Probate & Trust Law Section Conference Manual ... - Minnesota CLE

in the transferred NQSOs. As a result, at least
through the point of exercise, a gift of NQSOs
delivers the entire option spread to the donee, unlike
gifts of other appreciating assets, where the tax
liability on unrealized gain shifts to the donee.
Once the options are in the hands of the
donee, it is the donee who decides when the options
will be exercised. This can be problematic for the
donor, especially where the donor is a senior
executive of the issuing company. This is one of the
reasons why option gift strategies often involve
intervening trusts.
3. Gifts to Irrevocable Trusts. Just as gifts
of other assets are often made to trusts instead of
directly to the intended beneficiaries, gifts of
NQSOs often follow a similar pattern. The impetus
for such a decision is the desire to place the ongoing
control and management of the transferred assets in
the hands of a trusted individual or institution. This
issue is particularly sensitive where NQSOs are
involved and the donor has a significant presence in
the issuing company. Placing control over the
exercise of the NQSOs in a trustee often gives the
donor more comfort – e.g., that the options won’t be
exercised at an inappropriate time or manner and
that any sale of the resulting stock will be handled
with appropriate sensitivity.
The gift and income tax consequences of a
gift of NQSOs to an irrevocable trust are similar to
those described in the preceding section. The one
exception is where the trust is created as a grantor
trust (i.e., where the grantor is treated as the owner
of the trust for income tax purposes). Since Section
83 attributes to the grantor any compensation
income triggered by the exercise of the NQSOs,
grantor status for the trust has little practical effect
until after the option exercise. 7 Of course, having
grantor status can enhance the transfer tax benefits
7 Note that the 2004 final ISO regulations provide that
ISO status is not forfeited if the employee transfers an
ISO to a grantor trust and is considered the “sole
beneficial owner of the option while it is held in the trust”
under the Code and applicable state law. While the
meaning of this provision is not entirely clear, it probably
applies only to grantor trusts where the grantor is the sole
current beneficiary of the trust, not just the owner for
income tax purposes. Such a trust would not yield the
kind of transfer tax benefits usually sought when donor’s
transfer options during life. However, it would provide
certain probate avoidance benefits in jurisdictions, such
as California, where revocable trusts are used for that
purpose.
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of the transfer plan, since the donor’s ultimate estate
will be reduced not only by the value of the
resulting stock, but also by the taxes that are
incurred on any sale thereof.
4. Gifts to GRATs. 8 Gifts to grantor
retained annuity trusts (GRATs) offer significant
transfer tax benefits with little or no gift tax
exposure. The idea is to transfer NQSOs to an
irrevocable trust bestowing an annuity on the donor,
which constitutes a “qualifying interest” under
Section 2702(b). After the donor’s annuity is paid
in full, any remaining trust assets usually pass to the
donor’s descendants or to a trust for them. If
properly planned and executed, the transfer shifts to
remaindermen that portion of the overall investment
return that exceeds Section 7520 rate in effect at the
time the GRAT is created. Of course, options can
actually drop in value (and even become worthless)
during the option term. In such event, the
remaindermen receive nothing, but the donor is in
no worse position (except for transaction costs) than
if the GRAT were never established. Moreover,
since there is little or no gift tax on the transfer to
the GRAT, the donor retains his/her remaining
unified credit even if the investment results don’t
pan out.
Because the GRAT is a grantor trust, the
initial transfer of NQSOs in exchange for a stream
of annuity payments is ignored for income tax
purposes. Moreover, using the NQSOs to fund
annuity payments is similarly ignored. 9
Consequently, no income tax liability results from
the funding of the trust or the payment of the
annuity with NQSOs. Each time an annuity amount
is paid with NQSOs an additional appraisal is
required. However, it may be possible to arrange
these additional appraisals for a reduced cost when
8 Funding GRATs with stock options may be a patented
method protected by U.S. Patent No. 6,567,790, assigned
to WEALTH TRANSFER GROUP, LLC of Altamonte
Springs, Florida. Please refer to the U.S. Patent and
Trademark Office website at “www.uspto.gov” and/or
consult your attorney for more information.
JPMORGAN CHASE BANK is in no way affiliated with
WEALTH TRANSFER GROUP, LLC. This notice is
being provided for informational purposes only and does
NOT constitute an endorsement of WEALTH
TRANSFER GROUP, LLC or any of WEALTH
TRANSFER GROUP, LLC's services or products.
9 Under the rationale of Rev. Rul. 85-13, 1985-1 C.B.
184, any transaction between the grantor and a grantor
trust (which generally includes a GRAT) is ignored for
income tax purposes.