Investors are focusing on Facebook’s FB 0.00% offering price as the company prepares to go public as soon as next week.

Tax specialists are paying attention to something else: how half a dozen of the firm’s luminaries, including founder Mark Zuckerberg, appear to be using a perfectly legal maneuver called a grantor-retained annuity trust, or GRAT, to avoid at least $200 million of estate and gift taxes on their own Facebook shares.

“I’m not surprised the Facebook insiders have chosen to use GRATs,” says John Bergner, a gift-and-estate tax expert at the Winstead law firm in Dallas. He calls the strategy “an excellent way to shift wealth to others at little or no tax cost and with minimal legal and economic risk.”

Facebook’s prospectus cites eight separate “annuity trusts” set up by insiders Dustin Moskovitz, Sean Parker, Sheryl Sandberg, Reid Hoffman, Michelle Yee (Mr. Hoffman’s wife) and Mr. Zuckerberg over the past four years. All told, these trusts hold about 22 million shares that will be worth more than $690 million if Facebook goes public at $31.50 a share, the middle of its projected range.

Spokesmen or representatives for the six shareholders declined to comment on these trusts, or were unavailable. But Mr. Bergner and others—including Howard Zaritsky, a lawyer and estate expert in Rapidan, Va.—say they feel safe assuming the “annuity trusts” are GRATs, based on their knowledge of the territory and the language in Facebook’s prospectus.

“GRATs offer a perfect vehicle for wealthy investors who put money in start-ups, while other trusts don’t,” Mr. Zaritsky says.

And Facebook offers a good vehicle for explaining GRATs, one of several legal but arcane techniques the truly wealthy can use to sidestep estate and gift taxes.

In essence, these trusts transfer asset appreciation from one taxpayer to others, virtually tax-free.

The benefit can be huge. If the Facebook insiders didn’t use GRATs for those shares, but held them until they died or gave them away to friends or relatives after the offering, then the gift or estate tax owed on the shares would be more than $200 million. (This calculation assumes a $31.50 share price and the current top gift- and estate-tax rate of 35%; rates are scheduled to rise to 55% next year.)

A successful GRAT requires several ingredients: a person worth millions—or potential millions—who wants to avoid gift or estate tax and is willing to part with assets to do so; an asset that will rise in value while in the trust; and, if possible, low interest rates.

With these elements in place, the taxpayer sets up a GRAT with a set term of two years or longer and gives the asset to it before its value surges. Set-up costs include appraisal and legal fees.

Over the life of the trust, the person who set it up gets annual payments adding up to the asset’s original value plus a return based on a fixed interest rate determined by the Internal Revenue Service. That is currently 1.6%, near a record low.

Meanwhile, ideally, the asset soars in value, and that growth is outside of the grantor’s estate. When the GRAT’s term ends, the asset goes to the beneficiaries—usually into another trust set up for their benefit.

The result: no gift or estate tax on the appreciation, even though it has been transferred.

Here is an example, using figures from the Facebook offering document: Messrs. Zuckerberg and Moskovitz each disclosed “annuity trusts” holding 3.4 million and 14.4 million Facebook shares, respectively. The value of each share when the trusts were set up was less than $1.85, according to the prospectus.

After contributing their stock to the GRATs, the two founders would, over time, take payments equal to the original value of the gift plus a small return, Mr. Bergner says. Without knowing information that’s unavailable—such has how long the trusts will run or exactly how they are structured—it’s impossible to say what payments have already been or will be made.

But it is possible make an educated guess as to the appreciation that’s being shifted from the two founders’ estates. Mr. Bergner says that given a $31.50 share price, a conservative estimate of it is $29 per share, or about $100 million for Mr. Zuckerberg and more than $415 million for Mr. Moskovitz.

At current top rates of 35%, that means estate-and gift-tax savings of about $35 million for Mr. Zuckerberg and $150 million for Mr. Moskovitz. Other Facebook insiders and investors appear to be saving $20 million or more with their GRATs.

What if by some chance Facebook stock tanks? The stock would then be returned to the original owner.

“The person who sets up the GRAT is not really worse off, because he paid little or no tax in the first place,” Mr. Zaritsky says. “Either he wins or it’s a tie—except for the lawyer’s fees.” The principal risk with a GRAT is that the owner will die before the term is up, which isn’t likely in this case.

That, in a nutshell, is why the Facebook insiders would find it useful to put some of their shares in grantor-retained annuity trusts.

One question remains: Neither Mr. Zuckerberg nor Mr. Moskovitz appears to have children. So who are these trusts’ beneficiaries? Mr. Bergner says it is possible to name unborn children—as well as future spouses and current friends or relatives—as beneficiaries of a GRAT.

“There’s a window of opportunity here,” Mr. Bergner says, “and it’s good to use it.”

 
Al Gibbons is the past President of the Philadelphia Estate Planning Council and Recipient of their 2005 Distinguished Estate Planner Award.

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