Facebook Founders Use GRATs

06/20/2012

Now that Facebook has gone public, its founders are apparently using a tried and true planning technique to avoid estate taxes - a Grantor Retained Annuity Trust or "GRAT."  GRAT's are perfectly legal and are an excellent way to shift wealth to others at little or no tax cost and with minimal legal and economic risk.  Some have reported that this type of planning can help save Mark Zuckerberg and others at least $200 million of estate and gift taxes on their Facebook shares.

In essence, GRAT's are trusts that are used to transfer asset appreciation from one taxpayer to others, at a very low tax cost.  For Facebook owners, this benefit can be huge.

If the Facebook insiders didn't use GRATs for those shares, but held them until they died or gave them away to friends or relatives after the offering, then the gift or estate tax owed on the shares could be north of $200 million (assuming a $31.50 share price and the current top gift and estate tax rate of 35%; rates are scheduled to rise to 55% next year).

A successful GRAT requires a person with an asset that should appreciate who wants to avoid gift or estate tax and is willing to part with asset to do so.  A taxpayer then sets up a GRAT with a short term and gives the asset to it before the asset appreciates.  The term of the GRAT is important.  This is because the taxpayer is retaining an interest in the GRAT (or asset transferred to the GRAT for the term of the GRAT).  At the end of the term, the asset goes to someone else or is held in trust for the benefit of someone else.  Over the life of the GRAT, the taxpayer who sets it up gets annual payments adding up to the asset's original value plus a return based on ta fixed interest rate determined by the IRS.  That rate is currently around 1.6%.  Meanwhile, ideally, the asset increases in value, and that growth is outside of the taxpayer's estate. When the GRAT's term ends, the asset goes to the beneficiaries or a trust set up for their benefit.

The result: no gift or estate tax on the appreciation, even though it has been transferred.

Here is an example, using figures from the Facebook offering document.  Zuckerberg disclosed "annuity trusts" holding 3.4 million of Facebook shares. The value of each share when the trust was set up was less than $1.85, according to the prospectus.

After contributing the stock to the GRAT, Zuckerberg would, over time, take payments equal to the original value of the gift plus a small return. Without knowing information that's unavailable such as how long the trust will run or exactly how it is structured, it's impossible to say what payments have already been or will be made.

But it is possible to make an educated guess as to the appreciation that's being shifted from Zuckerberg's estate.  If Facebook has a $31.50 share price, Zuckerberg's GRAT would be worth about $100 million.

At current top rates of 35%, that means estate and gift-tax savings of about $35 million for Zuckerberg. 

What if by some chance Facebook stock tanks? The stock would then be returned to the Zuckerberg.  The person who sets up the GRAT is not really worse off, because he paid little or no tax in the first place.  Either he wins or it's a tie—except for the cost to set it up.  And that, in a nutshell, is why the Facebook insiders set up GRAT's - to save millions in a perfectly legal way.