TRUST LAWS IN THE U.S.
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South Dakota offers a compelling tax-planning opportunity for trustees and beneficiaries, where trust assets can grow free of state income tax and capital gain tax. With correct planning – combining no state income tax with trust vehicles like dynasty trusts, community property trusts, resident trusts and incomplete non-grantor trusts (“ING”) – families can create substantial tax savings, extending over multiple generations. Click here to see how South Dakota can save you taxes on your trust by using our tax savings calculator.
South Dakota was the first state in the country to eliminate the rule against perpetuities – leading to the creation of dynasty trusts, a very powerful planning tool that preserves family wealth over generations by avoiding federal estate taxation in perpetuity. Unlike many states that have merely amended the rule against perpetuities to extend a trust’s termination, a dynasty trust avoids federal taxation on trust assets forever because the trust never terminates.
For wealthy families all over the world, privacy protection is paramount. Fortunately, South Dakota boasts some of the best privacy protections built into its codified trust law, including quiet trusts (see below). South Dakota’s privacy statute ensures a total seal forbidding any release of trust information, including names of settlors, beneficiaries and trust contents, to the public during litigation. Most states do not have privacy statutes specific to trusts, so privacy is not mandated or guaranteed by law as it is in South Dakota. South Dakota’s statute seals all trust information from the public forever without the need to petition for a court decree. In states like Delaware, Nevada and Alaska, the court has discretion as to whether or not to seal the trust; however if that seal is granted, unlike South Dakota, it is not in perpetuity
A particularly valuable feature of South Dakota privacy laws is the creation of quiet trusts. Most states require trustees to inform a beneficiary of his/her beneficial interest in a trust at age 18, including the right to see the trust document and receive trust financial statements.
Imagine an 18-year-old discovering he is a beneficiary of a trust at the exact time he may be heading off to college or starting a career…perhaps a large stumbling block when it comes to ambition or plans. Under South Dakota law, quiet trusts can be created that grant the settlor, trust protector and the investment/distribution advisor the power to expand, restrict, eliminate or modify beneficiaries’ rights to discover information about a trust. South Dakota is universally considered to have the nation’s most comprehensive and flexible quiet trust statutes.
Under South Dakota law, a discretionary interest in a trust is not a property interest nor an entitlement. Additionally, limited powers of appointment and remainder interests are also not property interests – extremely advantageous from an asset protection standpoint when combined with a South Dakota self-settled trust or domestic asset protection trust. In a self-settled trust, assets can be legally shielded from third-party liability (including spouses in a divorce proceeding) and lawsuits while permitting settlors (the people establishing the trust) to retain some control over trust assets and enjoy a discretionary benefit during their lifetime.
In addition, South Dakota has one of the shortest fraudulent conveyance periods at 2 years as well as a “clear and convincing” burden of proof as to the specific creditor. An intent to hinder, delay or defraud must be proved. Additionally, South Dakota has many other beneficial asset protection statutes. For example, a statute that provides for reimbursement of legal fees to the trustee if the lawsuit is unsuccessful and top-rated LLC statutes make South Dakota a top asset protection jurisdiction.
Only available in a handful of states across the country, directed trusts enable the unbundling of trust administration and investment management. This allows families to combine the benefits of an independent corporate trustee, the hospitable trust and tax environment of South Dakota and the ability to retain preferred investment advisors no matter where they are based. In this model, the responsibilities of the trustee are trifurcated into three areas:
Investment responsibilities – An investment committee, advisor or protector chooses outside investment advisors and managers to direct the trust’s investment. Trustee has no fiduciary responsibility for monitoring performance of these outside investment managers.
Distribution responsibilities – A distribution committee, advisor or protector decides when distributions are made and directs the trustee (usually through a direction letter) on how much should be distributed and to whom.
Administrative responsibilities – The trustee handles contributions, distributions and other regular administrative functions with input from investment and distribution professionals.
Offering the country’s best statutes, South Dakota’s reformation/modification process is both easy and cost effective.
Reformations and modifications are usually completed when the grantor had not anticipated certain circumstances when drafting the trust. By reforming or modifying the trust, it would substantially further the trust or the purpose for creating the trust. Likewise, the reformation can generally be used to correct a mistake of fact or law, and the grantor’s intent can be established. Finally, in order to achieve the grantor’s tax objectives, the terms of a trust instrument may be modified in a manner which will not violate the grantor’s probable intention.
Reformations/modifications in South Dakota can be executed quickly while remaining private. In order to take advantage of South Dakota’s reformation and modification statutes, the trust must be changed to a South Dakota trust situs – so it’s important to review the trust document to see if Sterling Trustees can be named as trustee. Once appointed, Sterling can petition the court for the reformation.
Decanting is the process of moving assets of one trust into a brand new trust, with the power to decant trust assets usually written into the trust document. Once again, South Dakota has enacted progressive statutes. Most trusts permit trustees to pay trust principal to one or more beneficiaries also known as the power to invade the trust. South Dakota’s decanting statute permits a South Dakota trustee to transfer all trust property to another trust for the same beneficiary/beneficiaries, as long as the trustee has any discretion over income or principal distributions. Picking the most flexible decanting statute depends on the character of the trustee’s discretionary authority. According to Steve Oshin’s annual ranking of the best decanting statutes, South Dakota is consistently the number one ranked decanting statute providing families with the flexibility to accomplish their goals.
The decanting process involves the appointment of a South Dakota trustee to an existing trust, then the South Dakota trustee would decant (i.e., distribute trust assets) to the newly created South Dakota trust. In order to provide the nexus to South Dakota to enable decanting, it is critical to review trust documents to see if Sterling Trustees can be appointed as a trustee.
Some of the advantages of the South Dakota decanting statute include:
- Ability on a case-by-case basis to change beneficial interests
- Enable contingent beneficiaries to become current beneficiaries
- Notice to beneficiaries is optional
- Remove mandatory income interest
- Decant trust with ascertainable standard into a discretionary trust
South Dakota’s 8 basis point premium tax is one of the country’s lowest – the average U.S. premium tax is 200 basis points (i.e., 2%). States, including Massachusetts, New York, New Jersey, Florida, Nevada and California, all have premium taxes in excess of 200 basis points. So it’s no surprise that many advisors and grantors have utilized South Dakota in purchasing insurance policies.
By sheltering from personal liability both the individuals serving within the directed trust structure (investment and/or distribution committee members) and the trust protector, this powerful planning tool safeguards against claims connected to their duties in this capacity. Most SPEs are structured as South Dakota LLCs. Therefore, the people serving in these roles are agents or employees of the South Dakota LLC vs. serving individually as residents of their home state. This further ties SPE members and employees to South Dakota situs for asset protection/wealth preservation and income taxation purposes.
Additionally, SPEs may be able to get D&O and E&O insurance which may not be if serving in their individual capacity. All SPEs are registered with the South Dakota Division of Banking (SDDB) but are not regulated by the SDDB. All special purpose entities must work with a qualified South Dakota trust company so that the SPE can direct them on investment, distribution and trust protector decisions.
An often overlooked, but extremely significant factor when selecting the right trust jurisdiction is a state’s fiscal soundness and stability. South Dakota is attractive to many estate planners because the state has no income or capital gain tax on trusts. Since there’s no guarantee that this will always be the case, it’s important to evaluate the fiscal soundness of a state when selecting a trust jurisdiction. By any objective measure, considering multiple factors, South Dakota is unequivocally the most fiscally sound of all the top tier trust jurisdictions. To date:
- South Dakota has a AAA bond rating by all 3 rating agencies
- South Dakota has a constitutional prohibition against estate and inheritance taxes and requires a 2/3 vote of both houses of legislature to impose an income tax.
- South Dakota has a balanced budget requirement as part of its constitution
- South Dakota’s public pensions are over 103% funded, ranking it number one in the country
South Dakota is the nation’s first to enact progressive new legislation creating the South Dakota family advisor (LINK? see South Dakota Codified Law 55-1B-1). The role of the family advisor was created to deliver more control to grantors of trusts, beneficiaries and their advisors when used in conjunction with a directed trust.
The family advisor’s role can be compared to the trust protector except for one basic difference: a family advisor acts in a non-fiduciary capacity – with the power to modify, control and participate in many important aspects of trust administration. The South Dakota family advisor is a good choice for grantors and beneficiaries who may want advisors, such as attorneys, CPAs or investment advisors, to have some control over important aspects of trust administration without taking on fiduciary risk, which may scare or exclude advisors from serving due to the inability to get requite insurance coverage to protect themselves.
“With 0% state income and capital gains tax, trust assets compound state tax free compared to other states”
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