Investigating Charitable Lead Trusts with David Cay Johnston

Written by: Peter Haldis

Date: July 28, 2015

In researching our Philamplify assessments of the Hess Foundation and Walton Family Foundations, I interviewed David Cay Johnston, a Pulitzer-Prize winning journalist and expert on economics and tax issues. Johnston is a well-known critic of charitable lead trusts, an investment strategy that provides the Hess Foundation with much of its wealth. Read on to learn what he thinks of this controversial, but little-understood, philanthropic tool.

NCRP) What is the purpose of a charitable lead trust (CLT)?

JOHNSTON) To avoid paying taxes on the increased but untaxed increase in value from a family business’s corporate stock, a family can put these assets into a charitable lead trust, which throws off income that is donated to charities. The trustees decide where the money goes, and the causes it supports. The family can give large gifts to key charities, which may then put a family member on their board, where other elites also serve, further enhancing the family’s power and prestige. Because its income stream for a set number of years has been donated, the value of the present stock is reduced, enabling shares to be passed to heirs with little or no tax hit. The tax on investment earnings goes from being a burden to a minor annoyance.

In exchange for the tax reduction, the family gives up their stream of income from the company. However, shares put into the trust are still controlled by family, and, they go back to the family’s heirs when the trust expires. In essence, the wealthy donor gives up his investment income (which he doesn’t need) to prevent his children from bearing the cost of the estate tax. The shares from the trust go to the heirs when the trust expires, minus the charitable gifts made, significantly reducing the taxes owed. And, of course, not all of the stock has to go into the trust, so family members can still live off dividends from the part of the business not in the trust, as well as any jobs or pay as directors of the company.

NCRP) Why are you critical of this type of charitable giving instrument?

JOHNSTON) I have a real problem with charitable lead trusts. CLTs are an efficient and effective vehicle for avoiding taxes while retaining family control of a business, since the family continues to maintain voting control of the corporate shares in the trust. Because the family retains control of the company, the heirs will continue to be paid if they work or consult for the company. When the assets are passed down to their children and grandchildren, the trust eliminates or radically reduces estate, gift and capital gains taxes. I believe all gains should be fully-taxed without favors to the already rich.

The very nature of these tax avoidance devices undercuts the dynamism on which economic vitality depends, creating a subtle barrier to new enterprises and to wealth based on hard work and merit. The money is tied up tax-free, sometimes for generations, rather than being reinvested in the economy to create jobs. So far 21 states have repealed rules against perpetuity to allow dynasty trusts. That means the wealth can be locked up forever.

NCRP) How are charitable remainder trusts (CRTs) different from charitable lead trusts?

JOHNSTON) A charitable remainder trust is like an annuity or a pension for a single person or married couple, as opposed to an estate-planning strategy for a whole family. A person donates his corporate shares to the trust, which the donor controls. No one has to know about the trust except the government. The donor gets a tax deduction based on his life expectancy and tax bracket. He or she gets a check every month, 90 days or year, and pays no taxes on part of it because it’s the return of capital. When the trust expires, whatever is left in the trust goes to charity.

A charitable remainder trust should be started with highly appreciated stock. It’s supposed to be set up so that the remainder is at least 50 percent of the initial donation. There are two types of charitable remainder trusts: charitable remainder annuity trusts and charitable remainder unitrusts. A charitable remainder annuity trust helps the charity if the value of the company’s stock goes up, whereas a charitable remainder unitrust helps the beneficiary if the value of the stock goes up.

Charitable remainder trusts are generally used by individuals with charitable intent because they are usually not as lucrative as private deals. If the goal is to maximize income, the person is better off buying a private annuity. Charitable remainder trusts are used for charitable motivation and security. The person collects guaranteed income for life, then the charity gets the remainder. It is a socially beneficial thing to do.

Peter Haldis is a former philanthropy fellow for the National Committee for Responsive Philanthropy (NCRP). Follow @NCRP and @PeterHaldis on Twitter, and join the #Philamplify conversation!