Four years before the Facebook IPO, co-founders Mark Zuckerberg and Dustin Moskovitz each set up GRATs. Just before the IPO, those GRATs were estimated by Forbes to transfer a total of at least $185 million gift tax free to their non-charitable beneficiaries.
GRATs, or grantor retained annuity trusts, are a wealth transfer strategy that freezes the value of estate assets and allows people to transfer appreciation of property to children or other beneficiaries gift and estate tax free. “They are also a way to leverage the estate and gift tax exemption,” says San Francisco estate planning attorney Beth L. Kramer. GRATs operate as follows: the grantor (the person setting up the GRAT) contributes shares of stock or other property to an irrevocable trust and reserves the right to receive an annual payment from the trust over a stipulated period of time. If the grantor survives that period, then any assets left in the trust will be passed to his or her specified beneficiaries or to a trust for their benefit. (If the grantor does not survive the term, some or all of the GRAT will be included in the taxable estate of the grantor.) The grantor has some flexibility to direct how the remainder beneficiaries receive the remainder interest at the end of the GRAT term.
When the GRAT is established, the grantor reports a gift of the remainder interest of the GRAT based on the value of the gift at that time, less the value of the lifetime annuity interest (the present interest of the total of the annual payments). The annuity interest is valued using IRS specified interest rates. GRATs can be structured so that the annuity interest equals the value of the assets contributed so that the remainder interest is valued at zero. For all GRATS, if the assets grow at a rate equal to or less than the IRS-specified interest rate, then the grantor will receive payments large enough so nothing is left for any beneficiaries. If the assets grow at a greater rate than the IRS specified interest rate, then the excess is passed to the remainder beneficiaries without being subject to gift tax. Ultimately, assuming the GRAT assets appreciate at a rate greater than the IRS specified rate, GRATs allow the grantor to transfer wealth in excess of the exemption amount, because there is no gift tax on the appreciation of GRAT property.
Use a GRAT when you already have some assets accumulated for the future, and you have pre-IPO stock put into the GRAT that you expect to grow. CPA Jason Graham says, “It’s what I refer to as a freeze technique, in that you’re freezing the value of where [the stock price] is today. The appreciation is what you’re giving away, and that could be substantial, because if you’re dealing with a pre-IPO company that’s going to go 3x, then you’re going to be able to give away all that upside without incurring any transfer taxes.” In the worst-case scenario, if your company goes bankrupt or the price takes a nosedive, you’ll be out accounting and attorney fees. You can still get the stock back (even though it’s worth less).
The above article is an excerpt from Joyce Franklin’s forthcoming book, “Life, Liquidity & the Pursuit of Happiness: How to Maximize and Preserve Your Startup Wealth and Live Your Dreams”