Legal and Tax Structures in Organizing Or Restructuring A

The Family Office Association Audio Series: Volume 6 with David Berek, Legal and Tax Structures in Organizing or Restructuring a Single Family Office FOA Audio Series Volume 6 Legal and Tax Structures in Organizing or Restructuring a Single Family Office

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David Berek

David Berek is a partner in Baker McKenzie’s Chicago office. With nearly 30 years of experience as a lawyer and tax accountant, and a multidisciplinary approach to wealth management, he was recognized as the top private client planning professional by Family Office Review in 2015. Mr. Berek also teaches family office and multigenerational planning as an adjunct professor in DePaul University's wealth management graduate program.

Mr. Berek assists wealthy families, high net worth individuals, corporate executives and privately owned family businesses in advanced wealth planning, and devises transfer tax planning strategies for sophisticated partnerships and family office structures. His practice covers grantor trust planning, lifetime taxable transfers to generation-skipping transfer tax (GST) exempt trusts, and the utilization of self-cancelling notes, private annuities, and grantor retained annuity trusts. He also assists in creating and maintaining charitable remainder trusts, family foundations, pre- immigration planning and expatriate planning.

Contact David: [email protected]

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Angelo J. Robles

Angelo J. Robles is Founder and CEO of the Greenwich, Connecticut- based Family Office Association (FOA), a global membership organization that delivers private educational and networking opportunities, proprietary research, and access to salient thought leadership to multiple generations of wealthy families and the professionals who run their single-family offices.

A member of the Princeton Council on Family Offices and the NYU Stern Family Office Council, Mr. Robles has a long record of leadership positions at top financial-service companies, including UBS. Before Contact Angelo launching FOA, he founded and ran several successful entrepreneurial [email protected] ventures: He served as President of the New England chapter of the (203) 570.2898 Hedge Fund Association, and pioneered online retirement planning for Fortune 1000 executives with two Internet startups - 401KRollover.com and IRARollovers.com.

Author of several books and articles, Mr. Robles has appeared on Bloomberg Television and Radio, and has been quoted in the Wall Street Journal, Thompson Reuters, Institutional Investor, Opalesque, Registered Rep, HFM Week, Investment News, EurekaHedge, The Luxury Institute, Private Asset Management, The Greenwich Times and many other media outlets.

Family Office Association is a global community of ultra-high net worth families and their single family offices. We are committed to creating value for each family that we serve; value that grows wealth, strengthens legacy, and unites multiple generations by speaking to shared interests and passions. FOA has the resources to solve your most difficult challenges and help you achieve your collective goals: to invest intelligently, give strategically, and learn exponentially.

FOA is the community leader in serving all the key imperatives for ultra-high net worth families, respecting your privacy but enabling an intimate community of global families like yours. Our organization delivers private education and networking opportunities, proprietary research, and access to salient thought leadership that will interest all generations of your family. Contact Family Office Association 500 West Putnam Ave, Suite 400 Greenwich, CT 06830 Email: [email protected] Website: www.familyofficeassociation.com Twitter: @familyoffice Phone: (203) 570.2898

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Angelo Robles: Hello everyone, this is Angelo Your own individual situation varies. There is Robles at Family Office Association. In today’s a phrase, you know one single family office, audio podcast about single family offices, I am well you know one single family office. They joined by David Berek of Baker & McKenzie are all snowflakes, different. Because each LLP, where he chairs their Family Office family is different and has different sets of practice. David is an attorney very well family dynamics, investing focus, tax concerns, regarded in the family office community. We etc. Please consult with your own advisors are very fortunate to have him on the call for advice that would be specific to you. This today. David, how are you? is meant to be conversational and broadly from the perspective of a single family office David Berek: I am doing just great, Angelo, educational, a conversation starter. thank you for including me on this call. David on that point, let’s get right to it. Please Angelo: What we are going to cover in the start by giving our audience a brief overview call today a focus on effectively what we are at of your experiences over decades in the FOA and the main purpose of our existence, community? the single family office (SFO). David’s breath of experiences are practically unparalleled in David: Angelo, I think my background is the community, having practiced accounting unique in that I come to a client relationship and legal as well as active in wealth with both an accounting background for 10 management (all at a very high level) and years and a legal background since 1999. I working within a single family office. A mystery have worked within a single family office to many is the sequence and structures that and in a multi-family office (MFO) make up the single family office. After initially environment. And now I focus on practicing covering some broader topics, we’ll dive into law solely to work with family offices. What the private world of how to create a single I have seen over the past number of years family office, specifically from the perspective through talking with a lot of family offices is of structuring. how different families structure their family offices. Before we get started with David, it is important to note that this is a very complex You mentioned – if you have seen one family topic especially when we get to the structuring office, you have seen one family office. side of things. Our conversation will be broad. Working for the institutional MFO offered

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me the ability to see a number of different holistic picture that brings it all together. What organizations and how they were structured; I am saying is that very few others really have what led the family to enter into the family the experience of understanding the complete office structure; and what really motivated picture like you. Let’s take a moment, David, them to design their tax and legal structure. given the breadth of your technical training That experience was really helpful to me. and your background. Why is it that this “all Having the tax and legal background when inclusive holistic approach” for understanding I sat down with a family to hear about what taxes to investing, to family governance, and drove them to structure their family office a dynamics is so important? Why don’t you different way was really interesting for me. explain to our audience who may not quite understand and say “I just want an attorney Angelo: There are so many important areas pertaining Most clients perceive the legal structure as just to the family office. Again, "it is what it is" – part of the family office package. we are going to be a little bit Families do not always spend a lot of time more concentrated today on understanding it. They think it is going to be a basic the structuring side given your structure like everybody else has. core background. I think that is an area that the audience is hungry for. But everything really revolves to draw up what I want them to draw up, the around the family and the single family structure?” Why is a more holistic touch so office, and family legacy issues, and family important? relationships, the family business: the family office management, and the philanthropic David: It is a great question. I think most initiatives, a sequence in structure for decision clients perceive the legal structure as just making, effectively governance, investment kind of it is what it is – part of the family performance, investing in private companies, office package. Are the attorneys just pulling etc. that fundamental structure off the shelf? Families do not always spend a lot of time I could go on and on - legal touches understanding it. They think it is going to be everything. Now, I am not saying to the a basic structure like everybody else has. I audience out there that necessarily that legal learned this bias from talking with different should be the driving force. You want to have a families, especially during the process of

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reviewing their current structure, making but today, we would do something completely recommendations, and modifying the different. We would start from a completely structure. different perspective. There may be a I came away with this premise, Angelo. It mismatch in the tax and legal objectives over is top down and bottom up analogy; so top time. down is the family has these particular needs. This is what we want to accomplish with our I think it is easier to recognize this mismatch family office. I usually say those are personal when it is a personal issue. For example, a needs, like family governance, or consolidated new generation comes along and has different reporting or some issue that affects the family. needs. Everybody recognizes that. But how often do families step back and say “let us do an audit of our legal structure and make sure How often do families step back and say “let us that we are hitting on all cylinders.” We want do an audit of our legal structure and make sure to know if we are accomplishing what we want that we are hitting on all cylinders.” We want to to from a tax and legal perspective. know if we are accomplishing what we want to from a tax and legal perspective. Angelo: Absolutely, and maybe a sequence to follow up on that question. What type of The family wants a family office for certain changes in the family, the tax picture, and reasons. Then they turn to the lawyer and say legal structures? This is like changing family now go put one in place. The lawyer takes dynamics but not in the usual sense. We those inputs, these family dynamic objectives, discuss the term with family offices I guess, and puts together the structure. But as we however not the personal side, right? know, over time, things change. David: That is exactly right. It is a different You have to then do what I say is the bottom way of looking at family dynamics. I think up analysis, and look at the structure that everybody can relate to changes in the family the family has in place. Is it adequately like a new generation, a new birth, a divorce, meeting the needs of the family? Look at the or the sale of a business. All of the advisors foundational legal structures that have been are on the same page, and say, “hey, let us put in place. Are those still what we would take a look at how this impacts what we want design today? Because it could be the case to do going forward.” We have now had a that it was a great plan when implemented, big change - we have sold a business and

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have gone from a concentrated closely held from an operational sense, should be hitting business assets to liquid assets. What should about zero net income – break even. But if the we do now?” These types of family dynamics family office is throwing off losses, and those are easy to trigger a review. losses are sent to the owners of a family office management company, which may be long- Something as dramatic as that, going from a term trusts, you might have a mismatch, closely held business to liquid assets, advisors because the trust may not be receiving the full are probably going to step back and say, deductibility benefit of the passive loss. okay, we likely should now take a look at the tax and legal structure. But what about just adding a new generation? We now have You might inadvertently have non-deductible the long-term trusts that are being invested losses. That might lead to a discussion with differently, much more for the future. Does the accountant to consider if the family is that change the tax attributes that are being getting the right tax performance on the distributed out of the investment pool? Have current structure. Perhaps a change in the the tax attributes changed to the family’s investment component has changed the detriment? Is the family office structure still character of the income or losses flowing operating efficiently or in the manner that the through, and that may trigger a tax and legal family intended? structure change. I have found that type of issue to be a little bit of a sleeper – one of the Additionally, tax laws change, everyone agrees only sure methods to find those embedded with that. Recently in the past couple of years, tax leakage issues is to pragmatically we have had this issue with Section 469, collaborate with the advisor team. which addresses passive losses, especially Whether or not the family is entitled take a the treatment of passive losses in a trust. If deduction – that may still need to be worked a family had a structure set up with say an out. But I think families need to be on call to S Corp as the management company – very say I am going to monitor that. I am going to common in the 2000’s – that S Corp running determine whether the S Corp is the right the family office is potentially throwing off structure. Maybe we should re-organize losses. That is usually a good thing or okay. That means you are running close to the wire. into an LLC type structure. Those are the type Hopefully the family is deducting as much of of high level and broad examples that we want those losses as they can. Single family offices, to be as attentive to as you are with the family

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governance – but family governance may be But, I think family offices need to look at their easier. Generation three may understand the tax and legal structure just as often as they do family governance program. They may not the other side, the personal side. That worries understand the passive loss deduction issue. me about the impetus that is going to make a family office do that. Assume you have an Angelo: Absolutely, and maybe again kind existing family office that has been operating in of trying to be sequential, I am assuming business for years: have they had operational easier with a family new to wealth. Not family office reviews? Is the family office only is their culture more streamlined in achieving the goals that the family originally the liquidity of the entrepreneur, less family set out to accomplish? Or, have those original members, theoretically easier governance. I goals been adjusted and the objectives been am assuming starting with a clean slate, the adjusted? Therefore, does that mean that we opportunity from a legal and incorporating the should potentially change our structure? structure and tax side, we are going to get to that in a second. These are critical questions that need to be asked, Angelo. I have seen some longstanding But, I am assuming it is more complex in historic family offices who decided to a family that has had wealth through the completely switch structures. They acted like generations, and has family office entities; a new family and just said we are going to but maybe has not kept abreast of certain design a new one. We are going to transfer compliance and regulation. Certainly over from one regime so to speak to another regulation that has been enacted in the last regime because now our objectives are couple of years in terms of what qualifies as different than when we started. We now have a single family office. I do not want to lump it different goals. Our family office is bigger or it all together. But I am assuming you could go is smaller, or what have you. Being somewhat into many existing SFOs and likely find a lot of nimble and taking advantage of what the areas that could be improved. developments are I think are key.

David: Absolutely, and I think it should be part Angelo: Indeed, getting perhaps to the focus of a regular process to review. I think a lot of the call, and kind of the hook that I led with of family offices are looking at the regulatory in the beginning. We are going to do a deep environment and saying should we do dive, well at least as much as we could in a something about this? relatively short conversation. I do understand

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for those following along that it is going to get it is an LCC, or S Corp, or other entity, the a little complicated. Without having visuals, it is management company that is effectively the probably going to be a little bit difficult. single family office?

We are going to do the best we could in Every family office has a similar basic structure. The family affectively our audio has the assets holdings in the investment holdings company, podcast today. But you or the investment fund. The other structure is the may have to put a little management company. Two very distinct structures; one of bit of your imagination, them has all of the assets, the other has the management of those listening into the those assets. recording. Maybe to streamline it a little bit as well. We are also going to probably do it from David: I agree, it is a little difficult without a basic or relatively basic single family office, a visual. On the other hand, it causes the to a somewhat more complex one. listener to pay more attention to the words that are being spoken! I think I can describe David, for the audience listening in that is it adequately. I teach a family office class at starting from scratch. They had a liquidity DePaul University here in Chicago. I present event. I hinted earlier that would be with an three slides in a row. I say here is a really entrepreneur. They have their unique culture complex family office structure – lots of boxes. because it tends to be streamlined. Then I go to the next slide and some boxes disappear (captive insurance company, etc). Let us make the assumption. They have And then the simplistic version where we just their foundation prior to setting up the have essentially two boxes. Think of that single family office, of family governance concept (simplistic single family office). We (mission, generational direction, stewardship, have two fundamental structures. Every family communication protocols etc.). Now comes office has a similar basic structure. The family a little bit of the secret sauce even for a has the asset holdings in one entity. I will call relatively “simple SFO.” What comes next in that the investment holdings company, or the terms of structures? Let us say they have half investment fund. The other structure is the a billion dollars of liquid assets. How do they management company. Two very distinct own the assets? How do they create whether structures; one of them has all of the assets,

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the other provides the management of by other advisors, then the family will achieve those assets. There are a variety of ways income tax benefits from the structure. to add more structure to that, but that is the basic single family office. To take this premise to its ultimate extreme, the management company could outsource The duties that we house in the management absolutely everything, and it may then company are not necessarily different than have no business purpose. That is what your in a larger family office. As a family grows in average twenty million dollar family is doing. wealth, you just add on more boxes around When you start to pull activities and those two center piece structures. If they are responsibilities in-house and you follow a a billion dollar family, you might have a lot prescribed responsibility list, you start to add of boxes surrounding it. But you can always to that business purpose. The management break the structure down to those two basic company is doing something, running a functions: where the investments are and business. That is the essence of the family where the management of those investments office. Families pay for those activities by occurs. This is where we start when we talk charging a fee to the investment fund. By about the structure of a family office. What operating the family office like a business, can that management company do to help the the family achieves income tax benefits that family and grow the investments? may not have been available if they just held investments. Most expenses are not If we can design the responsibilities of that deductible by the average taxpayers who do management company to potentially replace not run a family office. In a nutshell, that is what other outside advisors are doing, like what starts the tax conversation of why a consolidated reporting, or an activity, and family office may make sense. some analysis. That management company Next, identify motivation begins to turn into its own operating business. the family’s into separate issues, such as " What I am getting to now is business purpose. we want a family This is a critical juncture. The structure office because we want good consolidated " " " works, if you have the management company reporting, or, we want family governance, or " performing duties that support a business we have multi-generational entities that need ." The next logical question is purpose. If the management company to be managed is the family , has responsibilities that are independently where spending money in taxes and can the family achieve efficiencies? legitimate and that would be otherwise done

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The efficiency is derived from the single family office structures, where they management company, if you can assign could fail possibly in an audit; and have some responsibilities and give it business purpose, of the deductions that were claimed now be we can achieve income tax benefits. Does taken away. Again, I know we are doing this that make sense, Angelo? Did I get too far in a little bit blind on the phone call on an issue the weeds on that? that is incredibly complex. What are some of Angelo: No, actually, let’s dive a little deeper the common mistakes that the average person into the weeds before we get to more of a mid- with “less experienced advisors” in setting up a level or sophisticated single family office. The single family office are likely going to be made management company that effectively makes in the way that you described it? up the structure, the services performed, and housing the talent that is inside the family David: The number one concern is the office. You bring up a critical point that again substantiation of the business purpose. Ask there is very little out there for the community the question - why do we have a family office? to really understand by researching on their What is the purpose of the family office? Here own. Is the single family office effectively I am not talking about the personal or the deductible? You kind of answered broadly wealth control side. I am talking about the expense administration. What is it that the family office is going to do? Why do we have The number one concern [of an SFO] especially to create that management company? Let us on an audit, is going to be the substantiation of get a very clear understanding as a family why the business purpose; which is stepping back we are creating it. What it is going to do? Then and saying why do we have a family office? ask, if the family office does those activities, What is the purpose of it? will any of those expenses be deductible?

speaking; and again, we know each person’s situation is going to be very unique and very This is pretty cut and dry. It is yes or no. The different. Please seek your own guidance from family may start off by saying we need a trusted experts. management company to oversee our aviation needs. We need someone What are common mistakes that if they are administering that now. It may be the doing it with an attorney or accounting firm that accountant, but it may be too cumbersome to may not be as experienced in broadly defined constantly be calling the accountant.

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There are a lot of filings. We just want to pull This is the purpose of the management that in-house. If the sole responsibility is just company. This is why we a deduction may managing the family airplane, I am going to be taken for the services that are being say the family office structure probably is provided – because the family has thought deductible. “Probably” is not the answer you out the purpose. The family is not trying to want to hear from a tax lawyer, but just that back into an objective after the fact. The function is pretty close. The activities family is defining from a prospective nature underlying the use of the plane need to what they want to accomplish as the family. substantiated business purpose - otherwise The family is identifying those they are non-deductible - that's OK also. responsibilities the management company The family needs to step back and say: “we should do. Therefore, you do not have any need a management company to do these kind of management stray where the things.” Once you identify what the family management company stops doing less or office management company is going to do, more one activity or another. you are headed towards deductibility. Some of those expenses may not be deductible – that’s With a management company business OK. Maybe the large vacation compound purpose document, the family is constantly on generates non-deductible expenses. You still top of the purpose. Therefore, if there is a need someone to take care of things there – situation where someone has to explain what that’s a responsibility for the management it is that the company does, the family knows company to make. Run those decisions exactly what it does. They are on top of it. I through the management company. The have seen families where the family dynamics management company is doing something that change. They do less of this or that. They sell is managing the assets. Although I have given the vacation home compound. All of sudden, a an example of something that they are doing large majority of the work that was being done that may be nondeductible - it still adds to the by the management company is no longer business purpose. Best practice is to step needed to be done. The family needs to be back and put together that kind of direction aware of these types of changes, and adjust. and document it, very similar to a family The family needs to determine whether the mission statement. This documentation management company is still viable. Is it supports the family office business purpose doing something that qualifies as a tax documentation. In the future, this deduction? Or should it continue but not understanding will prove valuable. deduct the activity - again, that is OK. 14 FOA Audio Podcast Series with David Berek | © 2016 Family Office Association and Angelo J. Robles FOA Audio Series Volume 6: Legal and Tax Structures in Organizing or Restructuring a Single Family Office

Is the family better off adjusting how the area that families can potentially get tripped family office is set it up? Angelo, you asked up? me what were the number one risks? I would say that likely is the number one risk David: I think that is a great question. I think – that the family does not have clearly defined if you have to look at the magnitude of the responsibilities of the management company. fees that are being paid to the CIO, and what Therefore your tax deduction is in jeopardy. If duties the CIO is doing. I do not have a clear that happens, you potentially fall into an audit cut answer for you, but it should be situation. Nobody wants that. That is painful. deductible if the family CIO is managing the family assets, just like an external advisor. Angelo: One more question on that aspect. Likely a common function of a family office If the family is going to put somebody on staff is going to be managing the investments. and pay them a salary to manage assets, Whether it is starting with an investment policy then you likely have a deductible expense. statement, asset allocation, and execution; Therefore, someone else outside the internal and whether internally or potentially through family enterprise is potentially doing less of third party managers. something. You are pulling the process in- house. The professional doing less on the The function of the CEO, potentially a CIO, outside the family otherwise would have paid meaning Chief Investment Officer, and and deducted. Now the family is having it possibly if they are a larger family – analysts or now done in-house - Why would that not be those working under the CIO. deductible? Let me break that down even a little more. Those assets are now broadly defined as That function such as offering investment the other box in the “holding company.” We oversight services above and beyond mere are probably trying to stick a little bit more to investment advisory, similar to a consultant the aspect of a simple or a more basic single type role. Those expenses are going to family office. I am actually jumping ahead come through to the average taxpayer from of my next question. From how I described XYZ trust company on let us say a K-1, the the CIO role in managing the assets of the reporting that they receive from a fund. That family from an investing perspective, is that expense is going to be subject to limitations on something that is deductible to the family the taxpayer’s income tax return. Those likely within the single family office? Is that another would be grouped into what we call investment

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advisory fees subject to two percent of we are having a person in-house in our adjusted gross income. management company providing a service that is deductible. Let’s say I am paying that CIO For most families we deal with, that two a hundred thousand dollars, and isolate the percent of adjusted growth income is a bigger family office management company expense number that you have to surpass that in order to just the hundred thousand dollars. What a to reach deductibility. Alternatively, you could deal that would be, right. Let’s also assume take that consulting role on investments and the duties of the CIO are deductible (not purely bring that in-house, and hire that person. Let investment advisory). I work out an agreement us say you go to XYZ trust company. You say: between the management company and the “John Smith, we want you t be our consultant investment entity. I calculate the fee for the on the family.” You are looking over the various investment entity this year to be a hundred funds that we choose. We would like to hire thousand dollars (again isolated to the CIO for you directly. We want you to quit XYZ trust this example). company and come work for us. You are going to be part of our payroll for our family. We charge a hundred thousand dollars of Mr. Smith is now part of our management income from the investment entity. We pay company. it to the management company. Now we have income at the management company That is a deduction now that we hired a level of a hundred thousand dollars. We person who was performing a role that is for have an expense because we have the production of income. That is business someone on payroll: a W-2 employee in the purpose. That is a deductible expense. CIO that is paid a hundred thousand dollars. Now the management company is going to Now, the management company has a net charge the investment entity a fee for that income of zero. But economically what have service. The management company is going we just done? to charge the investment entity for providing investment consulting. Step back for a moment Angelo, and just appreciate this. We shifted that hundred Previously, it had been done by the custodian thousand dollars, which otherwise flows or someone else. The profit in the investment through to the family’s 1040s, subject to entity was less because it covered somebody’s limitations like the two percent of adjusted payroll at the XYZ trust company. But now, gross income limitation, that might have been

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limited, over to the management company. If a family is running a fund to funds that We have employed a service in-house, and is incurring fees, those expenses can deducted the cost. We have charged be deducted if they are a function of the a fee, a hundred thousand dollar fee to the management company. Therefore, they can investment fund. Then we paid a hundred end up being fully deductible. That is where thousand dollars in expenses to our new CIO. from a tax law perspective you want to end up. The deductions have become very efficient because the family has deducted fees that But first I am going to let the family know previously may have been comingled with that before I can do a good job and achieve non-deductible or subject to limitations at the the best tax structure, I need to know what outside trust company level. the family wants to achieve. What types of activities will the management company be Before I can do a good job and achieve the best doing? Is there going to be a big CIO role? Do tax structure, I need to know what the family you have an airplane that you are managing? wants to achieve. What types of activities will Are there a number of real estate properties the management company be doing? that need to be looked over? I need to have an idea of what the family wants to accomplish so Angelo: Yes. That is a tremendous advantage that I can think about what the best structure within an SFO that is done correctly and might be. structured properly. Angelo: Given again, the mental image of the David: Let me tell you one more thing. When management company being one entity and I have mentioned this to families, their eyes the holding company with the actual assets in light up. “How come no one else told me about another, we are going to probably somewhat this before?” You have to step back and say transition somewhere between a more a basic it is not every expense. Some expenses are SFO to more of a mid level one. I’m assuming just straight up an advisory fees and subject to how assets are held and even how assets are the two percent floor regardless where they located are going to be incredibly valuable. Not are paid. Certain investment advisory fees will just from the obvious tax and potentially asset always be subject to the two percent floor. But protection standpoint, but other factors as well. if you have someone that is managing your But even a relatively modest sized SFO, two real estate portfolio, those expenses likely can hundred to five hundred million. be segregated. They are likely going to have a series

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of various assets, some combination of the basic single family office has a number of irrevocable trusts, revocable trusts, family different tasks that are performed. It is not just limited partnerships, GRATs, a variety of other one person’s salary so to speak. estate planning vehicles, a dynasty trust, etc. We do not want to make this an incredibly There are usually a number of tasks that the detailed estate planning conversation, which single family office management company probably in ten hours of audio, we could not is performing for the investment holdings fully cover, but if you had to try to – we are fund. I made the broad assumption that all of really going to test you now, David, if you the family’s assets were in one bucket, one had to try to somewhat transition giving our investment fund or holdings entity, an LLC audience a little bit of color on the ownership typically. But the reality, Angelo, as you point and the value of asset ownership and location, out, the assets are spread out in irrevocable transitioning from more of a basic SFO set up trusts, revocable trusts, offshore trusts, etc. to somewhat of a more complex one. Give us Think of the family wealth as a pie, and some insight. consider the asset location.

David: Yes, I will tell you, Angelo, I think if We mentioned that the management company there is such a thing as a secret sauce in this would likely be performing a variety of whole process, this is it. Hopefully everyone is activities. There should be an agreement still listening. between the management company and EACH asset/entity. The irrevocable trust that Angelo: Listen up, everyone. This is the time. owns the real estate in Montana should have an agreement between the management David: My example with an investment advisor company and the trustee of that trust detailing outside, and then the family brings the advisor what the management company will do for the inside. That probably makes sense that the trust. advisor’s compensation is fully deductible. I would say that if you just had one expense for The family needs to define the relationship. one function – if it was only that, it would likely Put together an agreement as we would with be scrutinized because one activity doesn’t any other third party. We will come up with “sound” like a business purpose. But most a charge, a management fee specific to the complex single family offices have a number entity served. Now I am going to fast forward. of activities that they are involved in. Even For the investment fund, that fee might be

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structured like any other private equity type of If the management company is consistently fee, 2/20 or what have you, some percentage generating negative returns there should be an based formula. Because we can clearly adjustment to the way fees are calculated. define, for example, that we will be paid only on performance let us say. But managing the Because the family wants to support a ranch in Montana, that should be structured business purpose. Businesses have as a completely different arrangement. That agreements with customers on how they are is going to take so many hours of our going to be paid. A family should have management company’s time and resources. similaragreements, that is helpful. Depending We are going to structure that fee as such. It on the type of entity being serviced, whether it is going to be based on an hourly rate. is an irrevocable trust or an investment fund, the fee should be thoughtful potentially We are going to change it on a yearly basis. charged differently. The family has to be This year, based on a budget, it is going to thoughtful about how you are coming up with be this much money. Then I am going to take that fee ratio. Another variable is considering all of those different fee arrangements and having other individuals or entities participate blend them into my management company. in profits of the investments if the family That is the management company revenue achieve a greater return. Some of the stream. The key is to assess the management fee could be paid to the owners management activities and assign a cost at a of the management company, which are realistice management company level. The maybe beyond the matriarch or patriarch? management company fee should be Maybe a dynasty trust owns a slice of the comensurate with the level of service the management company. If there is a good management company is providing to the year and the family sells a business, is it family. The family wants it to be reasonable possible for other family owned entities to based on the services. share in the success?

This budget is another area that I would review I am going to review really quickly. The key on a year-to-year basis, to ensure the fee is element to making this work is to have a appropriate. This budgeting process should clearly defined understanding of what the not be a disconnect between the accountants management company is going to do. Then, and the family and the management company. prepare the appropriate agreements with the

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various clients of the management company– There are other areas within structuring of a the irrevocable trusts, the investment fund. single family office that in a future conversation with David and others, we will cover. But in the Wherever the wealth is, make sure we have time today that we have, we have to make it a good appropriate agreements. Finally, Angelo, little more streamlined. We would have liked to in terms of describing who is involved, you have spent some time on family governance want to involve a multi-disciplinary team and committees, and how the legal and and process in reviewing the structure. We structure is very important for that. Make sure need strong tax counsel (attorney and CPA) it qualifies as a single family office; and the thinking of the structure. We need a corporate guidelines of what is exempt and what is not. minded attorney thinking about what type of Compliance so to speak, but those will be management relationship is involved, to put subjects of future discussions. those agreements together. And we probably need an attorney with litigation experience to determine what You want to involve a multi-disciplinary team and types of clauses should go into process in reviewing the structure — strong tax the agreements from a risk counsel (attorney and CPA), a corporate-minded management perspective. attorney and an attorney with litigation experience

If it ever becomes an issue, I do not want too one sided of an agreement for We cannot quite cover everything as much as example. I might have a litigator just take a we would like to cover. We would like to keep look at the management agreement to identify the focus on the rather deep complexities of where our risks are. the structuring issues in an SFO more so than some other legal aspects. Pardon my sidebar Angelo: Yes, that is a lot to consider. That is a everyone. But I just wanted to make you all fair amount of time and expenditures as well. aware of that. Not wanting to take a step back, But if we see the value in creating a single but kind of. The management company that family office, you want to do it right. You also likely is structured as an LLC. LLCs have want to get the applicable tax deduction where managing members who are probably in a you could. These are all of the things that need first generation family, pretty clean and simple, to be done right. If you are starting one, you perhaps husband and wife. have the chance to do it correct.

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Let us try to get a little deep without maybe the investment fund that is almost always going too long. For a family that may own a partnership for tax purposes, either an significant assets where there is more LLC treated as a partnership or a limited potential of lawsuits, i.e. real estate, and partnership. We do not have to think about private businesses. On the management side, that too much. The management company on does it make sense to have other entities but the other hand, I also structure as an LLC. But joining them as a managing member? We are wait a minute – I do not want it to be treated entering now into a really deep subject. I know as a partnership for tax purposes. I do not I’m asking you to cover this in probably three want it to just flow the tax attributes down to or four minutes before we transition into private the owners. I actually want the management trust companies and some other structures company taxed as a C-corporation for net on the more sophisticated side. But maybe in income or loss purposes. sticking with the basic to mid level. How would you respond to my question on LLC ownership and even on some of the holding structures for I do not want the character of expenses to the assets? pass right through to my owners of the management company who again are likely to David: Sure, I think it is a great question. be the matriarch or the patriarch. Having the LLCs are likely the preferred choice that you management company set-up in a corporate would start with, because with an LLC there is from provides a number of longer term tax so much flexibility. You can make allocations benefits. however you really want versus a corporate structure like an S Corp, for example, I started the conversation by saying I would where everything is pro rata per ownership use an LLC for the management company. percentage. An LLC is usually where you start, Here is another trend that I have seen lately, then you look for a reason why it might not which is Delaware is pretty popular in terms of work. LLC jurisdiction selection because there is such a long history. We think we know exactly Let us step back and recall that we have how the courts are going to react because we two entities that we are considering for the have a long history of case law in Delaware. entity structure. We have our investment fund Delaware also has a Series LLC statute which holdings entity where the assets are held. is helpful. We have our management company. For

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We have a good indication of what that case a dividend or pay it out of the wages, so it is law is going to produce if we have to try a case double taxation. I really want that management in Delaware. Therefore, the Delaware LLC is fee at the management company level to be preferred. very precise.

For the management company, I will also pick So to review my entity selection, I generally an LLC. But I prefer to consider other look at Delaware for my investment jurisdictions if the family is agreeable. I like to holding fund, also because I really like the use the Alaska LLC statute. Because recently, “series” legislation they have there. For the Alaska has been on the forefront of asset management company, prefer to use an protection. They have a strong LLC statute Alaska LLC treated as a C corporation. Now that has been tested a couple of times. some families just prefer do both in Delaware – that is fine. I prefer an Alaska LLC for my management company, and typically elect that LLC to be You can also go to a number of different treated as a C Corporation. I can recieve the states: South Dakota, Nevada, Wyoming: they benefit snd the advantage of the LLC statute, all have good statutes. One of the reasons but choose to tax the entity like a Corporation. from a legal perspective we are going through the analysis of where do we create this entity is for a litigation purpose, for creditor protection. The family office structure charges a fee to the investment holdings fund. I want to pay I like the idea that if a creditor is going to go expenses that are legitimate to run the family through the machinations to sue the family, wealth. I want to end up at zero taxable they are going to go to court in Delaware to income. Again, I am not looking to build up attach the funds in my investment holding wealth. Because quite frankly, if I have a C funds. And the creditor is not just going across Corp, that is difficult result. If I build up the hall to sue my management company. wealth, I will have to pay tax on net income. They have to actually bring suit in Alaska Then, to get the money out of that C Corp, I and try to get a charging order, to force am going to have to declare distributions out of my investment holdings fund. For some reason, I just think it sounds more difficult to say okay, if you are going

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to sue this family, you need to bring suit in a little bit into a direct investing family office. Delaware and Alaska. It just sounds better to How they may want to set up a separate me. What do you think, Angelo? vehicle and even totally different compensation structure for that. But why do we not have Angelo: No question, and again, we are going a little deeper understanding of series LLC, to have a limited amount of time on a very David? complex subject. We are probably not even really going to have the time for families that David: Sure. There are a number of states have a significant international exposure and that have series legislation. Essentially what setting up a series of entities offshore. As we that means is one LLC that has a number transition into kind of the sophisticated family of subsidiaries: all under one LLC umbrella. office structure. Maybe we will spend a little bit There is one filing in the state of Delaware of time on that. But that is probably worthy of with a number of sub-LLCs underneath that its own discussion. From those listening that umbrella. The investments can be allocated are not American citizens, we do understand according to the different series. Early in especially in many of the prior comments, that my career as an attorney, I worked on one most of it is simply not as applicable for you. client that had a hundred different series in their one Delaware LLC. When they made But the general thinking behind it still is. That a new investment or type of investment, say is another subject about international citizens emerging markets, they created a new series, setting up effectively family office and other and made the investment in that particular investment vehicles within the U.S. that is series. Think of it as your personal asset going to be worthy of its own discussion allocation. at a future time. But in the limited amount of time that we have left, and talking now I might choose to have my investment holding about sophisticated really complex issues for fund, which is an LLC, as a Delaware series families. Although you did mention a series LLC. I would create series underneath that LLC for effectively ownership of some specific LLC. Then the owners of the family wealth holdings, I do not believe that many of our might have different asset allocations: GST listeners are really going to understand that. dynasty trustor generation three solely invested in the private equity, generation Maybe starting on that in a brief definition of two solely invested in domestic equities, and what a series LLC does. Then we will transition generation one solely invested in fixed income.

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As I mentioned, you can have as many series I will call, making my own definition, “single as you want, or different owners of different family office planning.” series. I could have the grandchildren 20 percent invested in fixed income and 80 David: This “single family office planning” is percent in private equity. You can slice and interesting how it has developed. Because I dice the owners however you want. You could would say today, if you have a sophisticated have some owners only in one and not others. estate, you are going to have a provision for You can charge different fees to each of those a trust protector. It is a new trendy component separate series depending upon services of the estate plan. The trust protector role is offered by the management company. For to essentially make changes to the document example, the management company might be because of changes in tax laws. Or oversee doing a lot of work for the private equity series, the trustee to make sure the trustee is doing and not much at all on say fixed income. what the trustee should be doing.

Angelo: I do not want to get too far off the The most common example is that it allows track on estate planning issues, which again someone else outside of the family, usually a is another subject that we could spend literally third party, that acts only when they need to, to hours on. But one that probably does have ensure that the trust is being administered the some level of importance for complex and very way the trust should be administered. I would large families would have and you noted it a say it is a clever new addition. But it has really couple of times. Something like a dynasty trust been around for years beginning with offshore that could be incredibly tax beneficial over the planning. We always had a trust protector. generations of families. You had to have a trust protector with an offshore trust. Today it is much more just part As you are describing the various holding of the sophisticated estate plan. I credit that companies, and custody, explain to our development to family office principles. audience a brief foundation on the value, especially in a multi-generational family, where I would go as far to say that the family the trustee may not even be a family member governance concept is the ultimate motivator who is active in the benefits of the trust. Also, when you considering trust protectors. explain the value in having a trust protector: Because the family governance is really how I what that means, how that incorporates want the family to achieve certain values and effectively into very sophisticated estate. What ambitions. The trust protector is one of those

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resources that can enable the family to get about in terms of structuring the family office, back on track if they are not on track. An entry this state and that state, management fees, level family governance discussion is likely etc. All of those options operate independently starting with that trust protector. from the private trust company, and do not conflict with a private trust company. The dynasty trust is another single family office Thus, after structuring the family office, the planning stalwart that is going to be around next conversation might be about a private forever because we created it in Delaware or trust company. I would ask for feedback from one of the states that allows long-term trusts the family, and if they said they really want in perpetuity. Who knows who the trustee is more structured governance in the future, I going to be? I want to make sure that we are would say okay, let’s consider a private trust looking out after the beneficiaries; or that the company – just plug it in. family is benefiting from their advice and not giving the advice The private trust company operates, in my opinion, as that we don’t want the trustee to your family governance vehicle. It is the entity looking give. That is why we want a trust after the family wealth, offering guidance. A private protector. But if I do not want to trust company offers a built in board structure. have to wait until something bad happens with the trustee to have to call on the trust protector come in and fix it, I may consider a private trust company solution But that is an easy one to solve for, because –something functioning from the get go. A that is a clearly defined role and we know what private trust company is similar to a super trust to expect from a private trust company. Did protector role so to speak. that answer your question Angelo?

The private trust company operates, in my Angelo: It answered the question and opinion, as your family governance vehicle. somewhat into my next question. I effectively It is the entity looking after the family wealth, have two final questions as we begin to offering guidance. A private trust company conclude. Part of it you already answered. offers a built in board structure. Now you ask, Certainly getting a lot of play, not just in how does that interact with the family office? America but internationally is what is I would say it is an option that you add to a broadly defined as a private trust company, family office structure. All that I just talked Understandably so, as an amazing vehicle for

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governance as a trustee including of some governance, the proper boards, supervision, unique assets, not always traditional or classic, and oversight – all centralized in one place. which corporate trustees avoid. Angelo you mentioned overseas, we are I know we are butting up against the clock seeing more and more interest, especially a little bit. I am going to ask you to do the within the private trust company field, from impossible but still leave a little bit of room for overseas families. I would almost go as far effectively my final question. Tell us why in two to say there are twice as many private trust minutes other than what you told us already. companies being created outside of the Why? I am not saying for every family but U.S. as there are inside the U.S. I think that potentially for many big families to look at, why is because of the immediate governance a private trust company, could be so valuable? component that the U.S. environment offers.

David: In my opinion, and this There are twice as many private trust companies being just may be a person by person created outside of the U.S. as there are inside the U.S. opinion, but in my opinion, I think that is because of the immediate governance families set up private trust component that the U.S. environment offers. companies because they get instant governance. I met with one particular family that was interested in setting up a private trust company. I said well, Angelo: Why do international families wait a minute - We don’t have any legacy have any interest in American style family trusts that require a corporate fiduciary, so governance? why a private trust company (I was talking to generation one, and generation two was David: Because in the U.S. we have the like two years old) – we usually recommend experience of transferring wealth over private trust companies for long, well numbers of generations due to our tax established families that are required to have and property laws. We created a need for a corporate fiduciary. Therefore the private a governance vehicle like a private trust trust company facilitated that requirement. company. I think outside of the U.S., it is The answer I heard from this particular family becoming more and more prevalent that they was no, even before we set up the family want to continue to build those dynasties. They office, we want a private trust because that is see other outside family member influences where the 26 FOA Audio Podcast Series with David Berek | © 2016 Family Office Association and Angelo J. Robles FOA Audio Series Volume 6: Legal and Tax Structures in Organizing or Restructuring a Single Family Office

coming in. They want to adopt some of the a structure like a family office as opposed to best practices that we have had in the U.S., just having accounts? Would they achieve a one of which is the private trust company benefit for their broader family that is not in the concept. US by having a structure here? Those are the type of questions I am receiving lately. The other influence non-US families are interested in is the family office structure for I have to say, it is an emerging trend in my the same reason. They have seen it work here opinion of the past couple years. I have in the U.S. I do not think it has been as popular received a number of requests from families or as utilized as much outside of the U.S. We not in the U.S. curious about setting up are seeing a number of families coming into a family office structure here just to run a the U.S. and investing here, setting up a family diversification of their investment. They want to office even though they have very few if any part with let us say 25 percent of the family net members here in the United States. They want worth in the United States and draw access to to take advantage of that structure and the these investments. Why not have it in such a certainty of how they expect that entity to be structure? treated – because we have been doing it for a long time. Angelo: PTCs and international PTCs are worthy of its own podcast session. I know we Angelo: I may open up a can of worms with are only touching the surface of something that a complex question. Would an international needs a lot to talk about. family be able to do that with an entity of the U.S. without a family member needing to have There is a growing trend. We all know being a a green card or be a U.S. citizen and subject direct investor. Effectively wealthy families or to our complex tax laws? SFOs investing in privately held companies. Would you recommend, I do not want to David: It is a great question. It is a bit of a put words in your mouth, I am just phrasing can of worms. I was referring to utilizing the it from my own perspective, but would you U.S. knowledge base that we have here and recommend that a family that is a serious, investable assets, but probably not attain active, significant direct investor that has U.S. taxable presence. Just like a family attracted top talent, that probably needs to overseas can invest wherever, they can invest be compensated, not too differently than an here. If they do invest here, might that be in investment banker or a private equity investor

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as opposed to simply salary and bonus. Is the family members from the family members. family better off setting up a separate entity The funding could occur through performance and to a degree that chief person on investing based allocations or a note secured against – on direct investing is kind of a co-investor? the interest. Then your question is how does Whether the family is loaning them money to the family office work into that? be a co-investor. Or whether there are golden hand-cuffs to motivate them to be long-term The activity of making direct investments is with the family. Now here I go again. A subject similar to running a business and is deductible. that is worth an hour or two, on its own that we Why not charge the investment fund for those are going to need to cover in two minutes. I’m services that the analysts are providing. sorry about that, David. Now, we were straight down the middle of the David: I think you identified another trend. I fairway management company for a family have recently had a number of inquiries about office. That is one of the lead-ins to creating a building out a family office within a family that family office - direct investments, which has has already been making direct investments. been very popular the past number of years. They have been operating the XYZ capital We do not have to have the discussion of group, formed to make a few investments. whether we are doing the right things to get a They might have had their money at an tax deduction. Those are the right things. Why institution or what have you. Now the family not make it the most tax efficient that we can and potentially provide some other services to the broader family and have a full-fledged The activity of making direct investments is similar management company. to running a business and is deductible. Why not charge the investment fund for those services that Angelo: Indeed, could you give me one minute the analysts are providing. on another complex area for a sophisticated families? Likely what amounts to – although wants to enter into a separate and isolated sometimes onshore – often a BVI, i.e. British function, which is direct investments. We Virgin Island set up as a captive insurance would set up our own little company that does company? Why they are valuable for some that. And yes, we could use this new enterprise families especially those that are still active to compensate the internal staff. This could in the business or a series of businesses. be done with a series LLC to isolate the non- Kind of how they incorporate, or managed,

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or governed, or how a family would get the and I know it is a question I get asked. resources through a family office in overseeing One that again each family is going to be a captive insurer? different. We broadly went over a relatively more straightforward SFO. One that went David: Sure. This is one of those areas that is into more of a mid level. One that was kind of not for everybody. But for the right family, it sophisticated and not really having enough can be very meaningful. I can make complete time for any of us to potentially do the justice financial sense. You need two attributes: (1) that we wanted to do. But, this is worthy of You need an operating business as you had something – of further follow up of one or mentioned, and (2) you need an insurable risk multiple day programs under subject alone that you are facilitating. If you have those two trying to cover it all in an hour and ten minutes attributes, then essentially why not create your is effectively impossible. But a question that I own insurance company to provide the do get is what are the costs? coverage for that identifiable risk that you have. If things go well and there are no I am going to put some words in your mouth. claims, then there is wealth built up in that Correct me, a more basic SFO in terms of entity. legal documents, and structure; fifty to a hundred thousand, probably about hundred The entity is usually offshore. Who might to two hundred thousand for a mid level. But be a good owner for something like that? Most for a family that is going the route of a very commonly the answer is a family entity - complex family office with a series of – a lot of perhaps have a dynasty trust own the captive? complexities, including a private trust company Whether it is an offshore version of the and/or a captive insurer, very possibly, half a dynasty trust or onshore. There is nothing million to a million. Am I right? Am I wrong? A wrong with having your U.S. dynasty trust be little bit of color for my audience, please? the owner of that offshore interest. The money offshore in the captive insurance company, David: Yes, I think that is about right. assuming you do not have any claims, is building up wealth offshore. Now you have a Angelo: This was incredibly insightful for me, really efficient income tax driven wealth and I am sure my audience. We look forward transfer. to doing more and even deeper dives on some of these topics in the future. Thank you very Angelo: My last comment, slash question, much for your time, David. For those that

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are listening in, that may be do not get the something about each of us that we love transcript or other correspondence and that nothing more on an afternoon than talking maybe want to reach out to you. If you could about the structures for hours on end in a provide and be very clear given it is an audio single family office! But we are both dedicated. podcast, your contact info. I am sure they On that note, I would like to thank David and would appreciate that. everyone listening in both now and in the future to this FOA audio podcast. I’m Angelo David: Sure. First of all, thank you very much Robles at Family Office Association. We hope for inviting me. It is something that I am that you find this valuable. I look forward to passionate about. I really enjoy it. I have been the next one. Thank you everyone and have a doing it for a while. This was a great good day. Good bye David. afternoon for me. I am based in Chicago, but work with families across the country. I can be David: Angelo, thank you for this wonderful reached at Baker & McKenzie LLP: my e-mail opportunity! is [email protected] and my telephone number is 312-861-8184.

Angelo: Fantastic, and thank you so much, David. I greatly enjoyed it. It probably says