The Modern-Day Family Office: Personal Investment versus Trade or Business
July 2, 2024
By Jacqueline T. Kelly

With the enactment of the Tax Cuts and Jobs Act (TCJA), deductions for miscellaneous itemized expenses under Section 212 have been suspended for tax years 2018 through 2025. This change has significant implications for family offices because a family office must be recognized as a trade or business to deduct expenses under Section 162. Recently, an employee of a family office approached our team with a question regarding application of the Lender Management v. Commissioner[1] ruling from 2017 and potential ways to restructure the family office to take advantage of this ruling. This conversation raised a question worthy of a broader discussion:  What makes a family office a trade or business?

Unfortunately, the Internal Revenue Code lacks a definition of “trade or business” for general application purposes.  To date, the U.S. Supreme Court has not provided a uniform definition or standard. In the absence of a clear definition or standard, the determination of whether a family office is a trade or business must be made utilizing a facts and circumstances analysis performed on a case-by-case basis. Our team reviewed the relevant case law for factors that weigh either in favor of or against a finding that a family office is a trade or business.

One of the first family office cases to consider whether a taxpayer’s activities gave rise to a trade or business was Higgins v. Commissioner[2], a U.S. Supreme Court case from 1941. This case set the precedent that management of your own personal investment does not constitute a trade or business. The taxpayer had extensive investments in real estate, bonds, and stocks and hired a team to assist him with handling his affairs from an office in New York pursuant to his detailed instructions.  The taxpayer sought permanent investments and any changes were made under his own orders; meanwhile, his office staff kept records, received securities, interest and dividend checks, made deposits, forwarded reports, and undertook the care of investments as the taxpayer instructed. Of note, the Court indicated that there was no reason expenses could not be bifurcated and allocated separately to business and personal activities, with a deduction allowed for the business expenses. However, the Court did not provide a clarifying or straightforward test for future instances.

In 1963, in Whipple v. Commissioner[3], the U.S. Supreme Court again drove home the notion that investing your own money and managing your own investments does not give rise to a trade or business. However, the courts have also consistently indicated that various professionals earn fees and commissions for work that includes investing their clients’ funds and that the selling of such expertise is as much a business as other professional activities such as selling legal or medical services. In 2011, the Tax Court in Dagres v. Commissioner[4], allowed the deduction of a bad debt loss under Section 166(a) incurred by a venture capitalist taxpayer as ordinary and necessary business expenses, recognizing the active management of investments as a trade or business.  The Tax Court noted that while a manager of a venture capital fund is providing a service that is an investment mechanism for his customer, it is his trade or business, and in exchange for his service he receives a fee. The Tax Court indicated that neither the contingent nature of his fee nor its treatment as capital gain changed its classification as compensation for his services.

In 2017, a taxpayer prevailed in Lender in demonstrating that its bona fide operating family office should be treated as a trade or business eligible to deduct its investment-related expenses as an ordinary and necessary deduction under Section 162. Some of the key facts upon which the Tax Court determined that a trade or business existed included: (i) Lender Management provided services comparable to those provided by hedge fund managers to their clients, going beyond what an investor would typically undertake for his own benefit, (ii) most of the assets Lender Management managed were owned by members of the Lender family with no ownership interest in Lender Management, (iii) Lender Management employed a number of people including a full-time CFO and also utilized an external firm to offer comprehensive investment management services to its clients, (iv) Lender Management was compensated for its services with a profits interest for successfully managing the investment LLCs, rather than solely benefitting from a typical investor’s return, (v) there was no requirement or understanding that Lender Management would continue to manage the family investment vehicles indefinitely – clients could withdraw their investments (with or without reason), and (vi) the IRS did not cite any applicable attribution rules that would deem Lender Management as owning all of the investment LLCs interests

The cases discussed above provide valuable guidance for family offices seeking to achieve trade or business status. However, as the cases demonstrate, a fact-intensive inquiry is essential. Each family office must carefully document its activities, establish a profit motive, ensure active management, and comply with regulations to be recognized as a trade or business. If you manage a family office or are considering restructuring your current setup to achieve trade or business status, reach out to the professionals at Shields Legal to see how we can help you navigate these complex rules.

THIS POST IS FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSTITUTE OR CONTAIN TAX OR LEGAL ADVICE.


[1] T.C. Memo. 2017-246 (2017).

[2] 312 U.S. 212 (1941).

[3] 373 U.S. 193 (1963).

[4] 136 T.C. 263 (2011).

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