Why Private-Equity Millionaires Love South Dakota
A quiet revolution is underway in the world of high finance, and its epicenter isn't New York or Silicon Valley, but the unassuming prairies of South Dakota. Dealmakers, the titans of private equity, are increasingly turning their gaze to the Mount Rushmore State, not for its natural beauty, but for its remarkably favorable trust laws that offer a potent shield against one of their biggest headaches: taxes on carried interest.
For years, the debate surrounding carried interest – the 20% share of profits general partners typically take from their funds – has raged in Washington. Critics argue it's essentially compensation for services, and thus should be taxed at ordinary income rates, which can climb as high as 37%. However, under current law, it's often treated as a long-term capital gain, enjoying a significantly lower federal rate of 20% (plus the Net Investment Income Tax of 3.8%). This disparity alone represents billions in potential savings for the industry's wealthiest. But what if you could sidestep state-level taxes on that wealth entirely, and ensure its perpetual growth across generations, largely out of reach of future tax hikes? That's precisely the allure of South Dakota.
The mechanism is elegant in its simplicity and powerful in its effect. Private equity principals, facing substantial carried interest gains, are establishing sophisticated trusts in South Dakota. These aren't your grandfather's simple trusts; they are often dynasty trusts or directed trusts designed to last for generations, sometimes even in perpetuity. By making South Dakota the legal situs of these trusts, the wealth held within them is insulated from state income taxes and state capital gains taxes – because South Dakota has none.
"It's a no-brainer for anyone looking to preserve significant wealth," explains a tax attorney specializing in trust and estate planning, who requested anonymity due to client confidentiality. "When you're talking about hundreds of millions, even billions, in carried interest, even a few percentage points saved at the state level translates into colossal sums. And South Dakota's laws are exceptionally robust when it comes to asset protection and flexibility."
What makes South Dakota truly stand out among other trust-friendly states like Delaware or Nevada? Its pioneering legislation allows for features that are incredibly attractive to the ultra-wealthy. For one, it permits directed trusts, meaning the grantor (the person setting up the trust) or their chosen advisor can retain significant control over investment decisions, while a professional trustee handles administrative duties. This separates investment management from fiduciary liability, offering a level of oversight and comfort many grantors desire.
Furthermore, South Dakota has abolished the Rule Against Perpetuities, a centuries-old common law doctrine that limited how long a trust could exist. This means a dynasty trust established in South Dakota can theoretically last forever, sheltering assets from federal estate taxes for an indefinite number of generations. This perpetual growth potential, combined with the absence of state-level income or capital gains taxes on the trust's earnings, creates an incredibly powerful wealth accumulation vehicle.
Another unique feature is the concept of decanting. This allows a trustee to essentially pour the assets from an older, perhaps less flexible trust into a newer, more modern South Dakota trust, updating its terms to adapt to changing family needs or legal landscapes, all without triggering new taxes. This flexibility is a significant draw for families with complex, evolving financial structures.
The state has actively cultivated this environment. The South Dakota State Legislature has consistently updated its trust laws, often making them the most progressive and grantor-friendly in the nation. This proactive stance has transformed a state once known primarily for agriculture and tourism into a global hub for wealth management, attracting an influx of legal and financial professionals to cities like Sioux Falls.
The implications of this trend are multifaceted. For the private equity elite, it means unprecedented opportunities for wealth preservation and transfer. For South Dakota, it translates into a booming trust industry, bringing jobs and economic activity. However, it also fuels the broader debate about tax fairness and the ability of the wealthiest to leverage state-level differences to minimize their tax burden, particularly on income streams like carried interest that are already subjects of national contention.
As long as the federal carried interest loophole persists, and as long as South Dakota continues to offer such a potent combination of tax benefits and trust flexibility, it's clear why the state will remain a beloved destination for private-equity millionaires looking to secure their legacies and keep more of what they earn. The quiet prairies, it turns out, are anything but sleepy when it comes to the intricate dance of modern wealth management.
