Key Tax and Non-tax Considerations When Funding Family Offices in the USA
In this Chambers Expert Focus podcast, Michael Kosnitzky and Joshua Becker from the Private Wealth team at Pillsbury Winthrop Shaw Pittman discuss what to take into account when forming and operating a family office.
Joshua Becker
A family office manages investments for a wealthy family with the primary goal of increasing and transferring wealth across generations.
Mike and Josh outline what they consider the core tax and non-tax considerations to factor in when forming and funding a family office structure – the first being income and gift tax issues, particularly in the wake of the Tax Cuts and Jobs Act 2017, which had the effect of denying deduction from most investment-related expenses.
“Current rules potentially disallow all family office expenses, including employee compensation, rents, due diligence-related expenditures, and fees paid to accountants, lawyers and investment managers.”
This is particularly significant in a family office context as most – if not all – expenses may be deemed investment-related and thus non-deductible without further planning, which Mike and Josh go on to detail.
“In order to build and maintain a good family office structure, a practice must cover all the bases. It’s about more than just income and gift tax – there are family law, general corporate law, aviation law, confidentiality planning and lots of other considerations, too.”
As such, Josh believes that taking the Adviser Act into account when managing the assets of a family will become an even bigger issue for family offices going forwards, especially in light of forthcoming legislative changes. However, if the family office is only investing family money – rather than third-party capital – it may prove to be the exception.
“Fortunately, the Adviser Act contains a family office exemption. Family offices will not be subject to compliance and disclosure if they provide investment advice to family clients only and do not hold themselves out to the public as investment advisers.”
The final key factor to consider when it comes to forming and funding what Josh terms “a 21st-century family office” is their increasing number of direct investments.
“On the non-tax front, family offices should expect to receive the same managerial and control rights as a private equity firm might expect if it were making a direct investment of the same size.”
On the tax side of things, family offices must keep QSBS (qualified small business stock) eligibility under Section 1202 of the Federal Income Tax Act right at the top of their radar, as it is becoming hugely important – especially for family offices making direct investments in much the same style as a tech start-up.
“Properly structured, this tax incentive presents an opportunity to exclude a huge amount of tax on capital gains.”
Pillsbury Winthrop Shaw Pittman
