Maybe you’ve heard: Bloomberg News reports that Romney escaped taxation on some of his income by donating it to the Church, only that he donated less than he said he did, only that he didn’t have to donate as much as he said he would, or something like that.
Confused? Fair enough. I’ll try to walk through what happened (though estate tax isn’t really my specialty, and I haven’t ever worked with a charitable remainder unitrust (“CRUT”).
A CRUT is an irrevocable trust. What that means, essentially, is that it is a legal entity that an individual can form. As a legal entity it can own property. And a CRUT’s principal purpose is to own (and to distribute) property. In order to qualify as a CRUT, a trust must be set up to pay a fixed percentage of its assets to one or more beneficiaries.1 Upon the beneficiaries’ death, whatever is left in the trust is paid to a designated charity.
Clear? Not entirely? Okay, how about this: I decide to form a CRUT (and am significantly wealthier in this hypothetical world than I am in the current one). I form the trust and contribute stock that is currently worth $1 million. I set it up to pay me 10% of its value every year and, on my death, whatever is left will go to Loyola University Chicago, where I teach.
If, at the end of year one, the assets have not appreciated, I will receive $100,000 from the CRUT, and it will be left with $900,000. At the end of year two, with still no appreciation,2 I get $90,000 and the CRUT has $810,000 left. Etc. Assuming I die after year 3, Loyola will get $729,000.
Note that, over the course of the three years, I’ve received $271,000. How am I taxed on that amount?
In this case, I’m not, because the CRUT hasn’t earned any money–I’m basically getting distributions of my initial contribution back.
But if the CRUT earned money, I’d be taxable on that money. Assume, in year one, that the CRUT had earned $50,000 of interest and $50,000 of long-term capital gains. Note that now the CRUT has assets of $1.1 million, meaning I get a distribution of $110,000 (my 10%). The first $50,000 are taxable to me as ordinary income, the next $50,000 as long-term capital gain, and the final $10,000 won’t be taxable to me (because it’s a return of my money). And the CRUT is left with $990,000.
So what’s the game, then, if Romney’s taxable on the distributions from his CRUT? One game is the deduction. A person who sets up a CRUT gets a deduction when he or she contributes money to the CRUT, not in the amount of the contribution, but in the amount of the present value of the amount calculated to go to the charity.3
That’s a benefit, but pretty insignificant. The bigger benefit is, when you contributed appreciated property to a CRUT, you don’t have to pay taxes on the appreciation. That is, assume I have my $1 million of stock, but I only paid $100,000 for it when I bought it. If I sell it, I pay taxes on a $900,000 gain.4 But if I put it in the CRUT, I never pay taxes on it.
Note that a lot of people (Joanna Brooks5 included) seem to think that the scandal is that Romney’s CRUT will give less to the Church than he promised. Though that’s possible, I doubt Romney made any promise of value to the Church; because the Church is only the default beneficiary if he doesn’t name another, it wouldn’t surprise me if he hadn’t even mentioned the CRUT to the Church.6 Romney may well have expected the value of the CRUT to rise (it was, after all, established in the 90s, when asset prices were increasing). Clearly his CRUT isn’t making the 8.7% or so (because it pays out 8% annually) it needs to maintain its assets—Bloomberg reports that it’s basically all in cash now.7
And, of course, because of when he established the CRUT, he can, without violating the law, die with nothing left in the trust (and thus, with nothing going to the Church). For those of us who want to establish a CRUT today, at least 10% of what we initially put in the CRUT must remain at the end to go to charity.
All of this, though, leaves me with one question: what was this FOIA request that Bloomberg News filed? In general, tax returns aren’t subject to FOIA, and government officials are specifically forbidden from disclosing such information. I’ve written to the reporter and, if he gets back to me, I’ll update this post.
Update: The reporter got back to me (within a couple hours of my question, actually); he confirms that CRUT returns, like 990s filed by non-church tax-exempt organizations, aren’t subject to the Code’s non-disclosure rules. I don’t have time to confirm that this is the case or to tie down how to get there, but it makes intuitive sense: if you can see the returns of a tax-exempt organization, it makes sense that there should be the same obligation on conduits that also provide tax exemptions.
(Thanks to Kevin Barney for alerting me to this controversy and suggesting I write something about it. Of course, I take full responsibility for what I’ve written. Also, I’d love to have any corrections from people who actually know CRUTS, as opposed to people like me who refreshed law school memories with 15 minutes of research to write a blog post!)
- The fixed percentage must be somewhere between 5 and 50%. ↩
- Notice that, in this hypothetical world, I’m a pretty bad investor? ↩
- Present value because a dollar today is worth more than a dollar in a year. If Romney set up a $1 million trust with the expectation that 8% would go to the Church in 20 years, he couldn’t take a deduction for $80,000. Instead, he would have to calculate the present value of $80,000. Assuming a 5% annual interest rate, the present value would be $30,151.16, which would be his deduction. ↩
- Okay, I’m changing the game here: now I’m a pretty darn good investor! ↩
- whose perspectives, I should add, I generally enjoy, and who really shouldn’t be expected to have any idea about the ins and outs of CRUTS. ↩
- Though, since I’ve never worked in the area, I don’t know what the general practice is—it is certainly possible that donors tell the charity that they’ve set up a CRUT. ↩
- And cash, while secure, doesn’t provide any kind of return. ↩