Tuesday, March 13, 2012

A Way to Avoid Gift Taxes

As an estate planning attorney in Massachusetts, gifting to the next generation (or multiple generations) is often a concern for those that have accumulated wealth.  A great tool in today's low interest rate environment is a GRAT.  Below is an article in Forbes that is a prefect example of having your cake and eating it too (minimizing or not paying a gift tax AND transferring wealth to the next generation). 

Facebook Billionaires Shifted More Than $200 Million Gift-Tax Free

Not too young for estate planning: In 2008 Mark Zuckerberg, then 24, put $3,023,128 worth of Facebook stock into a grantor retained annuity trust.
Mark Zuckerberg and Dustin Moskovitz, the co-founders of Facebook and two of the world’s youngest billionaires, may seem too young to be thinking about estate planning. But in 2008, when they were both 24, they used an estate planning tool that is more familiar to people two or three times their age. It involved putting pre-IPO stock into a special kind of trust that will explode in value when the company goes public. In the process Zuckerberg and Moskovitz, by FORBES conservative estimate, will together shift $185 million to trust beneficiaries without having to pay gift tax. Sheryl Sandberg, Facebook’s CEO, who was then 39, used the same strategy to transfer at least $19 million tax-free.
There’s nothing illegal about what these executives did. In fact, their experience is a case study in how the ultra-rich and even the moderately wealthy can work within the parameters of the tax law to transfer vast sums of money without having to pay gift tax. Incidentally, according to the 2012 FORBES Billionaires list, Zuckerberg (#35 on the list) has a net worth of $17.5 billion and Moskovitz (#314) is worth $3.5 billion.
The wealth-transfer strategy that the Facebook billionaires used gets a passing reference in footnotes of the company’s public stock offering. It indicates that each of these company executives is the trustee for a separate annuity trust named after them and funded with shares of Facebook stock. (Moskovitz left Facebook in 2008 to co-found Asana.)  This is almost certainly a reference to the popular estate planning technique known as the grantor retained annuity trust or GRAT.
Here’s how these trusts work: the person setting up the trust, known as the grantor, puts company shares into a short-term irrevocable trust and retains the right to receive an annual income stream, known as an annuity, for a preset time (for this type of asset, it is typically 5 to 15 years). If the grantor survives that period – a condition for this tool to work – any property left in the trust when the annual payments end passes to family members or to a trust for their benefit (they are the remainder beneficiaries).
The annuity should be approximately equal to the value of the assets transferred, plus an assumed interest rate that the government imposes, known as the Section 7520 rate. If the assets in the GRAT appreciate by more than that rate, all the excess passes to the beneficiaries with little or no gift tax. If the appreciation never occurs, the trust can satisfy its payout obligations by returning more of the assets to the grantor—the person who created the trust.
For more than a decade, it has been possible to form what’s called a zeroed-out GRAT, in which the remainder is theoretically worth nothing so that there is no taxable gift. In 2008, when the Facebook GRATs were set up, there was federal gift tax (at a 45% rate) if you gave away more than $1 million in cash or other assets during life. A zeroed-out GRAT enables wealthy folks to use their lifetime gift tax exemption for other transfers. Plus, there’s no exemption wasted if the asset does not perform as hoped.
How much will the Facebook billionaires wind up shifting this way? Let’s assume that the shares were bought under the company’s 2005 Stock Plan and were purchased at 83 cents per share. Under that scenario, using share quantities from Facebook’s securities registration statement filed on Feb. 1, Zuckerberg transferred $3,023,128 worth of stock (3,642,323 shares) to his GRAT; Moskovitz put $11,955,748 worth (14,404,516 shares) into his; and the starting value of Sandberg’s trust was $1,576,988 (1,899,986 shares). The SEC filing does not indicate how long each GRAT will last, who are the beneficiaries or what the shares were worth at the time.
More revealing is how much will be left at the end of the GRAT term because that’s what will go to beneficiaries free of gift tax.
FORBES asked Lawrence P. Katzenstein, a lawyer with Thompson Coburn in St. Louis to run the numbers, using the Tiger Tables Actuarial Software, which he created. We assumed that the GRAT lasts five years, with the stock growing modestly at a rate of 3.6% for the first four years (a conservative estimate); during this time, the annuity to the grantor will be paid with shares of stock. Then we assumed that in year five of the GRAT, before making the final annuity payment, Facebook goes public at $40 per share and the GRAT ends without any further change in the stock price.
Based on these assumptions, the total tally for tax-free transfers through the three GRATS is $204,353,993, divided as follows:
Moskovitz: $147,573,190
Zuckerberg:  $37,315,513