Trust Taxation

Federal Estate Tax Planning

Dynasty Trusts

A South Dakota Dynasty Trust is a powerful planning tool that preserves family wealth across multiple generations because it allows trust assets to remain in trust indefinitely, helping avoid federal estate taxation in perpetuity.

South Dakota became the first state in the nation to allow Dynasty Trusts by abolishing the Rule Against Perpetuities in 1983. Because South Dakota permits Dynasty Trusts to continue indefinitely, trust assets are not subject to mandatory distributions that could otherwise diminish the long-term tax advantages of the trust.

• Available to residents and non-residents, provided the trust has a South Dakota trustee and is governed by South Dakota law.
• Allows trust assets to remain in trust indefinitely, helping avoid federal estate taxation over multiple generations.
• Preserves family wealth by reducing the tax burden on future generations while still allowing beneficiaries to benefit from trust assets.
• South Dakota imposes no state taxation on trust income, dividends, interest, or capital gains, creating additional long-term tax planning opportunities.

State Income Tax Planning

Incomplete Non-Grantor Trust (ING)

An Incomplete Non-Grantor Trust (ING) is a powerful state income tax planning strategy that potentially eliminates state income tax on capital gains while also taking advantage of South Dakota’s Domestic Asset Protection Trust laws. It is an incomplete gift that never leaves the settlor’s estate, meaning there is no gift tax, while its non-grantor status causes trust income to be taxed at the trust level.

Illustrative ING Tax Savings Example

• Closely held business with fair market value significantly over basis with a gain in excess of $20 million.
• Transfer of closely held stock into an Incomplete Non-Grantor Trust created in a jurisdiction with no state income tax.
• No gift tax consequence.
• Assuming a home-state income tax rate of 6%, approximately $1.2 million in state income tax savings.
• Assuming an estimated future investment portfolio of $16 million earning a conservative 4% undistributed total return, continued state income tax savings of approximately $38,400 per year.

For additional context on non-grantor trusts and the use of ING Trusts in tax planning, explore the article below.

Tax Planning With Self-Settled Non-Grantor Trusts | By NYC Attorney, William Lipkind →

State Taxation of Trusts

Resident Trust – No Taxation on Undistributed Income

Undistributed trust income retained in a trust is typically subject to state income taxation based on the laws of the applicable state. However, situsing a trust in a jurisdiction that does not impose a state income tax, such as South Dakota, creates a compelling planning opportunity by allowing undistributed trust assets to grow free of state income tax over multiple generations.

A Resident Trust is a trust with situs and trust administration in a jurisdiction other than where the settlor, beneficiaries, or co-trustees reside. The United States Supreme Court and state courts across the country have consistently held that it is unconstitutional under the Commerce Clause and Due Process Clause for a state to tax undistributed, non-sourced trust income in a Resident Trust. These decisions reinforce that significant state income tax savings may be achieved by simply selecting a top-tier, no-income tax state such as South Dakota in the planning process.

Key Court Decisions

• Kaestner – In Kaestner, the U.S. Supreme Court struck down North Carolina’s attempt to tax undistributed income of a Resident Trust properly sitused and administered in a no-income tax jurisdiction such as South Dakota, holding that a beneficiary’s domicile is insufficient to establish nexus for taxation.
• Fielding – In Fielding, the U.S. Supreme Court denied cert, leaving in place the Minnesota Supreme Court’s decision striking down that state’s attempt to tax undistributed income within a Resident Trust. The court held that the domicile of the settlor is not sufficient to establish nexus for taxation.
• Additional appellate decisions – Pennsylvania, Minnesota, and New Jersey each have appellate court case law indicating that taxing undistributed income in a Resident Trust is a violation of the Commerce Clause of the United States Constitution and Due Process.
• Planning Implications – Supreme Court and state appellate case law make a compelling argument for the movement of trusts into states like South Dakota where there is no state income tax.
• Long-Term Tax Savings – Trusts with situs in states without a state income tax would avoid taxation on undistributed retained trust income, which has a substantial impact on the value of trust assets over subsequent generations, particularly in high-tax states like California, New York, North Carolina, and New Jersey.

Kaestner Case: Background, Discussion, and What It Means For You →

 Webinar: Supreme Court Strikes Down Taxation on Undistributed Trust Income →