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.
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:
Facebook declined to comment.
Who might the remainder beneficiaries be, given the extreme youth of the grantors? Neither Moskovitz nor Zuckerberg—now both 27—has children. Moskovitz is still single. Zuckerberg at last report was still involved with long-term girlfriend Priscilla Chan. Sandberg, 42, is married to Dave Goldberg, the CEO of SurveyMonkey and has kids.
Under the circumstances, the most likely beneficiary of the GRAT is another trust. If the Facebook billionaires were well advised (and there is every indication that they were), each of these trusts, as the remainder beneficiary of the GRAT, would be extremely flexible. The trust could benefit descendants, but also provide, in the case of Moskovitz and Zuckerberg, that if they didn’t have children, the trust could benefit extended family members, including parents, siblings, and nieces and nephews. Another provision could allow the trustee to add charitable beneficiaries. That way, the Facebook fortune could be used to benefit people in need even if the founders never have children of their own.
As a parent, Sandberg might be concerned about making her children too rich. She could cap their share of the trust assets and have the excess come back to her, rather than going to her children. At that point she could choose to donate the funds to charity.
What can other wealthy folks learn from the Facebook billionaires? The GRAT is a terrific tool for shifting assets that you expect to suddenly increase in value. With property that is difficult to value, as may be the case with closely held stock or real estate, a GRAT offers an additional benefit. By expressing the annuity as a percentage of the initial value of the GRAT, you permit the trust to simply pay a larger annuity if the IRS determines the property is worth more than you initially figured. This minimizes the additional gift tax the IRS might try to impose if it audits the value of the gift.
But GRATs are not ideal for transfers to grandchildren and more remote descendants. The exemption from generation-skipping transfer tax (currently $5.12 million) can’t be applied until the trust term ends, by which time you hope asset values will be higher.
For people who want to set up a GRAT, low interest rates make this is an ideal time to do it. The Section 7520 rate for March is 1.4%– a historic low.
Interest rates aside, this huge wealth transfer opportunity may not last forever, however. There have been proposals in Congress to do away with zeroed out GRATs, a move that president Obama favors.