The South Dakota Community Property Special Spousal Trust: A Compelling State and Federal Tax Planning Tool

spouseProving once again South Dakota’s status as a top tier trust jurisdiction AND the vital importance of proper situs selection in the wealth planning process, South Dakota’s Governor Dennis Daugaard just recently signed a progressive new legislation which unanimously had passed both the South Dakota House and Senate creating the South Dakota Community Property Special Spousal Trust – House Bill 1039 (2016) (Sections 29-42). The trust may be a revocable or irrevocable trust created by one or both spouses with both spouses as beneficiaries.

This is a very powerful state income and estate tax planning tool because it will likely allow married settlors of the trust to avoid state taxation on undistributed retained income within the trust (because South Dakota does not have an income tax) AND treats the property as community property at the death of the first spouse, applying a 100% percent step-up in basis at date of death, therefore, avoiding federal capital gains taxation of marital/trust assets when sold. (In non-community property states, the step-up in basis at date of death is only 50%, which means that taxes would be owed on the remaining 50% of the cost basis of the marital property when sold). Combining these benefits creates a powerful tax move that has the potential to result in compelling federal and state tax savings, particularly if the trust is also designed as a dynasty trust, which would avoid federal estate taxation on trust assets over subsequent generations in perpetuity. In addition, the trust may also be created, in appropriate cases, to take advantage of South Dakota’s Domestic Asset Protection Trust laws for protection from creditors.

South Dakota’s new legislation becomes effective July 1, 2016. At this time, the only other state with a similar statute creating a Community Property Special Spousal Trust, applying to non-residents, without a state income tax is Alaska. However, given that state’s extremely unstable financial situation and recent statements and submitted budget proposal by Alaska’s Governor Bill Walker regarding the creation of a state income tax in the very near term, it appears that South Dakota is the preferred choice for this type of trust planning primarily because of its widely known financial strength, no state income tax, and clear commitment to being the most progressive trust jurisdiction in the nation.

For information about South Dakota’s progressive and industry leading trust laws, click here. For a more thorough discussion of taxation of trusts, click here for a recent webinar. Contact Bridgeford Trust via our contact page for additional information.