With both the Senate and House voting on the tax overhaul bill and opening the way for it to become law, one potential implication from the slashed corporate tax rate might be how some, possibly the largest, family offices choose to structure themselves, although initial reactions suggest FOs will tread carefully.

As already suggested in these pages earlier this week, family offices themselves might be affected by the decision to cut corporate tax from 35 per cent to 21 per cent. Until now, the vast majority of such organizations have been structured as limited partnerships, since they don’t exist mainly to make a big profit like a listed business on the S&P 500, say, but to efficiently guard and grow a family’s money. 

While wealth management industry figures say it is a worthwhile question to ask whether family offices might change structure, so far the response seems to be cautious. 

“The change in the corp. tax rate will not in itself have a material impact on single family offices. One reason is that most SFOs are not taxed as C-corporations; instead, they use a pass-through format,” Miles C Padgett, private client/wealth management counsel, at Kozusko Harris Duncan, told FWR. 

A factor in the mix for family offices is “Pass-through” – term getting a lot of attention in the Senate/House bills, relates to the income derived from commercial activities that their owners or shareholders pay on their personal income taxes. The idea is to treat people the same whether they earn income from a corporation or some different business structure. The pass-through system means that a non-corporate taxpayer is entitled to a potential deduction on newly defined "qualified business income" such that a full deduction effectively reduces the maximum marginal tax rate from 37 per cent to 29.6 per cent.

“Lowering the corp. rate will not be a sufficient reason to choose to be a C-corp; many SFOs operate near break-even or with only modest profits in any event, Padgett said. The cut to, say, 20 per cent will not affect how SFOs structure themselves and what they do, he continued. 

Suzanne Shier, who is wealth planning practice executive and chief tax strategist/tax counsel at Northern Trust, said said the idea of possibly changing a family office into a C-corp is a “question that should be asked and analyzed”, she said. “C-corps do offer administrative simplicity and are not subject to the alternative minimum tax,” compared to some other structures, “but there is tax on income at the corporate level and on dividends at the shareholder level”.

As far as Padgett is concerned, the tax effect that matters for wealth management is from provisions such as those affecting individuals and trusts. For example, in the individual provisions there is now a limitation on what qualifies as carried interest entitled to long-term capital gains treatment. That could affect some staff of a single family office, he said. 

“Even though in certain less than common cases the restriction on carried interest applies on SFOs, it would not be a material restriction for most SFO staff on receiving long-term capital gains treatment for their carried interests,” he said. The restriction on carried interest will not apply to all SFOs, he continued. Only where the family members and investors are not related to anyone in the family office.

“The takeaway is that even if it does apply, it is not a material change to present reality. Under current law, if an underlying asset held for less than a year, if sold at a profit, it is taxed at those to whom it is allocated, such as at CGT rates. Instead of holding asset for a year, must be three years, which is not that unusual,” Padgett said.

“One other change that is most important is on individual clients and trust clients of single family offices. It will mean more work for SFOs in the next year or so. Deduction for state and local taxes is being suspended,” he said. 

States
With a trust in a high-tax jurisdiction such as New York or California there will be more focus on moving trust to a low-tax jurisdiction such as Nevada, New Hampshire, South Dakota or Delaware, where there isn’t a state income tax, he said, adding that this process is already happening but will accelerate. “It is going to make the move that much more compelling.”

Northern Trust's Shier said the development of the "pass-through" doctrine was a significant aspect of the bill. "The idea is to treat business income similarly whether it is business activity is in a “C-corporation” treated as a separate taxpayer or different business structure such as a limited partnership or liability company. This is a complex area and likely to soak up a good deal of advisors’ time," she said.

With the 20 per cent pass-through deduction from individual income there is an effective tax rate of 29 per cent. For example, if an individual has $100 of qualified business income from a limited liability company, they take a $20 deduction, and they have $80 taxed at 37 per cent, their tax on the business income tax the deduction is claimed for is $29.6. High-income taxpayers face certain limits on the deduction for pass-through business income, she said.

What about RIAs?

Shirl Penney, CEO of Dynasty Financial Partners, reckons the tax legislation is generally positive. "The overhaul is overall favorable to independent advisers who own their own firms versus those who are employees," he said in emailed comments to this news service.
 

"The tax overhaul isn’t likely to be a primary factor in an adviser’s decision to go independent but it amounts to another positive benefit of owning and running your own business. It’s not likely to be a primary factor however it’s another positive benefit of owning and running your own business.  Also the proposed estate tax changes would allow for an RIA owner that works with children to transfer more of their business to next generation without paying estate tax on asset. So overall favorable to RIA business owners versus W2 employee advisors," he said, referring to the doubling of estate tax exemptions.