The Lender Playbook for Modern Family Offices

Tax News You Can Use | The Northern Trust Institute

 

Damon Lim, Associate Wealth Advisor and
Jane G. Ditelberg, Chief Tax Strategist

 

January 12, 2026

The 2025 One Big Beautiful Bill Act (OBBBA) made permanent the elimination of IRC §212 miscellaneous itemized deductions. This change impacted, among other things, the investment expense deduction available to ultra-high-net-worth (UHNW) families before it was suspended temporarily in 2017. In the absence of a deduction under §212, can a family office deduct advisory fees, due-diligence costs and investment-management expenses as business expenses? The answer is that these are deductible as business expenses only if the family office qualifies as a trade or business. This creates a new planning imperative: Family offices must now operate in a manner that unmistakably reflects a genuine investment-management enterprise rather than a passive administrative vehicle if these expenses are to be deductible.

In Lender Management v. Commissioner,¹ the Tax Court upheld §162 treatment for expenses generated by a multigenerational family office led by an experienced investment professional, which delivered individualized investment-management services, operated with professional-grade infrastructure and earned compensation tied to performance rather than passive investor returns. The court concluded that the expenses arose from the family office’s conduct of a trade or business (investment management) and were deductible.

It is important to note that Lender did not hold that all family offices may deduct their investment expenses. However, it distinguished previous cases holding that expenses of managing a taxpayer’s own investments did not qualify as business expenses. In the absence of other guidance from the courts or the IRS, the Lender case provides the primary guideposts for family offices seeking business-expense deductibility.

Revisiting Lender

Lender Management LLC served multiple branches of the extended Lender family, each with distinct investment goals, cash-flow needs and risk tolerances, and it provided individualized services such as investment research, asset allocation decisions and financial planning. The family members were not a unified economic unit. They lived in different states, did not all know each other, and some were in direct conflict. And each had their own investment objectives, risk tolerances and financial goals. In effect, this office functioned more like an investment adviser with multiple clients than a single-family administrative hub. Lender Management LLC also operated with business-grade infrastructure, including five professional employees, and it received profits-interest compensation distinct from a normal investor’s return. Based on these facts, the Tax Court held that the office’s activities rose to the level of a trade or business, allowing it to deduct its expenses under §162.

Now that the OBBBA has terminated the miscellaneous itemized deduction, family offices and their advisors looking for ways to reduce taxes have focused on the Lender model as the benchmark for how a family office must be structured, staffed and compensated to withstand IRS scrutiny. For many UHNW families, replicating the core elements of Lender is the key to preserving deductibility in a landscape where §212 has vanished for good.

What Is Trade or Business?

“The taxpayer must be involved in the activity with continuity and regularity and… the primary purpose for engaging in the activity must be for income or profit.” – Commissioner v. Groetzingerr²

While the Tax Court in Lender did not specify which of the facts of that case were dispositive, characterization of the operation as a trade or business played an important part. The Internal Revenue Code does not define the term “trade or business,” leaving the determination to case law and facts analysis. Courts have long emphasized that a taxpayer must conduct the activity with continuity and regularity, and that the primary purpose must be to earn income or profit. Yet profit alone is not decisive; the focus is on the nature of the taxpayer’s activities rather than the mere existence of economic gain. A critical distinction exists between passive investment activity such as monitoring one’s own portfolio and providing services to others for compensation. When a taxpayer receives compensation separate from ordinary investment returns for performing investment advisory, financial-planning or asset-management services, the activity is more likely to be treated as a trade or business.

The Tax Court’s analysis in Lender is illustrative: The court likened the family office’s work to that of a hedge fund manager, emphasizing its investment research, due diligence, cash flow management, asset-allocation functions and its receipt of profits-interest compensation for those services. By contrast, taxpayers who merely oversee investments for themselves or their relatives without service-based compensation have consistently been viewed as investors rather than businesses.³ Together, these cases define the dividing line between passive investment oversight and a true enterprise in the eyes of the tax law.

Post-Lender Developments

Hellmann v. Commissioner⁴ is a Tax Court case that the parties settled privately before the court ruled on the merits. What we do have is an order entered by the court requesting additional information; that order provides insight into the court’s thinking and analysis.

Although the family office at issue appeared to replicate Lender’s structure, the court pointed to crucial differences. In Hellmann, the same four family members owned both the management company and the underlying investment entities in identical proportions, eliminating the disproportionality of ownership that was central in Lender. The order noted that, unlike the Lender family, whose members were geographically dispersed, unfamiliar or even openly-hostile with one another and who pursued divergent investment objectives, the Hellmann investors functioned as a unified economic group. The four family members were personally and geographically close, all residing in the same city, and the family office made collective investment decisions for the group. The court noted that a key factor drawn from Lender is whether the family office is actively engaged in providing services to others. In addition, the fact that the same people owned the management company and the underlying investment entities in Hellmann in the same proportions meant that there was no economic difference between paying the family office and doing the investments directly.

How Should the Ownership Be Structured?

Family offices seeking §162 trade-or-business treatment should structure ownership so that the management company is economically and operationally distinct from the underlying investment entities. This means ensuring that most end-level investors are not owners of the management company and that the manager’s personal ownership in the management company is financially separate from the underlying investors.

The Lender decision shows that courts look for separation between management and investors, investor autonomy and the absence of any implicit obligation that the management company serves the family indefinitely. Lender Management LLC succeeded because family members invested individually (i.e., not collectively), could withdraw capital if dissatisfied, had divergent interests and often had no ownership stake in the management company at all. The court viewed these features as evidence that Lender Management LLC was managing clients’ money, which is critical for §162 business characterization.

By contrast, in Hellmann, the same family members owned both the management company and the investment entities in identical proportions, effectively collapsing the distinction between manager and investor. This lack of ownership separation weakened the argument that the office was operating a true service business rather than merely overseeing its own capital.

How Should the Family Office Be Compensated?

Family offices seeking §162 treatment should structure compensation to reflect true service income rather than passive-investor returns. Practically, this means adopting management-fee and profits-interest models similar to commercial investment managers. Compensation is a central factor courts evaluate when determining whether an activity qualifies as a trade or business.

In Lender, the Tax Court found business status where the family office earned both a management fee and a performance-based profits interest, rather than simply receiving investor-level returns. Lender Management LLC also received Class A interests in the investment LLCs (akin to carried interest), which created genuine entrepreneurial risk because compensation depended on investment performance. Investors could withdraw capital subject to liquidity limits, underscoring that the profits interest represented payment for services. By contrast, Hellmann’s compensation structure aligned too closely with passive returns, weakening its business argument. To avoid similar outcomes, family offices should incorporate meaningful performance risks and clearly separate service compensation from investment returns.

Key Characteristics of the Trade or Business of Investment Management?

 "No matter how large the estate or how continuous or extended the work required may be, looking after one’s own investments are not deductible…” – Higgins v. Commissioner⁵

To strengthen the position that a family office qualifies as a §162 trade or business, its structure and daily operations should resemble those of a genuine investment management enterprise rather than a purely administrative office. This requires providing substantive, front-end investment advisory and financial-planning services tailored to the unique needs and risk profiles of individual family members, much like Lender Management LLC, which served multiple branches with distinct objectives. A family office structured in this manner will employ full-time professionals with meaningful responsibilities, compensate key personnel through service-based salaries or guaranteed payments and engage outside experts while retaining ultimate decision-making authority. It should actively manage underlying portfolio companies where appropriate and maintain documentation showing that profits interests and fees are earned for bona fide investment-management services rather than by virtue of family affiliation. This combination of individualized service, professional infrastructure and service-based compensation aligns the operation with the characteristics of a true business under §162 and distinguishes it from the Supreme Court’s decision in Higgins that a taxpayer managing their own portfolio is not in a trade or business.

Key Takeaways:

• OBBBA permanently eliminates §212 miscellaneous itemized deductions, increasing the pressure on family offices to qualify as a trade or business to take advantage of the §162 business expense deductions.
• The IRC does not define the term “business” or “trade;” instead, the IRS examines the facts of each case to determine the classification of an entity.
• A family office is far more likely to qualify as a §162 trade or business when it delivers substantive, individualized investment‐management services with professional staffing and formal operational infrastructure.
• A family office strengthens its §162 trade-or-business position when its compensation mirrors that of a true investment-management enterprise – a service-based, performance-dependent income rather than passive investor-level returns.
• Family offices should avoid unified ownership structures, preserve investor withdrawal rights and maintain a clear distinction between the manager’s economic interests and those of the investment entities it serves.

 

¹ Lender Management LLC v. Commissioner, TC Memo 2017-246.

² 480 U.S. 23, 35 (1987).

³ See, e.g., Higgins v. Commissioner, 312 U.S. 212 (1941). Whipple v. Commissioner, 373 U.S. 193 (1963).

⁴ Hellman v. Commissioner was settled before the court ruled so there is no opinion to cite. However, the court’s thinking on this case is revealed in an order dated October 1, 2018 in the cases docketed as 8486-17, 8489-17, 8494-17 and 8497-17

⁵ 312 U.S. 212, 218 (1941)