CRUT Tax Shelters, Explained: Why Mitt Romney’s Charitable Remainder Unitrust Makes Sense

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by Susan Lyon

Mitt Romney is taking some heat for a tax move he made in 2007, regarding his use of a common tax-planning tool called the charitable remainder unitrust, or CRUT. A recent Bloomberg story takes a look at the device and delineates accusations that Romney is using the CRUT to unfairly avoid paying taxes. But let’s take a closer look – is this true?

How Do CRUTS Work and Why Does Romney Have One?

CRUTS aren’t new – they date back to 1969. Wealthier taxpayers have been using them for years to claim a tax deduction for a charitable contribution, move money out of their taxable estate, shield money from potential creditors and set up an income based on a fixed payout percentage of the remaining principal for themselves. Mitt Romney set one up in 1996.

Here’s how it works:

Romney creates the CRUT, which makes him the settlor. He names a charity, which gets everything remaining in the CRUT when he dies. In this case, Romney named his church, the Church of Jesus Christ of Latter Day Saints as the charity. In exchange for donating money or assets to the CRUT with a charitable beneficiary, Romney can take a tax deduction for charitable giving.

So far, so good. Let’s take it a step further:

Romney didn’t have to donate cash to the CRUT. He can also donate securities, as well. If, instead of transferring securities to the CRUT, he instead sold the securities to raise cash, and then transferred the cash to the CRUT, he’d have to pay capital gains taxes – which would mean less money would be available to go into the CRUT. But by transferring appreciated stock to the CRUT, though, Romney was able to avoid a current capital gains tax liability on the securities. And so the securities and everything else Romney put in the CRUT grows in a favorable tax environment. It’s tax-deferred, and from the charity’s point of view, tax-free, assuming they get something when Romney dies.

Meanwhile, Romney gets a stream of income from the CRUT. Under the IRS’s rules, the CRUT must distribute money back to the Romneys. Specifically, it must kick back not less than 5 percent of the assets in the trust every year, although it cannot kick back more than 50 percent in a given year.

When the Romneys set up the trust in 1996, they settled on an 8 percent distribution rate. That is, the trust was designed to kick off an 8 percent payout for a certain number of years, or until Romney (and presumably his wife) passed away.

Why Is Romney’s CRUT Controversial?

The features of a CRUT as explained so far are not particularly controversial. However, some Democrat sympathizers are crying foul – not because the maneuver is legal, but because the CRUT itself can be designed to leave almost nothing to the charity – they say defeating the purpose of the charitable tax deduction.

So it appears to be with Romney’s CRUT; since the trust was established in 1996, the corpus of the trust – that is, the amount of assets held in the trust earmarked for charity if Romney doesn’t use it – has fallen as the trust distributed assets back to the Romneys. This has some people up in arms.

Are they right?

No, and here’s why:

Look at the first paragraph describing the basic of what a CRUT is. The CRUT generates a fixed payout percentage of the corpus each year to the non-charity beneficiary. In this case, it’s the Romneys. That means that if the investment gains and income don’t keep up with the distributions, the payout amount falls every year. That’s not in the Romney’s best interests. The point of the CRUT is to create a tax-free environment for the assets to grow for the benefit of the charity. Congress set up the charitable remainder trust and unitrust to encourage people to give to charity without having to worry about the risk of running out of money for themselves.

Now, here’s what Bloomberg missed:

Let’s get in the Wayback Machine, and go back in time to 1996, when the trust was set up. At the time, 8 percent was less than the average homeowners were paying on 30-year fixed mortgages for most of the year. At the time the plan was set up, it was not at all abusive, nor was there any particular reason to believe the balance of the plan would decline with that payout rate. All the CRUT had to do was match the rate of return of a 30 year mortgage. It’s like getting a 3.7 percent payout today, and at the time, was a perfectly reasonable and standard assumption of the expected rate of return on reasonably conservatively invested capital.  Indeed, many pension funds at the time were assuming rates of return of 10 percent or more in the late 1990s. For the standards of the time, the Romney payout levels were quite conservative.

Furthermore, the IRS actually imposes a maximum allowable payout rate on charitable remainder trusts. It resets it every month to adjust for prevailing interest rates. The IRS does this specifically to ensure that there is a meaningful remainder left over for the charity at the end of the settlor’s life. Set it too high and people will burn through the trust faster than the trust can earn investment returns. Set it too low and no one will set them up at all, because the income isn’t competitive with fixed annuities, CDs, treasuries or other conservative income investment.

Currently, that rate, called the 7520 rate, is 1 percent.  But in 1996, that 7520 rate in place for most of 1996 was 8 percent, or very close to it. Which is exactly the rate the Romneys selected.  That was the plain-vanilla, straight-ahead planning assumption prominent at the time, and written right into the tax code. Based on what was known at the time, there was every expectation that the LDS Church would eventually receive a significant payout. The Romneys would have paid income or capital gains taxes, eventually, on anything the CRUT didn’t pay to the charity, because they paid taxes on distributions. The Romneys’ chief benefit here is this: Money transferred to the CRUT was out of the taxable estate. But it would have been out of the estate anyway had the Romneys just donated it and not used a CRUT.

Once the CRUT is in place, the Romneys were committed to continuing with the plan – even as the 7520 rate fell from 8 percent then to just 1 percent today.

Meanwhile, it’s not like the Romneys get a free ride on the money they receive from the CRUT. Distributions to the settlor are taxable. What’s more, they’re taxable under a system called “worst-in, first out.” Any payouts the Romneys take are calculated under the worst tax system available from their perspective. If there’s income in the portfolio, the Romneys are assumed to take that out first, then followed by short-term capital gains, then long-term, and then trust corpus, in that order. If the CRUT has a lot of income in the portfolio, the Romneys have to pay income tax on that money – at a very high tax bracket. It’s much more than they would have paid had they simply held on to the appreciated securities and paid capital gains taxes on them when they sold them.

Why Charities Need CRUTS to Survive

It’s not as big a tax break as the fever-swampers imagine. It is true, though, that the Romneys were able to take a deduction against ordinary income when they made the contribution, while later becoming eligible to pay taxes on payouts based on a combination of ordinary income, short-term and long-term capital gains. Sooner or later, the Romneys, like any other CRUT settlor, must pay taxes on any money not ultimately given to charity.  Then when they do receive a distribution they must pay the worst tax rates possible on any money they receive back from the trust.

Claudia Sangster, director of philanthropy, estate and trust services and the Harris Charitable Fund Program director and an expert in philanthropic planning in Los Angeles, California, defends the practice.

“This is how charities keep alive,” she says. “Yes, it’s deferred giving. And they don’t know when they’re going to get it, but it puts it in their pipeline.” This is a staple of charitable giving for middle class, upper class, and high net worth people alike, she says. “Anyone who wants to give to a charity, but needs income and can’t afford to give the whole thing away uses these! It’s something charities rely on!”

The bottom line?  There is nothing untoward, unethical or even particularly unusual about the charitable remainder unitrust. It’s not a wealth preserver – “there’s always a better way to make money,” says Sanger. And they sure aren’t evil.