The Wild West of Bank and Finance Laws

Do you get a lot of credit card offers in the mail from banks you’ve never heard of? Chances are, the bank’s HQ is in, you guessed it, South Dakota. Flip over a few credit cards in your wallet and read the fine print. Why set up an issuing bank in South Dakota? In 1981, the state abolished laws limiting the interest rate on credit cards. South Dakota is home to the big sky, (sorry, Montana) and the sky’s the limit when it comes to interest rates on your Visa or Mastercard.

In 1983, South Dakota was the first state to establish perpetual trusts. In a nutshell, perpetual trusts allow monies to remain in place for generations, with no one having to pay inheritance taxes.

Trusts are wealth structures favored by high-net-worth families and individuals, and South Dakota has a history of legislating highly favorable laws for settlors and trustees. The sweet green icing on the money layer cake is no income tax, no capital gains tax and no inheritance tax. The cherry on top are laws that ensure the investor of extreme privacy and secrecy from any blue and brown suits that may try to penetrate their personal Fort Knox. Assets held in South Dakota trusts have increased from 57 billion to $360 billion in the last 10 years.

According to the Pandora Papers, among South Dakota’s wealthy foreign opt-ins are Ecuador’s President Guillermo Lasso, Chinese real estate billionaire Sun Hongbin, and Guatemalan industrial products titan Federico Kong Vielman.

IWTA founder Jack Brister weighs in: “Though it is true that South Dakota, along with Wyoming, have strong state-level asset privacy laws, it should be known that these laws don’t allow U.S. or international persons a means of U.S. tax avoidance.

U.S. persons are always subject to U.S. tax no matter where they reside or where their assets are located.  Trustees are held liable for the appropriate tax reporting and payment of tax due and no state law can remove these federally-mandated responsibilities.

The skinny on the matter is that the U.S.-legislated law in which the premise is a trust, even those established under U.S. law, are foreign trusts unless specific criteria are met. The purpose for enacting such a broad definition of what a foreign trust is was to cast a wide net to ensure U.S. persons could not use such structures to avoid their tax responsibilities without facing severe penalties.  In doing so, the U.S. limited its ability to tax trusts established in the U.S. by foreign persons where the trust had no U.S. assets or income and the beneficiaries were not residing in the U.S.

This is because the U.S. has no authority to tax foreign persons if they are not deemed to be U.S. residents and have no U.S. assets or income. Reminder: capital gains and most interest income are tax-exempt. Business income and real property gains are subject to taxation.

These rules apply equally to a foreign trust.  Therefore, when a trust is established under state law where the primary fiduciary responsibilities are with a foreign person and not the U.S. trustee (generally a U.S. trust company), and the trust has no U.S.- sourced income, the trust treated as a foreign person, which means there is insufficient nexus to the U.S., resulting in the U.S. having no legal taxing authority.”

Which U.S. States Have the Most Trusts According to the Pandora Papers?

According to Axios, trusts held in the states listed below account for about 1 trillion dollars in secretly-held assets. According to Bloomberg, South Dakota state data alone show one half trillion dollars of wealth in trusts.

How the U.S. Treasury Views Americans’ Reporting of Foreign Assets

The U.S. Bank Secrecy Act demands that foreign banks disclose assets and accounts held by U.S citizens, and that U.S. citizens report those accounts or face a penalty, with $10,000 being the threshold of compliance. FBAR, the Foreign Bank Account Report, is the most-commonly filed disclosure form, while those with assets over $200,000 if living abroad and $50,000 if living stateside, are required to file FATCA (Foreign Account Tax Compliance Act) form 8938. For more on FATCA filing rules, see our blog post. For more on FBAR rules and compliance see the IWTA FBAR primer.

FATCA and the Banking Secrecy Act (BSA) are under the jurisdiction of FinCen, the Financial Crimes Enforcement Network of the U.S. Treasury. FinCen investigations take place worldwide, supporting partner countries in combating money laundering, terrorist financing and other financial crimes.

One might assume that the U.S. would bring the same level of scrutiny to those transferring foreign wealth to U.S. financial institutions and shell companies, but that is not the case because the U.S. has no legal jurisdiction to assert taxing authority.

Why the U.S. is Becoming a Favored Foreign Tax Haven

Although the USA supports the OECD’s global tax effort, they have refused to sign on to the Common Reporting Standard (CRS) which pledges inter-country cooperation in reporting financial assets and accounts to outside jurisdictions. The CES was formed in 2014, per the request of the G20. 112 countries currently participate in the CRS.

The power and autonomy of individual state governance makes it possible for U.S. states to create what amount to independent tax havens under the umbrella of the USA. According to Axios quoting a study by Israeli academic Adam Hofri-Winogradow, 17 of the world’s 20 least-restrictive jurisdictions for trusts were American states.

Will Congress and The Fed Intervene?

On October 6^th, 2021, members of congress introduced “The Enabler’s Act.” The Act would expand the 1970-era Bank Secrecy Act to legislating accountability to parties typical in aiding and abetting money laundering and tax evasion, such as accountants, lawyers, investment advisors, and even public relations professionals and art dealers.

The new provisions would in effect expand FinCen’s 2020 Anti-Money Laundering Act. According to The Hill, not only will the Enabler’s Act improve the chances of catching violators, it would close a loophole in the securities laws that currently exempts investment advisers from the same reporting and procedures that are required of broker-dealers, — in at least some circumstances.

The law does not call out registered investment advisers per se, but its definition of investment professionals is broad and could close the loop. Thus, a new set of whistleblowers may come forward with new insights and information regarding the shadowy world of dark money.

West May Still be Best

It should be noted that unless the Treasury Department revises the definition of a foreign trust for tax purposes, The Enabler’s Act, if passed, is not likely to impact the ability of foreign persons to use the U.S. as a place to establish wealth structures which may avoid their home country tax laws.