The latest trove of information informing the general public of the myriad ways in which the wealthy continue to get wealthier came earlier this month in the form of the “Pandora Papers”—documents based on confidential information obtained by the International Consortium of Investigative Journalists.
The Pandora Papers outline the offshore holdings of leading political figures from around the world. One fact stood out: A lot of them seem interested in South Dakota.
Why South Dakota?
The reasons the world’s rich and political seem to flock to Sioux Falls to establish trusts are not the big sky and Badlands National Park, but are instead a few provisions that make it attractive to anonymous wealthy folks who want to stay anonymous and wealthy.
1. No state income tax.
This is a big one, but it isn’t unique to South Dakota. In fact, nine states have no individual income tax: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. Nope, ducking capital gains alone isn’t going to bring in the investments.
2. No Rule Against Perpetuities
The rule against perpetuities is a staple of a first-year law school property class. It is a rule intended to prevent unvested property interests from existing, you guessed it, in perpetuity. Simply stated, it is a rule stating that interests in a piece of property must vest within 21 years after the death of an individual being alive at the time that interest was created. The policy rationale is that property law abhors a vacuum of ownership—we want to know who owns a parcel of land, with relative certainty, at any given time.
All the same, South Dakota isn’t alone in this respect either. Indeed, 19 states in total have repealed the rule against perpetuities. So this isn’t going to bring in the oligarch money, either.
3. Statute of Limitations
Now we’re getting to the meat of the issue. The statute of limitations in South Dakota for an existing creditor against a trust is six months—for a new creditor it is only two years. In most other jurisdictions these limitations periods are four years and even as much as 10 years.
What this means is, if a creditor wants to argue that a conveyance to a trust was fraudulent—that is, it was intended to hide assets and prevent the collection of a debt, they have about half the time to do so in South Dakota as they would elsewhere. Further, the standard in South Dakota is “clear and convincing” (greater than 50%) with the burden on the creditor. In New York, by contrast, it is a “preponderance of the evidence” (more likely than not). This makes for a much steeper climb for debtors seeking to reach assets in South Dakota.
4. Quiet Trusts and Court Seals
One aspect of South Dakota trust law that is likely going to receive a lot of attention in the media is the idea of a “quiet trust”—that is, a statutory provision permitting a grantor to control what information is available to anyone save for said grantor—even to the beneficiary. In South Dakota, you can be a beneficiary to a trust that you don’t even know about.
Second, South Dakota has a statutory seal that automatically seals all information regarding trust contents should an issue be litigated. Seals exist everywhere, but they are ad hoc and case-by-case. In South Dakota, sealing is default.
5. Domestic Asset Protection Trusts
South Dakota has a strong domestic asset protection trust (DAPT) regime, which is a self-settled, irrevocable trust that allows the grantor to be the beneficiary and retain full control over how the assets are used. A self-settled trust is one in which the grantor conveys their own assets into a trust for which they are the sole beneficiary. In essence, the assets are in a trust in name only, the grantor retains the ability to have access to those assets throughout their life.
What can be done?
The Pandora Papers will thrust into the limelight the issue of South Dakota trust law and raise questions about what can, or should, be done. The idea of “secret money,” ill-gotten gains hidden away by the world’s political elite in the state of Mt. Rushmore, will likely have quite a bit of political and pundit traction—but privacy is not the enemy here.
Changing the South Dakota Trust Law to remove the default sealing of trust records in litigation, or eliminate the quiet trust, would do little to curb the influx of cash, ill-gotten or otherwise.
DAPTs must be eliminated. Not just in South Dakota, but across the country. Trusts were originally intended to provide for the protection of an asset during a period of incapacity or unavailability. They have morphed into something else entirely, with provisions such as DAPTs permitting outcomes never intended to be an aspect of trust law.
The problem is that a DAPT is a relatively tax-wonky concept, and it’s not as easy to fit into a news blurb or segment. It is much easier to make veiled references to secret trusts and let the reader/viewer do the heavy lifting of attaching the idea to “dark money” influences in politics and secret off-shore bank accounts.
The strength of DAPTs has only magnified in recent years, with an IRS private letter ruling suggesting that, for estate tax purposes, the movement of assets into a DAPT would constitute a completed gift. These are the sorts of small incremental changes that permit outcomes like that seen in South Dakota to flourish. They aren’t sweeping reforms to tax codes, and they don’t come in on the heels of massive bills, but they’re massive in the aggregate.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Andrew Leahey is a tax and technology attorney in Pennsylvania and New Jersey.
Bloomberg Tax Insights articles are written by experienced practitioners, academics, and policy experts discussing developments and current issues in taxation. To contribute, please contact us at TaxInsights@bloombergindustry.com.