The American tax system is built on voluntary compliance. Taxpayers, and their advisors, are expected to be honest when preparing their returns and to do so while meeting all of the rules in the voluminous Internal Revenue Code. For the most part, this system works. But inherent in its design are many gray areas and strategies that may or may not run afoul of the rules. If you are in need of assistance with protecting your assets, contact our Wyoming domestic asset protection trust lawyer today.
We’ve seen many of these strategies gain in popularity and then go bust in recent years. Holding assets in Swiss banks was a great anonymity shield, until it wasn’t. The IRS started with voluntary disclosure before it moved on to enforcement. Similar fates met the Malta Pension Plan strategy and the conservation easement. No doubt many of those taxpayers honestly believed their strategy was legitimate, but a useful rule of thumb is that if your strategy is seeking to hide assets, it’s unlikely to prevail under scrutiny.
These high-profile blow-ups have the unfortunate side effect of casting shade on legitimate strategies that some might frown upon not because of illegality, but because of their personal policy preferences. Wealth is a complicated topic in America, and the antagonism toward the kind of success that our economy builds is misplaced. When families and businesses win, communities, workers, and industries win. Managing wealth is no easy task, especially when it is often built in first-generation wealthy families. Congress, state legislatures, and the IRS wrote the rules of the road for taxes, and it’s up to families to play by them.
The primary tension in the tax code is that it’s not just designed to raise revenue. Rulemakers insert all sorts of caveats, rebates, and deductions to try to shape behavior and investment decisions. When that complexity is loaded onto a system that’s fundamentally meant to collect taxes, there are bound to be strategies that are lawful and proper but still upset some people.
The Wall Street Journal recently reported on private equity executives establishing South Dakota trusts to hold their interests in “carried interest.” Private equity funds cannot give ownership in the underlying companies, but they can give a stake in the fund’s profits. This is called carried interest, and it is generally a pre-agreed percentage of profits. The taxation of carried interest is deferred when it is received by a trust. Executives will take their carried interest and place it into their South Dakota trust, sheltering it from state tax in the year it is received. The WSJ article describes how these executives structure their financial lives so there is still sufficient income flowing into their households outside of the trust for their maintenance and support. The carried interest builds inside the trust without state tax drag until the money is withdrawn by the beneficiary.
Many people object to this strategy and liken it to tax evasion. In their thinking, moving assets out of one’s state of residency and into a trust in South Dakota seems like it should break some rule. The problem with that objection is that not only is the strategy legal, it’s what South Dakota intended. Building a dynamic economy requires capital, and if South Dakota can offer a more competitive domicile for that capital, it’s in the state’s interest to do so. This is one of the many benefits of our federalist system: states can compete among themselves to offer the best law. States that dislike an outcome are free to enact legislation and tax laws that make their own jurisdictions more attractive to capital. Over the last four decades, South Dakota has worked methodically to build this progressive and modern estate planning framework for the benefit of both resident and non-resident settlors.
To be sure, a sham trust will not hold up to judicial scrutiny in South Dakota. As pro-settlor as the state is, its courts will not tolerate abuses of the law. It’s up to the settlor to ensure that a trust is properly constructed and that the rules are followed. This means giving control of the assets to the trust, which then administers and distributes them according to the trust agreement and at the direction of the trust officers. South Dakota has a deep bench of experienced and reputable trust companies that assist with statutory compliance and administrative matters. This is an important distinction from traditional shell trusts: real professionals, operating real companies, who actually live and work in South Dakota.
For those who choose to establish a South Dakota trust, the benefits extend well beyond taxation. Strong privacy protections, court-tested asset protection, and powerful tools for family governance round out the advantages of these trusts. This is not a trust designed to be administered by a passive bank trustee; it’s a total trust framework built for shared family governance of the family wealth enterprise. Any state tax benefit is simply icing on the cake.
Private equity has few fans on Main Street, but South Dakota law invites non-resident settlors in every sector of the economy and profession, from all 49 states, to consider the many benefits and certainty it offers to its domiciled trusts. South Dakota has been refining this framework for more than four decades, and its doors remain open to any family and their capital seeking the benefits of modern estate planning without the imposition of other people’s public policy preferences.
Contact Stuart Green Law, PLLC today to schedule a consultation.