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- With the One Big Beautiful Bill Act ending an investment tax break, more wealthy families are reconsidering a valuable but rigorous tax strategy, lawyers and CPAs told CNBC.
- The Lender model, born from a court ruling involving a bagel-maker family fortune, provides a roadmap for family offices to deduct investment expenses.
- Running a family office as a bona fide asset management business requires great time, expense and hard conversations with family members.
A woman in the background is mediating a disagreement between two men in this close-up. A finger is being pointed at one guy while the other is not assuming responsibility.Fatcamera | E+ | Getty Images
A version of this article appeared in CNBC’s Inside Wealth newsletter, a weekly guide to the high-net-worth investor and consumer. Sign up to receive future editions, straight to your inbox.
More wealthy families are revisiting a tax strategy that can generate big savings but also draw IRS scrutiny, lawyers and CPAs told CNBC.
In 2017, a Tax Court case involving the family behind Lender’s Bagels helped establish a pathway for family offices to still deduct investment expenses if they operated as a trade or business. The so-called “Lender” model took off after the Tax Cuts and Jobs Act, passed that same year, temporarily suspended miscellaneous itemized deductions.
Now with the One Big Beautiful Bill Act making the suspension permanent, family offices are showing renewed interest in the Lender model. But qualifying as a bona fide asset-management business requires more than simply managing the family’s own wealth. Families may need to reshape how the office operates, hire more employees to build out professional services, and decide who gets to run the office, which can strain family ties, according to Joseph Medina, a CPA and partner in EY’s private tax group.
“This is not like flipping a light switch,” said Medina. “There will be real winners and real losers because not everyone in the family is going to potentially own the family office. That means if there’s a homerun investment, some portion of the family could be richer than the other. If there’s really bad investments, then someone has to bear the economic cost, and it’s probably the person who owns the family office.”
Given the time and expense involved, families have to ask if the juice is worth the squeeze, he said. There are other potential routes for deducting these expenses if they support an operating business or charitable endeavors, he added.
In Medina’s view, whether the Lender model is right for a family office depends on the size of its investable assets and the investment talent it has in-house. He said it generally takes at least $300 million in investable assets to justify the infrastructure needed to save on investment-adviser fees. Family offices that are more services-oriented than investment-focused often are not a fit for the Lender model.
To be clear, the Lender ruling gave family offices a roadmap, not a template. The Tax Court’s decision rested on the specific facts of that case, and whether another office qualifies as a trade or business depends on its own facts and circumstances.
Kevin Matz, a partner at the law firm of ArentFox Schiff, said families don’t necessarily have to duplicate the Lender family office, but the ruling provides useful guidance. Lender Management, the Lender family office, served four generations and dozens of family members who were geographically dispersed and, in some cases, barely knew one another, Matz said. That helped show the office operated at arm’s length as an investment-management business, rather than simply managing one family’s shared wealth, he added.
Crucially, Lender Management was compensated with profits interests in each of the family’s investment LLCs, which had substantial allocations to private equity, Matz said.
“That means if you don’t generate the benchmarks, you do not get compensated,” he said. “There is true entrepreneurial risk.”
Charging a flat management fee for managing mostly marketable securities likely wouldn’t have passed muster with the court, Matz said.
The family office’s chief investment officer was Keith Lender, grandson of the family’s patriarch, which could have raised red flags. However, Keith worked full time for the business, had distinguished credentials such as an MBA from Northwestern University, and had previously worked for large corporations.
Requiring specific qualifications of family employees means some families have to raise the bar. And that’s a good thing, according to partner Sarah Kerr Severson at ArentFox Schiff.
“People outside the lender model have a crutch because they have ostensibly greater freedom when they’re setting up their family office. It just invites an apathy that you can’t have in an operating Lender model because you know you’re being supervised,” she said.
Matz said that families can minimize risk of an audit by hewing closely to the Lender family office’s circumstances, including its C corporation status.
That said, some families are simply not willing to take the risk despite the potential savings, according to Medina.
“They don’t want to be a family that a court case is named after,” he said.
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