Module 4

XYZ Inc., a C corporation, has $200,000 in taxable income this tax year. It distributes half to its shareholders in the form of cash dividends. As far as XYZ Inc. is concerned, which one of the following amounts, if any, is subject to the corporate income tax? A) $200,000 (None of the corporate dividends are deductible.) B) $100,000 (This is $200,000 less the dividend distribution.) C) $0 (C corporations do not pay income tax.) D) $150,000 (Half of corporate dividends are deductible.)

A) $200,000 (None of the corporate dividends are deductible.) Since XYZ Inc. has taxable income of $200,000, that is the amount subject to tax. Dividends are not deductible.

Which of the following are reasons that second-to-die policies are attractive for estate planning? One second-to-die policy will be cheaper than two single life policies. The underwriting focuses on the younger, and perhaps healthier insured person. The second-to-die policy allows for full use of the unlimited marital deduction. A) I and II B) I, II, and III C) II and III D) I only

A) I and II Options I and II are reasons to use second-to-die policies in estate planning scenarios. Option III would not apply because the policy only pays upon the second death and since there are no spouses remaining, there would be no marital deduction available.

Buy-sell agreements ensure A) that a fair sale price for the business is established. B) continuity of ownership and management. C) a method for employees to buy the business from the owner(s). D) the owner's estate receives fair value for the business.

B) continuity of ownership and management. The primary purpose of a buy-sell agreement is to ensure continuity of ownership and management by keeping shares in the hands of those who are active and interested in the business.

Which of the following are unique tax benefits for C corporations? An income tax exclusion for the cost of providing the first $75,000 of group life insurance An income tax deduction for meals and lodging furnished for the convenience of the employer An income tax exclusion for dividends paid to shareholders An employee income tax exclusion for benefits received from an accident or health plan sponsored by the employer A) I only B) I and II C) III and IV D) II and IV

D) II and IV Only the first $50,000 of group life insurance coverage is deductible to the corporation. Corporations do not receive a deduction for dividend distributions, but corporations that own another company's stock can exclude 70% of the dividends received.

Phillip and his family own all the shares of a small corporation that manufactures specialty shoes. The firm employs 120 full-time workers. There is no market for the stock, but Phillip would like to be able to cash in some of his shares each year so that he can live better, have more money for daily expenses, and do some traveling. Which one of the following is the best solution to his liquidity problem? A) Establish an ESOP B) Work out a redemption buy-sell agreement with family members C) Consider a public offering D) Establish a SEP-IRA

A) Establish an ESOP An ESOP would create a market for the company stock and thus allow Phillip to cash in some of his shares. Funding a SEP-IRA requires cash outlays, a public offering would have limited appeal to investors and would be expensive, and a redemption buy-sell agreement would work only if Phillip were to pass away.

Even if the host is not held liable for the damages as a result of entertaining guests, there can still be significant expense due to A) defense costs. B) insurance premiums. C) event preparation. D) out-of-court settlements.

A) defense costs. Most people occasionally entertain guests. People who host events have a risk of lawsuits from guests who may be injured or may injure others. While most of the time everyone has a wonderful time and no one gets hurt, all it takes is one person who is careless or intoxicated and a significant liability exposure occurs. Even if the host is not held liable for the damages, the defense costs can be quite high.

All the things that make a high net worth business owner's business unique, including the knowledge, experience, relationships, and human resources that create value can be categorized as their A) intellectual capital. B) inventions. C) business secrets. D) trade secrets.

A) intellectual capital. Intellectual capital consists of all the things that make the business owner's business unique, including the knowledge, experience, relationships, and human resources that create value. It may also consist of trademarks and patents as well as brand names that the business has developed. If a business owner client has invented a product or a process that is unique, it may be the business's most valuable asset.

Partnership income is taxed at the A) personal tax rates of the individual partners. B) S corporation rate. C) estates and trusts rate. D) C corporation rate.

A) personal tax rates of the individual partners. Partnership income is taxed at the personal income tax rates of the individual partners, because it is taxed to the partners.

First-to-die life insurance policies, as used in a business situation, are primarily structured to A) provide funds for a buy-sell or cross-purchase agreement. B) cover disability-related business overhead expenses. C) provide funds to pay estate taxes. D) cover a mortgage or college education fund.

A) provide funds for a buy-sell or cross-purchase agreement. A primary business use for a first-to-die policy is to fund a buy-sell or cross-purchase agreement. For example, if one of the covered business partners dies before retirement, the business is provided with enough cash to purchase his or her share of the business without invading current assets. Covering a mortgage or college education fund is a common use when policies are written to cover a husband and wife. Disability-related overhead expenses would be covered under a business disability policy. A second-to-die policy is primarily used to help pay estate taxes.

Money purchase plans A) require the employer to contribute a fixed percentage of compensation to employee accounts. B) are employee funded. C) are only permitted for companies with 100 or fewer employees. D) have a maximum contribution amount of $20,500.

A) require the employer to contribute a fixed percentage of compensation to employee accounts. The requirement of an employer contribution equal to a fixed percentage of compensation is a characteristic of money purchase plans. The limitation of 100 or fewer employees applies to SIMPLE plans. The maximum contribution amount of $20,500 is for employee deferrals to a 401(k) plan. Money purchase plans are funded by the employer, and the overall contribution limits to a money purchase plan in 2022 is 25% of an employee's compensation or $61,000, whichever is less.

The greatest potential for loss for a high net worth client when driving a high-end or collectible automobile is A) the potential for liability claims. B) damage to the body of the car. C) the theft of the high-end sound system and GPS. D) theft of the entire car.

A) the potential for liability claims. While damage to a high-end car or the theft of the car or contents may create a sizable claim, they do not create nearly the potential for loss that a liability claim can. People with money have more to lose as a result of an at-fault accident and as such should have much higher than usual liability coverage.

The defined benefit plan benefit formula that provides $250 per month of service, 30 years maximum is known as a A) unit benefit dollar formula. B) unit benefit percentage formula. C) flat benefit or fixed benefit percentage formula. D) flat benefit or fixed benefit dollar formula.

A) unit benefit dollar formula. A set monthly benefit multiplied by the number of years of service is a unit benefit dollar formula.

Bill Dunston is the sole shareholder of Dunston Press, a small publishing company. All of the employees of Dunston Press are considerably younger than Bill, turnover is relatively high, and 12 of his 20 employees are part time. He is considering implementing a retirement plan for the company and wants to avoid fixed contribution obligations. He also wants to receive the maximum benefit possible. Which one of the following plans would be most appropriate, considering Bill wants to maximize contributions on his behalf relative to those of the other employees? A) Money purchase pension plan B) Age-weighted profit sharing plan C) Salary reduction SEP plan D) Cross-tested profit sharing plan

B) Age-weighted profit sharing plan An age-weighted profit sharing plan allocates contributions on the basis of age, which would work to Bill's advantage since he is the oldest employee. Money purchase plans and SARSEPs require the same contribution percentage for all employees. A cross-tested profit sharing plan is used to allocate contributions on the basis of compensation.

What is the primary disadvantage when a life insurance policy is classified as a MEC? A) The policy can no longer be used to fund a buy-sell agreement. B) All or part of any cash withdrawals will be taxable as ordinary income. C) The policy effectively becomes an annually renewable term policy. D) All or part of the death benefit must be returned to the grantor.

B) All or part of any cash withdrawals will be taxable as ordinary income. The primary disadvantage of a life insurance policy being classified as a MEC is that all or part of any cash withdrawals will be taxable as ordinary income. In addition, withdrawals may be subject to a 10% early withdrawal penalty. The policy effectively becoming an annually renewable term policy is one possible result of significantly underfunding a universal life policy. Status as a MEC does not determine whether a policy can be used in a buy-sell agreement.

Which one of the following is a significant concern when funding a PPLI policy? A) PPLI policies are usually too structured to allow much investment flexibility. B) Initial overfunding may cause it to be classified as a MEC. C) The normal universal life structure only allows money market investments. D) Once an investment adviser is selected he or she cannot be changed during the life of the policy.

B) Initial overfunding may cause it to be classified as a MEC. If a policy fails the seven-pay test, it will be classified as a MEC. Benefits of PPLI policies include that they allow a great deal of investment flexibility, investment advisers can be changed, and they usually have a VUL structure that allows any number of investments.

Which one of the following currently is the most common form of business organization? A) Limited liability company B) Sole proprietorship C) Partnership D) C corporation

B) Sole proprietorship The sole proprietorship is the most common form of business organization, with over 70% of U.S. businesses filing income tax returns indicating they are sole proprietorships. Partnerships account for less than 10% of all U.S. businesses, and approximately 20% of all U.S. businesses are corporations.

With a SIMPLE plan A) the employee may not make elective contributions. B) all contributions to an employee's account are fully vested. C) the plan is subject to the nondiscrimination rules applicable to other qualified plans. D) an IRA must be established.

B) all contributions to an employee's account are fully vested. The contributions to an employee's account under a SIMPLE plan are fully vested. A SIMPLE plan is not subject to the nondiscrimination rules applicable to other qualified plans. A SIMPLE plan can be either a 401(k) plan or an IRA. An employee may make elective contributions to a SIMPLE IRA or a SIMPLE 401(k) plan.

One disadvantage to an insider sale is A) the owner will realize greater overall taxation than through a sale to an ESOP or a third-party sale. B) the generally longer timeframe required to complete the sale. C) the buying employees need to take greater responsibility for growing and improving the company. D) the seller is required to provide the financing to the buyers.

B) the generally longer timeframe required to complete the sale. An insider sale, as with a sale to children, is generally a 5‒10 year process when done right.

The following are requirements of S corporations, except A) they must be a domestic corporation. B) they may have multiple classes of stock. C) shareholders are limited to individuals, certain trusts, and estates. D) they have no more than 100 shareholders.

B) they may have multiple classes of stock. S corporations are limited to one class of stock.

When traveling overseas, which policy that provides coverage in the United States also can provide coverage in the foreign country? A) An automobile policy B) A health insurance policy C) An inland marine policy D) A homeowners policy

C) An inland marine policy Auto, home, and health insurance policies only provide coverage in the U.S. and perhaps Canada and parts of Mexico. Overseas, only an inland marine policy with worldwide coverage included can protect assets overseas as it would in the U.S.

For tax purposes, which one of the following forms of business is not considered a pass-through entity? A) Sole proprietorship B) Partnership C) C corporation D) S corporation

C) C corporation C corporations are taxed at the corporate level and distributions to shareholders are taxed as well. Losses do not flow through to shareholders. For tax purposes, sole proprietorships, S corporations, and partnerships are considered pass-through entities as all earnings and losses are passed through to its shareholders.

When serving on a board, even for a not-for-profit, individuals would be best protected from lawsuits as a result of their board work by A) a liability umbrella policy. B) not accepting any compensation. C) a directors and officers insurance policy. D) their homeowners policy.

C) a directors and officers insurance policy. Since liability umbrella policies exclude coverage for these actions, high net worth clients who serve on boards should be protected by directors and officers (D&O) insurance. The organization itself may have an employment practices liability policy as well as a D&O policy. If so, those serving on the board should obtain a copy and review it to ensure they are insured adequately. If not, they should purchase their own. Homeowners policies would not provide coverage either. Even volunteering for the role, as many high net worth clients do, still exposes the board member to risk.

The retirement plan that would allow an older, high income, self-employed individual to maximize their retirement savings would be a A) a simplified employee pension (SEP) plan. B) solo 401(k) plan. C) defined benefit plan. D) a SIMPLE IRA plan.

C) defined benefit plan. The solo defined benefit plan would allow for the greatest annual contribution. The annual contribution is actuarially determined and a small business owner should have sustainable income of at least $250,000 per one source.

All of the following are potential personal security risks except A) home invasion. B) extortion. C) serving on a board. D) kidnapping.

C) serving on a board. Home invasion, kidnapping, and extortion are all personal security risks that high net worth people need to be concerned with. Serving on a board presents personal liability risks, but not to one's security merely from serving on the board.

An advantage to a third-party business sale is that A) it ensures the company will remain in the community. B) it is the least expensive method to sell a business. C) the sale can be accomplished in a relatively short time frame. D) the owner will receive the majority of the sales proceeds well after the change in control.

C) the sale can be accomplished in a relatively short time frame. A third-party transfer can usually be accomplished in one year or so. Insider transfers and transfers to children can take several years to accomplish. Third-party sales provide for most of the cash flows to be front loaded, which is an advantage, rather than a disadvantage, over other exit planning strategies.

The tax benefits related to an ESOP include the following, except A) the company is able to deduct contributions into the ESOP. B) the earnings of S corporation shares held in the ESOP are not subject to federal income taxes. C) the seller of S corporation shares are able to defer a capital gain event through the Section 1042 provisions. D) earnings within the ESOP grow tax-deferred and are only taxed at distribution.

C) the seller of S corporation shares are able to defer a capital gain event through the Section 1042 provisions. Sellers of C corporation shares are able to defer capital gains by reinvesting into allowable securities under the Section 1042 provisions. Sellers of S corporation shares do not have this option.

Which of the following are common reasons to value a closely held business? For estate planning In the situation of a divorcing business owner For calculation of annual business property taxes that are due In order to establish the value of a gift or charitable contribution of shares A) I only B) II, III, and IV C) I and II D) I, II, and IV

D) I, II, and IV Item III is not a valid reason to obtain a business valuation.

Specialty homeowners insurance is needed for high-value homes because A) the government-sponsored flood insurance program does not provide adequate limits for the dwelling or contents for homes valued over $250,000. B) unique and high-end furnishings and specialty rooms may be inadequately covered by a standard homeowners policy. C) older homes with historical value may need extra ordinance and law endorsed coverage to bring the property up to code if damaged. D) all of these.

D) all of these. If the home is older there may be a need for an extra ordinance or law endorsement in order to bring the property up to code when damage is repaired. If the home has historical value, restoration cost coverage will be needed, as standard contemporary materials may not be adequate to restore the property. Some items may not be able to be replaced and so extra high limits and guaranteed replacement cost or restoration cost coverage may be needed. This would also apply to custom or unique features and materials. If significant remodeling has been done, such as a room in the basement converted to a wine cellar, specific coverage will be needed so that specialized rooms or features can be replaced. The standard flood policy provides only $250,000 coverage on the dwelling and $100,000 on contents.

Perhaps the best preventive measure high net worth clients can take to reduce the likelihood of personal and security losses is to A) purchase appropriate insurance policies. B) get highly trained guard dogs to protect the property. C) keep a top-notch legal team on retainer to represent the client when needed. D) educate themselves as to how, when, and where threats can materialize.

D) educate themselves as to how, when, and where threats can materialize. Insurance policies can only respond to claims, not prevent them. The same goes for a crack legal team on retainer. Guard dogs may prevent some risks, but the best option is to be educated about what threats can materialize and how. Security specialists can develop a comprehensive security plan that involves home protection and security, protection while traveling, and prevention of identity theft and other cyberattacks.

With a profit sharing plan, the employer A) may contribute no more than 15% of covered payroll. B) has a defined benefit plan. C) must make contributions each year. D) need not make contributions each year, but must make substantial and recurring contributions.

D) need not make contributions each year, but must make substantial and recurring contributions. One advantage of a profit sharing plan for the employer is that the employer need not make contributions each year. With a profit sharing plan, the employer may contribute up to 25% of covered payroll.