In the recent comedy of errors surrounding Elon Musk and Twitter, the state of Delaware played a crucial role in checking the bumbling billionaire’s freewheeling approach to contract law. After Musk, the CEO of Tesla, spent months ineffectually trying to weasel out of an April offer to buy the social media platform, it was a judge in Delaware’s so-called Chancery Court who ordered Musk to follow through on his $44 billion weed joke.
That trial took place in Delaware because Twitter, Inc. has its corporate registration there. So do Amazon, Google, Walmart and Meta (formerly Facebook). In fact, companies responsible for an incredible 45% of U.S. GDP [gross domestic product], and making up two-thirds of the Fortune 500, are registered in Delaware. So are innumerable shell companies, foreign subsidiaries and limited liability companies (aka LLCs) controlled by wealthy individuals.
This article is part of CoinDesk’s Tax Week.
Those big U.S. corporations register in Delaware because of the state’s extremely generous state tax rates and rules. They collectively save billions of dollars in corporate income taxes compared to registering in the states where they’re actually based – money that would otherwise go to services from health care to highways across the U.S.
At the same time, Delaware offers a slightly different benefit for entities and individuals around the world: effectively anonymous registration for shell companies that can be used to hide investment holdings from real estate to equities to, at least in theory, crypto. While the recent blowup of FTX highlights the extreme risk of largely unregulated “off shore” entities, the fact of the matter is that Delaware’s anti-transparency policies could enable the same kind of frauds right here in the U.S. In the world of traditional equities, they already have – again and again.
These various allowances are often collectively referred to by tax and fraud experts as “the Delaware loophole.” The most authoritative estimate available found that the Delaware loophole cost other U.S. states somewhere between $6.6 billion and $9.5 billion in lost revenues between 1995-2009. But that’s just an estimate: we can’t fully measure the impact of Delaware’s lax policies, because they also include measures making such oversight impossible.
“It’s hard to estimate [the impact], because we don’t know who’s behind these companies,” said author and former Financial Times reporter Hal Weitzman. “A lot of what we don’t know is hidden behind anonymous LLCs, and Delaware has been very vigilant about making sure anonymity persists.”
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Combined with the big tax advantages, this veil of corporate secrecy has turned America’s second-smallest state into a vital nexus point in the same global tax avoidance, fraud and money-laundering network that includes sketchy little outposts like the Cayman Islands and Bermuda. Weitzman details the whole sordid mess in his new book, “What’s the Matter With Delaware?: How the First State Has Favored the Rich, Powerful and Criminal – and How It Costs Us All.”
While defenders will argue that Delaware is simply offering a preferential business environment, it’s stunning how much overt fraud has flowed through its systems. Delaware entities were used by the corrupt lobbyists Jack Abramoff and Paul Manafort, more than a decade apart. Enron, the paradigmatic modern fraud, involved two thousand corporate subsidiaries that stretched across 23 states – but 685 of those, nearly one-third, were registered in Delaware.
And Delaware’s impact stretches well beyond U.S. borders: the perpetrators of Malaysia’s 1MDB mega-heist used eight Delaware companies to steal billions including funds used to finance 2013’s “The Wolf of Wall Street.”
Delaware is also, of course, the home of American President Joe Biden. Biden was for many years derisively known as “the Senator from MBNA,” the credit-card issuer, because he was a dogged supporter of Delaware’s lax rules. Among many others, that included rules allowing far higher credit card interest rates than other states do – which is why four out of five major credit card issuers are now registered in Delaware.
The story of Elon Musk and Twitter represents a putative upside to Delaware’s dominance of corporate registration. As defenders of the system often argue, Delaware offers a robust corporate legal setting, rich in precedent and expertise. But Delaware’s Court of Chancery is also deeply undemocratic: its cases are not heard by juries. So while the chancery system may occasionally produce a gratifying comeuppance for those who try to ignore the rules, their main role is creating rules none of us have any input into in the first place.
These are the (tax) breaks
Delaware offers the tax-avoidance equivalent of a Chinese buffet – you can have damn near anything you want, in prodigious quantities.
The most visible and perhaps largest element of the Delaware loophole is the state’s exemption of revenue from “intangible assets” from state corporate income tax. Intangible corporate assets most obviously include intellectual property like patents, brands, and logos – but creative accounting can stretch the designation beyond the point of absurdity.
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Weitzman tells the eye-popping story of Home Depot, which made a representative use of the intangible revenue loophole. In the early 1990s, Home Depot introduced its now well-known mascot “Homer.” The company simultaneously created a Delaware subsidiary called Homer TLC, Inc. to house its mascot, branding, and other intellectual property.
Home Depot then “negotiated” a royalty payment for using that IP that reached 4% of gross sales in 1999. Of course, that’s a negotiation in name only, because two related entities can’t be trusted to realistically price the exchange of assets. Because Homer TLC’s revenues were entirely from intellectual property, and Delaware has no tax on IP income, this in effect meant Home Depot payed no tax on 4% of its gross revenue.
And viola, huge tax savings. Homer TLC had just four employees but $2 billion in annual revenue funneled through Delaware by the early 2000s – all of it derived from intellectual property, making it tax free. Given the U.S. average effective corporate tax rate of 23.4%, Home Depot was using the Delaware loophole to legally steal around $468 million dollars per year. Above all, the victims were residents of Georgia, the state where the company was founded and headquartered, and where that $2 billion would have been taxed – if it weren’t for Delaware.
And that’s just using the loophole as its drafters intended. Once corporate lawyers get creative, all bets are off. Weitzman cites the incredible example of now-fallen telecommunications giant Worldcom. For a time, Worldcom effectively classified its own executives under a Delaware-registered entity, which charged the parent corporation for “management expertise.” Because that’s an intangible asset, that segment of revenue was suddenly free of state corporate tax.
“What that means,” Weitzman summarized, “is you can pay yourself to do anything, tax free.” Not coincidentally, Worldcom was later revealed to be engaged in much broader criminal accounting and tax fraud.
The intangible assets loophole is Delaware’s most broadly appealing menu item, but it also has offerings for more niche tax-avoidance tastes. For instance, the combination of anonymous shell corporations with a zero sales tax has turned Delaware into a hub for fine art sales and storage – which itself remains perhaps the largest completely unregulated asset market worldwide.
Art buyers may for that reason particularly benefit from Delaware’s completely anonymous corporate registration. The state doesn’t just protect information about the identities of the beneficial (that is, real) owners of a company – it doesn’t collect the information in the first place, stymying financial fraud investigations worldwide. That has made it a haven not just for corporate tax avoidance, but for the kind of tiny shell companies that can be used to hide all sorts of financial shenanigans.
A race to the bottom
Finally, why exactly has Delaware created a massive tax loophole at the expense (literally) of the other 49 states? What does Delaware get out of the deal?
The answer is: both a great deal, and embarrassingly little.
Corporate fees make up a whopping 40% of Delaware's state revenues. A local legal industry has also grown up around the loophole, made up of the lawyers and affiliates who help companies through the system – but also, incredibly, everyday folks who get paid simply to put their names on corporate registrations. But that adds up to a relative pittance compared to the billions in taxes avoided in other states – to say nothing of the nebulous social costs of enabling corporate anonymity.
This has persisted in part because Delaware’s industrial and jobs base has been brutalized over the past three decades – in part thanks to free-trade policies championed by Joe Biden and fellow corporate neoliberal Democrats. The decline of manufacturing in favor of services (including legal and financial services) is “more pronounced in Delaware than anywhere else in the Union,” Weitzman said. At this point, providing tax avoidance is a sizable part of the Delaware economy and tax base, increasing resistance to reform even as it impoverishes the neighbors.
This exemplifies a broader “race to the bottom” in recent decades, as states have increasingly competed to provide tax incentives to attract corporate jobs. These are often disastrous for states, such as in the case of Wisconsin’s catastrophic $2.85 billion in incentives for a Foxconn factory that was never built.
Those incentives almost always amount to a transfer from individuals and small businesses to large corporations who know how to work the system. The same can be said for the Delaware loophole specifically: a small organic farmer in Idaho might not have the time or know-how to benefit from registering a shell company in Delaware. But huge agribusinesses like Monsanto or Conagra know every detail, helping make their (often inferior) products cheaper. Over time, such imbalances create an uneven playing field that helps crush small business and buttress socially-damaging monopolies.
Heads we win, tails you lose
There have been significant recent efforts to close the Delaware loophole. Late in the Trump administration, the Corporate Transparency Act nominally implemented requirements for transparency around beneficial ownership of both corporations and LLCs, starting in 2024. That is, it would require disclosure of the named human beings currently able to hide behind anonymous shell companies, undermining some key aspects of the Delaware loophole.
But Weitzman is not optimistic about the measure, citing a myriad of issues including a built- in two-week reporting delay, a carveout for trusts, and the fact that the registry itself will be entirely private, only accessible to government officials and law enforcement. In this it could replicate the flaws of the U.K.’s Companies House, a public registry that, thanks to a lack of oversight funding, often includes clearly fake beneficial ownership information.
“The fact that you set up a registry doesn’t mean that you’ve solved the problem,” Weitzman said. “Somebody has to police that.”