States like South Dakota are “creating laws that are conducive to a massive exploitation of a federal tax loophole,” said Edward McCaffery, a professor at the University of Southern California’s Gould School of Law. “We have a tax haven in our midst.”
South Dakota’s sudden popularity illustrates how, at a time of rising U.S. economic inequality, the wealthiest Americans are embracing ever more creative ways to reduce taxes legally. Executives at South Dakota Trust Co., one of the biggest in the state, estimate that one-quarter of their business comes from special vehicles known as “dynasty trusts,” which are designed to avoid the federal estate tax. Creation of such trusts has surged in recent years as changes in federal law enabled more money to be placed in them.
Dynastic Wealth
While the super-rich use various tools to escape the levy – – some have exotic names like the “Jackie O” trust and the “Walton GRAT” — 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.
The dynasty trust isn’t South Dakota’s only lure. Another attraction, for customers in places like New York and Massachusetts, is the 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 like South Dakota, estimating the change would raise an extra $150 million a year.