RECAP: 2019 FOX Family Office Forum

Breakout C: Ask the Expert: An Interactive Dialogue on Profits Interest Structure

Presenters:
Wally Head
Vice Chairman, Gresham Partners LLC
Domingo Such
Partner, Firmwide Chair Family Office Services, Perkins Coie LLP

Session Description: 

Many families have spent time in the last year working with their accounting and legal teams to evaluate their current structure and weigh the pros and cons of moving to a profits interest structure. Two experts shared insights and facilitated discussion for those with a profits interest structure and those considering one, sharing experiences, and posing questions to peers in similar circumstances—with technical experts leveraging the wisdom and experience of the group.
 

“This seemed to be the one session that everyone was waiting for. The presenters spent most of the time answering member questions. Having access to SMEs on particular topics is invaluable.”
- Attendee Quote
“Best FOX session to date. Many take-aways.”
- Attendee Quote
Key Takeaways: 
  • One of the most material impacts of the Tax Cuts and Jobs Act of 2017 on high net worth individuals was the elimination of “miscellaneous itemized deductions.” As a result of this elimination, investment management expenses—including management fees paid to a family office management company in a conventional family office structure—are no longer deductible. The utilization of a profits interest structure allows the family office to recapture these lost deductions.
  • Under the profits interest structure, family members contribute assets (i.e., investments) to a family investment limited partnership in exchange for an interest in the limited partnership. The family office acts as the manager or general partner of the limited partnership. Rather than compensate the family office for its investment advisory services with a non-deductible management fee, the family office receives a carried interest or profits interest in the limited partnership. [NOTE: profits interest is synonymous with a carried interest].
  • Whether a profits interest family office structure can withstand IRS scrutiny, however, depends on whether the structure creates a true trade or business. The answer to that question lies entirely in the facts. If the facts belie the structure, the structure will fail to be the very tax shield it was created to provide.
  • Facts indicating that a family office profits interest-structured management company is in the trade or business of providing investment advisory services include: ○ Imposing corporate discipline (i.e., creating an operating agreement, maintaining by-laws, conducting board meetings, and memorializing the meetings in minutes)
    • Adequately capitalizing the entity, including putting the appropriate amount of expenses in the bank account (i.e., anywhere from 18 mos. to 36 mos. worth of expenses)
    • Providing health insurance, a retirement plan, and other benefits to employees
    • Creating contracts with attorneys, accountants, and other service providers
  • To proceed with the expense of creating and maintaining a profits interest structure, there should be an annual minimum of $500K in management fees that need to be sheltered.

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(FOX Members only)