the heckerling institute on estate planning january 17

Heckerling 2019: FUNDAMENTALS OF FAMILY OFFICES

The Heckerling Institute on Estate Planning January 17, 2019

FUNDAMENTALS OF FAMILY OFFICES FOR THE ESTATE PLANNER

A PRIMER ON FUNCTIONS, STRUCTURES AND RELATED ISSUES

• N. TODD ANGKATAVANICH

• RICHARD DEES

• WILLIAM J. KAMBAS

• ROBERT (BOBBY) STOVER, JR.

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I. INTRODUCTION

How is a family office developed?A. Putting the family office into context

B. Assessing the economic needs for the management of private capital

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II. STRUCTURING FOR THE MANAGEMENT AND ORGANIZATION OF PRIVATE CAPITAL

Which factors lead to success of a family office?A. Identifying different types of family offices and their evolution

B. Scope of services

C. Considering the right structure

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What is a family office?

Single family office (SFO)Dedicated to one family, perhaps with multiple households and generations

Multi-family office (MFO)Independent entity that manages the wealth of several families; it may be a small enterprise (at times growing out of a single family office), or it could be a division within a large bank or financial services firm

Virtual family office (VFO)Many services are outsourced. The office may have a few administrative or accounting staff, while outsourcing investments, legal, accounting, technology and other services.

SFO MFO VFO

Sample family office organization

Family offices are organized based on actual services offered, skills of the staff hired, and desires of the family. Below are two extremes, from the very simple “Founder’s Office,” to a complex large, multigenerational family office, as well as a medium-sized office example.

Founder’s Office

Founder

Accountant Personal assistant

External advisors Attorney

CPAInsuranceInvestments

Multigenerational office

Family officepresident

Chief operating officer

Chief financial officer

Business boardof directors

Chief investment officer

Chief philanthropicofficer

TaxAccounting:

Bill payPartnership acctg

ReportingFiduciary services

Client serviceConcierge servicesInsurancePersonal securityCommunicationFinancial planning Technology

Real estatePrivate equityMarketable holdingsManager oversight

Family foundationsVenture philanthropy

Closely held businesses

Investment committee

Foundation board

External advisors

AttorneyInsuranceConsultantSecurity

Medium-sized office

Family officepresident

Chief financial officer

Family council Business boardof directors

Chief investment officer Foundations

TaxAccounting:

Bill payPartnership acctgReportingTechnology

Fiduciary servicesFinancial planning

Real estatePrivate equityMarketable holdingsManager oversight

Family foundations

Closely held businesses

External advisors Attorney

CPAInsuranceInvestments

Familygoverning board

III. GOVERNANCE

A. Legal governance: the basic framework for the family office entity

B. Constitutional, committee, and counsel governance: family-oriented approach to decision-making and communication

C. Enterprise ownership:

A. managing liability

B. regulatory considerations

D. Memorializing the arrangement: creating agreements tailored to particular needs, including considerations unique to multistate and multinational families

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Wealth Generators Beneficiaries

FamilyOffice

Lega

l & B

enef

icia

lO

wne

rshi

p

Trustee

PurposeTrust

PTC Protector

Enforcer/Appointer

Con

trol &

M

anag

emen

tAs

sets

&In

vest

men

ts

FamilyTrust(s)

$ $

FamilyAssets

FamilyBusiness

FamilyInvestments

(FLP)Family

Foundation

UNDERSTANDING THE DYNAMICS

Family Members

BoardsCommitteesManagers

Letters of WishesFamily AssemblyFamily Council

Committees

Operations OutsideManagers

501(c)(3)sHomes Toys

REHedgeVCPE

Banks

OutsideAdvisors

DadMom

OutsideAdvisors

OutsideAdvisors

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Economic Benefits

Management & Values

IV. COMPENSATING MANAGEMENT

1. Attracting talent

• Key personnel

• Investors

• Co-ownership

2. Compensating talent

• Fringe benefits

• Equity incentives

3. Retaining talent

• Retention incentives

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V. GENERATING INCOME AND LOSSES

A. Profitable enterprises: tax treatment of profits and cash distributions• Capital gains?

B. Loss leaders: tax treatment of enterprise losses • Deductibility of expenses

C. Planning for 2019 and beyond

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Activities treated as a “trade or business”

• Trade or business determination is based on facts and circumstances, but must be:

• Regular • Continuous

And• Have a profit motive• Commissioner v. Groetzinger, 480 U.S. 23 (1987)

• Generally, the management of one’s own assets is not a trade or business:• Higgins v. Comm’r, 312 US 212 (1941)• King v. Comm’r, 89 T.C. 445 (1987)• Beals v. Comm,r, T.C. Memo 1987-171 (1987)

• Generally, a cost center is not a trade or business:• Strangeland v. Comm’r, T.C. Memo 2010-185 (2010)

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Sample profits interest structure

Family Office Structure

Services Performed or Contracted

Outsourced tax and legal services

Outsourced investment advisory

Outsourced personal services

Payroll, rent, etc.

100%

G2 Individuals

Legend

Partnership

Trust

G2 and G3Individuals

LLC treated as a corporation for federal tax purposes

G2 and G3 Trusts

Revenue: $0.2MInt. $1.0MDiv $1.0MCap Gain $6.0MCosts: ($8.6M)Profit:/(loss) ($ .4M)

Costs

Fee $200,000NAME Capital

LLC

FundsFunds

Funds

Profit Interest 15.74% of profit above hurdle.

Allocation of $8.5M of income earned by NAME Capital. Reduces income by $8.0M, is NOT a fee and retains character Int, Div, Capital Gain, etc.

NAMEPREFERREDHOLDINGS,

LLC

PE Hedge Public Equity

20055% Gross Receipts

+2% of NAV

1% NAV+

5% NAV

20102.5% of NAV

+25% of NAV

2.5% of NAV+

25% of NAV

Lender Management structure

Costs: Outsourced – Path Stone:

Total $1.1 millionTax compliance

Accounting functions

Payroll $300k to $400kInvesting

Largest % = 32%

M&MPE

LencoHedge

Public Equity

Lender Management

Murray 1990

Irrev TrMarvin LLC

Murray LLC

8373

KRLT MRLT

1%99%

Largest % = 26%

G1 = 2G2 = 3G3 = 4

G1 = 1G2 = 3G3 = 6

Marvin 1990

Irrev Tr

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Lender Management, LLC v. Comm’rT.C. Memo. 2017-246 (December 13, 2017)

• The owners of Management Company substantially differed from the owners of Investment Entities.

• Investors could withdraw their investments at any time if they were dissatisfied with the management services.

• Management Company had full-time employees and paid salaries to its full-time employees. In Lender, the Management Company had five employees.

• Management Company provided investment advisory services and financial planning services, comparable to hedge fund managers, to entities, individuals and certain third-party non-family members.

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Hellmann structure

Illustrative Costs: Outsourced:

Total $2.1 millionTax compliance

Accounting functions

Payroll $600kInvesting

SBG2AVE1 MG2 DH1

GF Management

LLC

SBGTs

EG

MG1SBG1

Various underlying investments

MEGTs DGHTAve T

SG MG DH

99% 99% 99% 99%

1% in each

99%var%

25% each

Sole owners and the only employees

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Hellmann v. Comm’rDocket Nos. 8486-17, 8489-17, 8494-17, 8497-17

• Brought before the Tax Court, settled out of court

• Court asked to determine whether Management Company’s (GFM LLC) activity constituted “trade or business” in the wake of Lenderdecision

• Factual differences from Lender:• GFM was managed by four family members, who are the sole owners

of GFM and of all the underlying investment partnerships, through trusts

• No “outside” investors

• Irrevocable non-grantor trusts, independent trustees

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Lender + Hellmann: Putting it together

1. Separate Entity. • Whether partnership or corporation, separate entity analysis. Avoid piercing the corporate

veil. • Consider cases Goodwin and Moline Properties as well as cases supporting availability of

Section 162.

2. Family Attribution. • Do Sections 162 and 212 include family attribution rules (consolidate ownership)?• If consolidation, then risk managing own assets. • Related-party transactions require a heightened standard of review.

3. Asset Ownership. • Family office does not actually own the assets as an investor.• Can a family office operate as a business entitled to Section 162, as a matter of law?

4. Professionalized Operations. • Private equity structure. • In addition to Lender, consider Higgins and Groetzinger (among others). • “Regular and continuous” operations with a consistent profit earning motive. • Expenses are “ordinary and necessary.”

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VI. EXPANDING THE ENTERPRISE – MERGERSAND MULTIPLE GENERATIONS

A. Multilayered structures

B. Structural flexibility: mergers, conversions, and liquidations

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VII. GENERATIONAL SUCCESSION OF THE FAMILYOFFICE AND UNIQUE TRANSFER TAX ISSUESWhen structuring profits interests in a family entity to be owed by (or in trust for) junior family members, there are unique and potentially draconian deemed gift tax issues that need to be carefully navigated to avoid triggering a potentially substantial deemed gift under Section 2701.

The risk posed if Section 2701 is violated in connection with a restructuring of an investment entity (such as a family limited partnership or LLC) is that the senior family member could potentially be deemed to have made a taxable gift (subject to immediate gift tax) of some or perhaps even all of his/her retained LP interests in the investment entity upon the issuance of the profits interest to the junior family member (directly or by way of a trust and/or entity).

There are possible ways to structure the issuance of profits interests to junior family members that are designed to circumvent the potentially harsh results of triggering Section 2701, but they involve some level of uncertainty and customization.

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Parent Retained Preferred(at inflated value)

Preferred (Discretionary Rights –

Inflated Value)

Common(Deflated Value)

Common Gifted to Kids(at depressed value)

Stockholders Agreement Provisions

Valued at $9.9m Valued at $100k

Pre-2701 Abusive Discretionary Corporate Recapitalization That 2701 Was Designed to Prevent


Question whether Section 2701 could apply to issuance of profits interest

A “transfer” includes a traditional transfer, capital contribution, recapitalization and change in capital structure.

After the transfer, if G-1 holds a “distribution right” in the form of the LP interest in Investment Entity (“a right to receive distributions with respect to an equity interest”) in a family “controlled” entity.

InvestmentEntities

G-1

Mgt Co.

LP interests

Profitsinterest

G-2

100% interest

LP interests

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Thank you

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• N. TODD ANGKATAVANICH

• RICHARD DEES

• WILLIAM J. KAMBAS

• ROBERT (BOBBY) STOVER, JR.

6786261.

Disclaimer

• This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer’s facts and circumstances.

• These slides are for educational purposes only and are not intended, and should not be relied upon, as tax or accounting advice.

• The views expressed by the presenters are not necessarily those of any organization.

SCORE No. 05543-191US

the heckerling institute on estate planning january 17

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