On November 2, the US House of Representatives released its proposed bill for the "Tax Cuts and Jobs Act." Shortly following the bill's release, the House Ways and Means Chairman, Kevin Brady, R-Texas, laid out his plans for moving the bill through the House. Brady released some minor technical amendments to the bill on Friday, November 3, in addition to substantive amendments noted below. The bill's proposed effective date is January 1, 2018. As currently drafted, the bill contains a number of provisions that may impact the operation of family offices and family investment vehicles.

Many dynastic families structure their affairs to be managed by a family office, often characterized as a partnership for US tax purposes. Additionally, within family wealth structures, families will typically consolidate investment assets in collective investment partnerships, such as family limited partnerships or limited liability companies.

The use of entities characterized as partnerships for business and investment activities with in-house investment professionals, whether related to business asset-management or investment services, is beneficial because it allows for the flow-through of tax attributes to the ultimate partners, while providing a mechanism for incentivizing those who participate in the management and operations of such vehicles. The following provisions of the proposed House bill are relevant to family offices and investment structures:

  • The bill would allow a portion of net business income allocated by pass-through entities, such as partnerships, limited liability companies, S corporations and sole proprietorships, to individual partners, owners, and shareholders to be subject to a maximum rate of 25%. In some cases, it appears that owners of family offices and family investment vehicles might benefit from this new rate structure as the maximum federal ordinary rate is currently 39.6%.
  • In determining what income qualifies as "business income," partners, owners and shareholders would be able to elect to: (1) treat 30% of their distributive share as business income, and 70% as wage income, or (2) determine the ratio of business income to wage income based on capital investment. However, an owner receiving income from passive business activities would be able to treat 100% of his distributive share as business income. Income currently subject to preferential rates, such as net capital gains and qualified dividend income, would retain its character and would thus be excluded from business income. Professional service providers, such as doctors, lawyers, accountants and others, would not qualify for the new reduced rate on pass through business income.
  • The bill would repeal the alternative minimum tax ("AMT"). The repeal of the AMT could dramatically benefit high net worth individuals.
  • The bill would limit deferral of gain on like-kind exchanges after 2017 to real property. Consequently, the utilization of sophisticated investment partnerships that navigate the contributed property built-in gain rules may become more popular as a means of deferring gain on non-real property investment assets.
  • Effective tax years beginning after 2017, the bill would repeal the Section 708 technical termination rules. This change would greatly simplify family structuring transactions that might otherwise be subject to the technical termination rules.
  • The House's original draft did not contain any provisions affecting carried interest. However, Kevin Brady's amendment released this week does contain a provision affecting carried interest, which would limit long-term capital gain treatment to gains arising from the sale of assets held by a partnership for more than three years (as opposed to the normal one year rule), subject to certain exceptions.
  • The bill would eliminate deductions for investment expenses, thereby making partnership incentive allocations to advisors all the more attractive from a deductibility perspective.
  • Finally, the bill does not contain any provision to repeal the 3.8% net investment income tax. As such, family investment activities that often generate income associated with the net investment income tax would still be subject to this additional 3.8% levy.

We expect amendments to the bill to emerge from the House by the end of this week, with changes in the Senate likely to follow. We have extensive experience working with clients in this area and welcome your questions.

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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.