2023-05-13
A Guide for Single Family Offices: Tax Strategy & Planning
Family offices can be an effective way to organize and centralize a family’s wealth and investment activities. The purpose of a family office is to provide services to an ultra-high net-worth individual (UHNWI) or a wealthy family. Services typically include wealth transfer planning, insurance, budgeting, investments, asset management, charitable giving, and tax services. Family offices come in all shapes and sizes, with the expertise of the team directly reflecting the needs of the family. One area of family office where there is an increased demand for expertise is tax and there are several external factors influencing this focus.
Economic slowdown
After ten or more years of bull markets, it is becoming harder for families (and investors generally) to maintain the same above average returns on investments. Last year began a period of small growth in GDP, rising inflation, and increasing interest rates. The economic outlook for 2023 in the USA, according to The Congressional Budget Office (1), is that of stagnating growth and falling inflation. The first half of 2023 signified greater market volatility and banking failures (Silicon Valley Bank, First Republic and Credit Suisse). At the same time, governments around the world are moving to higher tax regimes to address debt issues. This macro-economic slowdown combined with geopolitical changes globally, means family offices need to think carefully about how they plan for wealth preservation over the coming decade.
Regulatory changes
In the USA over the last three years, there has been a shift in tax law and regulations with the full impact of the Build Back Better Bill and the Inflation Reduction Act 2022 still pending. The Corporate Transparency Act (CTA) calls for greater insight into corporate ownership and requires certain companies (those that qualify as a ‘reporting company’) to report information to the Financial Crimes Enforcement Network (FinCEN). In 2020, the IRS announced a renewed effort to examine tax returns filed by high-wealth taxpayers and their related entities through their Global High Wealth (GHW) program and related IRS initiatives. With the many changing nuances in tax laws and regulations, it is important for families to have the right expertise to guide them through this ever-evolving landscape.
Effective tax planning can help to minimize the tax burden on a family’s investments and income, and ultimately ensure that a family’s wealth is passed on to future generations in a tax efficient manner.
Single family offices (SFO) will already be focusing on how to minimize tax liabilities by maximizing tax deductions, 401 (k) or IRA retirement accounts, deferring capital gains tax on real estate investments, optimum entity structuring, tax-free investments such as municipal bonds, charity giving, gifting and estate planning. Each of these strategies can be complex and usually designed in a bespoke manner to fit the specifics of a family’s circumstances.
The combination of ever-changing tax laws and less favorable economic outlook mean there has never been a more important time for family offices to focus on both reducing tax liability and creating tax alpha. This can be achieved through efficient investment decision making, particularly if a family’s wealth spans multiple generations, asset classes and geographic jurisdictions.
This article explores the idea that tax strategy and execution should not be the responsibility of one person in any family office. Rather, pursuing tax efficiencies can and should involve various individuals collaborating and understanding this ever-evolving field. Further on, we explore whether it is worth hiring a full-time, dedicated tax expert, outsourcing to a partner organization, or engaging a specialist advisor on a fractional basis. There are pros and cons to the various approaches and it’s impossible to apply a one size fits all solution.
How can family offices pursue tax optimization?
Strategy and structure
Whether a family is establishing a family office for the first time, or attempting to modernize in preparation for future generations, it’s important to have long-term goals and values in place. This will help shape the structure of a family office and aid decision making. Foundational ideas and thinking, such as, focus on long-term investing, impact on community or importance of family legacy will influence the way in which a family office is organized, funded, and taxed. This will in turn influence the services you offer to family members and the talent you require in-house versus engaging with external experts.
Here are some of the important tax considerations when structuring a family office:
- Should a family office be structured as a flow-through entity (partnership/LLP) or a stand-alone entity (CCorp)?
- Will the family office activities be considered a trade or business?
- How will the family office charge for its services?
- How can a family office be funded tax-efficiently?
- Is the family office going to be conducting ‘business’ in one state and country or across multiple geographies?
- What are the philanthropic goals of the family? What type of charitable entity makes sense?
- What existing/future generations can you plan for?
- How and when to establish estates and trusts?
- Are there gifts, estate and trusts that need to be created or updated in line with changes in tax rules.
Tax Alpha and Investing
Tax strategies frequently focus on reducing tax liabilities. Tax alpha is a measure of how much extra return an investor earns by making tax efficient investment decisions. In other words, it’s the difference between an investor’s actual after-tax return and what their return would have been if they hadn’t considered the tax implications of their investments.
Most family offices will utilize their in-house CIO and investment team to deploy tax alpha techniques such as tax-loss harvesting, utilizing tax-advantaged accounts, asset location, dividend reinvestment, municipal bonds, passive investing, holding investments until a more favorable tax threshold and tax-efficient ESG investing. Building a portfolio with these tax implications in mind is crucial as is the ongoing monitoring and forecasting of tax alpha. These strategies should be reported, shared and communicated with other team members as there is an inter-connectedness between all aspects of investment and financial decision making in a family office.
There is a lot to consider when deciding where, what, when to invest and how best to achieve tax alpha. It requires both a detailed and holistic perspective when considering a family’s wealth and should be taken into consideration with broader family goals and values, risk appetite, timing, cash flow, market conditions and any significant liquidity events.
Estate, gift, and trust planning are important aspects of wealth management. A specialist can help a family focus on developing and maintaining trusts to minimize estate taxes and maximize the transfer of wealth to their heirs. The Tax Cuts and Jobs Act has seen an increase of the federal estate tax exemption to $12.6 million (this can be combined as a couple to $24.12m). This is due to expire in 2025 when the amount will reduce to $5 million (adjusted for inflation) for a single individual. A tax expert can help a wealthy family lock in the current exemption ahead of the expiration date. The specific circumstances of a family mean a tax strategy such as estates and trusts often requires research and planning.
Operational Planning and Execution of Tax Management
- The day to day running of a family office includes important tax planning activities. Some of these tasks are administrative in nature and gradually this field is becoming more automated. Important activities include:
- Tax compliance through timely tax returns for the family office and individual family members
- Reporting on investment partnerships, trusts and gift tax
- Tax reporting internally and externally to the relevant federal/state/city organizations
- Tax planning and forecasting in combination with accounting team
- Internal education regarding processes and systems to ensure compliance
- Day to day processes that support governance
- Auditing
What type of tax expert?
What type of tax expert does a family office require and is this talent that should be hired and retained long-term, used on a temporary basis to support transitions or accessed via a specialist partner? There is no easy answer to this question as every family office is different and the answer might change over time.
Obviously as a family's tax demands become too complex, too time-consuming and/or the existing team members lack the depth of tax knowledge to effectively advise, it’s time to (re)consider your approach. Ideally, a family office should approach tax strategy in a proactive manner. Decisions should be linked to strategy and purpose. The pyramid model below is a useful reference. A common approach amongst more substantial family offices is to retain tax leadership (or oversight) in-house, perhaps as part of the remit of a CEO/CFO or General Counsel or via a Chief Tax Officer. All family offices should play to the strengths and capacity of existing team members. Specialist external expertise could be used for planning a large asset sale, creating a new charitable foundation, forming a new investment fund or researching the impact of non-resident family members. Tax operations can be managed by a full-time, in-house Tax Director/Tax Manager and be part of the CFOs remit or in a smaller organization could form part of a finance team member’s role. The same goes for the administrative aspects of tax co-ordination and reporting.
The Family Office Tax Pyramid
.png.jpg)
Tax Strategy and Planning
Returning to strategy and purpose, the nature of the family office will also influence the type of tax expertise that will work best. For example, those with a heavy real estate focus might benefit from having a tax expert on board to handle 1031 exchanges, filing for tax credits when renovating a historic building, conservation easement tax credits and calculating depreciation rates and potential capital gains. If a family office has a large focus on private equity direct investing, this could warrant tax expertise to investigate and proactively review tax relating to carried interest, partnership tax rules, tax efficient structuring and exit strategies. Several family offices have set up RIAs and this type of investment vehicle requires specialist legal, tax and compliance support. Clearly in all situations, depending on the scale, this could form part of someone’s role or be a dedicated, full-time person.
Market Comparisons
For comparison, Stryde Search analyzed 722 USA based family offices to evaluate what proportion had either a partial tax professional (over and above a CFO or GC) or a dedicated tax person.
722 USA Based Family Offices Analyzed:
Single Family Offices with Dedicated/Combined Role Tax Experts
On further examination the size of the family offices with dedicated tax professionals, including the CTO, were substantial with AUM at the multi-billion-dollar level and constitute some of the largest family offices in the world.
Through the same analysis, it is clear to see that accountants and attorneys frequently oversee tax issues on behalf of family offices of all sizes and it is the CFOs/COOs/GCs that are responsible for managing outside partners and overseeing tax strategy. This arrangement requires coordination and communication between the family office and outside providers for it to work productively. It is the role of an executive, who has seniority and expertise to build collaborative relationships with external partners, perform the important role of taking an integrative approach to tax and knowing when to bring new experts into a situation.
The Talent Landscape for Tax
A significant factor in determining the success of a family office is the talent it employs. Attracting and retaining quality talent is an important pillar of strong and effective family offices, as is the ongoing professional development of such talent. As mentioned above, tax talent can come in the form of a dedicated tax expert: Tax Manager, Tax Director or Chief Tax Officer or as an area of expertise at CFO, COO or General Counsel level. If hiring the former, it’s clear from the stats already provided, there is a small pool of people working within family office already, therefore individuals are likely to come from a professional services firm such as Deloitte, EY, PWC and could be from a family office practice.
Law firms with tax practitioners will be a good source of tax expertise. Senior lawyers/partners working with the latest case law on a range of client issues will possess up-to-date technical knowledge. However, a lawyer within a family office will have the contextual understanding and people skills needed for a family office setting.
Other executives such as CPAs, family office advisors and CFOs often qualified to oversee tax strategy could come from a multi-family office, private equity background or single-family office. Like the General Counsel position, if a CFO or COO has worked in family office, they will likely come with the multi-disciplinary understanding of tax and be able to add more value as a result.
The value to a family in developing in-house tax knowledge is that a CFO/GC or even Chief Tax Officer can spot issues ahead of time and take a more proactive approach to improve tax alpha. Over time experts in-house acquire invaluable ‘institutional’ knowledge. The larger and more complex the family, the more important it is to prioritize year-round thinking and multi-year forecasting for planning and calculating tax. Many in-house teams still utilize external expertise as it’s impossible to maintain subject matter expertise in niche areas such as special purpose acquisition company (s) (SPACs) and umbrella partnership real estate investment trusts (UPREITs).
The executive team should be able to engage with outside professionals when needed and have enough knowledge to ensure the best results, which may also result in a reduction in fees.
Budgeting for Tax Expertise
Compensation for employees and professional services fees vary greatly for tax expertise. Here are some useful reference points. These estimates are likely around 10% higher in 2023 due to increased inflation since the survey was conducted.
Sources: Family Office Exchange Survey 2021 and Morgan Stanley Family Office Compensation Survey 2019
Tax director compensation in a family office can vary depending on several factors such as the size of the family office, the complexity of its tax affairs, and the individual's qualifications and experience. Tax directors in SFOs can expect to earn a higher salary compared to those in public accounting or corporate tax departments due to the specialized nature of their role.
Another useful comparison is the hourly rate of tax lawyers at top-tier law firms. At Partner level, rates might be $1500 - $2000 per hour, with Associate rates around $1,000 per hour. It is easy to see that lawyers’ bills could escalate to astronomical levels if a family office is moving through a series of investment transactions or asset sales. It’s important to weigh up the costs of both and evaluate the risk/reward of all solutions. The Stryde Search Survey certainly suggests many family offices seem to use a full-time in-house GC or CFO with tax expertise creating strategy, spotting tax issues before they come up and ensuring compliance, supplemented with external General Counsel for extraordinary issues or technical advice.
For a smaller family office that doesn’t have the budget for full-time General Counsel or CFO, a fractional advisor could be an approach that makes sense, again, combined with external counsel for more specialist matters. Rates for seasoned family office advisors tend to be lower than senior lawyers at big law firms.
It's worth noting that compensation for Tax Directors and CTOs will include performance-based bonuses, equity ownership or profit-sharing arrangements, and standard benefits such as healthcare, retirement plans and other benefits. It is important to weigh the cost of the total compensation package with the anticipated value a tax professional can add. If highly skilled in pursuing tax alpha, the right individual could quickly cover their compensation cost through the implementation of successful tax saving strategies.
Final thoughts
One of the most challenging aspects of any family office is the ongoing structure and organization of the office and deciding which services should be delivered in-house and which to outsource to a third party. There is certainly no shortage of specialist service providers tailored to wealthy family offices. On the tax front, it does seem to make sense to keep tax planning and compliance in-house with a focus on automating processes as much as possible. This allows for regular planning, forecasting and control over information and is likely to be more cost-efficient. Unless the family office is on the large-very large end of the scale, using outside expertise for complex matters only brings the best of both worlds: cost savings on lower-risk or less complicated work combined with the latest thinking and quality assurance.
Whatever structure and approach a family office decides to adopt, creating a plan and thinking holistically will aid in the transition to being proactive versus reactive with regards to tax optimization.
1:https://www.cbo.gov/publication/58957#:~:text=In%202023%2C%20economic%20activity%20is,as%20inflation%20continues%20to%20slow.
If you'd like to find out more about Stryde Search and the services we offer, please visit www.strydesearch.com or contact Katherine Travell on kt@strydesearch.com
Thank you @LisaSlagel for your contribution and editing of this article.
Thank you Scott Spelfogel for your insights.
.jpg.jpg)
.png.jpg)
.png.jpg)
.png.jpg)
.png.jpg)
 (2).png.jpg)
.png.jpg)
 (1).png.jpg)
.png.jpg)
 (4).png.jpg)
 (3).png.jpg)
 (1).png.jpg)