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.
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.