An obscure court case that will have a big affect on family offices

Photo by PierreDesrosiers/iStock / Getty Images
Photo by PierreDesrosiers/iStock / Getty Images

Late last year, the US tax court handed down a ruling that will be a game changer for family offices. Effectively, the ruling will allow single-family offices in the US to be treated as businesses and as such be able to take advantages of tax breaks they couldn’t have in the past.

The case, Lender Management, LLC v. Commissioner of Internal Revenue (for those interested in the legal detail, here’s a link to the case) means that family offices like Lender Management can be treated as a business and as such are permitted to deduct their expenses under Section 162 of the Internal Revenue Code. Previous to the ruling, family offices weren’t treated as a business for federal income tax purposes and as such could only claim expenses under Section 212 of the IRS Code, which was a lot less generous than expenses able to be claimed under Section 162.

“This is very good news for an economic efficiency point of view for family offices,” says William Kambas, a US-based partner at the law firm Withers. “And it’s very good news for the acknowledgement of the bonafide businesses purposes of setting up a family office.”

He adds: “What’s really great to see is the vindication of what I’ve believed for a long time and that is: when family offices are properly structured they are bonafide businesses much like the general partner structure of a private equity group, or a general partnership of a venture capital fund.”

Kambas reckons the decision will be a boon for family offices, leading to more being set up. “The court ruling should encourage the setting up of family offices because it makes them more economically palatable.”

He adds: “I feel this is a very important case for people like me because we as lawyers have long histories in structuring businesses and entrepreneurial activities, and applying jurisprudence to family enterprises. And the Lender verdict effectively vindicates our efforts in taking a holistic and professional view for setting up a family office.”

But Kambas says family offices will need to know they are on strong grounds to take advantage of the court’s decision. “Anybody who thinks they can just take the Lender case and use it to take advantage of tax deductions for all family office operations would be mistaken. Family offices need to think about every component part of the operations of their family enterprise.”

Specifically, in regards to this point, Kambas mentioned three things family offices managers and family beneficiaries need to be aware of:

  • A family office needs to think about how it is staffed, how it is operated and what is the professionalism of its engagement with the entity it provides services to;
  • A family office also needs to know to whom it is providing its services to and what is the professionalism of its relations with those recipients of those services; and
  • A family office also needs to know how it is structured at the ownership level and also the detail of how any investment vehicles are owned, and the level of professionalism between the family office and the broader family itself.