What You Need to Know
- The Pandora Papers highlight how South Dakota has become one of the most popular tax havens in the world.
- Lawmakers looking to raise taxes on the wealthy are licking their chops at trust laws.
- One of the most popular trusts in South Dakota and other trust-friendly states has never been tested in court.
The most recent release of confidential documents from the super wealthy — dubbed the Pandora Papers — highlights how South Dakota has become one of the most popular tax havens in the world. Naturally, those looking to minimize taxes, especially in high-tax states, want in on the game, too.
South Dakota offers everything a wealthy person setting up a trust could want. There is no state income tax or capital gains tax, so investment gains on assets placed in the trust are tax-free if it’s structured correctly. Robust protections provide anonymity and shield assets from creditors. And special provisions allow trusts established there to last forever, which means those assets would never be subject to the federal estate tax (currently 40% for estates worth more than $11.7 million).
But there are some reasons why creating a trust in South Dakota — or any of the other states that have equally favorable trust laws such as Nevada, Delaware and Alaska — could backfire. That is true especially now, as lawmakers at both the federal level and in some states weigh policies to make the rich pay a higher share in taxes.
First, one of the popular types of trusts used in South Dakota and Nevada has never actually been tested in a court of law. That means it’s unclear, if it were to face a challenge from, say, a high-tax state looking to get its share, how a judge would rule.
Part of why the trust, known as an incomplete gift non-grantor trust, or ING, could be more open to scrutiny than other types of trusts is that someone using one is effectively talking out of both sides of her mouth.
Let’s say a wealthy person in California, a high-tax state, wanted to set up an ING in South Dakota. She would say it’s a non-grantor trust, which means it’s a wholly separate entity and, as such, pays its own income tax.
But, in the same breath as she says she’s hands off, she also says she still has some control over the assets she’s putting in there — and for that reason, her gift to the trust is incomplete so she isn’t tapping the annual $15,000 limit for gifts or the $11.7 million lifetime exemption before the federal gift tax starts to kick in.