I recently invested $50,000 in a pre-IPO company. Is it too late to transfer this purchase into a GRAT?
-- Allan Zolin
It's not too late to put your investment into a grantor retained annuity trust, or GRAT. But the closer the company gets to its initial public offering, the harder time you'll have convincing the
Internal Revenue Service
that your investment shouldn't be valued at the initial offering price, which may be higher than your original investment cost.
If the company is discussing an IPO, odds are it's talking to investment bankers -- the guys who help determine the opening-day share price. As soon as that pricing process starts, your shares take on a new value. At that point, you'll have difficulty convincing the IRS the ground-floor price of your original shares is still valid when the bankers think the stock is going to debut at a much higher price.
If you think this will become an issue for you, the only way to win this valuation argument with the IRS is to hire a third party to value your investment as it is right now, suggests Richard Van Benschoten, a senior associate at
Cowen Financial Group
In addition, putting assets into a GRAT works best when assets are at their cheapest. When you transfer an asset to a GRAT, you are essentially transferring your investment into an annuity and paying yourself back with interest. Any additional earnings your investments make above that interest rate will be passed on to your beneficiaries without estate or gift tax.
The smaller the value of the investment you put into the GRAT, the greater the odds that it will appreciate enough to make the move worthwhile. For the nitty-gritty on GRATs, check out this recent
More on Foreign Withholding
Based on two excellent "Global Tax Forum" articles that you wrote in mid-1999, I told my sister (a nonresident alien from a country with no tax treaty with the U.S.) that a brokerage account opened here in the U.S. will be exempt from U.S. capital gain taxes. She just opened an account at Fidelity and was told that the account is subject to 30% withholding on dividends and short-term capital gains. Is this a change in tax legislation since your last article, or is this a Fidelity misinterpretation of the tax code? Or did your article only mean long-term capital gains? -- Mario C. Lega
In general, a nonresident alien -- someone who isn't a citizen of the U.S. and doesn't have a residence here -- pays no taxes on capital gains, short- or long-term. (Check out this previous
Tax Forum for more on nonresident aliens and brokerage accounts.)
On the flip side, dividends
taxable to nonresident aliens. The tax is usually withheld at a 30% rate before the dividend is distributed to a foreigner.
I think this taxation of dividends is the root of your sister's problem.
When a mutual fund manager sells shares of stocks in a fund, the fund incurs capital gains. All capital gains must be passed on to the shareholders, regardless of citizenship.
If the fund incurrs long-term capital gains, they are passed on to the shareholders as long-term capital gains. No problem there. But when a fund passes on short-term capital gains, they get rolled up with dividends into one big distribution. For U.S. citizens, it doesn't matter because we pay ordinary income tax on both.
But for nonresident aliens, this poses a problem. If your sister has mutual funds that make dividend distributions, she'll pay tax on everything that comes with the dividend -- even short-term capital gains. (See this previous
Global Tax Forum for more details on nonresident aliens and mutual funds.)
She may be able to get a refund for these extra taxes paid, provided her
-- the form that reports the mutual fund's dividend distribution -- breaks out short-term capital gains and dividends, says Alicia Afalonis, an editor at the
, an information provider to tax professionals.
If so, your sister can apply for a refund for the amount of tax she paid that pertained to those short-term capital gains by filing a
-- U.S. Nonresident Alien Income Tax Return
. It's important to enclose both the Form 1099 and a statement explaining why she is eligible for the refund.
Filing a tax return just for a refund can be very time-consuming, so be sure it's worth the effort.
Send your questions and comments to
firstname.lastname@example.org, and please include your full name. Tax Forum appears Tuesdays, Thursdays and Saturdays.
TSC Tax Forum aims to provide general tax information. It cannot and does not attempt to provide individual tax advice. All readers are urged to consult with an accountant as needed about their individual circumstances.