A Bit of Nuance Regarding Governor Romney’s Charitable Remainder Trust

I received informative emails in response to yesterday’s post regarding a Bloomberg news investigation finding that Mitt Romney employed a charitable tax avoidance device that has since been eliminated by the IRS. 

Both Russel Willis from Portland, Oregon and William Gray from Richmond, Virginia wrote that the Bloomberg report — and I — had missed some important nuance.  Attorney Gray’s explanation was quite detailed, so for the tax junkies among you, I will quote it in full:

“CRTs were authorized by Congress in1969 as part of the major revision of the EO rules that carved out privatefoundations from the universe of charities for special treatment.  Infact, funding a CRT is one of only nine ways that one can get a charitablecontribution for giving away less than one’s entire interest in anasset.  Pursuant to IRC sec. 664, the trust pays one or more designated beneficiarieseither a fixed dollar amount or a fixed percentage of the trust asset valueannually for life or a term of years, and then whatever is left in the trust isdistributed to one or more designated charities.  The grantor is eligiblefor an income tax deduction under IRC sec. 170(f)(2) based on theactuarial value of the remainder interest, discounted to reflect the term ofthe trust, the income payout rate, IRS assumed interest rates,etc.  Comparable deductions are available for gift, estate and GSTtax purposes. 

CRTs are useful planning tools forindividuals who would like to make a gift to charity and receive a currentdeduction but who also want to reserve a stream of income for themselves orothers.  CRTs also are tax-exempt trusts, so donors can fund them withappreciated assets and avoid any capital gain tax when the CRT sells theassets, leaving the CRT with $1.00 to invest rather than the $0.80 or less thedonor would have had if s/he had sold the asset and then given or invested theproceeds.  In the late ’80s or early ’90s, aggressive planners began tofocus on this capital gain avoidance feature, whether or not their clients hadany real charitable intent.  Using a creative reading of the trustdistribution rules, they designed short-term, high-payout CRTs (e.g., atwo-year trust with a 80% annual payout) that allowed the donor to recoversubstantially all of the value of appreciated assets with little or no capitalgain tax liability.  In 1997 Congress determined that these”accelerated CRTs” were abusive and inconsistent with thepurpose of the CRT rules, so it amended IRC sec. 664 to limit annual payouts to50% and to require that the charitable remainder have at least a 10% actuarialvalue.    

I have not seen the terms of theRomney CRT, but the Bloomberg description indicates that it was not anaccelerated CRT but instead was intended to last for the Romneys’lifetimes.  As a “unitrust”, it pays 8% fixed percentage of theannual trust value rather than a fixed dollar amount.  While 8% may seeman aggressive payout by today’s standards, I note that the IRSassumed interest rate for June 1996, when the CRT was created, was8%.  The relatively low charitable deduction allowed (coincidentally alsoabout 8% according to the article) would have resulted primarily from the factthat the designated charity was likely to have to wait 30-40 years orlonger before the trust would terminate.  

The dwindling value of the trust, asreported in the Bloomberg article, may be largely a result of the trustee’sinvestment performance and subsequent economic conditions.  An 8% growthassumption, used in the actuarial calculation, has proved not to be realistic;and many CRTs established in the ’90s have seen their values declinesignificantly.  I note that the unitrust form allocates declineproportionately between the income beneficiaries and the charity, while the”annuity trust” form, the other permissible variety of CRT, wouldhave placed all of the burden on the charitable remainder since an annuitytrust is obligated to pay the income beneficiaries a fixed dollar amountregardless of how much the underlying principal value declines. 

The Bloomberg article is misleadingin implying that this trust was the type of abusive technique that led tothe 1997 restrictions on CRTs or that all CRTs are somehow suspect orabusive.  The Blattmachr comments contribute to that impression becausethe article does not make clear that they refer primarily the short-lived andabusive “accelerated CRTs”.  I have no grounds for speculatingon what combination of financial, tax and charitable considerations motivatedthe Romneys; but I can say that the type of CRT described is one thatreputable planners might have recommended to their charitably-minded clients in1996.  As the article admits at one point, it was “legal andcommon among high-net-worth individuals.” 

TAK