When Your Home State's Trust Law Is Enough, and When South Dakota Earns Its Place
Most states have a modern trust code that serves ordinary trusts well. South Dakota earns its place when the trust must last for generations, protect the person who funds it, keep family information private or accumulate income free of state tax. Arizona is a useful case study.
A client who has lived in one state for thirty years reasonably asks why her trust should be governed by the law of a state she has never visited. The answer is that for most trusts it should not be. For a revocable trust, a grantor trust whose income is taxed to the grantor in any event, or a family that wants a relative as trustee and a courthouse close at hand, home state law is usually entirely adequate.
South Dakota earns its place when the trust is meant to do one of four things: last for generations, protect the person who funds it, keep family information private, or accumulate income free of state tax. Arizona, which has a modern trust code and strong community property rules, is a useful example of where the line falls.
Where Arizona law has a problem drafting cannot cure
Two of the four goals run into Arizona's constitution and statutes. Arizona permits a trust to last 500 years, or indefinitely if the trustee has a power of sale, but the Arizona Attorney General has concluded that both provisions likely violate the state constitution's prohibition on perpetuities.1 South Dakota has no rule against perpetuities at all.2 And Arizona has no self-settled asset protection statute; South Dakota's permits a settlor to be a discretionary beneficiary of an irrevocable trust, with a two-year limitation period for creditors, or six months after a recorded transfer, and a clear and convincing burden on the creditor.3
Where the difference is a matter of degree
- State income tax on a nongrantor trust. Arizona taxes a trust as a resident if any fiduciary is an Arizona resident, and it defines fiduciary broadly, so an Arizona individual serving as cotrustee, and possibly as a fiduciary advisor, can bring the trust back within Arizona's 2.5 percent tax.4 South Dakota has no income tax. Arizona source income remains taxable wherever the trustee sits.
- Directed trusts. Arizona protects a trustee in following a direction unless the trustee acts in bad faith or with reckless indifference. South Dakota's excluded fiduciary is not liable for following a direction and has no duty to monitor the advisor.
- Decanting. Where distributions are limited by an ascertainable standard, Arizona requires the new trust to keep a standard at least as restrictive. South Dakota permits decanting under any discretionary power, and the new trust may be governed by the law of any jurisdiction.5
- Quiet trusts. In Arizona the duty to answer a qualified beneficiary's request for reports cannot be waived. In South Dakota information rights may be restricted or eliminated for as long as the family chooses.6
- Court file privacy. Arizona has no automatic sealing; the family must ask. South Dakota seals the entire trust court file on filing, without a motion and without expiration.7
- Premium tax on large life insurance policies. Arizona's rate is 1.70 percent, or about $170,000 on $10 million of premium. South Dakota's is eight hundredths of one percent above the first $100,000 of annual premium, or about $10,420 on the same policy.8
- Community property. Arizona's is native, and community assets receive a full basis adjustment at the first death without special planning. South Dakota offers the same result to couples in separate property states through a special spousal trust, which matters most to people who do not live in a community property state.
Where each state fits
For a revocable trust, a grantor trust, or a family that wants a relative as trustee and an Arizona court close at hand, Arizona law is entirely adequate, and nothing here suggests moving those trusts. South Dakota is the better home for dynasty trusts, self-settled asset protection trusts, nongrantor trusts built to accumulate income free of state tax, private placement life insurance, and families who do not want beneficiaries or the public reading the trust.
How the two work together
This is not a choice between the family's lawyer and a trust company. The lawyer continues to design the plan, draft the documents and counsel the family. Where South Dakota adds value, a South Dakota trust company serves as trustee and arranges review of the instrument by independent South Dakota counsel, so an Arizona lawyer drafting a South Dakota trust is not practicing South Dakota law. The client does not need to live in South Dakota or have any other tie to it; the trust company supplies the connection. Existing irrevocable trusts can usually be moved by a trust protector, by decanting or by a nonjudicial settlement agreement, without a court proceeding, and a change of situs that shifts no beneficial interest generally preserves grandfathered and GST exempt status.
Notes
- Ariz. Const. art. II, section 29; Ariz. Rev. Stat. section 14-2901; Arizona Attorney General opinion concluding that the 500-year and perpetual-trust provisions likely violate the constitutional prohibition. ↩
- S.D. Codified Laws 43-5-8. ↩
- S.D. Codified Laws ch. 55-16. ↩
- Ariz. Rev. Stat. section 43-1301 (definition of resident trust). ↩
- S.D. Codified Laws 55-2-15 through 55-2-21. ↩
- S.D. Codified Laws 55-2-13. ↩
- S.D. Codified Laws 21-22-28. ↩
- S.D. Codified Laws 10-44-2. ↩
Terry L. (T. L.) Turnipseed, J.D., LL.M., CTFA, is a tax, trust and estate attorney in Fort Lauderdale, Florida, and Head of Estate and Tax Planning at Alta Trust Company. He is a former tenured professor of law at Syracuse University. Reach him at tl@turnipseed.law or on LinkedIn. This article is general information, not legal advice.