Family Offices

In Episode 28 of How Tax Works, Matt Foreman discusses Family Offices, focusing on purpose, structure, and why they’re the perfect solution for booking a family vacation to Monaco.

How Tax Works, hosted by Falcon Rappaport & Berkman LLP Partner Matthew E. Foreman, Esq., LL.M., delves into the intricacies of taxation, breaking down complex concepts for a clearer understanding of how tax laws impact your financial decisions.

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Transcript

Matthew Foreman [00:00:00]:
Welcome to the 28th episode of How Tax Works. I'm Matt. In this episode I will discuss the family office, which both exists and kind of doesn't exist as well. How Tax Works is meant for informational and entertainment purposes only. This may be attorney advertising and it is not legal advice. Please hire your own attorney. How Tax Works is intended to help listeners navigate the intricacies and complexities of tax law, regulations, case law, and guidance to demystify how taxes shape the financial and business decisions that we all make.

Matthew Foreman [00:00:39]:
Before we get started, a few administrative things New episodes every two weeks. The next episode, probably two episodes. I haven't totally finished it, but I think it's going to end up being two, maybe three if I don't go fast is sort of like what I'm going to call famous tax cases. A lot of them are actually not terribly famous, but they're really ones that you should sort of keep in your proverbial toolbox. You know, they're ones that I use a lot. They're concepts a lot. I think they're ones that really underpin how Tax Works. Haha, pun intended.

Matthew Foreman [00:01:05]:
And I think there's something that you should really think about if you're a tax practitioner and talk about, you know, ones you use in common, questions with clients, ones that the specific facts are not really as relevant as the underlying concepts behind them. If you have any questions, comments or constructive criticism, you can email me at my FRB email address, which you can find via your favorite search engine. Upcoming webinars and speaking engagements are on the How Tax Works landing page on the FRB website. Now it's time to talk about family offices. So the first question that I get from people whenever I'm talking about family offices is what is a family office? Right. People have heard of them, they're not totally sure what they are. And I think it's important to note that before we even really get any definition is they don't exist. Right? The concept family office isn't like an office full of family members.

Matthew Foreman [00:01:53]:
I mean, I suppose in a very literal sense that is a family office, but that's not what it is. It's more of a conceptual, it's a bit of a piecemeal of different concepts of both legal structuring and tax structuring to basically achieve a number of goals. So it tends to be for the super super wealthy, not as high as it used to be, but it's really intended to manage the wealth and the day to day affairs of a family. So in terms of manager wealth. There's a number of different things that it does. I could go on for an hour about different things it does, but the most common ones are going to be, you know, managing investments, some legal, you know, managing legal risks and helping people, legal processes, buying a house, pre and postnup, things like that. A lot of times the family office sort of takes care of it. They bring in the advisor.

Matthew Foreman [00:02:40]:
It has a strong administrative and accounting role, both in terms of paying bills, budgeting, helping people with things, and a lot of personal administrative things. If you've ever, you know, there's a lot of people with family offices, they call someone and someone just books a flight for them. This is about when they want to leave, this is where they want to go, this is how they want to do it. That's can be professionals or by family members. A common thing that you get is philanthropy from family offices. A lot of times, a large part of it is a lot of the things I talked about, but also doing philanthropy. A lot of times the family office runs the family foundation, is in charge of how money's given away. Right.

Matthew Foreman [00:03:17]:
There's also a function, you know, sort of an insurance type function, to separate the family from the business liabilities, Whether to actually have insurance or just have separate legal entities such that the wealth is sort of shielded from, I hate to say this, the family itself or the family's business. Sometimes you use trust, sometimes you use different entities, but there's a variety of different ways to do it. And that leads into the risk management role profile. Right. A lot of people either building the wealth or you've had wealth, your life, et cetera, you don't know how to do risk management. You're entering new things like that. So sometimes by hiring people, that's something that's done again, insurance, different entities, or just understanding what the risks are, making sure you have people around. And finally, you know, I think one of the sort of underrated things that people talk about from a family office, I talked about management of wealth, management of investments.

Matthew Foreman [00:04:06]:
But it's not just that. It's not just making sure you're having a really high ROI sometimes it's just ensuring that the wealth transfers from generation to generation to generation. It may decrease over time as it's spent, but making sure that it's going to go from generation to generation, that goes back to budgeting, that goes back to accounting, Making sure everyone knows what's there. The goal, the underlying goal is to manage the administrative matters of a family and preserve or grow wealth. I I saw that somewhere. It stuck in my head, honestly. It was like an EY or one of the big four reports. We were talking about it.

Matthew Foreman [00:04:40]:
You can have what's called a single family office or a multi family office. Single family, you know, generally probably have to have 50 million at the very low end of it. I know, 50 million of assets, how poor are they? But that's sort of it. A lot of them are 100 million or more. To have a single family office, remember, you have a lot of professionals. I'll go into who you have later. But a lot of professionals. There's a lot of expense.

Matthew Foreman [00:05:00]:
So you need to have enough assets to throw off enough income in order to pay for these things. The multifamily office, pretty common, you know, three, four people, stuff like that. It kind of goes hand in hand with the concept of a fractional family office. So sometimes it's a couple families together that everyone sort of pools resources and hires, you know, the 30 people or whatever that they need. So sometimes they hire 1/3 of 10 people each and that's what they do. You just sort of get time on it and that's pretty common. Those are becoming more common. I saw somewhere, you know, that there's 10,000 family offices in the U.S.

Matthew Foreman [00:05:34]:
i don't know if that's true. Seems like an awfully round number to me. But you know, the whole concept of a family office is very multi generational, you know, so sometimes even a single family office at some point can look like a multifamily office. There's some questions. Question is whether there's two family offices. Sometimes as, you know, generations go on and on and they sort of splinter and different family groups, etc. A lot of times family offices look a lot like a wealth management business, but with different roles, different goals. Wealth management is very financially motivated.

Matthew Foreman [00:06:03]:
These may have other aspects as I discussed about. Right. Administrative accounting rules. A lot of family offices literally have someone whose job it is. If you, you have a question at 2 in the morning, that's their job is to know who to contact and you call them. I jokingly act like it's the head of security for a professional sports team, that any time an employee, a baseball player says, I need a car, you know, I need someone to bring me home, something's happened, etc. That's a lot of what goes on. The first, the first family office, I honestly think it was the Bessemer family Trust.

Matthew Foreman [00:06:36]:
I forget the actual name. It wasn't Bessemer. Bessemer is the name of steel. This, the process, it was Henry Bessemer that he designed in order to make steel more quickly, more efficiently and much more cheaply. And the people who've perfected it, who were not the Carnegie family, but they worked with him, they, they sort of created their own first way wealthing it. Bessemer Bessemer Trust is a company that only has a couple hundred. It's like 100 clients or something like that, but imagines a tremendous amount of money. It is theoretically a collection of single family offices.

Matthew Foreman [00:07:06]:
They have their own each one. But there's an overarching principles, right? A lot of these exist otherwise, you know, and do very well. The Guggenheim family, for example, the person who runs the investments for their family offices is the primary owner for the Los Angeles Dodgers. He's done that. Well, you know, at this point, a lot of hedge fund managers effectively run their own family office, at least the administrative investment part of it. They hire people for the administrative roles, you know, remember, And I think this is important. Although family offices have a lot of other functions, they are at their core a for profit enterprise. And it's really important to think about that and understand that that's what they're trying to do.

Matthew Foreman [00:07:47]:
All right, before we get into the structure, let's take a moment, listen to some music, relax a little. Be back in a. All right, welcome back. So let's talk about the structure of a family office. As I said, more than 10,000 family offices in the world and there are one kajillion multi family offices. That's a real number, I promise. So no two are going to be the same. There's a lot of commonalities and not even in terms of size.

Matthew Foreman [00:08:18]:
There are some very large family offices that don't have certain functions. They outsource it. They hire someone else to do things. There are some smaller family offices that have really, really strong administrative and budgeting functions. That's their core, that's what they're worried about. And it's whomever sets it up, whoever has the control is going to decide how to slant. So no two are the same. But there's a lot of commonalities.

Matthew Foreman [00:08:39]:
It's a lot like investment partnerships. They're a little different. The operating agreements are a little different, but that's what they are. All right, within the organization, there's a number of things. There's a manager person whose overarching job is to manage the organization. That is the family office. There are investment fund or funds, and that is how they invest in various things. Whether they, you know, a lot of times a family will own a business or two, they'll buy public securities, they'll invest in startups.

Matthew Foreman [00:09:06]:
A major, major, major amount of money that flows into startups and a major holder of qualified small business stock, for example, is family offices. Right. They'll have the million dollars that they'll want, that private equity venture capital wants, and that's who flows in through it. There's also a number of investors. It's, it's impossible to talk about family offices. And a lot of times when people do, they don't talk about the fact that at their core there are people whose job it is, you know, to, to invest on behalf of individuals, the members of the family. You know, family can be loose. Right, right.

Matthew Foreman [00:09:42]:
Not necessarily in the sense that you're going to bring in your neighbor, although maybe you could. Right. Multifamily offices could be something like that, but it could be family in the sense of second and third cousins. And I think that's really important. You know, British, British Royal family functionally runs a family office. Right. And that family is at this point, you know, pretty, pretty gigantic. Right.

Matthew Foreman [00:10:00]:
So the employees and what their roles. So there's the management team, there's a CEO or something similar, there's a general counsel, there's a cfo. Again, can be fractional. You might not need a full time general counsel. Some do. And you have a team of investment professionals similar to above. Right. A lot of CFA, CFP, different roles.

Matthew Foreman [00:10:20]:
Some are just CPAs who are good at investments. They look at the performance, they make decisions. A lot of different things for investment professionals. There's no one profile. I'm not entirely convinced licenses are necessary to be good at really any job. Obviously, you know, don't practice law without a law license, et cetera, and definitely don't practice medicine if you're not a licensed doctor. But that's really what we're looking for, right? Investment professionals, they tend to be some of the jobs that people really seek out. They're given a lot of autonomy.

Matthew Foreman [00:10:48]:
They're not just buying boring stocks and bonds, although that is a major part of their role. But they're able to invest in startup companies, they're able to evaluate Shark Tank, those kinds of things. Obviously the show is a little ritzy, ritzy Hollywood kind of thing, but the idea behind it of people investing and looking at investments and listening to pitches, the investment professionals in family offices do that. There's a significant accounting and legal staff, things from tax preparers, tax accountants, cost accountants, to bookkeepers. Very important people just putting together what is the budget, how are they spending, how are we trending, does someone want to buy a house? You know, they just got married, they want to buy a house, what's the budget, how are you going to do for that, et cetera. And then, you know, of course lawyers, right? And they also sort of, there's, there's a run between. There, there's a lot of overlap between especially tax lawyers and corporate lawyers. There could be, you know, retainer for other types of lawyers, things like that.

Matthew Foreman [00:11:43]:
There's a lot of administrative support. Very common issue within family offices is who hires the nanny, right? Who's helping to watch the kids. And things like that are very important. Who books the flights, who books vacations. Things that, let's be honest, I don't think anyone sits there and goes, boy, I really want to look at, you know, flight times. That's not. It's just so exciting. But if you can say, look, this is about what I want to leave, this is what I want to do.

Matthew Foreman [00:12:04]:
What are my options? That's great to have. There is a. I refer to a lot of times they are, they're executive admins on steroids and meth. They are 24 7. That's their job. So they really have to be available. Sometimes they have to travel for it. There are members of the family office that are administrative assistants that travel with individuals.

Matthew Foreman [00:12:22]:
247 they are with them. You'll see it. A lot of celebrities have people like that don't quite have a family office, but someone sort of in the background holding things for them. Then there's always a team of external advisors. A lot of the things that were inside also go outside, right? Legal, tax and accounting. Some of the time investment advisors are all outside. They just have someone whose job it is to interface with the outside ones. And then estate planning.

Matthew Foreman [00:12:45]:
I always, I always sort of make sure to think that that may be the single most important part of family office is making sure that things go generation to generation. Wealth, right? If you have enough money for a family office, you probably don't want the next generation to run out. So you need to make sure it happens. And sometimes the family office exists for a generation and it's given away. So let's talk about the legal structure of a family office. There is a single entity generally for what's called the family office. It employs a number of people. The ones that I discussed and what, you know, it's sort of inside it.

Matthew Foreman [00:13:19]:
Sometimes it's a C corp, sometimes An S corp can be a partnership. All talk about that in a moment. But there's a single entity for the family office. Then there's a number of funds. The funds, the family office entity is owned by the family or usually a trust for the benefit of the family, although it tends not to really kick off money. But then there's multiple funds or entities that actually do the investing into other funds, into various investments, et cetera. You know, whether those investments are private businesses, public securities, real estate, whatever, it doesn't really matter. There are many, many, many flavors, right? So the question becomes what? What do I see the most often? Right? And I will tell you that I haven't seen everything and I promise you I probably haven't seen most things.

Matthew Foreman [00:14:01]:
But from talking to professionals, talking to a number of people, you kind of get a sense of what exists. And to be honest, you know, there's ways to get more aggressive using cross border and things like that. But for the most part, people want fairly straightforward structures that achieve the goal of lowering taxes. Ma really not necessarily lowering taxes, but maximizing the return on investment. I always say it's okay to pay taxes as long as your net return post tax is good enough. So you want to structure to minimize tax, but you don't want to structure in a way that it becomes impossible to access or make decisions. So a lot use, you know, what's called the GPLP fund structure. The general partner is often the family office entity or there is a special entity solely to be the GP of the investment funds.

Matthew Foreman [00:14:47]:
The LPs are all the family members. Their ownerships go through again. There's often trusts, so it's very rare that they own it directly. There is a manager of the entity that is the GP that's generally like the CEO type or the head of investments, whatever their title will be. There's a thousand titles. Title inflation is absolutely real in this space. So I think that's important to note. The manager.

Matthew Foreman [00:15:10]:
So how is the manager compensated? Stated, you know, I joke, it's 2, 2, 20 or something similar. I don't know if that's really how it works. I don't know if a lot get that anymore. But basically they're paid a fee for their work. You know, you, you do this, you're gonna get paid, you know, a million dollars a year, whatever, and you earn extra money from successful investments. Basically what you do is the manager has a percentage of the investments, so they're earning a certain dollar amount negotiated by the year can also relate to how the overall investments are doing and they get a piece, they get a little taste of it at the end. So it really aligns the goals economically at least so far. It comes to the investments with the investment manager.

Matthew Foreman [00:15:49]:
You don't want them to be too aggressive. So it's important to sort of manage that portfolio, make sure it's done right, have that conversation. But I think that it's really important to know that that's how they get paid. Right. They get some salary and then a huge incentive usually in the form of like a profits interest. You know the fund itself are limited partnerships can be LLCs. I think post Soroban right after the tax court decision. I talked about it in two episodes earlier.

Matthew Foreman [00:16:13]:
There was a recent one I posted on LinkedIn for like 9 seconds. Don't intend to revisit it unless it goes up to the second Circuit, which I suspect it will. And there's another decision but that's, that's probably not until a 2027 problem. For there's another decision maybe mid-2026 at the earliest. And the idea of it and if you not haven't listened that up today, you should. And B basically what it is is there's an investment entity that's a partnership. The GP is an LLC and Sorrel Bond because the owners also want that profit from it. And then Soroban Capital Partners is an LLC which is sort of functions similarly to the to a family office.

Matthew Foreman [00:16:49]:
And then a number of investors come in as limited partners. Right. They just want max ROI on this bad boy. And I bet you a lot of family offices were the money behind in the LPs in Sorbonne capital Partners. So there Piware family offices in there. This is also a PE and VC is funded but again a lot of different ways. Limited partnerships are, you know general partnerships with limited partners has limited liability but the bulk of the economic interest throw a profits interest off the general partner tends not to own very much. Very very small part of it and then they have a profits interest.

Matthew Foreman [00:17:23]:
So once you clear a hurdle, make a whole bunch of money where in where formed? Right. What I call zero tax jurisdictions. So Delaware, Nevada, Wyoming, Alaska, South Dakota. Sometimes you get, you know, family offices that are formed in foreign countries. If there are foreign portions of the family, right. You, you do get that over generation people from different countries, you know, study abroad, move abroad, et cetera. You'll get foreign ones also when there's foreign investments, you may not have a US entity involved. They may just own foreign entities.

Matthew Foreman [00:17:54]:
Again, that's tax structuring. I'm not going to go into that. I don't feel like spending another 15, 20 minutes doing a really basic overview of it. But again, it depends. Generally pass through generally partnership. You do see some S Corps in old ones, but they've kind of largely gone away. And S corps are just as I discussed a thousand times here, they're a challenge to deal with. The family office manager entity itself, I think is a really, really important point.

Matthew Foreman [00:18:20]:
Point again, receives a service fee from the fund. Could be a 1099, could be some of the GP, how it's compensated, guaranteed payment. And they also receive generally what's a profits interest. That's episode seven. I talk about them. That's how it gets its carry. I've seen guaranteed payments. I generally don't see them there.

Matthew Foreman [00:18:37]:
There. There is a guaranteed salary. But what happens is the manager entity makes money otherwise for its stuff. Not a guaranteed payment, but a 1099. I have seen guaranteed payments, but they're rare. Generally the partnership is owned by the family, you know, which is lower tax. And if the entity is a partnership, which does happen for the. The.

Matthew Foreman [00:18:58]:
The manager entity is owned by the family. Easier for estate planning purposes. You don't really see S corps as the partnership as. As the family office management entity. They're just hard to deal with. They function much in the same way. And also the. The.

Matthew Foreman [00:19:14]:
The family office management is not intended to make money. It has the employees in it. So it generally runs at zero or close to what? A lot of times people are nervous. Nervous. Nervous is the wrong word. What people don't want is they don't want income from this entity. They're going to run it close to zero at the end of the year. How much profit did you make? Let's bonus it out.

Matthew Foreman [00:19:32]:
Give it to the employees. They did a great job. Hooray. Hooray. Right. So you do see a lot of C Corp from the manager entity. They're willing to pay more tax such that there isn't a phantom income. You know, if it made $100 and you don't distribute it in time, you could have income without cash.

Matthew Foreman [00:19:47]:
Right. So you have phantom income. Do you want to avoid that? So that's the idea. I have seen an S Corp as imagined entity. I don't know why they didn't end up hiring me. I didn't think they were terribly strongly structured. And I think the people who had brought me in for it sort of realized that I would have to do a lot of reorganizing and I don't think they Wanted to do it for good or for bad. So that's it.

Matthew Foreman [00:20:09]:
There's sort of a number of other issues within family offices. We're going to take a quick minute or so break, probably less and get some music in and I'll be right back. All right, we're back. Episode 28 Family Offices let's talk about some other issues and comments that I have. Right. So I read online six months ago, they're saying that Berkshire Hathaway is run like a family office. And the answer is no. Maybe, you know, it's pretty inefficient because it's C Corp.

Matthew Foreman [00:20:40]:
But if you were to pick a company, a public company that's run like it, Berkshire Hathaway kind of does like, at least conceptually it does it right. It's controlled by very few people. You have the investment managers, mix of public securities, private businesses, other investments. It is sitting on a gigantic amount of cash right now. So that's weird. Most, most family offices really don't sit on cash. If they do, they're put into Treasuries or Munis, things that have, you know, decent return and pretty risk free, tax preferred, stuff like that. So it's an interesting idea that Berkshire Hathaway is run like a family office.

Matthew Foreman [00:21:14]:
I guess it kind of is, but it's a public company so it's really sort of different. And again, C Corp, you really don't want that. The manager entity can be a C Corp. But definitely not the investments. Unless you have an extremely specific reason for the investment entity via C Corp. The manager compensation, the actual individual who manages the family office, they're going to get a salary, they get a bonus for good investment choices. Profits are just in the investment. So they get a quote, unquote, a taste of how everything works.

Matthew Foreman [00:21:42]:
And I think that it's really important to note when I talk about the family office manager, the person I'm talking to is the investment manager. If you have someone whose job it is to sort of, you know, just manage all the affairs and things like that, they might get some profits, interest, they might get a bonus for certain things. They tend to be salaried employees. When it's someone's job is literally to book, you know, book flights and handle administrative matters, how do you compensate them extra? Because there's good investments probably should. I don't say you should, but you can and maybe you should. But you know, this is their job, right? So it depends on what they are, what the risks are and how easy slash hard it is to hire someone. In a lot of ways, you know, to kind of sum this up in a lot of ways family offices are just admit a mix of administrative support, wealth management, accounting and legal. You know, it's really important to note that this is, you know, it's work, right? That this is, this is the creation of an enterprise, a business.

Matthew Foreman [00:22:40]:
Like I said, this is a for profit business and the goal is wealth management, wealth preservation, administrative support, a whole host of things that you have to do. But it depends how you want it to work, right? How, how the person who's setting it up, how the person in charge, how wants it to be structured. I've seen ones that have extremely tight, you know, they'll have five employees and 60 advisors that are outside that they take on some fractional level. I've seen ones that have 80 people inside, very large one and no outside whatsoever. They want it all inside. The people who are inside have very long non competes, they pay people out for six months, a year afterward so that no one really knows what's going on by the time that person gets a new job. And, and you know, it's important to note just in summary, right, this is who invests in startups, this is who invests in large development projects, this is who makes $50 million donations and this is where private equity and venture capital get their money, right? When they talk about wealthy investors, family offices are the core, the bedrock of that sort of thing. So those are the people who are doing long term investments, they're willing to take large risks, they have capital, they have investment professionals who understand the risks and they understand these kinds of investments.

Matthew Foreman [00:23:55]:
There are some family offices that invested in Uber, which worked really well and there are some family offices that invested in WeWork. Right. SoftBank, you know, essentially was running a family office type investment fund which really didn't work out terribly well, right? They invest in WeWork, but a whole host of money in it and it blew up in their face. So you know, it's a matter of picking enough winners. But also you don't need to invest in startups, you know, you could invest in, you know, there are ones that buy that, that sit around and they'll own three residential apartment buildings in a city and that's their core asset, it earns income. You know, they may have owned it for 25, 30 years, so there's not a lot of depreciation left, but it's earning income, it's profitable, it's well run, you know, that's a good thing and it's throwing off income a lot of times these exist and the investments are chosen as hedges against the business. Right. If you have a business and you own a host of, I don't know, laundromats, when you invest in other things with your profit, the family office is not going to want to invest in laundromats.

Matthew Foreman [00:24:59]:
They're going to invest in something that's very countercyclical or very consistent otherwise. And I think that's really important. So that was the 20th episode of how Tax Works. I hope you learned something. I'll be back in two weeks with the 29th episode where I'm going to talk about famous and really quite important tax cases to know, understand and use in your own practice. I hope you enjoyed it. And now for the best Song of all time.