For the past 30 years, South Dakota has been a bastion of extreme wealth, a place for multimillionaires and billionaires around the world to stash their money in vehicles known as trusts. As the explosive Pandora Papers investigation has exposed, the world’s wealthy employ complex schemes in order to avoid taxation, and the use of trusts is an essential strategy.
Trusts are common tools of wealth management, but they can be misused to foment massive dynastic wealth. For example, in a recent Institute for Policy Studies brief, my colleague Chuck Collins and I detailed how a multimillionaire or billionaire can create a dynasty trust, in which money can grow almost entirely protected from estate and transfer taxes. Trusts are how the family that owns Mars, Inc. has seemingly been able to pass billions on to each generation without losing a chunk of change to taxation.
In the weeks since the release of the Pandora Papers, much attention has been focused on the fact that the United States has become a place where the rich hide illicit wealth. Indeed, the country is now second on the Tax Justice Network’s Financial Secrecy Index, which ranks tax havens. But less has been said about exactly how the trust industry has gained a foothold in the South Dakota legislature and what it means for South Dakotans.
Although most of the state’s legislators did not get in the way as the industry proposed legislation after legislation to favor the creation of trusts, some spoke up. In 2018, then-state Representative Susan Wismer (D-Britton) told a house committee and its audience of trust lawyers that the state was enabling “fiefdoms from generation to generation” and that South Dakota’s unparalleled trust industry, due to the state’s tax climate and advantageous trust laws, was “really nothing to be proud of.”
The rest of the committee members, some trust lawyers themselves, were horrified that she would question the industry so central to South Dakota’s identity as “the premier trust jurisdiction in the United States,” as the state’s banking division boasts.
“When I unleashed in that judiciary committee,” Wismer told me back in March, “that was the first time that anyone had ever said boo against the trust industry for 30 years probably.”
South Dakota’s trust industry is bolstered not only by the absence of any state income tax, inheritance tax, or capital gains tax, but also by an official task force of trust lawyers that recommends legislation favorable to the industry.
Wismer had been an elected official in South Dakota since 2008, most recently serving as a state senator, but she lost her reelection in 2020. Her opponent received $2,000 from the South Dakota Trust Company, the state’s largest trust company.
If there’s anything to know about the trust industry in South Dakota, it’s this: What the trust industry wants, it gets.
The Rise of South Dakota’s Trust Industry
US states have increasingly loosened their trust laws over the past couple of decades in order to attract new trust business and compete against traditional corporate-friendly states like Delaware. More continue to adopt this new status quo, unwilling to be left behind as their neighbors become little domestic tax havens.
South Dakota has quickly become the poster child of the trend, made clear by how often the state is mentioned throughout the Pandora Papers. Currently, there are more than $500 billion in trust assets managed by 106 trust companies in South Dakota; that number of trust assets has more than doubled in the past five years.
Many factors have contributed to the rise of the trust industry in South Dakota, including the entrenchment of conservatism in the state. South Dakota Republicans have held a trifecta in state government since 1995—which is also the year that legislation allowing the creation of trust companies was passed.
But key is the influence of the trust industry in drafting the legislation. Trust law is incredibly complicated, and legislators lacking expertise tend to take the side of “business” without fully understanding the consequences of tying up wealth away from prying eyes, creditors (including child support claims), and the US Treasury. Sometimes no one opposing trust legislation even testifies in bill hearings.
South Dakota’s “citizen legislature”—a legislative body that can be found in primarily rural states with small populations—has exacerbated the problem. The legislature is made up of part-time lawmakers who are compensated with little to nothing for their work, so they hold other, primary occupations. During her tenure in the statehouse, Wismer worked as an accountant, as she does now, while earning the $12,851 per year that South Dakota pays lawmakers.
The intention is for states to be governed by regular citizens instead of career politicians. That’s not exactly what happens in practice.
In a state with a citizen legislature, lawmakers often don’t have the time, the resources, or the staff to fully study or understand issues before they vote. It also means that lawmakers skew affluent, as they have the time to do what is essentially seen as a “community service,” and is therefore poorly compensated. That’s part of the reason state legislatures are disproportionately male and white.
Perhaps the strongest catalyst that led to South Dakota’s trust dominance is that it was one of the first states to abolish what’s called the rule against perpetuities, which controls how long trusts can last. Under the rule, which was designed centuries ago, trusts can only last so long: technically, the lifespan of the youngest beneficiary alive when the trust was created plus 21 years. To many wealthy families who wish to create legacies, that is not long enough.
In 1983, South Dakota repealed the rule, which meant that wealth in trusts could grow virtually untaxed… forever. Over the following decade, trust business in traditional banks soared. Then, noticing South Dakota’s potential—remember, the state does not collect income tax—trust lawyers helped draft the language that would become the state’s 1995 trust company statute, and then chartered the first trust company in the state.
Today, there are more than 100 trust companies in operation, though fewer than 1 million people live in South Dakota. Meanwhile, the trust task force, created in 1997, is still going strong.
The Impact on South Dakotans
Most South Dakotans may never interact with the trust industry. Yet the industry helps to breed an anti-tax, anti-regulatory environment, which not only leads to shaky, regressive tax systems but also contributes to limited government investment in state residents.
In total state investments per person, South Dakota lags behind 42 other states and the District of Columbia. This is the case even though South Dakota has had a robust budget surplus for several years. Just this year, the state had a record surplus, not necessarily due to “our respect for freedom and our continued emphasis on fiscal responsibility,” as Governor Kristi Noem claimed. Instead, it was because of federal Covid relief that has left many states flush with cash. And while some states are using their budget surpluses to invest in social services, South Dakota has two reserve accounts to sock away funds, because the first reached its legal limit.
The revenue that South Dakota does raise is done at greater expense to the poor than to the rich. Those in the bottom quintile of earners in South Dakota pay 11.2 percent of their income in taxes. Meanwhile, the average effective tax rate for the top 1 percent in the state is 2.5 percent.
“We run our state government on 4.5 percent sales tax,” says Wismer. Many buildings on college campuses or even state institutions are possible, she says, because of “a whole lot of donated money.”
T. Denny Sanford, South Dakota’s only billionaire, has donated so much money to institutions in the state that his name is emblazoned across it, most notably the legion of buildings that make up Sanford Health, the health system headquartered in Sioux Falls.
Earlier this year, Sanford helped establish a need-based scholarship fund for students attending public universities in the state, spurring the state legislature to commit some funds too. Until then, South Dakota was the only state in the country not to offer a need-based scholarship program.
It’s worrying to think what South Dakota may do when it cannot rely on charitable donations like those from Sanford, who has been under investigation for possible possession of child pornography. Still, it’s clear that the state has become a home for illicit wealth because it aims to attract economic development through the goodwill of the wealthy rather than direct investment in South Dakotans.
What Lawmakers Can Do
There are a number of solutions to tie up tax loopholes and curb the use of trusts to avoid taxes, some currently on the table in Congress, and all which would strike a blow to the trust industry at large. For example, current proposals in the reconciliation bill would reduce the estate tax exemption from $11.7 million to $6 million, reducing how much a person can stash into a trust and avoid initial estate taxes.
Wealth planners know what these solutions might be and are urging their clients to act quickly before a more progressive Congress can. That’s partly why South Dakota now has more than $500 billion in trust assets, up from $367 billion in 2019.
“The pandemic got people thinking about their mortality, but it’s the potential change in tax law that drove people to look at South Dakota for advanced planning,” trusts and estate lawyer Pat Goetzinger told the outlet SiouxFalls.Business. He is also a member of the governor’s trust task force.
For their part, many state legislators have waved off the Pandora Papers’ revelations and pointed to the benefits of a South Dakota trust industry, though there are few besides about 400 jobs. With an official industry group that crafts trust legislation and no lawmaker after Wismer willing to take up the banner against it, if change comes to South Dakota, it will have to be federal change. After all, if South Dakota made it more difficult to set up trusts, the wealthy would just move their money to another trust-friendly state like Nevada. Until Congress acts, business will continue to boom. And Goetzinger’s clients, he said in April, are “lining up out the door and around the block.”
They’re not actually lining up outside the door, of course. They’re not in South Dakota.