Family Office Investments and Business Interest Proposed Regulations.

• Author: Serrate, Lindsey
• Position: FROM THE FAMILY OFFICE

Many taxpayers during this 2018 tax season will see differences not only in the amount of their estimated tax but also in the filing process. Family offices will experience changes to once familiar tax rules and a broadened tax base. To top it off, many tax forms have taken on new looks and formats. Certain tax deductions have been suspended until future years, and new tax laws (along with new limitations on deductions) have been enacted. Based on the Tax Act's colloquial name alone--the Tax Cuts and Jobs Act (TCJA)--one might imagine that taxes would generally be cut. Indeed, the Congressional Budget Office has reported that individuals and pass-through entities (partnerships and S corporations) will receive about $1.125 billion in net benefits over ten years and corporations will receive about $320 billion in benefits. That said, under the TCJA, some high-net-worth taxpayers may actually pay more taxes.

High-net-worth family offices generally positioned within higher tax brackets are experiencing a mix of lower tax rates; limitations on the deductibility of state, local, and real estate taxes, mortgages, and business interest; and the elimination of personal exemptions. This article will focus on certain tax aspects of family office investments in private equity and operating portfolio companies.

Family offices may invest in private equity by acquiring an ongoing business or startup, in which case the family gains control of the business and may hold it through a pass-through structure. The selected acquiring structure may be multi-tiered, depending on nonfamily and family investors and limited partners (LPs). General partners (GPs, management companies) provide management services to the business, family members, related entities, and third-party nonfamily members in return for a management fee and carried interest during profitable times. When performing due diligence prior to the acquisition, the management company may consult with a valuation company to analyze and report on the true enterprise value of the business. The enterprise value sets the purchase price and places a value on intangibles (such as goodwill), enabling the family office to estimate the rate of return on their investment, the tax benefits, and relevant borrowing opportunities. The basic formula for goodwill is: purchase price (fair value)--tangible assets = goodwill.

Prior to the TCJA, the family office could leverage the purchase of the business through debt in expectation of a real-time tax benefit from flow-through losses for a number of years generated not only from the loan or debt service interest but also from the depreciation and amortization of intangible goodwill and other assets. In previous years, acquisition interest was normally allowable as a business deduction; however, the Act has made some changes from a tax perspective.

Limited Business Interest

The Act has amended Internal Revenue Code...