Private-Equity Executives Embrace South Dakota Trusts to Slash Taxes on Carried Interest

A growing cadre of private-equity professionals is turning to South Dakota-based trust vehicles to reduce state and local taxes on carried interest, a strategy that blends sophisticated estate planning with increasingly aggressive tax optimization. The movement, often referred to in industry circles as the use of “SoDa trusts,” leverages the state’s lack of personal income tax and flexible trust rules to shift the timing and taxation of carried interest profits—typically a 20% share of fund profits allocated to fund managers and executives.

Historical Context and Evolution

South Dakota’s trust industry has deep roots in prudent wealth management and asset protection. The state established itself as a premier domicile for trusts through a combination of favorable tax treatment, robust fiduciary infrastructure, and political stability. Over the past decade, these advantages have broadened beyond traditional estate planning into more complex, multi-generational wealth strategies. The emergence of trust-based planning for private equity figures marks a notable expansion of the state’s financial services footprint, reflecting broader shifts in how high-net-worth individuals structure compensation, defer taxes, and shield assets from creditors.

Industry insiders describe the trend as a natural evolution of the private markets landscape. As carried interest remains a volatile and highly scrutinized component of compensation, managers seek definitive, legally sound vehicles to manage the tax consequences as profits flow through funds. South Dakota’s permissive trust laws, combined with no state-level income tax, create an attractive framework for deferring or potentially eliminating state taxes on income earned by a trust’s beneficiaries, including the original creator of the trust.

Mechanics of the Strategy

At the core of the SoDa approach is the nongrantor trust. In this arrangement, the trust creator cedes a degree of control, allowing the trust to own or hold future carried interest distributions rather than the individual. Because the trust is distinct from its beneficiaries, state tax considerations hinge on where the trust itself is taxed, and in many cases, South Dakota does not impose personal income tax on trust income. The result is an effective shield against state taxes on carried interest as long as the trust structure complies with applicable rules and remains within legal boundaries.

Key elements of the strategy include:

• Timing the transfer: Advisers emphasize moving the carried-interest position into the trust after a fund closes and the interest’s value is comparatively low. This timing minimizes potential gift-tax implications and aligns with compliance requirements for wealth transfer.
• Structuring for creditor protection: The vehicle is often pitched as a shield against creditor claims, in addition to tax optimization, which can appeal to high-net-worth individuals seeking asset protection.
• Indefinite duration: South Dakota trusts can be designed to endure for many generations, enabling wealth to be preserved and transferred with potential tax advantages that span multiple eras of tax policy.
• Flexible asset allocation: Trusts may invest in a range of assets beyond financial instruments, including tangible assets such as real estate or art, subject to jurisdictional rules and beneficiary access requirements.
• Independent valuations: To maintain compliance and ensure accurate tax reporting, valuations of the trust’s assets are typically performed by independent professionals.

Economic Impact and Regional Comparisons

The expansion of South Dakota’s trust industry has had measurable economic effects. Trust companies in the state have reported asset levels climbing to around $814 billion by the end of 2024, a substantial increase from a decade earlier. This growth mirrors broader shifts in the high-net-worth sector toward sophisticated, cross-border planning tools that balance liquidity, protection, and tax efficiency. The rise in assets under management supports jobs in fiduciary services, legal and tax advisory practices, and related financial services sectors, contributing to the state’s economic vibrancy.

Regionally, the SoDa trend contrasts with state-by-state tax policies that treat carried interest differently. In jurisdictions with higher personal income tax rates or more onerous rules around trust taxation, the relative effectiveness of this strategy can vary. While South Dakota benefits from no state income tax and a relatively permissive trust framework, states with aggressive taxation on trust income or distributions may limit the practical tax savings or trigger annual reporting and compliance obligations that reduce the strategy’s attractiveness.

Practical Considerations and Compliance

Experts caution that while the SoDa approach can yield significant tax savings, it is not a universal solution. The strategy requires careful navigation of federal and state tax laws, trust taxation rules, and the potential implications of wealthy individuals shifting income into trusts. Some of the critical considerations include:

• Gift and estate tax implications: Transferring interest into a trust can trigger gift tax or affect estate tax calculations, depending on structuring, timing, and the values involved. Professional valuation plays a central role in ensuring compliance and minimizing unintended consequences.
• Tax treatment of trust income: Although many states do not tax the income of a nongrantor trust, the state of the trust’s domicile and the beneficiaries’ states of residence can influence tax outcomes. Multistate considerations require careful planning and ongoing compliance.
• Creditor protections vs. legal standards: While asset protection is a stated benefit, the legal environment for sophisticated trusts involves scrutiny under federal bankruptcy laws, transfer-pricing rules, and evolving internal revenue service guidance on the taxation of carried interest within trusts.
• Regulatory and reputational risk: High-profile tax-optimization strategies can attract regulatory attention, particularly when they involve complex structures or cross-border elements. Firms must balance strategic goals with compliance risk and reputation management.

Public Reaction and Industry Dynamics

Within the financial community, the use of South Dakota trusts for carried interest planning is viewed through a pragmatic, risk-adjusted lens. Proponents frame the approach as a legitimate planning mechanism that leverages existing tax laws to optimize wealth preservation across generations. Critics, however, point to concerns about earnings concentration, potential erosion of tax bases for other states, and the broader debate over whether carried interest should face higher tax rates at the federal level.

Observers emphasize the importance of transparent reporting, rigorous independent valuations, and clear governance structures within these trusts. As asset levels in South Dakota and other trust-friendly jurisdictions continue to rise, policymakers and tax professionals closely monitor developments to ensure that strategies remain compliant and that long-term tax policy remains coherent with economic realities.

Looking Ahead

The trajectory of private-equity trust planning in South Dakota suggests that wealth-preservation strategies will continue to evolve in response to changing tax codes, regulatory scrutiny, and shifting market conditions. While the precise tax outcomes will depend on individual circumstances, fund structures, and state law, the core idea remains: wealthy individuals and their advisers seek to align legal frameworks with financial goals, balancing control, protection, and tax efficiency in a way that supports intergenerational wealth.

For the private-equity sector, the trend underscores the importance of sophisticated financial architecture as part of broad portfolio strategy. Fund managers and executives will likely continue exploring a diverse array of planning tools that can optimize after-tax returns while maintaining compliance and governance standards. As always, the effectiveness of any strategy will hinge on careful design, ongoing oversight, and a clear understanding of the evolving tax landscape.

Public confidence and investor expectations remain central to the ongoing use of these trusts. Stakeholders should anticipate continued dialogue among tax authorities, fiduciary professionals, and policymakers as the industry navigates the balance between tax optimization and fiscal responsibility. The discussion surrounding carried interest taxation—whether at current rates or higher federal levels—will influence, but not solely determine, the adoption of trust-based planning as part of broader wealth-management ecosystems.