the heckerling institute on estate planning january 17
TRANSCRIPT
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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.
16786261.
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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
26786261.
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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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Heckerling 2019: FUNDAMENTALS OF FAMILY OFFICES
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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
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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
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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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Heckerling 2019: FUNDAMENTALS OF FAMILY OFFICES
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
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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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Heckerling 2019: FUNDAMENTALS OF FAMILY OFFICES
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
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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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Heckerling 2019: FUNDAMENTALS OF FAMILY OFFICES
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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Heckerling 2019: FUNDAMENTALS OF FAMILY OFFICES
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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Heckerling 2019: FUNDAMENTALS OF FAMILY OFFICES
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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Heckerling 2019: FUNDAMENTALS OF FAMILY OFFICES
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
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Heckerling 2019: FUNDAMENTALS OF FAMILY OFFICES
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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Heckerling 2019: FUNDAMENTALS OF FAMILY OFFICES
Thank you
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• N. TODD ANGKATAVANICH
• RICHARD DEES
• WILLIAM J. KAMBAS
• ROBERT (BOBBY) STOVER, JR.
6786261.
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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