Family Office Structuring: Considerations in “Lender Model” Planning
Sophisticated high-net worth families are increasingly reexamining their approach to the structure of their family investment platforms. The traditional family office model, often a loose aggregation of entities bearing investment expenses at the individual or trust level, is being reexamined through a more technically efficient lens. Beyond organizational efficiency, sophisticated families are seeking to categorize their offices as separate trade or business for U.S. federal income tax purposes, with all of the beneficial economic and tax consequences that follow.
“Lender” Planning
At the center of this discussion is what is commonly referred to as “Lender” model planning, a framework grounded in the reasoning of a 2017 Tax Court case Lender Management v. Commissioner[1]. That case, and the structuring approaches that have developed around it, provide a roadmap for when a family office crosses the line from managing its own wealth to operating as an investment management business.
The economic objective of this planning is straightforward but significant. Since the enactment of the Tax Cuts and Jobs Act (TCJA), most investment expenses incurred by individuals and trusts are no longer deductible. By contrast, expenses incurred in carrying on a bona fide trade or business remain fully deductible. For larger family offices, the distinction can represent a meaningful annual difference in after-tax outcomes.
Introducing a Management Entity
In practice, this requires reorientation of both form and substance. A revised structure typically introduces a centralized management entity (frequently organized as a corporation) that functions as the manager across a suite of investment vehicles. Rather than relying primarily on fixed-service fees, the management entity participates in the economics of the platform through “profits interests” and targeted allocations. At the same time, it bears the cost of personnel, diligence, overhead, and other operating expenses. The goal is to replicate, as closely as possible, the economic and operational profile of an institutional grade investment manager.
However, simply inserting a management entity into the structure is not sufficient. The technical requirements that support trade or business status are exacting and highly fact dependent. One of the most critical is the concept of non-overlapping ownership. If the ownership of the family office management entity mirrors the ownership of the underlying investment entities, the arrangement begins to look like individuals managing their own capital: precisely the fact pattern the IRS is inclined to challenge. As a result, many structures introduce differentiated ownership blocks, often involving trusts or other planning vehicles, to create the necessary separation.
Compensation design of the investment manager is equally important. In Lender, the Tax Court focused heavily on the fact that the family office’s economics were tied to investment performance through profits interests, rather than being limited to fixed management fees. That feature signaled a genuine profit motive and aligned the family office with third-party investment managers.
Management Entity Choice
Entity choice also plays a meaningful role in the analysis. While both flow-through and corporate structures are used, there is a growing preference for corporate management entities in this context. A corporation can deduct investment-related expenses at the entity level without being subject to the individual limitations that continue to constrain partnerships and their owners. It also avoids certain recharacterization risks associated with carried interest holding periods enacted under TCJA. That said, these benefits come with tradeoffs, including potential exposure to double taxation and the need to manage regimes such as the personal holding company and accumulated earnings tax rules.
The Importance of Allocation Mechanics
From a partnership taxation perspective, the allocation methodologies are often where these structures succeed or fail. The ability to push expenses up to the management entity and allocate them in a manner that reflects the intended economics depends on satisfying the substantial economic effect requirements under the Treasury Regulation. This, in turn, requires careful drafting of operating agreements, disciplined maintenance of capital accounts, and a willingness to engage with the underlying economics rather than relying on boilerplate provisions. Capped profits interests, poorly constructed distribution waterfalls, or tax allocations that lack economic consequence can quickly erode the defensibility of the Lender model.
Another recurring issue is funding of the management entity. Profits interests, by their nature, produce variable and often unpredictable cash flows, while operating expenses are often fixed and recurring. Well-designed structures address this mismatch by building reserves within the management entity, layering in limited fixed-fee arrangements where appropriate, and coordinating distributions and loan repayment strategies across the broader family office platform.
Managing the Audit Risk
Finally, it is worth emphasizing that these structures are inherently factually specific and therefore audit sensitive. The IRS will focus on whether the activity truly rises to the level of a business, whether the ownership and compensation arrangements are consistent with that conclusion, and whether the allocations and deductions are supported by the governing agreements and underlying economics. In this environment, documentation, process, and consistency matter as much as the initial design.
Conclusion
“Lender model” planning is not a superficial restructuring. It is a comprehensive reworking of how a sophisticated family office earns income, incurs expenses, and presents itself from both a tax and operational perspective. When approached casually, it risks adding complexity without delivering the intended tax benefits. But when implemented with discipline, it can unlock meaningful efficiencies and align the family office with institutional level investment benefits.
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[1] Lender Mgmt., LLC v. Comm’r, T.C. Memo. 2017-246, 114 T.C.M. 638 (2017).