Creating a Family Office Helps Keep Focus on the Business
Owners of a closely held business generally spend the majority of their time focused on growing and managing the business. As a result, the management and knowledge sharing around financial matters among extended family members is sometimes neglected. A family with significant wealth and investments in various real estate and other assets often needs to create a “family office,” which entails establishing an entity to handle the affairs of the family and is managed in a similar fashion to a “for-profit” business. Asset management, accounting services and managing family affairs become the primary responsibilities of the family office.
Once a family office has been established, it is critical for a family to develop investment and succession plans to ensure their wealth is passed on to generations to come. Open and honest communication among family members is critical to the successful transfer of wealth between generations. Oftentimes, wealthy families wait to educate their children about their wealth and how it should be managed. This can be a detriment to the family should a patriarch or matriarch become ill and children are not informed about the family’s affairs.
For example, one family I had the opportunity to work with over the years had young children who were always sheltered from the business and finances even after the closely held business was sold. However, as the parents aged, a serious need arose to work out a succession plan for the family and educate their younger members on managing the finances to ensure prosperity for generations. It became critical to define roles and responsibilities for each member to ensure minimal disagreements and to protect the accumulated wealth.
As a family office evolves, there is often a need for a diverse team of advisors to work together and support the family. Legal, insurance, investment and accounting specialists are typically involved. In recent years, psychologists have become important team members as well.
A family office must maintain budgets and projections outlining income and expenses from the business for the life expectancy of the parents as well as the income and asset needs of the balance of the family. This is not an easy undertaking and will change over time. A family’s needs will evolve, as will the economic and tax policies that may impact the family’s wealth.
For example, as a result of the recently enacted federal tax reform, there was an increase in the federal estate tax exemption from $5 million to $10 million (unadjusted) per person. This increase allows families to make additional gifts for the benefit of their children. Careful planning around this regulatory change is critical to maximize potential benefits.
Another important change to consider is the new limitation, for individuals, placed on the amount of deductions allowed for state and local taxes. This $10,000 limitation has created a lot of buzz around the economic costs of living in high-tax states. Depending on a few factors, this change could cause an overall increase in federal taxes for many moderate- to high-income families. As a result, some families are considering their overall costs of living in a high-tax state versus the benefits received and may consider moving to a lower-tax state.
In summary, no two families work or operate the same. Differing needs always influence a family’s overall financial planning and goals. Parents, understandably, like to stay in control as long as possible. But the more lead time they provide, the more their children can begin to undertake some of the changes needed for a successful transition — which will ultimately yield better results for the entire family over the long term.
Warren D. Abkowitz
Warren Abkowitz, JD, CPA, is a tax partner with KPMG LLP. He manages the High Net Worth Individual and Investment Management Company tax services group within the Alternative Investment Industry Practice. He can be reached at 212-872-3851.
This article appeared in the November/December 2018 issue of New Jersey CPA magazine. Read the full issue.