Family offices, much like the families that need them, are works in progress. You can’t just set up a family office ownership structure and think it won’t need some type of attention in the future.
A number of factors could compel you to revisit your ownership structure to ensure it still makes sense for your family office and that you are getting the most out of its structure.
A few years ago, one family office, Lender Management LLC, was told by the IRS that it could not deduct its operating expenses under section 162 as trade or business expenses, but would have to do it under section 212 as miscellaneous itemized deductions, subject to the 2% adjusted gross income (AGI) floor.
In December 2017, the Lender family office argued that it should be able to deduct those expenses because managing investments and providing financial advice, even if it was only for family members, still constituted business activities akin to a financial advising firm. The U.S. Tax Court agreed, and the Lenders were able to take the deductions under section 162.
When the Tax Cuts and Jobs Act of 2017 (TCJA) was enacted a short time after that decision, section 212 deductions were eliminated altogether. With the Lender decision, family offices were given another avenue for capturing deductions.
Additionally, family offices should take note of how Lender Management was structured, which allowed it greater flexibility in how it claimed deductions.
More recently, Congress has brought forth proposed regulations that would limit the use of the family office exception from the definition of “investment advisor” and make them subject to registration as investment advisors, further complicating the family office structure.
A best practice in structuring a family business is organizing it in such a way that it is able to weather regulatory changes. You can only account for certain changes, though, which is why you and your accountant should stress test the structure every so often, especially if there have been any tax law changes. This will allow you to see how it is holding up to the changes and if you need to pivot in any way in response to them.
Estate tax law changes should also be a part of your discussion. Family dynamics ebb and flow all the time. You may have a long period where nothing changes and then someone in the family comes of an age where they want to join the family business or someone dies and you have to deal with the fallout from that. Or someone’s role has changed within the business, and you need to make certain the costs of all of the family employees are being recorded and deducted properly.
No matter the reason, whether it’s regulatory and familial, it is worthwhile for you and your accountant to review your structure to see if it still aligns with your family’s goals, and, at the same time, maximizes the value to the family.
For more information on this topic, contact our team.