The Hidden Ways the Ultrarich
Pass Wealth to Their Heirs Tax-Free
An inside look at how Nike founder Phil Knight is giving a
fortune to his family while avoiding billions in U.S. taxes.
By Ben Steverman, Anders Melin, and Devon Pendleton
Illustrations by Chris Nosenzo
October 21, 2021, 12:00 AM GMT+1
Sitting in the bleachers by the University of Oregon’s
running track, Nike Inc. founder Philip Knight offered the sort of lofty
promise many other super rich Americans have made over the past decade. The
bulk of his money, he told CBS News that day in 2016, would be given
away—eventually. “By the time the lives of my children and their kids run out,
I will have given most of it to charity,” he said. What Knight didn’t mention
was that, for years, he’d been using a range of legal techniques to ensure his
heirs keep control of most of his assets and profit from them in the process,
quietly transferring vast piles of money in a textbook example of how the rich
avoid taxes.
Knight is now 83, and since founding Nike in 1964 he’s built
a fortune worth about $60 billion. He’s hardly the only American billionaire to
take advantage of lawful tax-avoidance tricks—filings show JPMorgan Chase
& Co. Chief Executive Officer Jamie Dimon, Zoom Video Communications Inc.
founder Eric Yuan, and many others employ such tools. The family of Walmart
Inc. founder Sam Walton pioneered one of the techniques Knight appears to have
used. But because Nike is publicly traded and both Knight and his surviving
son, Travis, play roles on the company’s board and must report their stock
transactions, theirs is the rare case that can be examined in detail from
public filings, exposing a process that’s usually shrouded in secrecy.
Bloomberg Businessweek identified about $9.3 billion in Nike shares and other
assets Knight has moved to his descendants, starting in 2009. The full total
could be more.
“It’s a perfect case study in how the major estate tax
loopholes work in tandem and how the estate tax is entirely avoidable,” says
Robert Lord, a tax attorney in Arizona and a consultant for Americans for Tax
Fairness, an advocacy group. Lord brought the transactions to Businessweek’s
attention. Knight’s representatives declined to comment on them, beyond saying they
were integrated into his philanthropic strategy.
The U.S. started collecting estate taxes in 1916, levying a
10% rate on fortunes of $5 million (roughly $125 million today) or more. The
top rate steadily rose, to 77%, where it remained until the late 1970s. Then
rates began to fall, and at the turn of the 21st century critics of the estate
tax and the related gift tax started to score some major wins. During the
George W. Bush administration, Republicans successfully whittled away at the
levy by cutting the top rate and lifting the lifetime exemption for the
taxes—the total amount anyone can leave to heirs tax-free. President Donald
Trump doubled the exemption for eight years starting in 2018, so for the moment
only married couples leaving $23 million or more to their heirs need to worry
about estate and gift taxes at all. Last year the taxes brought in only $17.6
billion, out of $3.4 trillion in federal revenue, according to the U.S.
Department of the Treasury. Their decline is one of many factors that have
contributed to a dramatic increase in wealth at the top, helping make the 20
richest Americans, including Knight, worth a combined $1.9 trillion, according
to the Bloomberg Billionaires Index.
The past decade of record-low interest rates, rising asset
prices, and ever-looser tax rules has made this an historically ideal time for
the top 0.1% to pass wealth to their heirs. These trends have turned once-minor
loopholes in the tax code into gaping flaws. In Knight’s case, the tax savings
from a sophisticated estate plan were magnified by a remarkable rise in
Nike’s stock, which rode a surge in online sales to climb about 1,000%
over the past 12 years and bring the company’s valuation from $25 billion
to $250 billion.
First, Knight
cycled millions of Nike shares through a series
of trusts that effectively moved billions of dollars’ worth of stock price
gains from his estate to his heirs, tax-free. Then he put most of his
remaining shares into a vehicle called
Swoosh LLC and let a trust controlled by his son, Travis, purchase a
stake at a big discount. The chain of trusts let hundreds of millions of
dollars in dividends flow to Knight’s heirs with him covering the income taxes.
All this planning also ensured his family would retain control of his sneaker
empire.
Such moves almost always happen in strict secrecy. The
wealthy merely need a lawyer to draw up some documents. The IRS might not
review transactions until decades later, when the giver dies and an estate
tax return is due. That’s if the agency, underfunded and short on specialists,
even looks in the first place. “I’ve had estate tax audits basically handled by
receptionists in some offices,” says Edward Renn, a partner at Withers law firm
who’s based in New Haven.
Formerly, when it became clear that wealthy taxpayers and
their advisers had found a blatant loophole, Congress would close it. In recent
decades, lawmakers have preferred to keep them open, but legislation put
forward by congressional Democrats would seek to plug most of the ones Knight
has taken advantage of. Even modest reforms to an estate tax now paid by fewer
than 1 in 1,000 Americans at death could, in theory, serve as a check on
intergenerational inequality, taking a 40% bite from transfers of fortunes that
might not otherwise be taxed. “If you’re interested in taxing wealth,” says
Columbia law professor Michael Graetz, “the estate tax is the only mechanism
the federal government now has.”
To get ahead of the possible changes, the super rich are rushing
to set up trusts and transfer assets to heirs while they still can, as
lobbyists representing their interests work to maintain the status quo.
The foundation of Knight’s strategy is the grantor-retained
annuity trust, or GRAT. His first step was to set up nine GRATs,
which successfully transferred Nike shares now worth $6.1 billion to heirs
tax-free from 2009 to 2016. Two other GRATs that show up in public filings
received about $970 million of unspecified assets from Knight. The filings
don’t disclose the ultimate beneficiaries, but Lord says that, based on how
family wealth transfers usually work, they might include the family of Knight’s
late son, Matthew, who died in 2004.
Officially, gifts are taxable: If you send someone more than
$15,000 per year, you’re supposed to file a separate gift tax return, with the
total counting toward your $11.7 million lifetime estate-and-gift-tax
exemption. (Double that for married couples.) Once you reach that threshold,
you must pay a 40% levy. But giving heirs the right to profit, risk-free, from
your investments? Not a taxable gift if you route it through a GRAT. “It
looks like the heirs didn’t receive anything of value, but in fact they have
been given all of the upside growth potential,” says Ray Madoff, a law professor
at Boston College.
Lets heirs profit from an asset they don’t technically own, paying
an annuity back to the wealthy person who set it up—the grantor—and thereby
avoiding having the funds designated as a taxable gift.
1. Set up a GRAT (or have your lawyer do it) and make your
heirs the beneficiaries.
2. Put in assets, such as stocks, that have a good chance of
making money over time. Technically this isn’t a taxable gift, as long as the GRAT is
set to repay you the initial value of the assets in the form of an annuity,
usually over two or three years.
3. If the assets go up in value during this period, the gains
can stay in the GRAT, minus a (usually low) minimum rate tied to interest rates.
Whatever’s left goes to the heirs tax-free.
4. If the assets drop in value during that time, your heirs
are unaffected. You can pretend the GRAT never existed and try again. The more
GRATs you set up—and some of the ultrarich open one monthly—the higher the
chance some will succeed.
DID YOU KNOW? In an August survey of filings from 70
randomly selected S&P 500 companies, more than half had executives and top
shareholders who used GRATs. The total value of shares in those GRATs: more
than $12 billion. In one example, Dimon shuffled JPMorgan shares now worth $127
million into and out of GRATs in November 2020.
GRATs and other such tools have the basic goal of making
wealth look much smaller than it really is. It’s possible to have your gifts
appear to be worth almost nothing, even as you move millions or even billions
of dollars tax-free. The giver merely retains a promissory note—basically
an IOU that sees the trust agree to pay back the gift’s value over time. Smart
businesspeople ordinarily wouldn’t hand over a valuable asset in exchange for
something as flimsy as an IOU, but the rules let advisers construct the legal
fiction that this is a normal transaction and not a taxable gift to the trust.
After routing a fortune through GRATs, Knight put much of
his remaining Nike shares into Swoosh
LLC, which exploits a loophole President Barack Obama tried to close in his
final days in office. Called the minority valuation discount, it takes advantage of
rules allowing taxpayers to take discounts on assets that are harder to sell.
If you have a 25% stake in a $100 million private company, for example, it’s
probably not worth its theoretical value on the open market: To actually turn
it into $25 million, you’d need to persuade other shareholders to buy you out
or to sell the entire company, then get full price for your stock.
To exploit the loophole, wealth advisers intentionally put
their clients’ assets in structures that seem to make them harder to sell. If
you own an apartment building, for
example, you might put it in an entity whose ownership is split among trusts
for various family members. Each trust looks like it lacks control of the
building, which lets you tell the IRS that the sum of the slices is worth less
than the unified whole.
Or you do what Knight did: Take publicly traded stock such
as Nike shares and put it in an LLC, then divide that up between yourself and
your heirs in a way that qualifies for a discount, minimizing your own tax bill
while passing more assets onto heirs. Knight put the bulk of his Nike shares
into Swoosh in 2015. The following year, Travis’s trust purchased a slice of
Swoosh that effectively put him in control of Nike, according to Nike’s annual
report. The 48-year-old filmmaker got a 15% discount on the company’s stock
price at the time, delivering a $215 million tax-free gift from father to son. In
addition to part of Swoosh, the trust (which also benefits a broader array of
family members) holds $6.5 billion worth of shares, including those that left
Knight’s estate through GRATs.
Tax-Dodging Tools of the 0.1%
The Minority Discount
Artificially deflates the value of your asset by splitting
it among separate owners.
1. Take almost any kind of investment—a private company you
own, a piece of real estate, a stock portfolio—and put it in an LLC or another
legal entity.
2. Divide the LLC into pieces and spread it among your heirs
or trusts created on their behalf.
3. Claim that the combined value of the pieces is less than
the value of the whole, because no one entity controls the entire investment.
Some advisers insist that their client’s stake is worth 30% to 40% less than it
would otherwise be, with bigger discounts for smaller stakes lacking voting
power over the LLC.
4. Later—perhaps after you die—your family can get together
and sell the entire asset on the open market and profit from its real,
nondiscounted value. This works even for an LLC containing publicly traded
shares that, if they hadn’t been locked up in the LLC, could easily have been
sold off for their full value.
DID YOU KNOW? The family of Thomas Frist Jr., co-founder of
hospital chain HCA Healthcare Inc., holds its 22% stake in HCA through an
entity called Hercules Holding II. His three children own pieces of Hercules
through various trusts. The family has at least $500 million worth of HCA
shares in GRATs and $18.2 million in a generation-skipping tax-exempt trust.
Knight’s estate planning is “very artfully done,” Lord says.
The attorney, whose tax work once included helping clients use loopholes, until
he grew concerned about rising wealth inequality, first ran across filings in
May showing Knight’s transactions. Each filing alone looked relatively
innocuous, but when Lord put them all in a spreadsheet he quickly realized he’d
found something significant: The number of Nike shares Knight ran through GRATs
matched those that ended up in a trust that had also become the destination for
Swoosh shares. “I’ve never seen anything like this, where you can put it
together,” Lord says.
GRATs fit into a category of trusts called intentionally
defective grantor trusts. They’re useful to the wealthy because when the assets
they hold increase in value and are sold, their creator, not their beneficiary,
is taxed for the gains. In effect they let rich parents pay income taxes for
their children. This loophole, like others, came about in an effort to close a
different one. Formerly, when the wealthy paid much higher income tax rates
than they do now, they’d hide income by routing it through multiple trusts that
owed lower rates. Lawmakers in the 1950s responded by making those trusts
“defective,” taxing whoever set them up instead, usually at the highest rate.
But although that closed the income tax loophole, advisers later realized their
clients could avoid the estate and gift tax by setting up an “intentionally
defective” trust with their descendants named as beneficiaries. Knight’s
regulatory filings don’t disclose exactly how much his heirs may have benefited
from this feature, but Businessweek estimates the total could be more than $140
million.
An era of low rates has made tactics like these especially
lucrative. The IRS requires that swaps of assets into trusts be structured
somewhat like loans, and it sets minimum rates based on government bond
yields. For Knight, low rates meant that Nike’s dividend, which has since
2009 delivered $380 million to trusts ultimately benefiting his heirs, would
easily cover interest payments on his transactions, Lord says.
Mark Wolfson, a managing partner of investment adviser
Jasper Ridge Partners who counsels Knight on philanthropy and estate planning,
says the billionaire’s transactions “are integrated with Mr. Knight’s
philanthropic strategy. For example, the trusts include charitable
beneficiaries, and most of Mr. Knight’s assets are expected to be transferred
to charitable organizations.” An estimated $50 billion remains in Knight’s
estate, according to the Bloomberg Billionaires Index, and would be taxable
when he dies, assuming he doesn’t have a plan to avoid those taxes, too.
Given his philanthropic goals, one remaining option would be
a charitable
trust, which can wipe out an entire estate tax bill. Charitable
trusts—and specifically split-interest charitable
trusts—can work a bit like GRATs, in that they also give heirs the
chance to profit on the trust’s investments and are most effective when
interest rates are low. The key difference, of course, is that they must
also donate funds to a family foundation or another charity. According to
IRS data, Knight already has one charitable trust, which contained assets worth
$889 million in 2019.
Tax-Dodging Tools of the 0.1%
The Split-Interest Charitable Trust
Wipes out tax bills by placing assets in trusts that are
directed toward philanthropy while also benefiting you and your family.
1. Set up what the IRS calls a split-interest trust,
so-named because its proceeds are divided between charitable and noncharitable
beneficiaries. These come in a few different flavors. The charitable lead trust is especially
useful for erasing estate taxes when interest rates are low.
2. Place assets in the trust. This transaction doesn’t
trigger estate or gift taxes as long as you follow IRS rules. A charitable lead
trust, for example, must pay small amounts to charity annually over a set
period, often 10 or 20 years, but can then give the rest to your heirs tax-free.
3. Invest your trust in more aggressive assets, such as
stocks, because your heirs will benefit from any upside. The size of your tax
deduction is based on IRS estimates of how much is likely to go to charity over
the life of the trust—calculations based on interest rates at the time you
donate the money. If your trust’s investments beat those assumptions, something
that’s especially easy to do in low-interest-rate environments like the current
one, your heirs can end up with as much as or more than you originally placed
in the trust.
4. While your trust must donate to charity, the funds don’t
need to get there quickly. They can flow into pots of money you control,
including a family foundation (which can pay as little as 5% per year to
nonprofit causes) or a donor-advised
fund (a more flexible charitable vehicle that has no such requirement
whatsoever).
Even though Knight escaped billions of dollars in gift
taxes, he could have avoided even more. “If Knight wanted to move the entire
estate to his kids free of estate tax, he could have easily done it,” Lord
says. Knight could have put far more in GRATs to start with, for example, and
set up far more of them (though his charitable goals might have rendered such
efforts unnecessary).
For the first time in decades, the most lucrative estate tax
loopholes are under serious threat. The proposal House Democrats passed through
the Ways and Means Committee in September would cut the lifetime exemption in
half, to about $12 million for a married couple, and it explicitly targets
minority discounts and grantor trusts, including GRATs. Existing trusts,
including Knight’s, would be allowed to keep operating.
The proposal would also limit the effectiveness of dynasty trusts,
a powerful and increasingly popular tool that allows a fortune to propagate to
multiple generations tax-free. IRS rules require that wealthy families pay
estate or gift taxes for each generation the money passes through—so, for
example, a $100 million gift from a rich couple to their grandchildren gets
taxed twice. But to appeal to the wealth management industry, certain
states—notably Alaska, Delaware, Nevada, and South Dakota—changed their rules
to allow for the creation of dynasty trusts, which can last forever and
allow multiple generations of heirs to live off the family fortune tax-free. (Wolfson
says Knight’s trusts don’t fit this category.)
Tax-Dodging Tools of the 0.1%
The Dynasty Trust
Allows a family fortune to do what even the richest
billionaire can’t: live forever, by preserving wealth for distant generations.
1. File to open a trust in a state such as Delaware
that’s abolished the long-standing tradition of requiring trusts or other legal
arrangements to have an expiration date. You don’t need to live in one of these
states to take advantage of its looser rules.
2. Get enough assets into the trust to provide for multiple
generations of heirs, starting with a relatively small amount to avoid
triggering a big tax bill. Trump’s tax reform established the current tax-free
ceiling of $11.7 million, or $23 million for a married couple.
3. Once you’ve seeded your dynasty trust, set up transactions
between it and other entities you control, including GRATs or your own bank
or investment accounts. These deals should appear, on paper, to be legitimate
deals, but the terms can be as generous as possible. A dynasty trust might
“buy” an investment from you for only 10% of its value, with a promise to pay
back the rest eventually. There’s no limit on how big the trust can get.
DID YOU KNOW? An Amazon.com Inc. Securities and Exchange
Commission filing showed that at the end of 1998, Jeff Bezos’ mother and
stepfather, Jackie and Miguel Bezos, held 112,500 shares in a “generation
skipping” trust set up two years earlier. Those shares, potentially held for
Jeff Bezos’ children and any nieces and nephews, are worth $2.3 billion today,
adjusted for stock splits.
If the most popular routes around the estate tax are
ultimately blocked, charitable trusts might become one of the few remaining
ways for a large fortune to avoid being taxed at a 40% rate when passed from
generation to generation. To date, Knight has focused his philanthropy on only
a few institutions, such as Stanford, where he went to business school, and the
University of Oregon, where he was an undergraduate and ran track more than 60
years ago.
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