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Is a Family Office Structure Good Estate Planning?

Estate Planning For Life's Stages

During estate planning, one of the situations that you must plan for is the possible sale of real estate, artwork, and especially operating family businesses. What is sometimes overlooked in planning is what happens after there has been such a sale.

When you do own real estate, artwork, or an operating business, the family office structure is dictated by several factors, such as business needs, control requirements and income tax efficiency. However, usually there’s little or no thought given to the legal, accounting, management and other services that directly or indirectly benefit the owners of the company. If the real estate, artwork, or business are held as investments, it’s an asset used for a trade or business and the expenses can be tax deductible, says Forbes’ recent article entitled “Planning For After a Sale Of Real Estate, Artwork Or An Operating Business.”

In the past, when the liquid proceeds of a sale were invested into an investment portfolio, these expenses could be deducted as expenses to produce income under Section 212 of the federal tax code. However, that has changed. The Tax Cuts and Jobs Act (TCJA) of 2017 suspended Section 212, until at least 2025, making legal, accounting, tax and similar advisory service expenses no longer deductible,  those expenses are trade or business expense of an operating company and, therefore, deductible under Section 162.

A real advantageous structure, even before TCJA, has been a family office structure where you can deduct the fees and expenses of managing family wealth as an operating company. The Tax Court in 2017 decided that the family office that managed the wealth of the heirs of the founder of Lender’s Bagels was able to deduct these expenses because Lender Management is an operating business. As a result, it’s possible to set up a family office that can deduct expenses as an operating company. However, this doesn’t ask all of the questions a family should ask in setting up an operating family office, along with issues that can mean adverse income tax effects.

Missouri Revocable Trust

Here are some of the right questions the family should ask:

Is the family’s goal for forming or maintaining a family office best served by making it an operating business? If an operating family office isn’t necessary to achieve the family’s goals, it won’t be worth the trouble to set one up and to maintain its operations.

If the strategy of forming and maintaining an operating family office best serves the family, then which tactic is needed to achieve the family’s objectives? This includes the choice of entity, being limited to only family as clients, outsourcing, governance and oversight.

Is the formation and maintenance of an operating family office going to be enough to achieve the family’s goals in the long-term? The operating family office should be run as a profitable business to be sustainable over time. If it’s profitable, it will have sufficient income to deduct expenses and return a profit to the owners of the family office. This is important to avoid the loss of Section 162 deductions to evidence that the family office exists for something more than just tax advantages.

What specific steps are required to set up and maintain an operating family office, and are those steps even possible for the family? Even if the operating family office is possible, will the habits and behaviors of family members who are used to doing things their own way with their money mess it up? Despite knowing that there are tax savings, can they conduct business in a more formal, collaborative, manner, and will their behaviors be disciplined in the operating business to meet the approval of creditors, clients, vendors, and employees? When it comes to the investment of liquid wealth, this discipline is frequently absent, and many poor behaviors and attitudes continue for the older generations and are allowed to grow for the younger generation.

Reference: Forbes (Aug. 12, 2020) “Planning For After a Sale Of Real Estate, Artwork Or An Operating Business”

Suggested Key Terms: Estate Planning Lawyer, Inheritance, Asset Protection, Business Succession Planning, Tax Planning, Financial Planning