Forbes recently highlighted how Facebook co-founders Mark Zuckerberg and Dustin Moskovitz established grantor retained annuity trusts (GRATs) to transfer significant amounts of wealth tax-free. In 2008, Zuckerberg and Moskovitz established GRATs which will enable the Facebook executives to transfer as much as $185 million to future offspring or others without paying any gift tax. Most wealthy individuals recognize that this year offers a golden opportunity to transfer $5.12 million in assets without incurring any gift tax. However, the Facebook executives followed a similar tax strategy to the Walmart founders, the Walton family, by funding their GRATs with their rapidly appreciating Facebook shares.
GRATs function by allowing a grantor (Zuckerberg and Moskovitz) to place shares or other assets into an irrevocable trust and retain the right to receive an annual payment back from the trust for a period of time. Typically, to avoid the risk of premature death, advisors select a shorter time period of 2 to 4 years. If the grantor survives that period, any property left in the trust when the annual payments end passes to family members, other beneficiaries, or another trust.
A crucial aspect is determining the value of the remainder interest in the annuity. In calculating how much value will be left at the end of the annuity term (the remainder) — and thus how big a gift the grantor is making — the IRS does look at the performance of the actual stock (or any other asset) in the trust. Instead, the IRS assumes the trust assets are earning a meager government-determined interest rate. With a zeroed-out, or “Walton” GRAT, the grantor receives an annuity that leaves nothing for heirs if assets grow only at the IRS’ lowly interest rate. If the assets grow faster, the excess goes to the heirs gift tax free. If assets or stock under-perform or decrease in value, there is no downside for the grantor because the annuity can be paid by returning some shares each year to the grantor.
As a result, a GRAT is an ideal instrument to shift assets you expect to suddenly increase in value. Hence, rapidly appreciating stock of technology giants (Facebook) or growing retails empires (Walmart) have proven to be the perfect assets to utilize within a GRAT. President Obama and Democrat legislators have targeted zeroed-out GRATs as tax loopholes of the wealthy and have proposed legislation which would eliminate their use. Until that time, the GRAT remains a valuable wealth transfer tool.