Among the nation’s billionaires, one of the most sought-after pieces of real estate is a former S.S. Kresge five-and-dime that’s been converted to offices in Sioux Falls, S.D. A branch of Chicago’s Pritzker family rents space in the building on South Phillips Avenue; the Minnesota clan that controls the Radisson Hotels chain has an office down the hall; and Miami and Hong Kong families rent other rooms. Most days, the offices are shut. Even when empty, they provide their tenants with an important asset: a South Dakota address for the trust company that holds their wealth.
South Dakota was a pioneer in “dynasty trusts,” which allow families to escape estate taxes forever. The state offers iron-clad secrecy for trusts and protection of assets from creditors and former spouses. It also has rules that make it easier for families to set up their own trust company, rather than rely on a bank trustee, and to enhance their control over trust investment decisions. An added attraction: South Dakota levies no state income taxes on investments.
In the past four years, the amount of money administered by South Dakota trust companies has tripled to $121 billion, almost all of it from out of state, according to the state’s Division of Banking. South Dakota is particularly adept at “creating laws that are conducive to a massive exploitation of a federal tax loophole,” says Edward McCaffery, a professor at the University of Southern California’s Gould School of Law. “We have a tax haven in our midst.”
As much as anyone, Pierce McDowell III can take credit for this transformation. The president of South Dakota Trust, he works upstairs from the hall of empty offices, which he rents out to family trust companies. McDowell, 56, 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 across the country establish trusts there. At the time, most states limited the duration of trusts to the lifetime of a living heir, plus 21 years. Only three—South Dakota, Idaho, and Wisconsin—did not impose any time limit. Because the estate tax is imposed on large fortunes at death, McDowell wrote, wealth that’s big enough to last for generations will have to contend with multiple tax bills. A trust set up in South Dakota, however, could shield a big fortune from estate taxes for centuries as it hands out cash to great-great-great-grandchildren and beyond.
Assets administered by South Dakota trust companies
Over dinner at a Sioux Falls restaurant, McDowell, a lawyer who now devotes all his time to managing trusts, elaborates on the idea. He has curly gray hair and a quick laugh and wears an open collar under a quilted winter vest. “I like to equate it to the wine in this glass,” McDowell says, covering his cabernet with his right 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.”
The amount that can be put into a dynasty trust is usually limited by federal rules. The limit was about $1 million during the 1990s. Throughout the 2000s, the ceiling rose, reaching $5 million by 2011. The limit was scheduled to revert to $1.4 million at the end of 2012. McDowell says his clients rushed to meet the deadline during the last few months of 2012, creating billions of dollars’ worth of new trusts. He had to turn away customers and hire retirees to handle the crush of paperwork. By the end of the year, he says he’d added about 500 trusts to his rolls, more than twice the number in a typical year: “I call it the trust tsunami of 2012.”
The families needn’t have rushed: On Jan. 1, 2013, Congress made the $5 million limit permanent. While President Obama’s annual budget proposals have called for closing the dynasty trust loophole—many states now permit them—Congress has not done so.
For the richest families, even a $5 million dynasty trust represents only a fraction of their fortune, so lawyers have invented complicated strategies—one is an installment sale of assets to an intentionally defective grantor trust—to squeeze bigger sums into the vehicles, as much as $39 million, according to a presentation published by South Dakota Trust last year. McDowell’s firm now administers trusts valued at $14 billion, according to its website, almost all of them originating in other states. An additional $75 billion is overseen by the offices downstairs on South Phillips Avenue, each of which is technically a separate trust company catering to just one family, sometimes with McDowell serving on the board. The companies pay rent to McDowell for office space and fees to handle paperwork and administrative duties such as filing tax returns; he declines to comment on the price of these services. All are necessary steps if the families want to prove the trusts are truly South Dakotan.
In 2010, the Pritzkers, whose members include U.S. Commerce Secretary Penny Pritzker, revealed in a securities filing that one branch of the family had moved $360 million of Hyatt Hotels (H) stock to trusts overseen by a native South Dakotan named Thomas Muenster. Muenster, whose sister married a Pritzker, maintains an office in the Kresge building. Other tenants include companies such as Carlson Family Trust, serving the Minnesota family behind Radisson and the TGI Fridays restaurant chain. In July, the two top executives at Monster Beverage (MNST), the energy drink maker, shifted $478 million of their stock to undisclosed “entities” controlled by a trust company based in the building, according to regulatory filings. The Monster executives declined to comment, as did the Carlson family. Pritzker, her brother Jay Robert Pritzker, and their brother-in-law Muenster didn’t respond to messages seeking comment.
Amount South Dakota raised in 2012 on taxes from earnings made by trust companies
In South Dakota, a farm state that’s home to 2 of the 10 poorest counties in the U.S., lawmakers say they’re bolstering the trust industry to generate work for local law firms and bankers and to forge ties with prosperous families that may one day decide to build a factory or warehouse there. So far, the trust industry’s contributions to state coffers have been modest. Without an income tax, South Dakota doesn’t get revenue directly from the trusts. Companies like McDowell’s pay taxes on their earnings, a levy that raised about $1.2 million in 2012, according to the state Department of Revenue, out of a state budget of about $4 billion. Nor has the industry become a major employer. The state estimates that about 100 South Dakotans work for locally chartered trust companies.
There are an unknown number of jobs in local trust units of national banks such as Wells Fargo (WFC) and more work for area law firms and accountants. The trusts aren’t required to hire local money managers or invest in area businesses. “If you’ve got several hundred well-paying jobs, it’s worth it to us,” says Governor Dennis Daugaard, a Republican who used to travel to Minneapolis pitching tax-saving trusts when he worked at a bank in Sioux Falls. “It also gives us the opportunity to develop relationships with people who have the ability to encourage business here of other sorts. Now, I can’t point to a single case where that’s occurred yet, but I think it’s possible.”