South Dakota’s Treasures: Rolling Hills, Sweeping Plains and Dynasty Trusts
From Mount Rushmore National Memorial to the Crazy Horse Memorial to the Corn Palace and Wall Drug, South Dakota offers numerous must-see attractions. You might ask what a state with a population of just 858,469 (as of July 1, 2015), less than the population of San Jose, California, the epicenter of the Silicon Valley and the richest city in the country (according to Bloomberg’s 2015 ranking of richest cities by gross metropolitan product) have to do with one another? The answer lies in South Dakota’s zero state income tax and its lenient trust laws in the country, which make it an interesting option for the very wealthy when considering impactful estate planning strategies for dynastic families.
Estate planning tools in South Dakota center on the use of dynasty trusts. Originally used by families like the Rockefellers and Carnegies, the intent of these irrevocable trusts is to protect wealth through several generations and the changing winds of different tax codes over time. Previously, laws against structures for perpetuity required such trusts to disband 21 years after the death of the last beneficiary alive when the trust was written. However, in 1983, South Dakota became the first state to allow for trusts to endure in perpetuity, essentially jumping outside the federal transfer tax system on estates. With no limit on the length of time a trust can exist, wealthy families can set up a trust within South Dakota and continue to disburse funds to their great-great-great (add as many “greats” as you wish) grandchildren untaxed, indefinitely. It is important to note that in response to perpetual trusts, Congress established the Generation Skipping Transfer Tax (GSTT) in 1986, which places limits on the amount of assets that can be passed to future generations free of federal tax.
While there are now 21 states, plus Washington, DC, that allow perpetual trusts, the primary reason that many utilize South Dakota to administer their generational wealth is that the state has no state income tax. Neither the assets contributed, nor income – capital gains, dividends, interest – generated from the trust assets, are taxed by the state of South Dakota. And at death, the state does not collect an estate tax on the funds.
South Dakota also goes the extra mile to shield trust assets in the event of a bankruptcy, lawsuit or divorce. Under friendly laws enacted by the state, an individual can transfer assets to a trust and receive benefits from that trust while still being shielded from creditors. Other protections are offered in the form of ironclad privacy laws, which allow courts to permanently seal records related to trusts with a simple petition.
Additionally, there are no residency issues, which is important for anyone enjoying the California climate or elsewhere. South Dakota law does not require the people investing in trusts established in their state to actually live there. It also allows families to control their own dynasty trust investments, rather than hiring trustees.
Another benefit is the state’s legislation around the creation of a Special Purpose Entity, a powerful planning tool that places a liability umbrella over the individuals serving in the roles of trust protector, investment committee, or distribution committee member, thus protecting them from personal claims from trust beneficiaries.
A family trust administered in South Dakota has the potential to last through the lifetimes of generations not yet born and the financial gains can be significant relative to trusts whose taxation erodes the remaining value over time. As with any irrevocable, multi-generational trust, you may have a lot of control over a dynasty trust, but your descendants may have very little. By the same reasoning, the trust income or property will have to be divided among more and more beneficiaries. If the grantor and each beneficiary have 2 children, then there will be 64 beneficiaries in the 6th generation. Depending on the size of the trust, this may become impractical to maintain. The 64 teams in a March Madness Basketball bracket comes to memory.
Needless to say, these trusts are complex and must be carefully explored with your investment advisor and estate planning attorney. There are distinct pros and cons, but under the right circumstances, they could be worth further consideration.
The information provided here is for informational purposes only and is based upon the best information available, which may be supplied by other sources. The preceding should not be considered individualized advice, and you should consult your estate planning attorney for specific guidance.