Wealthy families run headfirst into accounting, tax and legal challenges as their wealth grows.

Wealthy families run headfirst into accounting, tax and legal challenges as their wealth grows.

The burden of compliance on families grows in direct proportion to the complexity of their investments. These complex investments push them up the complexity ladder on the tax side too.

Families that invest in alternative assets develop a new appreciation for what time of year it is. Without complexity, taxpayers aren’t horribly concerned about April deadlines. Instead, it is the month they write checks. A single investment in a private equity fund may produce a K-1 with dozens of line items, state apportionment questions, and foreign tax credits. Multiply this across a portfolio of twenty alternative investments, and the annual tax compliance burden can run to six figures.

A family that invested in real estate in multiple states faces a corresponding explosion in tax compliance obligations. The family may end up carrying state losses and generate tax notices too. All complex assets carry these inherent multipliers - some amount of accounting, some amount of legal, some amount of investment management cost.

At death, the complexity compounds. Every asset must be valued as of the date of death. Publicly traded securities are easy. Closely held business interests, real estate, and alternative investment fund positions require valuations. Tax returns must be filed for the estate, and now the holdings may have more family member owners. Younger generations that never before received a K-1 now get eleven of them. Dealing with tax payments in a dozen states means more tax returns, estimates, and state registrations. More mail, more deadlines, and more penalties.

During life, a wealthy family does not need attorneys to a substantial degree outside of the business context. They need an estate planning attorney to help them put together their wills and trusts. They may consummate family transfers. Beyond the estate, a business attorney is probably sufficient for most matters – dealing with a household employee, reviewing documents relating to an investment, a contract for a house renovation. As the asset base grows, the need for attorneys goes up, but family legal work is mostly about asset titling, governance and transfers - until death.

At death, the full complexity materializes at once for all kinds of assets. Leaving behind a dozen partnerships means the family must ask a series of questions. Who are the partners, and what are their rights? What do the governing documents say about transfers at death? Is there a right of first refusal? Can the interest be transferred to a trust or only to an individual? These questions do not answer themselves quickly. And this is only one asset. The estate of a family with a sophisticated asset base can take years to administer.

In the next post, we begin to think about the relationship between the assets and the next generation.
Part of Wealth Machine, a Secret Art of Planning series.