Converting a Family Office to a Private Trust Company

The advantages and disadvantages of this option and how to implement it

New Dodd-Frank regulations affecting family offices (FOs) will require certain FOs to register with the Securities and Exchange Commission as investment advisers, under the Investment Advisers Act (IAA), by March 30, 2012, unless they restructure their organizations. One option that many FOs are considering is whether to become a private trust company (PTC). There are several considerations involved in making this decision, however, and creating a PTC may not necessarily be optimal. Becoming a PTC has some advantages as well as drawbacks.


Among the advantages are:
· It allows for family control, privacy and greater protection from liability for decision makers.
· A PTC can be established in a tax-friendly state that doesn’t levy state income or capital gains taxes on trusts.
· It may be exempt from registration as an investment adviser with the SEC if the PTC is regulated by state law and submits to some level of regulatory oversight.
· It potentially enjoys more flexibility in managing and investing trust assets, such as offering relief from pressure to diversify concentrated positions.
· A regulated PTC also permits the creation of a common trust fund, which offers the same opportunities for efficiencies and economies of scale.


Some disadvantages are:
· PTCs are relatively untested entities
· When family members are involved in a PTC, there’s potential for family conflict if the trustee is not truly independent of family control.
· In addition to having high initial capitalization and start-up costs, a PTC will have continuing administration costs.
· In cases of mismanagement, breach of trustees or poor investment performance, family members may have little practical recourse against the fiduciary, as compared to recourse afforded by a corporate trustee (such as a bank or trust company).
· There are potential adverse estate, gift, generation-skipping transfer (GST) tax and/or income tax consequences if certain family members retain too much influence over specific PTC activities, such as distribution decisions.
· There are additional regulatory, oversight and financial reporting requirements.

Decisions to Make

Once an FO chooses to become a PTC, it must make several decisions. For example, should the trust be regulated or unregulated? In which jurisdiction should the trust be established? How will the PTC be organized? What kind of entity will the PTC become (for example, a corporation or limited liability company)? What about its ownership and governance structure? How will the PTC be compensated for services?

The first step is to determine the jurisdiction in which the PTC should be formed and, depending on that jurisdiction, whether the trust will be regulated or unregulated. A regulated PTC is chartered to offer trust services and is regulated under state or federal law. An unregulated PTC is incorporated in a state that allows a “limited purpose corporation,” therefore recognizing the unregulated PTC as providing fiduciary services to a single family.

Most states require that a PTC be fully regulated and have formal capital and policy requirements, as well as regulatory oversight and reporting requirements. Regulated PTCs aren’t required to register with the SEC as an investment advisor, and the state regulatory process makes independent review possible. This is because a trust company, which is supervised by state or federal authorities, satisfies the definition of a bank and isn’t considered an investment adviser under the IAA.

By contrast, an unregulated PTC isn't chartered as a state trust company and generally isn’t subject to supervision, though it may perform limited fiduciary services. This kind of trust company may not create a common trust fund, though it offers families more privacy and is less expensive than a regulated PTC to form and operate. Consequently, such unregulated PTCs may have to satisfy the SEC’s family office exemption rule to avoid its registration requirement.

Once an FO decides whether to formulate a PTC, its decision about whether to be regulated or unregulated will affect the choice of jurisdiction available to it. At least 10 states recognize, by statute, regulated PTCs; Alabama, Colorado, Delaware, Massachusetts, Nevada, New Hampshire, Pennsylvania, South Dakota, Tennessee and Virginia. Two states currently permit unregulated PTCs to act by administrative exemption: Nevada and Wyoming; and three states recognize unregulated PTCs by statute: Massachusetts, Nevada and Pennsylvania.

Other jurisdictional considerations include:
· Costs of forming a PTC in addition to capital requirements
· The state’s income taxes and their impact on PTCs, trusts, grantor and beneficiaries
· The state’s applicable fiduciary laws and investment standards affecting the trustees and the trust.

As a practical matter, the PTC's geographic location may also be a factor. Bear in mind that legal matters involving a trust must be handled in the trust’s jurisdiction. For some families, having a PTC in a distant state may pose too many logistical difficulties because of the time and travel involved.


There are many issues to address when structuring a PTC, such as determining the PTC’s purpose, as well as the roles and responsibilities of the PTC’s shareholders, directors and its investment and distribution committees.

PTCs often take over the functions and formalize the structure of an existing FO and help preserve family privacy. Additionally, the PTC creates a separate identity for dealing with the business world, centralizes administrative functions for the family, such as tax preparation and investment management, and segregates the family and investment functions from other family entities, such as a closely held family business.

Notice 2008-63, on the structure and roles of members of a PTC, is fairly explicit and identifies two basic levels of governance and their composition:

Shareholder(s). Responsible for electing a board of directors, approving amendments to bylaws and articles of incorporation and approving extraordinary corporate actions, such as a merger, a recapitalization, among others.
Director(s). Elected by the voting shareholders, and responsible for the daily business of the PTC, including hiring and compensation, operational matters and appointing committees to assume specific functions. One to three directors is a practical size for this group and should include at least one person who's independent, with no beneficial interest in any trust for which the PTC acts as trustee and shouldn't be related or subordinate to a grantor or beneficiary of the trust. One independent director must serve at all times.

Remember, potential adverse estate, gift, GST or income tax consequences may arise if certain family members retain too much influence over specific PTC activities. The IRS issued guidance in the form of a proposed revenue ruling (Notice 2008-63) that identified potential adverse tax consequences associated with a PTC. For instance, when a grantor retains too much power over trust property or the grantor may alter, amend, revoke or terminate enjoyment of that property and causes unintended grantor status for tax purposes.

In selecting directors, shareholders need to bear in mind that the PTC's bylaws must prohibit any director or member of the trust’s distribution committee from acting on or approving any discretionary distribution from a trust that such person or his spouse created or has a beneficial interest. A discretionary distribution is defined as a distribution for any purpose in excess of health, education, maintenance and support (“an ascertainable standard,” as defined by IRS guidelines). Such a limitation, therefore, heightens the importance of selecting independent directors for the trust.

This material is provided for illustrative/educational purposes only. This material is not intended to constitute legal or tax advice. Effort has been made to ensure that the material presented herein is accurate at the time of publication. However, this material is not intended to be a full and exhaustive explanation of the law in any area or of all of the legal or tax options available. The information discussed herein may not be applicable to or appropriate for every situation and should be used only after consultation with professionals who have reviewed your specific situation.

Hide comments


  • Allowed HTML tags: <em> <strong> <blockquote> <br> <p>

Plain text

  • No HTML tags allowed.
  • Web page addresses and e-mail addresses turn into links automatically.
  • Lines and paragraphs break automatically.