Have you heard of The Family Office? If so, chances are you have heard of The Family Bank and The Irrevocable Dynasty Trust too. You may even have a plan that includes these. If you do have them, do you truly have what you think you have? Or, are your entities just hollowed out versions of the real thing?
Either way, it may be beneficial for you to learn more about these structures and how they work.
THE FAMILY OFFICE
It’s a Business
Some may think The Family Office is 1) a wealthy family that 2) hires advisors to 3) manage their estate.
While some of this may be true, a real Family Office is a business run by family members. The Family Office starts with a wealthy family who wants a strong estate plan in place, which will help them to manage and grow their wealth with tax efficiency and asset protection.
The Family Office should be a legal entity. We often structure The Family Office as an LLC taxed as a C Corp. Your Revocable Living Trust and your Irrevocable Dynasty Trust should own it. Its primary functions are management and control. If your Family Office is not structured as a business, then you are renting and not owning so to speak.
In your Family Office, the family can pay management fees, business expenses, buy business vehicles, and pay employees. You have the control, but you use advisors to help where needed. This practice of keeping the control within the family allows for The Family Office to last for multiple generations.
The primary function of The Family Office is management and control. This operates as a key part of the overall asset protection plan in conjunction with The Family Bank.
THE FAMILY BANK
It’s a Business Too
The primary functions of The Family Bank is to hold and protect the assets. We set it up as a business such as an LLC or Limited Partnership. Your Revocable Living Trust and your Irrevocable Dynasty Trust should own it. As a limited partnership, The Family Office will also own a 1% interest in The Family Bank. It should hold or own your cash, portfolio assets, non-qualified investments, low or no risk assets, and your interests in subsidiary entities.
The Family Bank functions as the owner of your valuable assets. It has no control (remember The Family Office has that), so it operates as a safe house to protect your assets. If creditors were to come after your Family Bank, they would have a very difficult time collecting because all the management and control is in The Family Office. If creditors went after The Family Office, they would have a difficult time collecting because The Family Office essentially owns nothing. This theme of separating management and control from ownership of assets is one of the crucial elements of asset protection planning. If your plan doesn’t include this type of protection, you may want to think about whether you need it or not given your circumstances.
The Family Bank functions as a place to hold your assets in a safe and tax efficient manner. A Dynasty Trust may also function as a place to hold assets in a safe and tax efficient manner.
THE DYNASTY TRUST
Holds Assets in a Safe and Tax Efficient Manner
A “Dynasty Trust” is a Trust designed to hold and protect your property over multiple generations. Dynasty Trusts take advantage of jurisdictions that have gotten rid of laws that require trust termination such as the Rule Against Perpetuities. They also benefit from the tax rules to minimize or eliminate multi-generation estate taxes.
Because we design these Trusts to last a long time, they utilize advanced planning tools such as Trust Protectors, jurisdiction independence, mandatory alternative dispute resolution, spend thrift clauses, statements of wishes, and succession provisions to keep your wealth growing as long as the Trust is in place.
A Dynasty Trust can help your children to inherit a vast amount of wealth without it ruining them. We facilitate this by capping consumption, which we refer to as “throttling the burn rate.” Generally speaking, those who spend money for fulfillment find that the more they spend beyond a certain amount (studies have shown $90,000 to $150,000 in disposable income), the less happy they are. In contrast, those who are successfully productive and seek to continue to be productive by learning, growing and providing for others around them actually thrive and continue to thrive. In other words, the more productive they are, the happier they become.
INTEGRATION
Bringing It All Together
So, how does all of this planning work together? And more importantly, is your planning working like it should for you and your family? Let’s look at a fictional family as an example of how to integrate these planning tools for your benefit.
The Jones Family
Mike and Sarah Jones are married with two children, Rusty, 7, and Susie,13. They own a real estate brokerage company called We Sell Houses, structured as an LLC. Further, they own 20 residential rental properties, owned by five LLCs of which the Jones’ are the sole members. They further have equity interests in two LLCs: a car wash called Bug Off, and a storage facility called Pack It In Storage, both of which business interests they own personally with a partner named Joe. Their current net worth is just over $12 million.
What does this set up mean for Mike and Sarah?
Pros:
They have their businesses set up as LLCs, which means they have isolated the liability of the LLCs to the LLCs. If something were to go wrong at one of their properties and they were to get sued as a result, their personal assets would be protected as long as they are keeping business and personal assets separate. They have greater asset protection with Bug Off and Pack It In Storage because they are multi-member entities.
Cons:
They own everything personally, which means they have no anonymity. Their single member LLCs (all the property LLCs and the real estate company) are subject to Mike and Sarah’s creditors. If someone sued Mike or Sarah in a motor vehicle accident case that was their fault, for example, creditors could pierce the single-member LLCs they have set up. Additionally, if Mike and Sarah were to pass away, all of their business interests are subject to probate.
What did we do for Mike and Sarah in this example? Let’s start with the cons of this type of planning.
Cons:
Although you get greater asset protection with each multi-member business entity, the downside is that it becomes more complex and you have to do a separate tax return for each entity because it has to have its own tax ID. They are typically taxed as partnerships.
Generally speaking, this type of planning is more complex. So the tradeoff is simplicity and less asset protection for complexity and great asset protection. It also costs more to put in place. Part of what you need to consider is where you think you will land when it comes to the worth of your taxable estate and what is your comfort level when it comes to risk tolerance. That said, outside of the cons, there are several pros when it comes to properly setting up your Family Office.
Pros:
Trusts and Asset Protection
In Diagram 2, we created a Revocable Family Trust (Rev Trust) and an Irrevocable Dynasty Trust (Dynasty Trust). The Rev Trust helps Mike and Sarah avoid probate when they pass away. It is a majority member of their Management LLC (Family Office) and a limited partner for their Business Limited Partnership (Family Bank). The Dynasty Trust is a second member for Mike and Sarah’s LLCs, and a limited partner in the Family Bank. Note that Mike and Sarah structured their business entities as multiple member entities, which provides for more substantial asset protection (even though Mike and Sarah owned all the properties together before, for tax purposes, married couples are treated as one member in an LLC).
The Family Office
We created a Family Office and a Family Bank. Here, the Family Office is a business owned by the Rev and Dynasty Trusts. It has control and acts as the manager for each of the business entities. It can therefore streamline fees and expenses through one operating account instead of having to deal with multiple operating accounts to process, for example, all of the rental income that stems from the 20 rental properties.
The Family Bank
The Family Bank accumulates cash and other assets as set forth in Diagram 2. It has flexibility to use the assets as needed for the estate as a whole. When the Family Office, which has control, and the Family Bank, which holds the assets, work together as set forth herein, it creates an incredibly strong level of asset protection. In Diagram 2, Mike and Sarah have an additional level of asset protection where the Family Bank and the Dynasty Trust own the Properties LLCs.
In addition to the Dynasty Trust providing asset protection, it also provides for tax efficiencies. Although the exemption amount in 2022 is $12.06M per person and $24.12M for a married couple, in 2026, that amount sunsets and drops to about $6M per person. Because Mike and Sarah have a net worth of above $12M, they will likely be candidates to pay federal estate tax when they pass away. Tax law allows you to put assets that are in your taxable estate into a Dynasty Trust, which is outside of your taxable estate.
TAXABLE VS. NON-TAXABLE ESTATE
Why Pay Taxes If You Don’t Have To
If you look at Diagram 2, essentially everything above the Generation Line consists of Mike and Sarah’s taxable estate. Everything below the Generation Line (the Dynasty Trust) is outside of their taxable estate.
Example:
So let’s say it’s 2027 and you and your spouse pass away with an estate worth $15M. The sunset provision dropped the federal estate tax exemption to $12M for a married couple, which means you have $3M of taxable income at about 45 percent or a $1.35M tax burden. That is, if you haven’t done proper tax planning. If you have done proper tax planning, then you can do a number of different things before you pass away to move assets into the Dynasty Trust of which your children are the beneficiaries. If you moved $3M plus of assets into the Dynasty Trust prior to passing away, then instead of paying $1.35M in federal estate taxes you pay $0.
CONCLUSION
I hope you can see the benefits of having a true Family Office in place. This involves Integrated Planning and Dynasty Planning and should result in tax efficiencies, asset protection and more. Ultimately, we have seen many examples where the Family Office lasts beyond Generation 3 when the family is working the business. In other words, the family members are not “trust babies”. They have a job in the business, and they are doing real work and getting paid for it. The families who do this in an effective manner grow a Dynasty of productive children and heirs and continue to grow their wealth for multiple generations. We would be glad to meet with you and customize a legal diagram for you to help you in any way we can to, if needed, make your Family Office truly integrated.
DO YOU REALLY HAVE A FAMILY OFFICE?