JAN. 25, 2023: This year’s tax-saving strategies for family offices

Wealthy investors could face higher tax bills this year due to appreciation of assets and other factors. But some favored tax strategies are losing steam in the wake of higher interest rates. In this issue, we break down some useful tools and techniques to minimize your tax bill, according to the analysts and experts we interviewed.  

Also in this issue, we talked with Edward Marshall, a widely regarded family-office expert and consultant, about the trends and changes he foresees in the next few years. He tells us that what stood out in his firm’s recent survey of family-office members and professionals, the talent gap in the space and whether any regulatory changes are on the horizon.

As we glide through January, if you have any predictions or insights into what family offices can expect in the year ahead, please pass them along. We’d love to use them to guide our reporting and are open to running op-eds or commentaries submitted by readers.

Crain Currency is always looking to invite new members into our exclusive network of family-office professionals and family members being served by them. If you know someone who would benefit from being part of our network, please take a moment to invite him or her by clicking here.

And as always, we’d appreciate comments, ideas and insights that would make this newsletter more useful. Please forward these to Executive Editor Frederick Gabriel at [email protected] or me at [email protected].

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HANDPICKED: This year’s tax-saving strategies for family offices

By MARCUS BARAM

Against a backdrop of higher interest rates, the rising popularity of wealth taxes and a world economy entering a period of slow growth, strategies to minimize taxes have never been more important to family offices.

“More than ever, family offices are using this time of uncertainty to take a pause and reflect,” said Jo Anna Fellon, national leader of private client services at Marcum LLP in New Jersey. Many of her family-office clients are facing higher tax burdens due to appreciation of their assets, she said. 

“As a result, they’re looking for opportunities like utilizing more tax loss harvesting” as well as increasing their use of gifts and interfamily loans, Fellon said.

THE HIGHLIGHTS

• Family offices could face higher tax burdens this year due to appreciation of assets.
• Though proposals to increase federal taxes fell through last year, lawmakers in seven states are now pushing wealth taxes.
• In surveys, family offices have expressed concern about cross-border tax issues.
• 64% of survey respondents are not confident that their tax operations are high-performing.
• From a tax perspective, 2022 was a roller-coaster year for the wealthy and ultrawealthy.

On one hand, Republicans successfully blocked the Biden administration’s efforts to increase the top marginal income-tax rate, tax capital gains at ordinary rates and expand the net investment income tax to include active pass-through income. 

On the other hand, efforts to implement wealth taxes are gaining  momentum. Two weeks ago, seven states that together represent about 60% percent of the country’s wealth — California, Connecticut, Hawaii, Illinois, Maryland, New York and Washington — introduced legislation aimed specifically at an individuals’ net worth. 

And two trusted strategies — qualified opportunity zones (QOZ) and donor-advised funds (DAFs) — could soon lose some of their shine, tax law experts say. 

Will Sinclair, the New York-based head of JPMorgan Private Bank’s Financial Institutions Group, said he’s not seeing as much demand for QOZ funds — investments in the development of economically distressed communities that may be eligible for tax benefits — “given that the benefits for current investments have been reduced.” But he is seeing “some select demand” for closely held, family-controlled QOZ funds.

Though donor-advised funds have been extremely popular because donors get an immediate tax deduction, Fellon said, there is talk of potential new rules. 

Proposed regulations would create two types of DAFs: qualified and nonqualified. Qualified would require the fund to distribute the donations to charity within 15 years of receiving the donation, whereas nonqualified would extend that deadline to 50 years. 

The hitch is that deductions for donations made to nonqualified DAFs would not be allowed until the funds are distributed to a qualified charity. 

As family offices increasingly expand their investments and operations into other countries, cross-border tax issues become more relevant. In fact, nearly three-fourths (72%) of respondents to Credit Suisse’s survey of single-family offices cited international tax consequences as a concern in 2022. Yet they remain uncertain about their own tax strategies, with 64% of respondents to Ernst & Young’s survey of single-family offices saying they are not confident that their tax operations are high-performing.

SOME TAX SEASON TIPS

Here are some tax strategies that make sense in the current environment, according to wealth managers and tax lawyers.

Tax-managed investing: “It’s not what you make, it’s what you keep,” noted Rajesh Nakadi, head of investments at the global family-office unit of BNY Mellon Wealth Management. Thanks to stock market losses in 2022, more clients are harvesting those losses to offset gains in other parts of their portfolios, thereby reducing their tax bills. Volatility in the markets “adds to tax loss alpha,” Nakadi said, with more opportunities to buy and sell positions and with algorithmic advances in trading making it more efficient and precise. 

Intrafamily loans: One significant tax-related change in the past year due to the spike in interest rates, Fellon said, is that grantor retained annuity trusts — used in estate planning to minimize taxes on large financial gifts to family members — have become less advantageous. For families with significant assets, “you can make intrafamily loans as a way to create liquidity for the matriarch or patriarch by way of an interest payment back.” As an example, Fellon said that if a family makes a $10 million loan to a generation-skipping trust, the appreciation of that money goes into the trust as an asset, and the interest comes back to the loan giver as liquidity or cash.

Gifts: Sinclair of J.P. Morgan said clients are taking advantage of the increase in the lifetime gift exemption — from $12.06 million in 2022 to $12.92 million per individual in 2023 — and the increase in the annual gift limit to $17,000 from $16,000. “Those are the largest annual increases we have seen in years and allow clients to meaningfully lower estate tax burdens,” he said.

Charitable remainder trusts: In this era of higher interest rates, “charitable remainder trusts work better” than grantor retained annuity trusts, said Joshua Rubenstein, a New York-based trust and estate attorney and chair of Katten’s private wealth department. Such irrevocable trusts let you donate assets to charity and draw annual income for life, with the contributions qualifying for a partial charitable deduction.

Pass-through entity state tax elections: “Some family offices and accounting firms are getting increasingly comfortable” with these vehicles as a workaround on the state and local tax cap limitation, Sinclair said. It has long been a technique used by operating businesses to family investment partnerships, since it gives them a way to deduct state taxes from their federal tax.

Split-dollar life insurance estate planning: In the wake of a big court case decided in favor of the taxpayer, Sinclair said interest in this strategy has increased. Under this technique, two trusts or people buy insurance on the life of a particular family member, and the policy is owned by an irrevocable life insurance trust, helping minimize gift and estate taxes. 

“At the end of the day, everybody makes their own blend of choices, and my choice may be slightly more expensive than yours,” Rubenstein said. “But if it gets me closer to where I want to be and maybe I want control, I don’t want to give it all away. Maybe I wanna die with the most toys.” 

PEER-TO-PEER INSIGHTS: EDWARD MARSHALL

Edward Marshall is the global head of the family office and high-net-worth sector at Dentons, a multinational law firm with locations in more than 80 countries. Before that, he served family offices at Credit Suisse, Citibank and Boston Private. Marshall is also a senior adviser to the Ultra High Net Worth Institute, a think tank that promotes best practices and professional development in family wealth.

Dentons recently did a survey of 188 family offices from 32 countries that focused on direct investing. What findings stood out to you the most?

There are a lot of hypotheses [about family offices] and information that seems intuitive, but until you see the data, it’s very hard to prove. For example, in the U.S. there’s this notion that family offices want to work together on direct deals and deal flow. Well, in the Middle East, it’s very different. We asked them how often do you work with other family offices, and the answer was very low. It could be for a lot of different reasons. Maybe the family office is an extension of the family business, and there are fewer external people working with them. It could be the types of deal flow that they’re looking at compared to Europe or North America. 

Obviously, the post-pandemic American workplace is very different, with a focus on remote work, new technologies, even changing norms on governance. When it comes to working at a family office, what changes do you foresee in the next few years?

On the human-capital side, the demand for people to get into the family-office side is huge. But there is a big shortage of talent. It’s not keeping up with the demand, and it’s kind of changing how some of these family-office talent searches are going. I think some families are surprised by what the compensation is now for a lot of these roles as compared to just a year or two ago. 

What kind of roles are most in demand?

It’s hard to say because every family office is a reflection of the individual office. So maybe one family values the CIO role, one family values the CFO role, and one values the kind of integrator role of the COO. 

Are there lessons you could share for other professionals dealing with family offices in terms of how they operate, succession issues, philanthropy?

This notion that if you’ve seen one family office, you’ve seen one family office — I don’t believe it, because otherwise, you couldn’t study or learn anything about them. When you work with families — family businesses, family offices — you start to see patterns of what successful families do. They focus on strategies and how things get done instead of constant firefighting. That’s challenging. But at the end of the day, people have to realize that family offices are a reflection of the principal, a reflection of the wealth holders and the family. And that can be a challenge for people who come out of a very large company or investment firm and have different experiences there. 

Do you see any major regulatory changes coming over the next year? 

Less on the single-family-office side. The regulators are looking at a number of issues. One of them is off-channel communications [business-related texts on personal devices and numbers]. But I can’t think of something else right now that would be similar to the concerns [over new rules and regulations] that people had a year and a half ago. 

Interview conducted by Marcus Barum 

LOOSE CHANGE

Where are the renewables projects? Renewable energy is attracting investors, but little progress is being made on the actual projects, The Wall Street Journal reports in a deep dive. New wind installations fell 77.5% year over year in the third quarter of 2022, and utility-scale solar “likely fell 40% last year.” The biggest culprits appear to be “supply chain and trade issues,” such that “average lead times for securing high-voltage equipment have risen from 30 weeks to more than 70.”

Tax scandal in UK could hurt top lawmaker: One of the richest members of the UK Parliament and the Tory party chair, Nadhim Zahawi, is embroiled in a flap over his taxes that could cost him his position. In recent days, the UK learned that Zahawi, while chancellor of the exchequer last year, paid a penalty of as much as 5 million pounds in a settlement. Prime Minister Rishi Sunak has asked his ethics adviser to investigate.

Shifting from savings accounts to find higher yields: Wealthy consumers are taking their money out of savings accounts at banks that don’t offer high-enough interest rates, The Wall Street Journal reports. For example, Bank of America’s wealth division saw deposits drop 17% in 2022. Those consumers are moving into money market funds, Treasuries or saving accounts elsewhere, as some banks have increased rates sooner than others. A key takeaway — shop around, not only among banks but also within any one bank’s offerings. For example, the article notes that a $100,000 certificate of deposit would yield 3.75% when bought directly from JPMorgan, but a similar CD from JPMorgan offers a 4.75% yield when purchased through the brokerage Fidelity Investments. At BofA, its Merrill Lynch Wealth Management unit now offers a 3.98% rate on savings accounts with deposits of more than $100,000.

NEXT WEEK: We’ll look at some states’ recent wealth tax proposals — whether such efforts will succeed, what they mean for family offices and high-net-worth individuals, and why wealth taxes around the world are so faddish. Feel free to reach out to our reporter, Steven Weiss, at [email protected].