{"id":1738,"date":"2023-02-22T14:48:23","date_gmt":"2023-02-22T14:48:23","guid":{"rendered":"https:\/\/williambissett.com\/?p=1738"},"modified":"2023-05-12T20:49:38","modified_gmt":"2023-05-12T20:49:38","slug":"grats","status":"publish","type":"post","link":"https:\/\/williambissett.com\/2023\/02\/22\/grats\/","title":{"rendered":"Grantor Retained Annuity Trusts &#8211; GRATS &#8211; An Estate Tax Minimization Strategy Perfect for Startup Founders"},"content":{"rendered":"<div id=\"dslc-theme-content\"><div id=\"dslc-theme-content-inner\"><p><strong><u><a href=\"http:\/\/williambissett.com\/wp-content\/uploads\/2023\/02\/Legacy-scaled.jpg\"><img decoding=\"async\" class=\"aligncenter size-medium wp-image-1827\" src=\"http:\/\/williambissett.com\/wp-content\/uploads\/2023\/02\/Legacy-214x300.jpg\" alt=\"\" width=\"214\" height=\"300\" srcset=\"https:\/\/williambissett.com\/wp-content\/uploads\/2023\/02\/Legacy-214x300.jpg 214w, https:\/\/williambissett.com\/wp-content\/uploads\/2023\/02\/Legacy-732x1024.jpg 732w, https:\/\/williambissett.com\/wp-content\/uploads\/2023\/02\/Legacy-768x1075.jpg 768w, https:\/\/williambissett.com\/wp-content\/uploads\/2023\/02\/Legacy-1097x1536.jpg 1097w, https:\/\/williambissett.com\/wp-content\/uploads\/2023\/02\/Legacy-1463x2048.jpg 1463w, https:\/\/williambissett.com\/wp-content\/uploads\/2023\/02\/Legacy-scaled.jpg 1829w\" sizes=\"(max-width: 214px) 100vw, 214px\" \/><\/a><\/u><\/strong><\/p>\n<p><strong><u>Summary:<\/u><\/strong><\/p>\n<p>What if you could save $2 million dollars in future taxes without losing control of the business, upsetting your investors, or really harming yourself financially.\u00a0 What if the future tax savings was even more?<\/p>\n<p>If it is of interest, keep reading and we will outline the benefits of the Grantor Retained Annuity Trust, a little-known strategy in the estate planning\/high net worth world.<\/p>\n<p><strong><u>Key Takeaways: <\/u><\/strong><\/p>\n<ul>\n<li>Minimize future potential estate tax by reducing your estate while retaining ownership of your company.<\/li>\n<li>Flexible structures, but typically set up for the benefit of your children.<\/li>\n<li>We\u2019ve utilized this strategy with entrepreneurs of all kinds from early Google employees to AvidExchange to less well-known entrepreneurs.<\/li>\n<li>It\u2019s a complex concept but very simple to execute. So prepare to go into the weeds of estate tax planning as we tackle the basics, and a little more.<\/li>\n<\/ul>\n<p><strong><u>Entrepreneur Challenges:<\/u><\/strong><\/p>\n<p>Entrepreneurs face many hardships and must wear multiple hats inside the business.<\/p>\n<p>For startup founders, you raise capital to fund the growth. You are involved in sales, marketing, legal and HR.\u00a0 You have to work with the team to take customer feedback and constructively use it to grow the company. \u00a0You navigate payroll, hiring, regulations, and a host of other things thrown at you.\u00a0 The list is endless in the things that must be overcome to grow the business.<\/p>\n<p>Business growth is there to support current and future clients.\u00a0 Without growth, it\u2019s harder to invest into the business to provide better service, technology, products and other enhancements.<\/p>\n<p>The growth is there to provide opportunities for the current and future team.\u00a0 Company growth gives employees the opportunity to grow professionally.<\/p>\n<p>Growth also rewards investors with returns and the potential to put future capital to work in your successful business.<\/p>\n<p><em>But it\u2019s also there to support the entrepreneur, the founder.\u00a0 But typically, the list of those who benefit from the company falls in the order we just highlighted.\u00a0 Because you, the founder, have to wait so long to see the full suite of benefits of the company\u2019s growth, you leave opportunities to maximize the growth out of the picture.\u00a0\u00a0 \u00a0<\/em><\/p>\n<p><strong><u>Opportunities for Entrepreneurs (and investors in high growth companies):<\/u><\/strong><\/p>\n<p>There are, however, many opportunities for the business to help the entrepreneur and other members of his\/her team.<\/p>\n<p>One such opportunity is utilizing the provisions of the tax code \u2013 we\u2019ve written in the past about Qualified Small Business Stock (QSBS) which allows a great exclusion for capital gains of certain businesses.\u00a0 But that\u2019s not the only benefit for you.\u00a0 Congress intentionally sets up provisions of the tax code to promote certain behavior &#8211; sometimes by accident.\u00a0 And sometimes crafty professionals are the ones who figure out how to utilize the accident to benefit individual taxpayers.\u00a0 Fortunately, for entrepreneurs there are several provisions in the tax code you can utilize for yourself, family, and employees (and investors).<\/p>\n<p>One such provision in the tax code particularly useful to the entrepreneur is the Grantor Retained Annuity Trust \u2013 otherwise known as the GRAT.<\/p>\n<p>A GRAT is a great tool for individuals who own an asset expected to quickly appreciate in value, like an entrepreneur\/founder of a fast growth company.\u00a0 A GRAT is successful when the assets contributed appreciate faster than the IRS Section 7520 rate, which is currently 4.6%. The trust can be set up for the individual to receive their original contribution back by the end of the selected term, and direct who (typically children or other family members) receives the appreciation value remaining in the trust. This allows the individual to transfer assets to the next generation gift and estate tax free gift and estate tax free to the next generation.<\/p>\n<p><strong><u>Founder Concerns: <\/u><\/strong><\/p>\n<p>Founders can be understandably cautious with their stock.\u00a0 They have investors, potentially new vesting periods and other issues to navigate.\u00a0 But make no mistake, the GRAT is a commonly used vehicle in the venture backed world.\u00a0 The key provision or terminology is \u2018grantor retained\u2019.\u00a0 The grantor is you and the fact that you \u2018retain\u2019 the asset AND the control over the asset via a trust means you have NOT given up control.\u00a0 This has been tested over the years and I have yet to talk with a VC who hasn\u2019t allowed the founder or early team members to utilize it.<\/p>\n<p><strong><u>The Problem: <\/u><\/strong><\/p>\n<p>Let\u2019s take a quick look at an example of how a single GRAT may work.\u00a0 Assume a company raises $2 million at a $10 million pre-money valuation \u2013 or a $12 million post money valuation.\u00a0 The investors likely believe this can be a $100 &#8211; $150 million business in the next 5-10 years.\u00a0 If we take the long road, a year over year growth rate of about 28% for 10 years would get us to $140M \u2013 assuming no additional capital raised, dilution, etc.<\/p>\n<p>Let\u2019s assume we have two co-founders and together they own 60% of the company.\u00a0 At the end of 10 years, their shares are valued approximately $42 million each.\u00a0 That\u2019s a very good outcome.\u00a0 The downside to having all this wealth is it creates an estate tax problem for you and your heirs.\u00a0 As a result, you are going to spend countless hours with attorneys working to reduce the estate tax through complex LLCs, Trusts and other instruments.<\/p>\n<p>A GRAT (or likely a series of GRATS) allows you to plan and reduce some of the estate tax ahead of time.<\/p>\n<p>The current estate tax exemption amount \u2013 or what you can pass to heirs estate tax free \u2013 is about $13 million per person, $26 million per couple.\u00a0 Anything above that gets taxed at 40% &#8211; at the Federal level (few states have an estate tax anymore).\u00a0 However, in 2026, the current exemption expires and your exemption will be closer to $7 million per person or $14 million per couple.<\/p>\n<p>Congress has a bit of a spending problem which continues to create more deficits and larger debts.\u00a0 One way to close that gap is by increasing taxes.\u00a0 Some in Congress have even proposed lowering the estate tax exemption amount back to $2 million per person \u2013 and $4 million per couple.\u00a0 It\u2019s unlikely to happen but not completely out of question.<\/p>\n<p>So as you can see our two entrepreneurs have a current estate tax problem \u2013 which can easily become a much bigger problem.<\/p>\n<p><strong><u>The Solution:<\/u><\/strong><\/p>\n<p>Contribute company shares to a Grantor Retained Annuity Trust for a period of years (must be at least 2 years). \u00a0Since the trust owns the shares, it receives any pro-rata distributions made by the company.\u00a0 Each year the trust pays you back a portion of your contribution (shares) plus a little interest in the form of an annuity.\u00a0 Any assets remaining in the GRAT at the end of the term or years passes to the beneficiary you choose and you can dictate when and under what conditions they can access it.\u00a0 But you are the grantor (the person who established and funded the Trust) and have certain powers as such.<\/p>\n<p><u>What\u2019s the Catch:<\/u><\/p>\n<p>Grantors must outlive the term of the GRAT or all assets revert back into their estate.<\/p>\n<p>GRATs are most effective in low interest rate environments when the hurdle is low for appreciation of the contributed assets. When interest rates are high, there is the risk that the GRAT \u201cfails\u201d because the assets transferred into the GRAT grow at a rate lower than the section 7520 rate. \u00a0If that is the case, since you still receive your initial contribution back, your only loss is the cost to set up the trust.<\/p>\n<p><strong><u>Example: <\/u><\/strong><\/p>\n<p>The entrepreneur puts $500,000 of his\/her company stock into a 10-year GRAT in January 2023.\u00a0 The 7520 rate \u2013 the minimum rate you can loan money to an entity like this \u2013 is 4.6% and the business grows at 28% so the trust makes 24% per year.\u00a0 At the end of year 10, the Trust has a value of $5.9 million.<\/p>\n<p>The GRAT must repay the principal ($500,000) plus the interest (approximately $230,000) back to the founder.\u00a0 The founder gets back approximately $730,000 (principal plus interest) and the Trust gets to keep approximately $5.1 million \u2013 free from any future estate taxes.<\/p>\n<p>You wouldn\u2019t do a 10-year GRAT for a number of reasons but you could set up a series of \u2018rolling GRATs\u2019 to accomplish a similar outcome.<\/p>\n<p>But we\u2019ve frozen part of your estate and allowed the appreciation to grow outside of the business. And there are all kinds of \u2018fun and interesting\u2019 ways to do this and determine beneficiaries and future beneficiaries.\u00a0 The goal was to take something that is out of your control \u2013 future estate taxes \u2013 and put it back within your control.<\/p>\n<p>If one of our co-founders did the transaction and the other one didn\u2019t, then the estate tax equation for each would look like this.\u00a0 As you will see, this simple solution increases the amount of money left to heirs by $2 million and correspondingly reduces your estate tax by a similar amount.\u00a0 All done perfectly legal and while allowing your investors to know you are taking care of yourself but maintain control of the stock\/voting rights.<\/p>\n<p>Founder #1<\/p>\n<table>\n<tbody>\n<tr>\n<td width=\"208\"><\/td>\n<td width=\"208\">Founder<\/td>\n<td width=\"208\">GRAT<\/td>\n<\/tr>\n<tr>\n<td width=\"208\">Net Worth<\/td>\n<td width=\"208\">$37 Million<\/td>\n<td width=\"208\">$5,100,000<\/td>\n<\/tr>\n<tr>\n<td width=\"208\">Estate Tax Exemption (Couple in 2033 \u2013 10 years from now)<\/td>\n<td width=\"208\">$15 Million<\/td>\n<td width=\"208\">No Estate tax due as it was moved outside of the estate<\/td>\n<\/tr>\n<tr>\n<td width=\"208\">Estate Exposed to Estate Tax<\/td>\n<td width=\"208\">$22 Million<\/td>\n<td width=\"208\"><\/td>\n<\/tr>\n<tr>\n<td width=\"208\">Estate Tax (@40%)<\/td>\n<td width=\"208\">$8,800,000<\/td>\n<td width=\"208\">$0<\/td>\n<\/tr>\n<tr>\n<td width=\"208\">Net Estate<\/td>\n<td width=\"208\">$13,200,000<\/td>\n<td width=\"208\">$5,100,000<\/td>\n<\/tr>\n<tr>\n<td width=\"208\">Total left to heirs<\/td>\n<td width=\"208\">$18,300,000<\/td>\n<td width=\"208\"><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p>&nbsp;<\/p>\n<p>Founder #2<\/p>\n<table>\n<tbody>\n<tr>\n<td width=\"208\"><\/td>\n<td width=\"208\">Founder<\/td>\n<td width=\"208\">GRAT<\/td>\n<\/tr>\n<tr>\n<td width=\"208\">Net Worth<\/td>\n<td width=\"208\">$42 Million<\/td>\n<td width=\"208\">$)<\/td>\n<\/tr>\n<tr>\n<td width=\"208\">Estate Tax Exemption (Couple in 2033 \u2013 10 years from now)<\/td>\n<td width=\"208\">$15 Million<\/td>\n<td width=\"208\"><\/td>\n<\/tr>\n<tr>\n<td width=\"208\">Estate Exposed to Estate Tax<\/td>\n<td width=\"208\">$27 Million<\/td>\n<td width=\"208\"><\/td>\n<\/tr>\n<tr>\n<td width=\"208\">Estate Tax (@40%)<\/td>\n<td width=\"208\">$10,800,000<\/td>\n<td width=\"208\">$0<\/td>\n<\/tr>\n<tr>\n<td width=\"208\">Net Estate<\/td>\n<td width=\"208\">$16,200,000<\/td>\n<td width=\"208\">$<\/td>\n<\/tr>\n<tr>\n<td width=\"208\"><\/td>\n<td width=\"208\">$16,200,000<\/td>\n<td width=\"208\"><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<!-- AddThis Advanced Settings generic via filter on the_content --><!-- AddThis Share Buttons generic via filter on the_content --><\/div><\/div>","protected":false},"excerpt":{"rendered":"<p>Summary: What if you could save $2 million dollars in future taxes without losing control of the business, upsetting your [&hellip;]<!-- AddThis Advanced Settings generic via filter on get_the_excerpt --><!-- AddThis Share Buttons generic via filter on get_the_excerpt --><\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[55],"tags":[],"_links":{"self":[{"href":"https:\/\/williambissett.com\/wp-json\/wp\/v2\/posts\/1738"}],"collection":[{"href":"https:\/\/williambissett.com\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/williambissett.com\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/williambissett.com\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/williambissett.com\/wp-json\/wp\/v2\/comments?post=1738"}],"version-history":[{"count":4,"href":"https:\/\/williambissett.com\/wp-json\/wp\/v2\/posts\/1738\/revisions"}],"predecessor-version":[{"id":1828,"href":"https:\/\/williambissett.com\/wp-json\/wp\/v2\/posts\/1738\/revisions\/1828"}],"wp:attachment":[{"href":"https:\/\/williambissett.com\/wp-json\/wp\/v2\/media?parent=1738"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/williambissett.com\/wp-json\/wp\/v2\/categories?post=1738"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/williambissett.com\/wp-json\/wp\/v2\/tags?post=1738"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}