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The Impact of Facebook’s IPO on Estate Planning


May 23, 2012
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Someone asked me about the impact of the IPO price on the Grantor Retainer Annuity Trusts (GRAT’s) created by Facebook insiders.  As explained in this posting, these GRAT’s are very useful estate planning devices, and the Facebook IPO price proved somewhat useful to the insiders. By way of background, a GRAT is a trust to which a grantor transfers property and receives an annuity for a term of years (the “Term”).  The formula and the source of the interest rate (The “§7520 Rate”) are set forth in IRS regulations.  The client selects the Term and the property to transfer to the GRAT.  The regulations require that the property transferred be valued at fair market value (FMV) at the time that it is contributed to the GRAT. No doubt, the underwriters provided ample support for the $31 FMV of Facebook stock at the time of the transfer, before the stock was publically traded. Facebook stock closed at $38 on its initial public offering day.  What the reader should know is that the difference between $38 and $31 escapes transfer taxes, which is why the use of a GRAT is so attractive.  Because the regulations require that the gift be valued and calculated at the time of transfer, it does not allow for upward or downward changes in FMV.  It is therefore hard to imagine that the pre-IPO price was going to be below what the market would eventually set as the real price.  Facebook stock is thus a perfect example of appreciating property being ideally suited for a GRAT. To better understand a GRAT, consider the following example.  Assume that the FMV of the subject property is $100, and the interest rate is 1.6%.  The formula assumes the property will grow to $101.60 at the end of year one and to $102.41 at the end of year two.  If the property appreciates in value at a rate greater than 1.6%, the appreciation in excess of 1.6% is not part of the gift. The $7 increase in value of the Facebook stock exceeds 1.6%, so the strategy worked. The $5,120,000 Federal Estate Tax exclusion (the “Exclusion”) is set to expire at year-end.  The §7520 Rate dropped to 1.2%.  Clients should take advantage of incredibly low interest rates and a lackluster economy that depresses FMV of assets.  The insiders of Facebook have shown us the utility of GRATs for assets that are expected to appreciate. I want to send a message to skeptics and procrastinators.   If the Exclusion drops to $1,000,000 as scheduled, where will your estate find the cash to pay the estate tax if you do not act this year?