Although it might seem your clients have little in common with the inside executives at Twitter, the company’s recently released initial public offering (IPO) documents would indicate otherwise.
Twitter executives have developed a plan to reduce their eventual gift and estate taxes in advance of their IPO, in case the stock offering causes the value of the company to skyrocket. A closer look at the planning strategies employed by Twitter executives shows your clients don’t have to be sitting on the next hot Silicon Valley IPO to benefit from their use. Even if your clients don’t own pre-IPO shares, the same freeze and discounting strategies can save them from a hefty tax bill.
Twitter’s trust strategy
Twitter’s now-public IPO documents indicate that both its chairman and largest shareholder have transferred substantial amounts of their stock holdings into what the documents call “annuity trusts,” which are believed to be grantor retained annuity trusts (GRATs). Further, the company’s chief executive and his spouse transferred shares into an irrevocable gift trust.
The rationale behind these trust strategies is simple. The executives are anticipating the value of their shares to grow substantially following the company’s IPO and logically wish to shelter this appreciation from taxes to the greatest extent possible.
The strategy works — and can work equally well for your clients — because it freezes the value of the shares at their pre-IPO prices for transfer tax purposes.
Mechanics of the trusts
A GRAT essentially combines a trust that is established for a certain predetermined period of time with an annuity that pays the trust creator (the grantor) a set value for each year of the trust’s existence. This annuity payout is the grantor’s retained interest. The remaining value passes to the grantor’s beneficiaries, and, thus, out of the grantor’s estate.
See also: 6 trusts you should know about
The value of the taxable gift to the GRAT beneficiaries is equal to the fair market value of the property transferred into the GRAT minus the grantor’s retained interest. The grantor’s retained interest is the actuarially calculated value of the annuity stream he will retain over the GRAT’s life, based on the Section 7520 rate in effect the month the GRAT is created. In a low interest rate environment, the GRAT strategy can substantially reduce the value of the taxable gift, resulting in lower transfer taxes generally.
The primary downside of the GRAT strategy is that the grantor must outlive the trust term for it to work. In the case of the Twitter executives, who are all under 50 years old, the odds are good the strategy will succeed.