A recent post by Deborah Jacobsat Forbes.com discussed Facebook’s founder, Mark Zuckerberg’s possible use of tax planning techniques to make large tax free gifts. Ms. Jacobs’ post points to footnotes, contained in the offering statement, which indicate Zuckerberg and several other Facebook executives are each a trustee of their own annuity trust. Jacobs believes these footnotes suggest each of them have established a grantor retained annuity trust (GRAT), and I think that is a reasonable inference. GRATs can be a very effective wealth transfer tool, particularly where rapidly appreciating assets are used. I think stock in a company which has changed the way a large portion of the population interacts with each other qualifies as such an asset, even more so when the stock will soon be offered in the largest tech IPO in history.
A GRAT, for which there is expressed authority in the tax code, involves the transfer of assets to a trust in exchange for an annuity payment for a set number of years. The value of the annuity interest is calculated based on the size and term of the annuity, along with an imputed interest rate prescribed by the IRS (the section 7520 rate). The difference in value between the assets transferred and the annuity interest retained by the Settlor is a gift, but if the values are the same there is no gift.
This is where the magic comes in. If the assets transferred appreciate at a rate higher than the section 7520 rate, which is currently 1.4%, the trustee can make all of the required annuity payments and all the excess appreciation is effectively transferred with no gift tax liability. Between 1965 and 2005 the average rate of return in the first 21 days following an IPO was 22%.
Jacobs suggests that Zuckerberg transferred a little over 3.6 million shares at a value of $0.83/share for a total value just above $3 Million. She assumes that the Facebook stock appreciates 3.6% for 4 years, and in year five the company goes public at $40/share. At the end of a five year GRAT term, Zuckerberg’s trust could hold more than $37 Million worth of stock, without incurring gift tax, a potential $17 Million in tax savings for his heirs.
But you do not need to be worth $17.5 Billion (Zuckerberg’s estimated wealth) to make a GRAT work for you, and you don’t have to own the next Facebook. At AMM we have helped clients who own companies whose stock is expected to appreciate in the near to mid-term use GRATs with great effectiveness.
As a general illustration, let us take a corporate executive (unmarried with a net worth of $8 Million), who over the course of several years has received stock grants as part of his compensation for a privately held company. The stock, valued at the IPO offer price, is worth $1,000,000. If that executive transferred his stock into a GRAT this month and took back approximately $150,000 for 7 years, there would be no gift on the transfer. If the Trustee then cashed out the stock interest in the first three weeks following the IPO, invested the proceeds and earned 5% a year, at the end of the GRAT term the trust would own assets worth $470,000, a potential $211,000 in tax savings.
In addition, the estimated tax savings do not include the possibility of a lower valuation if the transfer is done several years before the IPO is planned, and if the Trustee thinks the originally held stock will out-perform the market (maybe it is Facebook stock) there is no requirement to liquidate and diversify. Also, the estimated tax savings do not take into account possible valuation discounts which may be available on transfers of minority interests in private companies (which can easily be 30% or more). With respect to the above example, $211,000 is probably a conservative estimate of the savings produced by a well designed GRAT.
Moreover, you don’t need to be looking at an impending IPO to use a GRAT. Any asset which is expected to appreciate at a rate above 1.4%, or an asset which currently has a depressed value, but is expected to rebound, may also be good. Closely-held stock, real estate, and even a portfolio of publically traded securities are assets which can be used to fund a GRAT.
The GRAT is one of many tax planning techniques that can be used by wealthy taxpayers to reduce their tax burden. By Ms. Jacobs’ estimates, Mark Zuckerberg and his colleagues may have used GRATs to transfer almost $205 Million dollars without tax; potentially saving them nearly $92 Million in taxes. All wealthy taxpayers have this same opportunity, now that is something to “Like”.
My colleague, Alan Wandalowski, has some additional commentary on opportunities with GRATs, here.