The American tax system is built on voluntary compliance. Taxpayers, and their advisors, are expected to follow the rules, report honestly, and navigate a code that is both complex and constantly evolving. For the most part, that system works, but the way it works creates inevitable tension.
That tension comes from complexity. The Internal Revenue Code is not a simple set of rules designed only to collect revenue; it is layered with incentives, exceptions, and policy decisions that shape behavior. When you combine that complexity with voluntary reporting, you end up with opportunities for strategies.
Let’s go a step further: Not only do we see these opportunities in the federal tax code, but we see even more opportunity with the state and local level tax codes. Most people don’t there are thousands of tax jurisdictions within the United States: City, County, State, library, etc. I have read that there is 10,000 tax jurisdictions in the US.
And this is important because this greatly impacts trust planning.
Let’s get into it.
I mentioned this idea of complexity and competing interest within the tax code. Legislators use the tax code to incentivize behavior from the masses. As I said, there is opportunity for strategy and planning.
Some of those strategies hold up under scrutiny, and others collapse very quickly. We’ve seen this cycle play out repeatedly over the last two of three decades, and it tends to follow the same pattern. A strategy gains popularity, advisors grow comfortable with it, and then eventually the IRS steps in and draws a line.
Swiss bank accounts are a clear example. Offshore LLCs. For years, they were viewed as a reliable way to maintain anonymity and shield assets, until the system broke down and enforcement caught up. The IRS didn’t start by bringing cases; it started by offering voluntary disclosure, and then it moved aggressively once it had visibility.
We saw similar arcs with the Malta pension plan strategy. In each case, there were taxpayers who genuinely believed they were operating within the rules, but the underlying structure pushed too far. When the IRS finally addressed those strategies directly, the outcome was predictable.
A useful rule of thumb comes out of these examples. If a strategy is built on hiding assets or obscuring ownership, it is very unlikely to survive long term. The IRS is patient, and it has a long memory.
The problem is that when these strategies collapse, they don’t just affect the people who used them. They tend to cast doubt on everything around them. People start to blur the line between what is illegal and what is simply unpopular or politically inconvenient.
That distinction matters more than most people realize. The tax code is not a moral document; it is a legal framework. There are plenty of strategies that are entirely compliant with the law and still make people uncomfortable because of how they work or who benefits from them.
A large part of that discomfort comes from how the tax code is designed. Congress does not just write rules to collect revenue; it uses the tax code to influence behavior, encourage investment, and direct capital into certain areas of the economy. When you build a system like that, you are going to create outcomes that feel uneven depending on your perspective.
This brings us to what we’re seeing right now with South Dakota trusts. There has been recent attention, particularly in the Wall Street Journal, on private equity executives placing carried interest into South Dakota trusts. The framing of that coverage suggests that there could be something improper happening, or at least something that should be questioned.
When that carried interest is received inside a properly structured South Dakota trust, the taxation of that income can be deferred at the state level. The trust accumulates the income without state tax drag, and distributions are made later according to the terms of the trust. In practice, many families structure their affairs so that they still have sufficient income outside the trust to support their lifestyle.
From the outside, this can look like income is being moved out of a high-tax state and into a low- or no-tax jurisdiction in a way that feels like it should not be allowed. That perception is what drives a lot of the criticism. People look at the outcome and assume there must be something wrong with the structure.
But the reality is that this outcome is not an accident. It is exactly what South Dakota designed its laws to accomplish. Over the past four decades, South Dakota has built one of the most modern and comprehensive trust frameworks in the country, specifically to attract capital from both resident and non-resident families domestically and abroad.
This is federalism in action. States are not required to operate under identical legal frameworks; they are allowed to compete. Each state can decide how it wants to structure its laws, and capital will naturally move toward jurisdictions that offer the most attractive combination of certainty, flexibility, and protection.
If another state does not like that outcome, it has options. It can change its own laws, adjust its tax policies, or build a more competitive environment for capital. What it cannot do is assume that a strategy is improper simply because it produces a result that is politically unpopular.
That said, there are real limits here, and they matter. A sham trust will not hold up under judicial scrutiny, even in a state as favorable as South Dakota. Courts are very clear on this point: if the structure is not real, it will not be respected.
That means the settlor has to actually transfer control of the assets to the trust. The trust has to be administered in accordance with its governing document. The fiduciaries involved have to perform their roles, and the structure has to operate as intended.
This is where South Dakota’s ecosystem becomes important. The state has a deep bench of experienced, professional trust companies that handle administration, compliance, and fiduciary oversight. These are not shell entities or paper arrangements; they are real institutions with real responsibilities.
That distinction separates legitimate planning from the types of strategies that tend to fail. When a structure is properly designed and properly administered, it is far more likely to withstand scrutiny. When it is not, it tends to unravel very quickly.
It’s also important to recognize that the benefits of a South Dakota trust extend well beyond taxation. The state offers some of the strongest privacy protections in the country, along with well-developed asset protection laws and a robust framework for long-term trust administration.
More importantly, these trusts are designed to support family governance over time. They allow families to create structures where decision-making is shared, responsibilities are defined, and wealth can be managed across generations in a disciplined way. That is a very different objective than simply reducing a tax bill in a single year.
The tax outcome, if it exists, is secondary. It is not the foundation of the structure, and it should not be the primary reason for implementing it. When tax becomes the only objective, the structure is far more likely to be challenged or to fail.
So when we evaluate strategies like South Dakota trusts, it is important to stay grounded in the right framework. The question is not whether the outcome aligns with someone’s personal policy preferences. The question is whether the structure follows the rules that were intentionally put in place.
If it does, then it is part of the system. It reflects the choices made by lawmakers and the competitive dynamics between states. If it does not, then it will eventually be challenged and likely fail.
That line is clearer than most people think. The difficulty is not in understanding the rule; it is in applying it consistently, without letting perception or politics distort the analysis.
And that’s ultimately where good planning lives. Not in pushing the edge for the sake of it, and not in avoiding strategies simply because they are controversial, but in building structures that are durable, compliant, and aligned with the long-term objectives of the family.