Building a family office to steward

family wealth and values

Advanced Planning | UBS Family Office Solutions

 Contents

Co-authors Centers of excellence 3

Introduction 4
Ann Bjerke Executive summary 5
Head of Advanced Planning
Family Office Solutions
Chapter 1: What is a family office? 6
One North Wacker Drive
Chicago, IL 60606 Definition of a family office 7
History of family offices 7
(312) 525-7532 Scope of family office services 8
ann.bjerke@ubs.com
Types of family offices 10

David Leibell Chapter 2: Evolution of the single family office 12

Senior Wealth Strategist, Advanced Planning Structuring a single family office 14
Family Office Solutions Legal and tax considerations 16
1285 Avenue of Americas
Recent case law: Lender and Hellmann 17
New York, NY 10019

(212) 821-7063 Chapter 3: Funding the family office 20

david.leibell@ubs.com Choice of entity 22
Ownership of management company 24
Securities law considerations 25
Brian Hans
Senior Wealth Strategist, Advanced Planning Staffing the family office 26
Family Office Solutions
1285 Avenue of Americas Conclusion 27
New York, NY 10019

(212) 821-6912
brian.hans@ubs.com
Centers of excellence
UBS Family Office Solutions The Advanced Planning Group An additional resource for UBS clients
UBS Family Office Solutions is a team consists of former practicing estate and prospects is our Family Office
of specialists that exclusively works planning and tax attorneys with Compass, which is intended to be
with USD 50 million+ net worth extensive private practice experience a practical guide for families setting
families and family offices. The team and diverse areas of specialization, up their own dedicated family office.
helps clients navigate challenges including estate planning strategies, The Compass takes you through
and opportunities across their family income and transfer tax planning, a structured process and prompts your
enterprises, including their businesses, family office structuring, business thinking about your family’s needs and
family offices, philanthropic structures, succession planning, charitable how your family office should be set up
and passions and interests. Having planning, and family governance. to meet these needs. You will also find
this expertise under one roof allows examples of how other families have
for integration and layering of services The Advanced Planning Group designed their family offices. Please
across the UBS ecosystem, delivering a provides comprehensive planning reach out to your Financial
personalized, holistic client experience. and sophisticated advice and Advisor to request a copy.
education to UHNW clients of the firm.
Within Family Office Solutions sits The Advanced Planning Group
our Family Office Design and also serves as a think tank for the
Governance practice. This team firm, providing thought leadership
facilitates discussions with clients and creating a robust intellectual
about family office structure. It serves capital library on estate planning,
as a thought partner for families tax, and related topics of interest to
considering options for managing their UHNW families.
family’s wealth and resources, and for
families with an existing family office.
It advises families across North America
on family office organizational design,
structure and governance, as well as
operational best practices and strategy
to manage and sustain their wealth for
future generations.

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Dear reader,
There is a saying that goes, “If you have seen one family
office, you have seen one family office.” Family offices are
as different as the families they serve—one size does not
fit all. For families who are seeking to coordinate and
consolidate their investment management and planning,
a well-structured family office can play a crucial role
in the preservation and growth of wealth through
the generations.

Just as every family is different, so too We have written this paper to guide
is what’s required of every family office. you through some of the issues faced
Since business families established the by family offices. After all, good
first family offices in the early 20th planning has timeless benefits. Indeed,
century, their number has steadily some of those original family offices
increased, with the first decades of formed over 100 years ago are still
the 21st century seeing the most rapid presiding over the founders’ legacies,
growth. As they have multiplied, family continuing to serve their families well as
offices have taken different forms, they adapt to changing circumstances.
depending on a family’s needs.

At UBS, we partner with families across Regards,

the world, helping them establish and
manage family offices suited to their
goals and circumstances. We offer you
the benefit of our expertise in structure
and governance, as well as operational
best practices and strategy for
managing and sustaining wealth
across generations.
Ann Bjerke Brian Hans David Leibell

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Executive summary

A family office safeguards a Most family offices evolve A family’s businesses, wealth
family’s wealth and values to suit a family’s changing and needs evolve over time.
across generations. It needs, starting within a family Revisiting the family office’s
implements investment, business and then becoming management and
wealth planning and a stand-alone organization. structures ensures that it
philanthropic strategies The funding, legal entity, adapts to those changing
designed to achieve the ownership and activities of a needs. A successful family
family’s long-term goals. family office all have office not only preserves
Depending on the family’s implications that require wealth but also helps to
objectives and wealth, the thoughtful consideration. achieve philanthropic
size and structure of each objectives and preserve
family office will differ. family values.

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What is a family office?
Families create family offices to manage their wealth
while nurturing their identity and values. They look after
a range of areas from wealth management to wealth
transfer, philanthropy and family governance.
Definition of a family office

The Family Office Exchange (FOX), a connected to the family’s wealth cohesion for families around their
membership organization of family objectives. Typical family office wealth.”2 In its ideal form, the family
offices, defines a family office as “a services include providing directly or office helps steward family wealth by
unique family business that is created coordinating with outside supporting the following four
to provide tailored wealth professional services such as tax, dimensions of the family:
management solutions in an investment management, wealth
integrated fashion while promoting transfer (including estate and 1. Business legacy
and preserving the identity and philanthropic planning), risk
values of the family.”1 The family management, family governance and 2. Financial legacy
office acts as the quarterback for the financial education and development
stewardship of the family wealth, of the talent of family members. In 3. Family legacy
coordinating with the family’s addition, the best family offices have
outside professional advisors and a higher purpose, which is “to bridge 4. Philanthropic legacy3
creating and implementing strategies generations to create continuity and

¹ Family Office Exchange, Fox Guide to the Professional Family Office (2014), at p. 3.
² Kirby Rosplock, The Complete Family Office Handbook: A Guide for Affluent Families and the
Advisors Who Serve Them (2014) at p. 1.
3
Ibid., at p. 9.

History of family offices

In the US, the early family offices were established by business-owning families that made their wealth during the Industrial
Revolution. One of the first family offices was established in 1882 by John D. Rockefeller Sr. as a mechanism for centralizing the
family’s wealth and philanthropy. Numerous other business-owning families of great wealth followed Rockefeller’s lead, such as the
Mellon, DuPont and Phipps families.

The growth of family offices connected to family business continues today. A recent study found that more than three quarters (77%)
of family offices still have a related operating business.4 Because these entities are private and emphasize confidentiality, it’s difficult
to get a true number of the family offices currently in existence in the US. It’s estimated that there are more than 3,000 single family
offices (SFOs), and at least twice that number embedded within private operating companies (primarily family businesses).5

4
Global Family Office Survey, 2024.
5
The UBS/Campden Wealth Global Family Office Survey, 2019.

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Scope of
family office services

Understanding the services a family office oversees

or provides directly gives a strong indication of how
it operates in relation to a wealthy family. There are
six basic categories of services that family offices
typically provide:

1. Strategic wealth management: 2. Investment planning: Whether 3. Trusts and estates: This service
This involves long-term strategic investments are handled in-house involves overseeing the structure
planning for accomplishing family or outsourced, proper investment and execution of the legal
wealth objectives for current and oversight—including asset documents necessary for efficient
future generations. In addition to allocation, portfolio construction, wealth transfer. The family office
determining goals, strategic wealth creation of investment policy is also the keeper of these
management includes building the statements, manager selection documents, often overseeing their
family’s governance structures, and due diligence—is at the core administration and working with
including family boards and of family office functions. Also those serving in any fiduciary role.
councils, as well as family mission included in this category are Many wealthy families choose
statements and constitutions. investment recordkeeping to establish a private family trust
and reporting (including company under the laws of a
consolidated reporting). trust and tax-friendly state (e.g.,
South Dakota, Nevada or New
Hampshire) to act as trustee of the
various family trusts. In fact, in
some circumstances, the private
family trust company can act as
the family office or the family
office can be an affiliate of the
private family trust company.

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 Family education involves
teaching each generation
of the family necessary skills
to ensure they will be effective
shareholders, directors
Figure 1. What can a family office do?
and managers.

Family office

Strategic wealth Family governance Tax and financial

Investment planning Trust and estate Philanthropy
management and education planning

• Family governance • Asset allocation • Legal strategies •C

 haritable • Family education • Bill pay
structures • Investment policy • Estate planning giving vehicles • Family meetings •C
 ash flow and
• Family boards and statement (foundations, budgeting
• T rust donor-advised • Communication
councils • Liquid investments administration •G
 eneral ledger/
funds) • Family counseling
• Family mission • Due diligence • P remarital accounting
statements and • S trategic • Legacy/succession
• Manager selection agreements philanthropy • T ax planning
constitutions strategies
• Monitoring • Insurance • F oundation
governance •R
 eview of
• Trading/execution tax returns
• Alternative • Reporting
investments
(HF (Hedge Fund), • T ravel and
PE (Private Equity), scheduling
RE (Retained • Concierge
Earnings)) • Collections
• Corporate finance • P roperty
• Global custody management
• ESG/Impact
• Risk management
•M
 arket solutions
(FX, structured
products,
derivatives)

4. Philanthropy: This service 5. Family governance and 6. Tax and financial planning: Tax
includes developing strategies for education: Once family planning includes the oversight of
helping the family be effective governance structures are in personal and business tax returns.
in its charitable giving. Creation place, the family office Financial planning includes cash
and oversight of the family’s coordinates the necessary flow management and budgeting
giving vehicles, such as family meetings and communications for individual family members
foundations and donor-advised to make sure such governance along with bill pay and concierge
funds, are also a component structures are working effectively. services such as management of
of family office philanthropic Family education involves teaching family real estate and art.
services. Involving the rising each generation of the family
generations in the family’s necessary skills to ensure they
philanthropic initiatives can be will be effective shareholders,
an effective way of transferring directors and managers of
values and engaging younger the various family governance
family members in the overall structures and businesses.
family governance structure.

Source: UBS Family Office Solutions Group, Feb. 2020.

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Types
of family
offices

Family offices are as unique as the families they serve. They

should be structured in a manner that best represents the
particular needs of the family. When a wealthy family is
considering a family office, there’s a steep learning curve.
Numerous for-profit entities provide family office services.
These include private banks, private wealth divisions of large
brokerage firms, registered investment advisors, accounting
firms, private client law firms and consultants. All have their
place in the structure and execution of family office services,
but the family first needs to consider the type of family office
it will create or participate in. These include:

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 Some family offices have
tremendous in-house expertise,
operating closely held
businesses, and decide to
use that expertise to make
direct investments.

Single family office (SFO): An Virtual/coordinating family office Family-owned multi-family office
entity that manages the financial and (VFO): A VFO outsources most if (MFO): A company that manages
personal affairs of one wealthy not all activities, gaining access to the wealth of a group of wealthy
family. Such an entity typically has people, products and services when families. It’s usually owned by one
several staff members including a needed. It typically employs one or or more of the founding families.
chief executive officer, chief two people to handle day-to-day The idea is to reduce the overall cost
investment officer, staff operations and coordinate outside of services when compared to a
accountants, bookkeepers and advisors and outsourced services. full-fledged single family office.
employees handling family real It’s usually headed by a senior family
estate, art, and family education and member, the family business chief Commercial MFO: Typically a
governance. Complicated tax financial officer or a trusted boutique investment firm owned
planning, certain investment professional, such as a CPA or by a third party that provides
classes (for example, hedge funds attorney. Many private banks and investment and certain other
and private equity) and wealth private wealth divisions of large ancillary services to wealthy
transfer planning are typically brokerage firms have set up families. These businesses range
outsourced. Some family offices, specialized departments to provide from pure investment shops to
however, particularly those affiliated these entities with full service around those that provide a full range of
with family businesses, have investing, along with specialty advice family office services.
tremendous in-house expertise in wealth transfer, succession
operating closely held businesses, planning, philanthropy, family
and decide to use that expertise to education and family governance.
make direct investments in these
types of entities. There can be a
dedicated family office location,
separate from the family business,
with little or no crossover staffing
and its own tech infrastructure for
privacy and confidentiality purposes.

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Evolution of the
single family office
Most family offices begin within the family business
before evolving into dedicated entities. Structuring
family offices takes careful planning, including legal
and tax considerations.
Since the majority of family offices Embedded family office: An family matters (e.g., estate tax
evolve from a family business or the embedded family office provides planning). Finally, if the family
sale of a family business, services to family members within decides to sell the business or bring
understanding the evolution of such the family business. There are in outside investors, it will need to
entities helps put the spectrum of typically no separate employees. address those “personal” expenses
family offices in context. Most family Services are provided by family that the business has been covering.
businesses, no matter what the asset business employees, specifically
level, provide family office-type long-tenured, trusted employees. Separate VFO: Sometimes
services to owners and their family Most services are outsourced under motivated by the scale of family
members. It isn’t uncommon for a the oversight of a family member wealth or the increasing number of
family business to also be called the or trusted employee. This type of family members, with a separate
family bank. The formalization of structure can work well for smaller VFO, family office services are moved
these services into a family office families in the founder or sibling out of the family business to a
structure depends on several generations or families with total dedicated entity that only handles
factors, including: wealth less than $250 million, family office services. While most
when hiring dedicated employees services continue to be outsourced,
1) the size of family wealth; may be unwarranted or cost- management is professionalized and
prohibitive. There are several dedicated specifically to the family
2) the current generation of the downsides to this type of structure. office. These types of entities work
family business (i.e., a family office First, family business employees may well with families with total net
serving the founder and their not be particularly skilled in providing worth of $250 million to $1 billion.
descendants or a family office oversight of family office services
serving third, fourth and fifth such as investments, wealth transfer SFO: Once a business-owning family
generations); and family governance. Second, crosses the billion-dollar mark, things
these employees may favor tend to change. More of the
3) the size and complexity of family members active in the administrative services are brought
the family; business to the detriment of inactive in-house. In addition, SFOs typically
family members. Third, these entities have a chief investment officer who
4) cost; and tend to have less confidentiality and may invest in many asset classes
privacy for family members. Fourth, in-house. The SFO tends to have the
5) the willingness of family members the employees often have other greatest internal costs, but these can
to work together on their personal duties, so there is a competition be offset by the fact that investment
financial matters. The stages of between business-related duties and fees to outside providers are
family office evolution when family office-related duties. If there’s reduced by in-house management
connected to the family business a major transaction, an employee and economies of scale due to the
are typically. may be distracted from handling size of assets under management.
important but perhaps less urgent

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Structuring a single
family office

If a family determines that a single family office is

the best approach for coordinating and centralizing the
management of the family wealth, it is important to
follow a methodical process in order to help ensure the
delivery of the scope of services needed by the family,
achieve the desired legal and tax results, and establish
a governance structure that will serve the family
over multiple generations.

14 of 28
Mission and strategy. A family Family decision-makers and legal advisors sufficient or should new
office mission may include: stakeholders should consider holding advisor partnerships be established?
several meetings at the outset to This will help the team determine the
1) preservation and regeneration ensure that opinions, concerns and role the family office will play. It will
of family wealth; ideas are raised, debated and also help determine which services
resolved. Communication on topics should be handled directly by the
2) a coordinated approach like involvement of spouses, family office and which should be
to decision-making; investment philosophy, employment outsourced. The business plan should
opportunities for family members at also address governance, legal
3) development of family talent the family office and processes for structures, staffing, tax, accounting,
and entrepreneurship; making hiring decisions can be IT, etc. One mantra the team should
important at the outset to ensure remember during the business
4) support of family unity; and the family is on the same page. The planning process is: “Don’t overbuild.”
strategy is not stagnant: It should be
5) strategic philanthropy. reviewed and revised every few years It is important to understand the
and upon the occurrence of upfront legal, tax and accounting
While the mission of the family office significant changes in family costs to establish and maintain a
may be initially determined by the circumstances. single family office. A recent UBS
senior generation establishing the Global Family Office survey estimated
family office, it will likely evolve over Business plan. Once the mission and that the average cost of running
time as rising generations become strategy are in place, the next step is a family office in 2022 is 42.2
involved in decision-making a business plan. Creating an basis points (bps) of assets under
and governance. effective business plan for the design management, that varies depending
of a family office requires putting on the size of assets. In a family
Once the initial mission of the family together a team, including family office with assets of USD 100 million
office is clear, strategies to achieve members, trusted advisors and, under to USD 250 million, this cost is
the goals are easier to evaluate. A some circumstances, a family office 58.6 bps. When assets rise to
crucial element of strategic planning consultant. Mapping out the current USD 251 million to USD 1.0 billion,
for a family office is to align the goals situation is a good place to start. Who though, the cost falls to 42.5 bps.
of the family with the goals of the currently advises and supports the And, for large offices managing
family business (if there is one), the family? What is working and where assets of USD 1.01 billion or more,
family office and family philanthropy. are the gaps? Are the existing tax and average costs fall to 31.7 bps.6

6
UBS 2022 Global Family Office Report.
15 of 28
Legal and tax considerations for
structuring a single family office

As a result of tax law changes that took effect in 2018 and

other legal developments, many families are revisiting the
structure of their family office in order to avail themselves
of the ability to deduct investment management fees for
income tax purposes.

Background entities, including family offices, imposed strict standards for

Historically, expenses incurred for engaged in investment management determining whether investment
the production of income or the may no longer be able to deduct management and related activities
management or conservation of these expenses. constitute a trade or business.
property held for the production of Investing one’s own assets does
income (e.g., investment advisory Under Code §162, expenses incurred not rise to the level of a trade
fees) were deductible under §212 of in an investment management or business.
the Internal Revenue Code (the Code) business are fully deductible. The
to the extent those expenses 2017 Act’s elimination of Some of the relevant factors that
(together with other miscellaneous miscellaneous itemized deductions courts have considered are whether
itemized deductions) exceeded 2% of (including those under Code §212) the enterprise has a full-time staff, if
adjusted gross income for a given tax did not impact the ability to deduct the nature of the services provided
year. However, the passage of the Tax expenses under Code §162 for are commensurate with those
Cuts and Jobs Act of 2017 (the 2017 expenses incurred in an investment provided by investment managers in
Act) changed these rules. management “trade or business.” the marketplace, whether the
Therefore, an investment investment manager receives
Code §67(g) was added by the 2017 management enterprise that is compensation and the type of
Act, which suspended the deduction recognized as a trade or business compensation received, and whether
of miscellaneous itemized deductions can still deduct investment the owners of the service provider
subject to the 2% floor for tax years management expenses. and the “client” are the same.
2018 through 2025. As a result,
unless a deduction for these expenses Regarding what constitutes an
is available under another section of investment management trade or
the Code, certain individuals and business, courts have historically

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 Applicable case law:
Lender and Hellmann

The US Tax Court has addressed the question of whether an investment

management activity rises to the level of a trade or business in two recent
cases. The first case is Lender Management LLC v. Commissioner of
Internal Revenue, T.C. Memo. 2017-246 (2017). In the Lender case, the
Lender family (who founded Lender’s Bagels) established an investment
management arm of its family office in the structure shown in Figure 2.

(continued)

Figure 2. Structure of Lender Management LLC

Marvin Lender trust Keith Lender trust

Lender
family
members
Lender Management LLC

Management fee and profits interests

Management Advisory and related services

Investment LLC Investment LLC Investment LLC

UBS Financial Services Inc., its affiliates and its employees are not in the business of providing tax or legal advice. Clients should seek
advice basedUBS
Source: on their particular
Advanced circumstances
Planning Group, Feb.from an independent
2020. UBS Financialtax or legalInc.,
Services advisor.
its affiliates and its employees are not in
the business of providing tax or legal advice. Clients should seek advice based on their particular circumstances from an
independent tax or legal advisor. This source is the court’s opinion.

17 of 28
Recent case law: Lender and Hellmann (continued)

Continued from preceding page benefits programs and other expenses

involved in running the operations of
Lender Management LLC served the entity.
as the investment management
company and it provided investment The Tax Court held that Lender
management services to the three Management LLC was engaged
Investment LLCs. The Investment in a trade or business and that its
LLCs were owned by various Lender expenses were deductible under §162
family members. The two Lender of the Code. The court identified
family members who owned Lender the following specific factors as
Management LLC also held minority being significant in its determination
interests in the Investment LLCs. that Lender Management LLC was
In order to facilitate investment engaged in a trade or business;
management and diversification for (i) Lender Management LLC’s
Lender family members, the three compensation structure was similar
Investment LLCs were established. to that of a private equity or hedge
Each LLC invested in a different asset fund manager as opposed to just
class, one invested in private equity, representing returns of a passive
another in hedge funds and the last investor because of the profits interest
held publicly traded securities. for its services in addition to its
management fee; (ii) the difference
In exchange for acting as sole in ownership of Lender Management
investment manager for each of the LLC and the Investment LLCs; and
three Investment LLCs, similar to what (iii) the fact that Lender Management
would be seen in a private equity or LLC had full-time employees and
hedge fund, Lender Management substantial operations in managing
received a profits interest as well as a the investments of the
management fee from the Investment Investment LLCs.
LLCs. Lender Management LLC
deducted expenses related to salaries The second recent case regarding
and wages for its staff, repairs investment management trades is
and maintenance, rent, taxes and Hellmann v. Commissioner of Internal
licenses, depreciation, employee Revenue, Tax Court Order,

18 of 28
 Those family offices and others
engaged in the investment
management activities may enjoy
material tax savings by following
the structure and rationale set
forth by the Tax Court in the
Lender and Hellmann cases.

Docket No. 8486-17, filed October Lender some of the family members If otherwise in line with the family’s
1, 2018. The Hellmann case was were geographically dispersed, objectives, those family offices
settled by the taxpayers and the did not know each other, and had and others engaged in investment
Internal Revenue Service prior to a very different investment goals and management activities may be
decision from the Tax Court after the objectives. able to deduct expenses (including
initial court proceedings. However, third-party management and related
the Tax Court issued an order in the In the Order, the Tax Court in fees) by following the structure
case, denying the taxpayer’s request Hellmann reiterated the importance and rationale set forth by the Tax
for a ruling that the facts of the of the following factors in the Court in the Lender and Hellmann
case were so similar to the Lender analysis of whether an investment cases. Specifically, the management
case that a trial was unnecessary management enterprise constitutes a company should:
and the taxpayer should prevail as a trade or business:
matter of law. In the order, the Tax 1. Be owned by different family
Court discussed the Lender case and 1. The nature and extent of members or in different
contrasted the facts of the the services provided by the percentages relative to the
Lender case with the facts of employees of the family office; owners of the investment LLCs or
the Hellmann case. “clients;”
2. The expertise of and the time
The Tax Court noted that the spent by the family office 2. Receive a profits interest
structure in Hellmann lacked the employees as compared with and a management fee for
disproportionality of ownership as outside investment managers and its compensation;
between the management company consultants;
and the assets being managed that 3. Provide extensive services rather
was present in the Lender case. In 3. The differentiation of investment than only administrative or “back
the Hellmann case, the same four strategies for different family office” services; and
family members who owned the members based on individual
management company also owned investment desires and needs; and 4. Have full-time employees.
the assets being managed in the
same proportions. In addition, the 4. The proportionality between the
Tax Court highlighted that the family share of profits indirectly flowing
members in the Lender case were to each family member through
more akin to independent clients their share of ownership of the
than in the Hellmann case because in family office relative to that same
family member’s ownership of the
managed funds.
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Funding the
family office
The funding, legal entity, ownership and activities
of a family office all have implications that require
thoughtful consideration.
Many family offices fund their profits interest, or carried interest,
operations and expenses through meaning that the family office only
a profits interest structure as was receives cash to cover expenses if the
present in the Lender case. The investment LLCs are profitable. If, in
favorable tax treatment and ability any given year, the cash received due
to deduct investment advisory fees to the profits interest is insufficient
and other professional fees is possible to cover expenses, the Smith Family
only if the family office assumes Office, or its owners, would be liable
meaningful economic risk. In the for the balance of the expenses. This
chart below, the Smith Family Office structure substantiates the position
would receive a management fee that the family office is a bona fide
and economic return through a trade or business.

Figure 3. Smith Family Office structure

G2 individuals
and trusts

Board of directors Owned by LLC 1

Real estate

Fee
Owned in
Employees’ legal, Individual LLC 2 various
Costs family members percentages
tax and accounting PE, VC,
fees; rent and/or trusts Profit Interest; hedge funds by individuals
% of profits above hurdle and trusts

Service LLC 3
CEO, CIO, agreement Marketable
employees securities

Smith Family
Foundation

UBS Financial
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Group, employees
2020.are notFinancial
UBS in the business of providing
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and itsClients should seek
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or legal advisor.
should seek advice based on their particular circumstances from an
independent tax or legal advisor.

21 of 28
Choice of
entity

An additional element of the strategy However, when considering

that might be considered is using a C corporations it is important to pay
C corporation (or making an election special attention to other, less
to have the entity treated as a desirable tax consequences that
C corporation for income tax purposes) might arise. Two such considerations
as the management company. are the personal holding company
A C corporation is entitled to a tax rules and the accumulated
presumption under the tax law that it earnings tax rules.
is engaged in a trade or business and,
therefore, should be entitled to deduct The determination as to whether a
its ordinary and necessary expenses corporation is a personal holding
incurred in connection with the trade company and, if so, if it is subject to
or business. From a tax standpoint, the personal holding company tax is an
this may strengthen the argument that analysis subject to many nuances and
the management company is engaged exceptions. In general terms, a
in a trade or business. However, the personal holding company is a
presumption under the tax law that a corporation (i) that receives
C corporation is engaged in a trade or predominantly income from passive
business is rebuttable. In other words, sources (interest, dividends, rents, etc.)
simply incorporating an enterprise that and (ii) of which five or fewer
would not otherwise pass muster as individuals own, directly or indirectly,
an investment management trade or more than 50% of the value of
business will not carry the day, but the stock. In addition to their regular
it may be used by a management corporate income tax liability, personal
company as a positive factor tending to holding companies are subject to an
show that it is engaged in a bona fide additional corporate level tax on their
trade or business activity. personal holding company income
(a defined term). As such, many family

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 Analyzing whether a corporation
is a personal holding company and,
if so, if it is subject to the personal
holding company tax is subject to
many nuances and exceptions.

office investment management that may be subject to higher If, however, the family office acts as
companies will fall within the individual federal income tax a holding company, then this is an
definition of a personal holding rates by retaining the funds in issue. If, for example, the family office
company and thus should consider corporate solution. Accordingly, owns an interest in a commercial
the application of the personal family offices that structure their office building through one or more
holding company tax rules. investment management companies limited liability companies and there’s
as C corporations should consider litigation against the owner of the real
The accumulated earnings tax is the potential application of the estate, the court would look through
another additional corporate-level tax accumulated earnings tax. the LLCs and the family office for
imposed on corporations that retain purposes of determining diversity.
earnings in excess of what is necessary In addition to the tax issues, there’s If the family owns the family office
to meet the reasonable needs of the an often overlooked privacy issue. through one or more trusts, that
business. Without the accumulated For purposes of diversity jurisdiction in structure will become a part of the
earnings tax, corporations would be federal court, the court looks through court’s records.
able to avoid having their shareholders any entity other than a corporation. If
pay tax on dividends from the a family office is organized as a limited The parties to the litigation can seek a
corporation by retaining the cash liability company, this potentially can protective order barring the disclosure
within the corporation. As a result, expose the family’s wealth structure (or of that information, and a court often
unless the corporation can show that at least a part of it) to the public. will grant it. However, it’s unlikely
retained earnings are intended to meet that, if a third party—such as a media
the reasonably anticipated needs of If the family office doesn’t hold any outlet—challenged the order, the order
the business, the accumulated underlying investments, then this isn’t would survive scrutiny.
earnings tax may apply. Given the an issue. In many cases, a family’s
reduction in the corporate tax rate that investments are held through trusts, The importance of this issue varies
came as a result of the 2017 Act, LLCs or other entities, and the family from family to family. Some families
the Internal Revenue Service (IRS) is office is only providing management aren’t concerned about the potential
more likely to focus on corporations and other services to those entities. exposure. Other families are more
seeking to avoid issuing dividends protective of their privacy.

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Ownership of
management company

Income tax considerations are critical Due to the intra-family nature of the
when considering the ownership of family office structure, if the carried
the management company (i.e., Smith interest is undervalued or overvalued
Family Office), and for those reasons, it relative to what the value would be in
may not be advisable for the the commercial market, a taxable gift
management company to be owned by could result. Furthermore, the carried
Generation 1. However, transitioning interest should be carefully analyzed
ownership of the management regarding whether it would be
company to younger generations may considered an interest to which §2701
result in gift and estate tax of the Code applies. If §2701 of the
consequences. If the management Code applies to the carried interest, an
company is funded through a profits unintended gift might result.
interest, a proper valuation of the
carried interest should be obtained.

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Securities law considerations

Family office management and The definition of “family client” is to offer investment opportunities
advisors will need to be familiar with complex and important to understand. to key talent as means to create an
the federal and state securities laws It covers certain family members, attractive compensation package. The
which can affect their operations. certain trusts and entities operated for definition of “key employees” includes
Because a family office will generally family clients, key employees of the an employee of the family office (or an
provide advice relating to the family’s family office and certain family-funded affiliated family office, also a defined
investments in securities, it will be charitable organizations. Family term) who is an executive officer,
subject to regulation and registration members include all lineal descendants director, trustee, general partner or any
requirements under the Investment of a common ancestor (up to 10 other employee, other than a clerical
Advisers Act of 1940 unless it falls generations removed) and spouses or or secretarial employee, who has
within an exemption. The Dodd-Frank spousal equivalents of those participated in the investment activities
Act created a rule in 2011 which descendants. The family member of the family office for at least 12
provides an exemption for family definition includes individuals adopted, months. Former key employees are
offices from regulation and registration stepchildren, foster children and also recognized as key employees,
as an “investment advisor” if they former family members (e.g., divorced such that a former CEO, for example,
meet certain requirements.7 family members). Note that the can maintain their investments with
definition does not include in-laws. the family office but cannot make
The “Family Office Rule” contains Accordingly, if a family office provides additional new investments after they
complex definitions and requirements investment advice to the mother-in-law no longer work at the family office.
that family offices need to examine of a family member, for example,
closely in light of their particular facts it may lose the ability to claim the
and circumstances. Generally, to be exemption from regulation under the
considered a family office that qualifies Advisers Act. The family office may be
for the exclusion, it must provide able to request a “no-action” letter
investment advice only to “family from the SEC on this issue.
clients,” be wholly owned and
controlled by family clients and cannot The inclusion of “key employees”
hold itself out to the public as an under the definition of family client
investment advisor. creates the ability for a family office

7
Rule 202(a)(11)(G)-1 under the Investment Advisers Act of 1940.

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Staffing the family office

Proper staffing is crucial to the success of a family the staff increases, the family should be thoughtful
office. Family offices often begin by transitioning about providing employment opportunities to family
a key administrative employee from an operating members and how that may impact the dynamic and
company to a full-time employee for certain performance of the family office. They may want to
family members and evolve to a larger staff. Key roles consider creating employment policies that set forth
include a Chief Executive Officer, Chief Investment the requirements and credentials necessary to work
Officer and Chief Operating Officer and often require in the family office and create guidelines for resolving
in-house legal counsel, compliance officers, trust conflict in a system where a family member employee
officers and foundation personnel. As the size of may also be a client.

Compensation of family office employees

Recruiting and retaining key employees for family office When designing compensation packages, family
leadership roles often requires creative incentive-based offices should consider whether the incentive
compensation. Many family offices allow certain key compensation programs are aligned with the family’s
employees to co-invest in direct investments (and may goals and balance the potential longer-term
make loans to employees to facilitate the investment) investment strategy of the family with the
and participate in a carried interest in order to share shorter-term liquidity needs of the employees. As
in the profits of investment ventures at a lower capital these plans can become very complex, it is important
gains tax rate. It is also possible for a family office to to carefully structure and implement an appropriate
create a plan that grants performance shares, units or and tax-efficient compensation structure.
cash that vest over time or after attaining certain goals.

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Conclusion

As a family’s businesses, wealth and needs evolve over

time, the family should revisit the management and
structures in place that serve and implement their
vision. With strong commitment and governance,
a family office, in its many forms and iterations, can
provide a family with investment, organizational, legal
and tax benefits.

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