The Wall Street Journal had a "tax report" in its weekend edition illustrating some of the devices used by the elite with sophisticated tax advisers to ensure that theiy can avoid paying as much estate tax as possible. See Laura Saunders. Tax Report: How Twitter Insiders Cut Their Taxes, Wall St. J. (Oct. 12-13, 2013), at B9.
Twitter chair Jack Dorsey (36) and largest shareholder Evan Williams (41) and CEO Richard Costolo (49) have been asiduous in "canny estate-planning moves" that "could save [them] a total of at least $115 million and perhaps far more." Id. What are the devices listed?
- The GRAT
The GRAT is a "grantor-retained annuity trust". Dorsey apparently holds about one-tenth of his Twitter shares in such a trust, as does Williams. GRATs are used to transfer appreciated assets to someone else, without paying tax on the appreciation. The grantor/owner of the GRAT gets annual payments over the trust's life that add up to the value of the original contribution plus a formulaic "return" on that value at an interest rate specified by the IRS, currently around 2%. If the owner outlives the term of the GRAT, he's gotten his original contribution (plus the formulaic return) back and any appreciation on the assets is transferred out of his estate to someone else (usually another trust on behalf of children).
Here's how Wikipedia describes a GRAT, in part:
it is possible that the actual interest earned on the assets will be substantially higher than the IRS theoretical interest. Thus at the end of the term, the value remaining in the GRAT may still be large, even though the initial IRS calculation suggests that it should have been zero. This remaining value is then passed on to the beneficiary without incurring a gift tax.
And, of course, the grantor's estate has only whatever remains of the original contribution value and annual payments. That means substantial gift-and-estate tax savings. The article estimates the tax savings for the GRATs listed in the Twitter IPO filing to be at least $113 million.
- Gift Trusts
Gift trusts used by Williams for his Twitter shares may have been set up, the WSJ article suggests, to avoid potentially much higher estate and gift rates upon the expiration of the 2012 estate and gift tax regime. [Congress rather foolishly failed to take the opportunity to reinstate meaningful estate and gift tax regimes, leaving the rich able to pay miniscule taxes (at a rate of 35%) even on humongous estates in excess of the substantial exempted amount.] The article estimates a savings of about $3 million in taxes from the establishment of these trusts.
- Single-Member LLCs
Williams also holds about a tenth of his shares through a single-member limited-liability company (LLC). Such an LLC is a "disregarded entity" for federal income tax purposes so that income on the shares are income to Williams. But the legal entity has extraordinary tax avoidance ability for estate taxes. Because the shares are held through an entity with limited marketability, the value of the entity is determined at a severe discount from the actual value of the shares held by the entity. In the example in the article, if Williams gave shares directly to his children worth $1 million, there would be about $400 thousand of gift tax due. But put the $1 million of shares in a single member LLC, and give the membership interest in the LLC to your child instead and suddenly you can treat this indirect transfer of $1 million of shares as though it is worth, say, only $650 thousand, thus reducing taxes to $260 thousand. The kid can easily unwind whenever needed. Voila--the government is left $140 thousand short but rich capitalist and kid have the same aggregate wealth as before! The article adds another twist--let the gift trust buy those discounted LLC interests with an IOU, putting even more stock in the trust at below market value and further minimizing taxes.
Oh, and another caveat--these devices are used with the assets that "people know they won't need.'" Id. Remember that these guys (and as usual, they are mostly guys) are worth many times more than ordinary Americans and so can "do without" several million dollars easily, compared to those ordinary Americans for whom their retirement savings in toto don't approach "several million."
So should these gimmicks for avoiding larger liability for estate tax work? I don't think so--they are purely tax motivated, and they depend on tax rules that make them possible so it would be very simple for a functioning Congress to get rid of these planning techniques. (Of course, we do not have a functioning Congress currently. We have a Congress hijacked by extremists who don't give a damn about the future of the country and do give a damn about protecting the wealthy from paying taxes.) The most worrisome of the devices is the "marketability" discount for LLC interests. Congress could rather easily create rules applicable to gift and estate taxes that remove the possibility of market discounts for such LLC creations where membership interests are transferred to related parties. It could similarly eliminate GRATs. Remember, these are essentially entities that have no economic rationale other than tax avoidance purposes and are only utilized by wealthy capitalists in the elite top 2% of the distribution who are already extraordinarily favored under the estate tax. There seems to be no justification whatsoever for allowing them this ready-to-use method of avoiding taxation by creating GRATs or LLCs that hold the shares that are the real assets transferred. It's hard to see any justification for gift trusts, either.