Presentation on theme: "CalCPA – LA Estate Planning Committee"— Presentation transcript:
1 CalCPA – LA Estate Planning Committee
May 8, Private and Virtual Trust Companies – Family Governance, CA Tax Planning and Family Office Jonathan C. Lurie, Esq. Partner | | Elham Ardestani, Esq., CPA Associate | |
2 OBJECTIVES AND TOPICS OF PRESENTATION
Identify succession planning for the family business Recognize governance issues of the family business and trusts Introduce private trust companies and “virtual” private trust companies and their role in governance Determine how to set up a board of the virtual/private trust company, including committees Consider CA and other state income tax issues Determine how to set up the family business and office Exit Strategies from the family business
3 Problems with Trustees
Trustees are loathe to make business decisions as they are constrained by a fiduciary duty Trustees are held to an extremely high fiduciary standard Compare to fiduciary standard of officers in an entity where the courts are loathe to second guess officers Business judgment rule (discussed on next slide) Trustee structure does not lend itself well to decision making, especially where an operating family business is concerned Trustee structure also does not properly address governance Case law on trustees – high and harsh standard if there are any issues or losses Not the case for officers inside an LLC or a business structure, including a Board of Directors
4 Private Trust Companies
Business Judgment Rule – officers or directors are presumed to exercise their discretion in best interests of the corporation/entity, absent a showing of gross negligence, disloyalty or bad faith Courts are reluctant to second guess corporate directors or officers Directed Trusts with bifurcated trustee and adviser roles still hold the adviser to fiduciary standard and the adviser has a corresponding risk of personal liability to the beneficiaries Families of wealth, especially where the family trusts contain an operating business, are creating private trust companies with directors to govern the trusts and make decisions Private Trust Companies are costly South Dakota has codified statute recognizing “Special Purpose Entities” Special Purpose Entities are unregulated under South Dakota and are used with the “directed trust” structure
5 Special Purpose Entities and “Virtual” Private Trust Companies
Under South Dakota statute, a Special Purpose Entity (“SPE”) is an LLC or another entity such as a corporation that includes a Board of Directors or a Board of Managers The SPE can serve as the different advisers for the directed trusts, without having the advisers directly appointed under the trust instrument The SPE “houses” the adviser committees for the trusts, such as the discretionary/distribution committee, the investment committee, and the protector committee The Board of Directors/Managers appoint and replace members of committees SPE provides a liability umbrella over individual advisers (through the business judgment rule and corporate structure) SPE provides family governance, allowing family members to serve without directly involving them in the trust or affecting trust tax positions SD institutional trustee acts as trustee of directed trust
6 Virtual PTC Operating Structure
Ownership Level Various Trusts (SD Directed Trustee) Virtual PTC Ownership Trust Irrevocable trust agreement Client as grantor Client can appoint and remove trustees Single purpose trust to own the interest in Virtual PTC LLC Capital contribution 100% ownership Virtual PTC LLC Control Level South Dakota Special Purpose Entity acts as adviser for various trusts; directs SD directed trustee Client appoints and removes all Managers during his life and determines who will do this after death Managers appoint, remove, and replace members of the Discretionary, Investment and Protector Committees by majority vote or by unanimity Board of Managers Administrative/Executive Level Acting Persons may be CA persons Carry out actions of the virtual PTC Handle day-to-day business of the virtual PTC Officers President: ________________ Secretary: ________________ Treasurer: ________________ Trust Officer: _______________ Decision-Making Level Investment Committee Discretionary Committee Protector Committee (non-CA persons) (non-CA persons)
7 CA State Income Tax - Blockers
California imposes income tax on a trust where (1) there is a CA fiduciary, (2) the trust is a grantor trust as to a CA resident, and (3) where there is a mandatory distribution requirement or an actual distribution made to a CA beneficiary How does CA tax planning translate into a Virtual Private Trust Company or Private Trust Company structure? Our interpretation is that you look to the fiduciary functions in these structures, such as distribution and investment functions, and make sure these positions are not held by CA persons Thus, persons on the investment and distribution committees should be non-CA persons If there are CA beneficiaries, the trusts should be discretionary trusts with ascertainable standard for distributions
8 CA State Income Tax – Blockers – Limitations on Committee Member Participation
Discretionary Committee: Committee members should not include the grantor, a beneficiary of a trust, or a person who is related to or subordinate party as to any such grantor or beneficiary (an “Independent Committee Member”) Independent Committee Member may participate in (1) decisions involving distributions or payments to or for the benefit of a beneficiary that are not restricted by an ascertainable standard, (2) any Tax Sensitive Decisions that are within the authority of the Discretionary Committee, or (3) any action that may be taken only by an independent trustee or an independent distribution adviser under the terms of that trust or applicable law
9 CA State Income Tax – Blockers – Limitations on Committee Member Participation – Cont’d
Investment Committee: Independent Committee Member acting on the Investment Committee may participate in (1) decisions related to any policy of life insurance held in a trust as to which the SPE is acting as the Investment Adviser to the extent the policy relates to the life of a Manager or Committee Member or to a Trustee, Adviser or beneficiary of that trust, or (2) any Tax Sensitive Decisions that are within the authority of the Investment Committee Tax Sensitive Decisions are decisions which would (a) cause a Committee Member or Manager to possess a general power of appointment, (b) cause inclusion of any assets of any trust in the estate of a Committee Member or Manager, or (c) be treated as an exercise of an incident of ownership over any policy under which the insured is such Committee Member or Manager
10 CA State Income Tax – Blockers – Limitations on Committee Member Participation – Cont’d
Protector Committee: Only an Independent Committee Member acting on the Protector Committee may participate in (1) discretionary decisions involving distributions or payments to or for the benefit of a beneficiary that are not restricted by an ascertainable standard, or (2) any Tax Sensitive Decisions that are within the authority of the Protector Committee
11 CA State Income Tax – Other Planning
Accumulation of income in discretionary trusts with non-CA grantor and non-CA trustees Purchase assets within trust rather than make distributions for purchase of asset Beneficiary Defective Inheritance Trust planning (“BDIT”) – Section 678 of the Internal Revenue Code provides that a beneficiary of a trust will be considered the owner (that is, the grantor) for federal income tax purposes of any portion of the trust that such beneficiary can independently vest in himself or herself. Create BDIT by severance of existing trust to create two trusts, one that will hold the income (contaminated trust) and another one for principal. Here, the contaminated trust is the beneficiary of the original trust Use income/contaminated trust for investments and purchasing assets Use principal trust for distributions
12 Business Succession Planning
Virtual private trust company and private trust company planning and use of structure Areas to consider in business succession planning Control – set up a control structure that is democratic and that does not entrench certain family in the business regardless of their ability Have outside members on the Board of Directors rather than just family members Governance should have a mechanism for selecting and replacing the team leader Board should include rolling board members, consider academic qualifications of directors and officers, include outside members and operate separately from the executives/officers Transfer Restrictions of interests in business Limiting the ability to transfer shares to outsiders Dealing with death and divorce Dealing with risk
13 Business Succession Planning – Cont’d
Areas to consider in business succession planning – Cont’d Employment within the business Strict rules relating to hiring of family Objective method for determining the compensation of family members that rewards them properly Make family employees accountable to the Board of Directors that will include independent/outside persons Distributions of income Make distributions so that all family members can benefit from the family business, including those who do not work in the family business Exit strategy Consider whether family members getting out of the family business would do so at a discount over a large number of years
14 Family Office – Set Up Before 2018, expenses incurred by individuals in managing their own investments were deductible only to the extent they exceeded 2% of the taxpayer’s AGI, subject to phaseout and AMT Beginning in 2018, miscellaneous itemized deductions are no longer deductible To address investment expenses among other considerations such as governance, consider setting up a family office Lender Management v. Commissioner, TC Memo (“Lender”) –held that operating expenses incurred by a family office in managing investments for family members were deductible as a trade or business expense under Section 162 of the IRC Family office structured as a partnership Family investment LLCs Full time manager position and a non-family CFO Trade or business of providing investment management services
15 Family Office – Set Up – Cont’d
Lender Management v. Commissioner – Cont’d Investors could exit at any time, or draw on their investments Lower tiered investments included non-family members Takeaways from Lender: Need to show that the office is carrying on an active trade or business of investment management and not just provided administrative or investment oversight services for the family Need to follow formalities and show documented, legally separate family entities within the family office. These family entities need to evidence that family members are not acting “collectively or with a single mindset” Do this by having documented, professional, business relationships with each other Need different ownership interests between the investment LLCs/partnerships and management entity
16 Bios Jonathan Lurie brought a solid reputation to Venable LLP’s Tax and Wealth Planning Practice when he joined the firm in late 2016 from McDermott Will & Emery LLP. An American College of Trust and Estate Counsel Fellow, he focuses his practice on representing an eclectic mix of clients in international and domestic tax and estate planning and trust administration. A native South African, he speaks Afrikaans and maintains a law license in that country. Jonathan describes half of his practice as involving technical problem-solving issues while the rest involves "people and their goals, hopes, and fears, and dealing with kids and retirement." One such example is a $200-million estate he has been working with for over 20 years involving a complex family situation and the formation of a charitable lead trust and family office. Jonathan takes pride in the fact that no property was sold to pay taxes, while the family has enjoyed working with him on the foundation and doing good in the world. Looking ahead, he hopes to expand beyond tax planning to focus more on governance and creating family structures that can keep families operating in a harmonious environment. Jonathan attended university and law school in Johannesburg, South Africa, and is admitted to practice law in the Republic of South Africa and Kingdom of Lesotho, in addition to California. Jonathan C. Lurie Partner Elham Ardestani is an associate in Venable's Tax and Wealth Planning Practice in the Los Angeles office. Elham focuses her practice on private client matters in the areas of estate and wealth transfer planning, trusts, family governance, business succession planning, charitable organizations, estate administration, and tax planning for high-net-worth individuals and families. Prior to joining Venable, Elham was an associate with a nationally recognized law firm in the private client services and tax, trusts, and estates practice. In this previous practice she worked on the formation and operation of private trust companies; advanced estate, gift, and generation-skipping transfer tax planning; and agreements related to grantor trusts, insurance trusts, and dynasty trusts. Elham has an extensive tax background and previously served as a senior associate in merger and acquisitions and financial services tax with PwC LLP, where she supported the merger and acquisitions team with tax due diligence, risk reporting, and pre- and post-deal restructuring with respect to tax consequences of acquisitions, consolidations, distributions, and liquidations. Elham Ardestani Associate
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