Advisors can help clients mitigate taxes, enhance wealth and protect assets.
In seeking to work with the ultra-affluent-a family
with a complex financial situation and a net worth of $25 million or
more-financial advisors must be able to provide sophisticated advanced
planning expertise. To compete effectively for these very high-end
clients, financial advisors need to be able to deliver highly
innovative and exclusive strategies, and sophisticated advanced
planning strategies fit the bill perfectly.
Simply put, advanced planning entails employing
legal strategies to mitigate taxes, enhance wealth and protect assets.
While sophisticated advanced planning strategies are in great demand by
the ultra-affluent, this does not negate the use of more basic advanced
planning strategies such as intentionally defective trusts, traditional
deferred compensation plans and self-settled spendthrift trusts.
The primary advisor plays a central role in a
client's financial life and, as a result, is well-suited to identify
the need for advanced planning expertise, usually provided by one or
more professionals who work in partnership with the advisor
complementing the existing relationship. In-depth knowledge of a
client's financial interests and familiarity with his or her goals is
mandatory, because there are no "cookie cutter" advanced planning
strategies. Each technique is tailored to each case, and the advisor's
experience with the client is necessary to fully analyze the
opportunity and create a solution.
There are an abundance of sophisticated advanced
planning strategies that can be pursued on behalf of your clients, but
it's important to remember that all transactions must have a clear
business objective and benefit. Advanced planning strategies are not
tax shelters, but business-led transactions with a subsidiary tax
benefit. It is essential that the advanced planning strategies
presented to an ultra-affluent client all are bright-line
transactions-no question concerning their legitimacy or legality-and
the standard must be adhered to by the tax attorneys and other
professionals that provide services to the relationship.
Sophisticated Advanced
Planning Strategies
Below we share some of the more inventive
transactions we have witnessed in recent years, many of which leverage
legal and regulatory frameworks to accomplish each client's unique
goals.
Example #1: One family used offshore special-purpose
entities to obtain credit at low interest rates and provide asset
protection for several of the separately incorporated divisions of the
family business. The low-rate loans were then used to fund a series of
vehicles that were part of the family's estate plan, enabling select
family members to receive a tax-advantaged revenue stream, possibly in
perpetuity. Meanwhile, nearly all the income taxes owed by the family
were offset by the interest payments on the loans.
Example #2: Another family with significant
investment returns used a conversion technique to structure assets that
would have been taxed as ordinary income into monies that were
partially treated as capital gains and partially tax-free. These tax
benefits are the by-product of providing the ultra-affluent a way to
better manage certain personal and/or business risks.
Example #3: A third family transferred the majority
of their operating business assets, along with their commercial and
personal real estate, into a series of offshore structures. The assets
were then reconfigured and "hedged," which effectively made them
inaccessible by creditors yet still available to family members. The
transaction had the additional benefit of nearly tax-free interfamily
transfer of assets.
Example #4: A successful musician established an
offshore corporate structure to house the rights to many of his
creative works, including associated royalties and residuals. The
earnings grow tax-deferred within the structure, and can be accessed by
the musician without taxation in the form of loans. Derivatives are
used as part of the annual tax planning process to delay payments. At
the time of death, the current income requirements will cease and the
loans will be paid in full. In effect, the musician will be able to
enjoy his wealth during his lifetime and transfer approximately 70% of
the value of the creative works to his heirs on a tax-free basis.
Example #5: A hedge fund investor used the losses
from conventional investments to offset some of the profits he realized
from several hedge funds. Working directly with the hedge funds, he was
able to reduce the tax rate on the balance of his investment gains to
4% with the use of "side pockets" and a multinational tax-arbitrage
strategy.
Example #6: A family office with international
business interests used a tax-arbitrage strategy between the various
countries where it had assets to offset currency risks and make better
use of its capital. This series of transactions, similar to those used
in corporate transfer pricing arrangements, also eliminated the income
tax obligations of the family members.
Example #7: A family discounted the value of their
fine art and rare coin collections using a leveraged derivative
transaction. These collectibles will eventually be transferred to the
next generation at one-fifteenth their current market value (current
estimated projection) due to the tax savings from the accumulated
interested on the loans and the discounting process.
Enter The Corporate Tax Attorneys
Few advisors can design and implement these types of
strategies by themselves. As with other areas of specialization, such
as insurance and business valuation, the advisor must forge working
partnerships with the experts who can develop these sophisticated
programs. The solutions outlined above are the product of corporate tax
attorneys who have adapted for high-net-worth clients the legal
reasoning and the tax strategies they use with national and
multinational firms.
Today, only a small percentage of practicing
corporate tax attorneys actively focus on the high-net-worth-market,
although the trend is accelerating. Furthermore, fewer advisors have
sought the expertise of these attorneys in addressing their client
needs. Advisors and corporate tax attorneys can work more effectively
with wealthy individuals and families by pooling their skills and
knowledge to create targeted services.
There are limitations to these sophisticated
advanced planning strategies. For the strategy to be a bright-line
transaction and provide the preferential tax and/or related benefits,
the prospective ultra-affluent client must fit a very specific profile.
These strategies cannot simply be taken "off-the-shelf" and implemented
for an ultra-affluent client. Instead, the ultra-affluent client must
have a particular profile and the strategy will usually need to be
somewhat customized to the client. Failing to find the "appropriate
client" for a strategy and then failing to properly modify the strategy
will most certainly result in the strategy being deemed a listed
transaction.
Creating A Competitive Advantage
Exceptionally wealthy families have demanded
institutional treatment due to the size of their net worth for years,
especially when it comes to pricing. But few have demanded
institutional tax treatment, despite a keen interest in improving their
tax situation. Our research confirms that ultra-affluent clients are
more interested in managing their tax burden than they are in growing
their net worth by investing. The financial advisors who understand
that concern, and offer assistance through outside experts, new ideas
and actionable plans will be embraced by wealthy investors.
In today's competitive environment, advisors who
identify and establish strategic relationships with talented corporate
tax attorneys can differentiate themselves from their peers, while
cementing their relationships with their best and wealthiest clients,
enhancing the productivity and reputation of their practices, and
positioning themselves as a premier provider to the ultra-wealthy.
Hannah Shaw Grove is the author of
five books on private wealth and advisory practice management. Russ
Alan Prince is president of the consulting firm Prince & Associates.