The Virtual Family Office and Personal Financial Planning

By Susan M. Tillery

Many consumers, as well as professional advisers, continue to think of personal financial planning as a tool to gather assets under management (AUM) or to sell products; however, CPA personal financial planners have developed a fee-for service model which offers integrated personal financial planning without AUM or product sales.  This model embodies the essence of true independence and objectivity, as well as the sought-after fiduciary model; thereby, making it most appealing to the client. 

The fee-for service model illuminates the CPAs role as the most trusted adviser. This model also serves as a clear pathway for the establishment of a Virtual Family Office (VFO) for business-owners.  This article discusses the fee-for service model, how it opens the door for a firm to offer VFO services and how both service offerings utilize professional collaboration.

The term virtual family office has been loosely used over the past 10 years. On one end of the continuum you have a formal investment management structure enabling the entity to take a deduction for investment fees; this is the subject of the recent Lender case (Lender Management LLC, T.C. Memo. 2017-246). On the other end of the continuum you have a more traditional structure providing tax efficiencies, asset protection and the coordination of professional services to high-net worth (HNW) and ultra-high net worth (UHNW) families. This article addresses the latter structure and focuses on the CPA financial planner providing integrated personal financial planning services within the virtual family office structure. The key aspect of this model is collaboration.

Virtual Family Offices

The VFO has become a recent option for individuals and families that have previously been using a single or multi-family office and have become disenchanted by the high costs (payroll and bricks and mortar overhead expenses) and inefficiencies of these models.  But more importantly for purposes of this discussion, it has become an excellent option for the business owner who is entrenched in running his or her business and has merged (usually unintentionally) business and personal activities. 

This unintentional merger is referred to as an embedded family office (EFO) and occurs when the business owner permits family and non-family employees to handle various personal matters for the owner(s) and their family. When only the owners and family employees are involved, the personal work accomplished through the family business is seldom, if ever problematic. But as the business grows, it most often hires non-family employees, adds qualified pension plans, employee benefit plans, and incentive-based compensation; then before anyone is aware, the business changes overnight. When this occurs, the common conveniences provided to the business owner become troublesome business practices. Examples include the use of employees to: 

  • Pay the business owner’s personal bills 
  • Attend to personal errands
  • Arrange travel, hotel and restaurant reservations
  • Prepare personal income tax returns, and even financial planning by company accountant
  • Review and handle personal leases and contracts by in-house counsel 

When these or other types of personal requests are made, there needs to be written company policies, strictly enforced for all employees, including the owner and family members.

These personal activities may seem immaterial and harmless enough until the impact on employees, non-family owners and unrelated third parties are considered. The effect of these activities is that the business redirects use of its assets, equipment, intellectual capital and employees. This redirection removes resources otherwise available for dividends, bonuses and/or contributions to pension plans; it also increases risks, some known and some unknown, which can create legal problems and significant unintended consequences. 

The use of resources may be non-deductible personal expenses and may constitute violations of bank covenants and ERISA, as well as breaches of fiduciary duties and contracts. Additionally, the business owner and executives are no longer able to make traditional representations and warranties which are a standard requirement for bank loans, financing transactions, mergers, acquisitions, and sales.  Business owners who find themselves with these embedded family offices need the CPA financial planner to establish a virtual family office to avoid crossing this fine line that no business owner knowingly desires to cross.

The best practices solution for this conundrum is creating a separate entity that becomes the virtual family office to replace the embedded family office. The entity can be either an LLC, FLLC or corporation as it serves to provide management and control for the business owner. In this regard, the VFO protects the owner’s operating business and assures the integrity of its books and records. It also removes unintended breaches of various covenants and fiduciary duties. Forming a VFO entity to manage and run the family wealth separately from the business is critically important for large and/or rapidly growing businesses.  The VFO structure provides them with the financial integrity to enter into an M&A transaction or other exit strategy that may be contemplated. 

In addition to protecting the operating business, the VFO manages the financial and non-financial wealth of the family. The VFO can legally incur, pay for and deduct expenses incurred for the creation or preservation of income. These expenses typically include accounting fees, tax preparation fees and estate planning fees.  If the facts and circumstances of the Lender case are met, the VFO can also deduct investment management and advisory fees, as well as other related expenses.

Used with permission of Financial Planning Advocate, LLC. All Rights Reserved. ©2019

A profit motive must exist, separate books and records must be kept, and an income tax return must be filed. The latter is a positive result, in that deductions not otherwise deductible on the business owner’s personal income tax return, may be deducted on the VFO entity’s tax return. In addition to providing a platform that permits greater tax benefits and efficiency, the VFO structure provides a legal entity for asset protections purposes. The importance of this last benefit cannot be over emphasized; the foundation of asset protection is a reasoned tax and estate plan. 

Personal Financial Planning

VFO’s utilize integrated personal financial planning services. Integrated personal financial planning deploys a tax centric focus to coordinate the various disciplines that support personal financial planning services. Integrated personal financial planning services include cash flow planning, income tax planning, estate and trust planning, retirement/financial independence planning, gift planning, charitable/philanthropic planning, risk management planning, asset protection planning, investment planning and/or investment management, business owner planning, and succession planning.

In 2018, there were more than 5.28 million HNW U.S. households having a net worth of between $1 million and $25 million.  The number of UHNW households, defined as having more than $30 million in investable assets, climbed to 226,450 in 2018. This increase in wealth in the U.S. creates greater financial complexity and a greater need for families to seek professional advice on a wide range of financial issues, including investments, estate and tax planning, the sale of family-owned businesses, as well as decisions tied to family succession.

This complexity requires intricate tax planning solutions and technology.  Technology is no longer a nice adjunct; it is imperative in the VFO and the integrated personal financial planning service models. Technology simplifies complexities, enhances capabilities and enables CPAs to formalize the personal financial planning activities they already offer. It also provides the CPA with the opportunity to be a disrupter instead of being the one disrupted.

Many CPAs are adding integrated personal financial planning services by utilizing the tax and financial planning advisory services model. This model offers numerous options for a firm to integrate personal financial planning into their existing practice. This best practice is significant, and if not embraced by CPAs, their current and potential clients will go elsewhere to find these services.  Consumers prefer a primary point of contact for their financial service needs, and in recognition of this trend, non-CPA advisers are offering more and more income tax services. Clients are already being enticed by offers for free income tax return preparation from other advisers, even their investment advisers. The number of investment advisers providing tax services to individuals has increased substantially in the last few years. 

When CPAs formalize personal financial planning services as a new service line, they attract HNW and UHNW clients because these individuals are looking for these services. Additionally, business owners are looking for a way to separate their personal and business lives and need a CPA financial planner to help them establish their virtual family office.  VFO’s and integrated personal financial planning services both utilize professional collaboration. Collaboration makes it possible for the CPA financial planner to offer both service lines. Through these service offerings, the CPA can provide a higher level of planning and customization.  No one person, or firm, can provide all these resources, or all the expertise required in these service offerings. Therefore, collaboration becomes the very key to providing these services.

A VFO utilizes integrated personal financial planning, but not every integrated personal financial plan requires a VFO. Therefore, for purposes of the following discussion on collaboration, we will discuss collaboration from the perspective of the VFO. However, it is important to keep in mind collaboration is needed for both; the only difference being, the VFO will usually require collaborating with a greater number of professional advisers than would be necessary for an individual client’s integrated personal financial plan.

Collaboration

Collaboration can increase a firm’s service offerings, referrals, centers of influence (COI), revenues, and even employee satisfaction. Additionally, collaboration can reduce a client’s professional services fees. VFO services can be used for HNW and UHNW individuals, as well as HNW and UNHW business-owners. All are looking for a trusted adviser who understands and implements collaboration in their service offerings. Prospective and current clients may not be able to articulate this need, but they are conscious of the fact that something needs to change in their current service offering. Collaboration goes beyond communication, coordination and cooperation between advisers. The ultimate purpose for collaboration is to tap into and harness the collective wisdom of the group.2

Any size firm is able to offer integrated personal financial planning services and virtual family office services to the HNW and UHNW simply by collaborating with other professional advisers. Collaboration brings the best advice to the table; it is cost efficient for the client, provides synergy – and synergy enables advisers to act with increased confidence. Additionally, collaboration expands each adviser’s network and centers of influence.  

Granted most advisers can say they are their client’s trusted adviser, however, because integrated personal financial planning and VFOs are primarily tax focused and require intricate tax planning solutions, the CPA is the logical choice as the trusted adviser for these two service offerings. The CPAs ethical standards, independence and objectivity requirements, tax knowledge and natural inclination to help clients make the best choices possible, has led clients to expect and ask their CPAs for these services.

A team of advisers for a VFO client, or for a client’s integrated personal financial plan, is simply made up of the types of advisers the individual client or VFO needs, such as:

  • CPA trusted adviser
  • CPA tax compliance adviser (this can be the CPA trusted adviser, or it can be an additional CPA on the team; rule of thumb, whoever is signing the tax return needs to be on the team)
  • Trusts and estates attorney
  • Transactional attorney
  • Investment manager,
  • Private banker
  • Risk management professional(s) (one for life, disability and long- term care, and one for property and casualty insurance),
  • Accountant/bookkeeper
  • Can also include house managers and concierge service manager

The majority of the team is outsourced; however, more and more CPA firms provide the investment management professional, as well.  A collaborative team brings total transparency, as well as independence and objectivity to the client’s VFO and/or personal financial plan.  This reduces overhead since there is no bricks and mortar or salary expense to deal with as is the case in a single-family office or the multi-family office. There is also a greater level of analysis, diversification, strategy and collaboration for the family’s wealth.  And most importantly, the collective wisdom discussed above.

Collaboration provides the solution for the twodisadvantages of utilizing a VFO, as opposed to a single or multi-family office:

  • Outsourced individuals in a VFO are not dedicated to a single family and therefore, have other clients. This lengthens response time to the client or the trusted adviser who is coordinating the team of advisers and may not be what the client prefers.  
  • Confidentiality and privacy are of greater concern with a VFO because more advisers and their businesses are involved in accessing confidential information.  

The first disadvantage can be dealt with by an agreement within the collaborative group to acknowledge receipt of an email, voicemail or text from a client within 12-24 hours, as a minimum response time. The latter disadvantage can be greatly reduced by offering a secure document vault to the client for all their documents. The collaborative group of advisers then has access to one set of documents on a need to know and read-only basis.

As the most trusted adviser in a collaborative team, there is increased responsibility for the CPA as the one who coordinates and manages all the other advisers. The CPAs knowledge base needs to be broader than the other advisers, in order to educate and prepare the client for each interaction with the other advisers and the CPA must act as an advocate for the client in relation to all the other advisers. 

As a team of advisers work together more frequently, this responsibility can decrease depending on the level of professionalism, knowledge, discretion and punctuality evidenced by the other professionals. The CPA trusted adviser who has the Personal Financial Specialist (PFS) credential can take on this role with full confidence because of the training and experience he or she has accumulated in the pursuit of this credential. 

The knowledge requirements and ethical standards for the CPA financial planning credential are rigorous. The CPA/PFS must adhere to the standards set forth for a CPA to be in good standing each year, as well as an additional set of standards when engaging personal financial planning clients. Since integrated personal financial planning deploys a tax centric focus, the CPAs tax expertise is critical and cannot be understated in this role.

The knowledge and continuing education the CPA/PFS must adhere to assures the client their CPA financial planner has the requisite knowledge and is up to date on all 285 personal financial planning topics in the PFS Body of Knowledge. All the resources pertaining to each of these topic areas are provided to the CPA/PFS by the AICPA’s Personal Financial Planning Division, which is dedicated to assisting CPA financial planners in all areas of their practice. The PFS credential demonstrates extensive tax expertise and comprehensive knowledge of integrated financial planning: estate, retirement, investments, insurance/risk management, asset protection, and cash flow planning.  This credential is granted to CPAs exclusively and is a statement that all financial planners are not alike.

Conclusion

CPA financial planners are well positioned to be the client’s most trusted adviser and provide integrated personal financial planning and VFO services through collaboration with other professionals. The tax and financial planning advisory services model highlights the fee-for-service option, but it is one of several that are available to provide the client with integrated personal financial planning and VFO services.  Both of these service offerings assist families in the determination of what they can achieve and how they can impact their community, whether locally or globally.  In many instances, this becomes a gateway to engage the next generation. 

The growth rate for the tax and financial planning advisory services model is expected to be close to 10%.3   VFOs did not exist 10 years ago and many CPA firms are unaware of this global best practice and the opportunity it affords them to help their HNW and UHNW families.In this time of disruption, businesses must choose whether they will be disrupted, or whether they will become the disrupter. Those looking for a way to be a disrupter and be fully engaged for the next decade, will find VFO and integrated personal financial planning services invaluable. The future of the tax and financial planning advisory model requires continuous innovation and value-added services.


1 Investopedia, Wealth, Trust & Estate Planning    https://www.investopedia.com/terms/h/hnwi.asp 

High Performance Teaming & Professional Collaboration.  White paper issued by the National Association of Estate Planners & Councils (NAEPC); all rights reserved

IBIS World 2018

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