I was reading an article about Shohei Ohtani, who just signed a contract worth $700 million. He went from the Los Angeles Angels to the Dodgers to play baseball. Some of the details from his contract have emerged. He’s going to be paid out over 20 years. For the first 10 years of his contract, he’ll only be making $2 million per year. Then, in the last 10 years of his contract, he’s going to be making $68 million per year. This got me thinking about some of the tax implications of his decision.
Ohtani has said, or it’s being attributed to him, that it was his idea to get paid less upfront so the team can bring in other players and go after that World Series win. But I was thinking, during those last 10 years, if he’s getting paid $68 million a year, depending on where he lives, could he have a lower tax liability? Yeah, so he definitely talked to his tax attorney and/or his CPA, that’s for sure. I’d love to know how much his commute has been reduced now that he’s switched teams, right?
100%, the way state taxation works is there has to be what’s called some kind of “nexus.” That’s a technical legal term, a constitutional law term. So, you have to have some kind of nexus to a particular jurisdiction for them to be able to legally tax you. There has to be some kind of activity; usually, it’s where you live, or if you’re there long enough and working, then you can also incur some type of nexus to that state. If he were to move outside of Los Angeles or even California after he’s done playing, he could change his domicile and potentially sever all types of nexus with California. Maybe he moves to Texas, where I’m located, or Florida, or maybe back to Japan, where he’s from.
The point is, he could potentially completely avoid any kind of state income tax when it comes to those later years where he’s receiving the vast majority of that money. From a tax perspective, it’s pretty brilliant, so kudos to him for making a smart move.
I imagine he has plenty of endorsement deals, so he’s getting other money coming in. $2 million is a lot of money, but in a state with high taxes, obviously, it’s going to get cut, and he has all those other things he has to worry about.
Let me jump in real quick—what’s interesting with California is that they have the highest state income tax rate. For someone, and I forget the exact threshold, but it’s basically a million dollars or more per year, the tax rate is almost 14%. I can’t remember if it’s 13.9% or a little over 14%, but let’s just say 14%. So, he’s saving 14% on essentially $67 million per year if he were to get out of California. To your point, yes, he could do some serious tax savings by getting out of there. Anyway, keep going with what you were saying about endorsements and all that.
Yeah, I’m sure he has other money coming in with endorsement deals. I imagine they’re going to be taxed like income tax, probably, right? If he takes that money, I know other athletes do this as well, and business owners, too. They get taxed on their income and then might set up some sort of investments. Are there ways they can protect their investments and mitigate their taxes with some other strategy?
Yeah, or even one of the things we saw with LeBron James and other athletes is that they want a percentage of ownership rather than just royalties or a percentage of what they’re endorsing. LeBron did that with Beats by Dre, and he’s a big investor in Blaze Pizza, which I’ve been a fan of over the years—I might have had a few pepperoni pizzas! So, let’s say LeBron is in LA now. What happens when he wants to sell Beats or his interest in Blaze Pizza? Can he do anything to mitigate those tax consequences as a California resident? This applies to anybody who lives in a state with income tax.
The answer is yes. You can take those closely held business interests or your investment accounts, your brokerage accounts, and move them to a trust that’s located in South Dakota. Again, we like South Dakota. You’ll always hear me talk about South Dakota because they don’t have an income tax. They have incredibly flexible trust laws, the best asset protection trust laws, and incredible privacy laws around their trusts. You can move all those assets to a South Dakota trust to avoid state income tax. So, when you’re selling a company for tens of millions of dollars or paying a lot in capital gains from your brokerage accounts, that’s a way to take a holistic approach to avoid state income tax.
Say you’re a business owner making a good salary per year, and you’re getting ready to sell your company, which is worth a lot of money. Are there ways you can avoid some of the high taxes with the big selloff before you sell it?
Yeah, that’s exactly what I’m talking about. Pre-liquidity business owners are some of my favorite types of clients to work with because I can provide them a ton of benefit and add a lot of value to their world. What we do is set up a domestic asset protection trust (DAPT) in one of these jurisdictions—again, South Dakota—for the purpose of avoiding state income tax when they sell that business.
It’s been the advent of domestic asset protection trusts in the U.S. that has allowed us to do this kind of planning. Historically, it’s called an ING trust, an incomplete non-grantor trust, which allows us to avoid state income tax. I won’t go into all the details about that, but California and New York have passed legislation to try to cut down on their citizens or residents doing that type of planning to avoid state income tax. There are still ways to get around that and accomplish the same thing, but it’s really been the advent of the domestic asset protection trust (the DAPT) that allows us to accomplish this kind of planning.
DAPTs don’t exist in every state. Only a handful of states have them—a minority of states—and only maybe three or four are really worth setting up a trust in. But really, Nevada and South Dakota stick out as the best two. We can help clients avoid state income tax by doing that kind of planning.
It seems to me, the more I talk to other attorneys, that these DAPTs are flying under the radar and that folks just unfortunately don’t know about South Dakota. They don’t know about all the great trust laws they have up there. Why do you think this is?
For a variety of reasons. I wish I could just pinpoint it and say it’s this one thing that we need to address. It’s good for me because it’s good for business, but a lot of clients aren’t getting the type of legal services they need because other attorneys aren’t focused on this. It’s really a shame. I was having a conversation with an attorney earlier today, and I was telling them about what I do. They said, “Well, you’re not located in South Dakota, and you’re allowed to set up trusts in another jurisdiction for clients who don’t live in that jurisdiction?” I was like, “Yeah, absolutely. We are allowed to use the best laws available for our clients.”
It’s just a lack of experience and exposure. I’ve been fortunate enough that my background lends itself to multi-jurisdictional planning. I originally started out in tax planning, and it evolved into this whole multi-jurisdictional trust planning world. I think that’s one thing. You and I were talking about this recently—I watched a YouTube video of an attorney with 45 years of experience, and the title of the video was something like “Why You Don’t Want to Set Up an Irrevocable Asset Protection Trust.” I watched the video, and everything he said about why you wouldn’t want to do it was incorrect. I don’t know where he’s getting his information from. He made the comment that courts are challenging all of these DAPTs, all of these asset protection trusts, but he didn’t give any details or explain what that means. Anyone who’s really in the know when it comes to the domestic asset protection trust world will tell you that these aren’t being challenged left and right. If there are any issues, it’s usually with what’s called fraudulent conveyances or fraudulent transfers.
There are rules around when you can and can’t transfer assets to a domestic asset protection trust. If you suddenly have a judgment against you and someone is pursuing you, trying to enforce it, you can’t just avoid that creditor by moving all your assets to South Dakota or to a foreign offshore jurisdiction. That’s considered a fraudulent transfer, and that’s where you get in trouble. It’s not just a matter of setting up the trust and it’s going to fail. That doesn’t exist. I see videos about that all the time online, and it’s usually from the same two or three or four commentators, but they don’t give any details, which is suspicious to me.
Absolutely, there was another video I saw where a gentleman was talking about trusts, and he was saying absolutely don’t use them because the government still knows, and you’re still going to have to pay taxes. I was thinking, well, of course, we’re not trying to hide anything from the government! The goal of this is to protect your assets, but you’re still paying your taxes. You’re still being a good citizen and doing the things you need to do. You’re not hiding anything, so it’s not a shady process, for lack of a better word.
No, 100%. It’s nothing nefarious, and these laws are not set up to help people who are trying to accomplish something nefarious. If anything, it’s trying to rebalance and recalibrate this world we live in that’s so litigious. We have attorneys making millions, tens of millions, hundreds of millions of dollars suing everybody under the sun. I’m not saying we shouldn’t have those kinds of attorneys, but that is an industry where they’re just going after people left and right. We’re trying to recalibrate and make sure people have the tools they need to make sure they’re not being incorrectly taken advantage of by attorneys who want to sue everybody.
Absolutely. So, one more question just to wrap up. Can you recap the benefits of South Dakota and the trusts that you can set up there?
There are a lot of different selling points on South Dakota, and we probably don’t have enough time to go into all the details, but there are a few key benefits.
One is true dynastic or true dynasty trust planning. Not all states allow you to set up a trust that exists perpetually, that can live infinitely. Many states say that at a certain point in time, the rule against perpetuities kicks in, and all the assets from the trust have to be kicked out and will eventually be subject to wealth transfer or estate tax, depending on your situation. South Dakota allows you to completely avoid that.
Next is privacy. There are really great privacy rules there—not secrecy. Some people in the industry like to make that distinction, and I think it’s a great distinction to make. It’s privacy, not secrecy.
And then, the big one is really asset protection—being able to set up for yourself an irrevocable trust where you still have control of your assets that you’ve moved into the trust. You’re still benefiting from it, but you’ve given up enough control to change the nature of ownership from you as an individual to the trust itself. A lot of states just don’t accomplish that.
Like I said, we deal a lot with business owners, and they are unique in their needs. One thing I keep running into more and more is business owners who have personally guaranteed different things. Because of that alone, there’s a level of legal risk that most people will never encounter. What they’re doing is making sure that their various business interests and personal assets are being protected through these trust structures in case something happens—maybe a deal goes sideways, and it’s no fault of their own, but they just want to make sure everything is protected.
The benefits of South Dakota are numerous.
Fantastic. What’s your favorite aspect of South Dakota trust planning?
For me, it’s the asset protection. It’s a no-brainer. The fact that you can set up a self-settled trust in South Dakota and protect your assets while still benefiting from them, and that there’s flexibility in these trusts when you pair them with a trust protector, is a no-brainer. I love it.
Yeah, I’ll pay you a compliment here. We started saying they’re self-settled as well as self-benefiting. Rob’s the one who really pointed out that they’re self-benefiting to communicate that the client is not losing any benefit whatsoever by setting up this trust and that they continue to benefit. There are more complex planning strategies that could be implemented for different reasons, where it’s called a hybrid domestic asset protection trust. You could set it up for the benefit of someone else, but we have a backdoor strategy where, if something were to happen with that situation, the person who set it up could ultimately be the beneficiary. So, I think to your point, it’s helpful to say it’s self-settled, meaning you set it up, and it’s also self-benefiting, meaning you yourself benefit from those assets that you put in there.
These trusts are truly a beautiful thing.