What is a Grantor Retained Annuity Trust and What Does it Have to do With Facebook?

I am a little late to the story, but I was shocked to learn that a few of the Facebook founders used an estate planning technique known as a Grantor Retained Annuity Trust (GRAT) to help their future heirs save on estate taxes.

It is very long term planning considering those mentioned in the article were all relatively (or even objectively) young to take on such an estate planning technique.  I thought this move deserved more hype then the stock going public, but then again I am in the estate planning world lol.  The estate planning attorney or financial professional that got their ear should be applauded.

According to Forbes,

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.

As of today, Facebook is down about 32% from when it opened, but that means nothing as this technique was a decades long move.

Part of what makes this story interesting is how it came to public light.  For the most part, estate planning techniques can be kept quiet, however, since these moves were made prior to the IPO of Facebook they all came to light when paperwork to go public was filed with the SEC.

What is a Grantor Retained Annuity Trust (GRAT)?

I don’t think the Forbes Article explains the technique all that well. So is how I explain the technique when I have to:

  • Grantor creates a Trust that is defective for income tax purposes (i.e. it is a completed gift for estate/gift taxes but for income taxes the trust and the grantor are often one in the same)
  • Grantor Retains (The “R”) an Annuity (“A”) – remember the definition of an annuity is just an equal stream of payments.
  • The Annuity is calculated using the government’s Section 7520 rate (assumed growth) and length chosen by Grantor

So in the end the Grantor “gets back” the value of the gift plus growth.  Contrary to popular belief you can’t just gift what you want – there are gifting laws in the United States.  The GRAT allows you to determine how much you “want” to pay in Gift Taxes by playing with the various levers in the calculation.

For example if you take back just a small portion of the value initially gifted then the gift taxes owed will be higher, concurrently/alternatively, if you use a longer term the value of the gift for gift taxes purposes will be smaller because the beneficiary will not receive their interest for a longer time.

Most people who set up a GRAT actually pay no Gift Taxes because they take the value of your initial asset plus the growth mandated by the government.  This subset of the GRAT is often referred to as a “Zeroed Out Grat.” If you are taking the entire asset back plus growth why is this technique popular? Why is Forbes guessing that Zuckerbag, et. al., used this technique?

Why Would the Founders of Facebook Use a GRAT?

In one word, Growth.  When they gifted the shares to their own GRAT they were valued at $X, when the shares went public, they were worth $X + Y, but the calculations were still based on the $X Value.

Only time will tell if this was a good use of time.  If the stock plummets then they wasted time and energy but no real money since they will receive their shares back (or other assets if the trust holds other assets).  However, it is likely that they already saved hundreds of millions if you are going with Forbes’ estimates, and if Facebook grows over the next decade or so then they will save even more.

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