Thursday, November 1, 2012

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 in 1969 as part of the major revision of the EO rules that carved out private foundations from the universe of charities for special treatment.  In fact, funding a CRT is one of only nine ways that one can get a charitable contribution for giving away less than one's entire interest in an asset.  Pursuant to IRC sec. 664, the trust pays one or more designated beneficiaries either a fixed dollar amount or a fixed percentage of the trust asset value annually for life or a term of years, and then whatever is left in the trust is distributed to one or more designated charities.  The grantor is eligible for an income tax deduction under IRC sec. 170(f)(2) based on the actuarial value of the remainder interest, discounted to reflect the term of the trust, the income payout rate, IRS assumed interest rates, etc.  Comparable deductions are available for gift, estate and GST tax purposes. 

CRTs are useful planning tools for individuals who would like to make a gift to charity and receive a current deduction but who also want to reserve a stream of income for themselves or others.  CRTs also are tax-exempt trusts, so donors can fund them with appreciated assets and avoid any capital gain tax when the CRT sells the assets, leaving the CRT with $1.00 to invest rather than the $0.80 or less the donor would have had if s/he had sold the asset and then given or invested the proceeds.  In the late '80s or early '90s, aggressive planners began to focus on this capital gain avoidance feature, whether or not their clients had any real charitable intent.  Using a creative reading of the trust distribution rules, they designed short-term, high-payout CRTs (e.g., a two-year trust with a 80% annual payout) that allowed the donor to recover substantially all of the value of appreciated assets with little or no capital gain tax liability.  In 1997 Congress determined that these "accelerated CRTs" were abusive and inconsistent with the purpose of the CRT rules, so it amended IRC sec. 664 to limit annual payouts to 50% and to require that the charitable remainder have at least a 10% actuarial value.    

I have not seen the terms of the Romney CRT, but the Bloomberg description indicates that it was not an accelerated CRT but instead was intended to last for the Romneys' lifetimes.  As a "unitrust", it pays 8% fixed percentage of the annual trust value rather than a fixed dollar amount.  While 8% may seem an aggressive payout by today's standards, I note that the IRS assumed interest rate for June 1996, when the CRT was created, was 8%.  The relatively low charitable deduction allowed (coincidentally also about 8% according to the article) would have resulted primarily from the fact that the designated charity was likely to have to wait 30-40 years or longer before the trust would terminate.  

The dwindling value of the trust, as reported in the Bloomberg article, may be largely a result of the trustee's investment performance and subsequent economic conditions.  An 8% growth assumption, used in the actuarial calculation, has proved not to be realistic; and many CRTs established in the '90s have seen their values decline significantly.  I note that the unitrust form allocates decline proportionately between the income beneficiaries and the charity, while the "annuity trust" form, the other permissible variety of CRT, would have placed all of the burden on the charitable remainder since an annuity trust is obligated to pay the income beneficiaries a fixed dollar amount regardless of how much the underlying principal value declines. 

The Bloomberg article is misleading in implying that this trust was the type of abusive technique that led to the 1997 restrictions on CRTs or that all CRTs are somehow suspect or abusive.  The Blattmachr comments contribute to that impression because the article does not make clear that they refer primarily the short-lived and abusive "accelerated CRTs".  I have no grounds for speculating on what combination of financial, tax and charitable considerations motivated the Romneys; but I can say that the type of CRT described is one that reputable planners might have recommended to their charitably-minded clients in 1996.  As the article admits at one point, it was "legal and common among high-net-worth individuals." 



November 1, 2012 | Permalink | Comments (2) | TrackBack (0)

Wednesday, October 31, 2012

A hidden football tax exemption

Every year my nonprofit law class has a lively discussion about whether revenue from college football games, including revenues from bowl game broadcast contracts, ought to be exempt from taxation on grounds that the activity is educational.  This discussion is particularly relevant to students attending my university, since our football program has been mired in scandal for more than a year and many of the facts that have emerged indicate that at least some football players are barely engaged in our school's educational program.

Now comes word that the citizenry is, at least arguably, further subsidizing college football programs by means of an additional, veiled tax exemption.  According to an item in the Nonprofit Quarterly, which in turn is reporting on an investigation carried out by Bloomberg News, many colleges require charitable donations to the school in return for the privilege of buying season tickets at face value. The donor/ticket purchasers then write off the value of the mandatory donations, costing the U.S. treasury as much as $100 million per year.  Ohio State University and LSU were singled out as particularly successful (or egregious, depending on your point of view) with this quite common strategy.


October 31, 2012 in Current Affairs | Permalink | Comments (2) | TrackBack (0)

Tuesday, October 30, 2012

Romney Charitable Tax Avoidance Device

I am one that rare species of Nonprofit Law profs who is not a tax expert, so this post falls under the category of "stories that look interesting but I don't really understand."  According to The Chronicle of Philanthropy, Mitt Romney uses a tax sheltering device, called a "charitable remainder unitrust," that "permits him to use a charity's exemption to defer taxes on capital gains from the sale of assets . . .."  The device, akin to "renting from your favorite charity of its exemption from taxation," was outlawed in 1997 but individuals who had existing trusts at that time are permitted to continue benefiting from them.  Perhaps one of our tax experts can explain further.


October 30, 2012 in Current Affairs | Permalink | Comments (2) | TrackBack (0)

Monday, October 29, 2012

A Helpful IRS

I have complained before on this blog about interactions between the Community Development Law Clinic, which I supervise at UNC Law, and the IRS.  Particularly on matters of commercial activities undertaken by charitable organizations, IRS examining officers have been obtuse and inconsistent.  However, we had a recent interaction with the IRS in which it proved flexible and helpful.

We represent a group that owns athletic facilities and organizes a sports league in its community.  The organization, which grew organically in accordance with community needs and which has always been managed by volunteers, incorporated under state law more than forty years ago but never applied for 501(c)(3) status.  During its forty years of existence, it covered its expenses, mostly by charging fees, but rarely produced any surplus.  It maintained financial records, but did not get serious about financial accounting and controls until three years ago when a more professional group of board members took control.  They now wish to apply for (c)(3) status because their facilities are in need of repair and the fee income will not cover the costs.

We approached the IRS with some trepidation, given that the Form 1023 asks for five years of financial information and this organization has only three to offer.  An officer on the technical advice line told us that this sort of thing happens frequently, that the IRS is accustomed to dealing with it and does not wish to penalize well-meaning community groups such as this one, and that they can deal with the required financial information by providing the three most recent years plus a projection for the next two.

I take back at least some of the unkind things I said (or implied) about the IRS and its dealings with exempt organizations.


October 29, 2012 in Current Affairs | Permalink | Comments (0) | TrackBack (0)