The rich and their trust funds benefit from SD addresses
By Zachary R. Mider
Among the nation’s billionaires, one of the most sought-after pieces of real estate right now is a quiet storefront in Sioux Falls.
A branch of Chicago’s Pritzker family rents space here, down the hall from the Minnesota clan that controls the Radisson hotel chain. Other rooms are held by Miami and Hong Kong money.
Most days, the small offices of this former five-and-dime are shut. But even empty, they provide their owners with an important asset: a South Dakota address for their trust funds.
In the past four years, the amount of money administered by South Dakota trust companies such as these has tripled to $121 billion — almost all of it from out of state. The families needn’t move to South Dakota, deposit their money at a local bank, or even touch down in the private jet.
Little more than renting an address in Sioux Falls is required to take advantage of South Dakota’s tax-friendly trust laws.
States such as South Dakota are “creating laws that are conducive to a massive exploitation of a federal tax loophole,” said Edward McCaffery, a law professor at the University of Southern California. “We have a tax haven in our midst.”
South Dakota’s sudden popularity illustrates how the wealthiest Americans are embracing ever more creative ways to reduce taxes legally. Executives at South Dakota Trust Co., one of the state’s biggest, estimate that one-quarter of their business comes from special vehicles known as dynasty trusts that are designed to avoid the federal estate tax.
Creation of such trusts has surged in recent years as changes in federal law have enabled more money to be placed in them.
While the super-rich use various tools to escape the levy, the advantage of dynasty trusts is that they shield a family’s wealth forever.
That defies the spirit of the estate tax, enacted almost 100 years ago to discourage the perpetuation of dynastic wealth.
Out-of-state customers also see a chance to shelter their investments from income taxes in their home states. In November, a government commission in New York recommended tightening trust laws to avoid income-tax leakage to states such as South Dakota, estimating the change would raise an extra $150 million a year.
Others are drawn by South Dakota’s iron-clad secrecy and protections of trust assets from creditors and ex-wives, with features emulating those available in Bermuda and other island havens.
South Dakota also enhances wealthy families’ control over investment decisions and their ability to set up their own trust companies rather than rely on a bank trustee.
Lawmakers in South Dakota, home to two of the nation’s 10 poorest counties, say they’re bolstering the trust industry to generate work for local law firms and bankers while forging ties with prosperous families that could eventually build a factory or a warehouse here.
The legislators are turning the Mount Rushmore State into the Bermuda of the prairie.
As much as anyone, Pierce H. McDowell III can take credit for this transformation. He works upstairs from the hall of empty offices, as president of South Dakota Trust.
At 56, McDowell has been promoting the state he affectionately calls “North America’s Siberia” for most of his career. In 1993, he published an article in a national estate-planning journal recommending that wealthy people nationwide establish dynasty trusts in South Dakota.
Because the estate tax is imposed on large fortunes at death, McDowell wrote, wealth large enough to last for generations must contend with multiple tax bills.
A father pays the tax when he leaves his money to his children, who pay again when they pass it down. Each generation faces a toll. The current rate is 40 percent.
McDowell’s solution was for the father to establish a never-ending trust that pays each generation of heirs only what they spend, while the rest of the money grows. In 1993, when McDowell was writing, that wasn’t possible in 47 of the 50 states because of an ancient rule limiting the duration of trusts to the lifetime of a living heir, plus 21 years.
The concept has been a part of Anglo-American jurisprudence since a case decided by England’s Lord Nottingham in 1681.
South Dakota repealed that rule in 1983, and unlike Idaho and Wisconsin — the other two states without the provision — it had no income tax. So, McDowell wrote, a trust set up there could shield a big fortune from taxes for centuries, escaping tax bills as it hands out cash to great-greatgreat-grandchildren and beyond.
Over dinner at a Sioux Falls restaurant, McDowell elaborates on the idea.
“I like to equate it to the wine in this glass,” McDowell says, covering his cabernet with his hand. “Here you’ve filled it to the rim and push it downstream to the next generation. You can sip from it, you can have the equivalent of outright ownership, but you don’t own it under the law. Your children — they too will have the opportunity to sip from it.” He cups his hands as if to cradle the precious liquid.
“In most states, the glass has to pour out completely in a generation or two. We did away with that in 1983.” He chops the air with his hand.
McDowell’s sales pitch got far more attractive when Congress gave the idea an inadvertent boost.
“I call it the trust tsunami of 2012,” McDowell said.
Bloomberg News photo by Zachary R. Mider
Pierce McDowell at South Dakota Trust in Sioux Falls poses next to a 1934 news clipping from when a notorious gang robbed the bank where his grandfather worked. As much as anyone, McDowell can take credit for transforming South Dakota into the Bermuda of the prairie: In just four years, the amount of money administered by such state trust companies has tripled to $121 billion, almost all of it from out of state.