In 1997, Congress cracked down on a popular tax shelter that allowed rich people to take advantage of the exempt status of charities without actually giving away much money.
Individuals who had already set up these vehicles were allowed to keep them. That included Mitt Romney, then the chief executive officer of Bain Capital, who had just established such an arrangement in June 1996.
The charitable remainder unitrust, as it is known, is one of several strategies Romney has adopted over his career to reduce his tax bill. While Romneys tax avoidance is legal and common among high-net-worth individuals, it has become an issue in the campaign. President Barack Obama attacked him in their second debate for paying lower tax rates than somebody who makes a lot less.
In this instance, Romney used the tax-exempt status of a charity -- the Mormon Church, according to a 2007 filing -- to defer taxes for more than 15 years. At the same time he is benefitting, the trust will probably leave the church with less than what current law requires, according to tax returns obtained by Bloomberg this month through a Freedom of Information Act request.
In general, charities dont owe capital gains taxes when they sell assets for a profit. Trusts like Romneys permit funders to benefit from that tax-free treatment, said Jonathan Blattmachr, a trusts and estates lawyer who set up hundreds of such vehicles in the 1990s.
Near Zero
The main benefit from a charitable remainder trust is the renting from your favorite charity of its exemption from taxation, Blattmachr said. Despite the name, giving a gift or getting a charitable deduction is just a throwaway, he said. I used to structure them so the value dedicated to charity was as close to zero as possible without being zero.
When individuals fund a charitable remainder unitrust, or CRUT, they defer capital gains taxes on any profit from the sale of the assets, and receive a small upfront charitable deduction and a stream of yearly cash payments. Like an individual retirement account, the trust allows money to grow tax deferred, while like an annuity it also pays Romney a steady income. After the funders death, the trusts remaining assets go to a designated charity.
Romneys CRUT, which is only a small part of the $250 million that Romneys campaign cites as his net worth, has been paying him 8 percent of its assets each year. As the Romneys have received these payments, the money that will potentially be left for charity has declined from at least $750,000 in 2001 to $421,203 at the end of 2011.
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Romneys trust was projected to leave to charity an amount with a present value of a little less than 8 percent of the initial contribution, according to an analysis by Friedman. Thus, the specifics of Romneys trust wouldnt have passed legal muster if it had been set up 13 months later, he said.
Because the trusts investments have been earning a return far below its annual payouts to the Romneys, its principal has dwindled rapidly.
In 2001, five years after it was established, the trust had a value of between $750,000 and $1.25 million. Since then, it has pursued a conservative investment strategy -- regardless of the ups and downs of the stock market -- buying a mix of money- market funds, federally-backed bonds and federal bond funds. Since 2007, it has moved its assets entirely into cash. By 2011, its investments earned a return of $48, down from between $60,001 and $100,000 in 2001. It paid $36,696 to the Romneys in 2011.
Romneys Favored
The current investing strategy favors the Romneys over the charity because they get a guaranteed payout, said Michael Arlein, a trusts and estates lawyer at Patterson Belknap Webb & Tyler LLP.
The Romneys get theirs off the top and the charity gets whats left, he said. So by definition, if its not performing as well, the charity gets harmed more.
The trustee for Romneys CRUT is R. Bradford Malt, chairman of the law firm Ropes & Gray LLP, and manager for Romneys various family trusts as well as his personal attorney. Ropes & Gray has also been for years the main outside counsel for Bain Capital.
If the CRUT maintains the same investing strategy, assets will continue to shrink, said Jerome M. Hesch, a tax and estate planning attorney at the law firm Carlton Fields. The trustee acted prudently in protecting against losses during a stock market decline, he said.
Nevertheless, whats going to go to charity is probably close to nothing, Hesch said.
