution.  Once again, a voluntary disclosure of unclaimed property by the company led to the release of auditing hounds by Delaware.  (Adding insult to injury, the audit was announced on the same day the state cashed Select Medical’s voluntarily submitted check.)  On top of the $17,000 already paid by Select Medical, Delaware concluded it had another $297,436 coming.  That’s a lot of “extrapolation.”

Other states will be watching the outcome of the Select Medical suit carefully.  Delaware is not the only state with aggressive unclaimed property laws, although it seems to be the reigning heavyweight champion of extrapolation.  Reformers have questioned the wisdom of retaining third-party auditors, who have obvious incentives to crank up the estimated value of undocumented (unreal?) unclaimed property.

Limiting the length of time the auditors can dig back in their search for unclaimed property makes sense too, especially since the current 30-year window takes us beyond the current age of long-term digital information storage.  Proponents of Delaware’s aggressive escheat law have complained that businesses are too slow to voluntarily disclose even documented unclaimed property.  Right now, they’ve got every reason to be terrified of what will happen if they do.  Perhaps that incentive could be reversed by ensuring a much smaller time frame for historical audits, to companies that promptly comply with voluntary disclosure procedures.

If nothing is done, it might not be long before companies sitting on unclaimed stocks, dividends, refunds, deposits, inventory, and other property conclude that it’s not safe to remain in Delaware, or any other state prone to severe bouts of extrapolation.