MODULE 8 QUIZ

Which one of the following will generally be the lowest? A)Average tax rate B)Marginal tax rate C)Trust and estate tax rate D)Kiddie tax rate

A)Average tax rate The average tax rate will be lower than the marginal tax rate for everyone except those in the lowest tax bracket because the average tax bracket incorporates the benefit of the graduated rates. The marginal tax rate highest rate of income tax; it is the tax which is paid on the last dollar on income earned. The kiddie tax rate will be the same as if the parent(s) had received the taxable income above a certain amount.

The applicable credit amount is the amount of transfer tax on the A)applicable exclusion amount. B)cumulative taxable gifts. C)annual exclusion amount. D)applicable credit amount.

A)applicable exclusion amount. The applicable credit amount is the tax on the corresponding applicable exclusion amount. The applicable exclusion amount is the amount of taxable transfers a person can make without actually having to pay gift or estate tax. No tax is actually paid on this amount because the applicable credit amount is the amount of transfer tax on the applicable exclusion amount and can be applied against any tax owed. The annual exclusion amount applies to federal gift tax. The first $15,000 (indexed annually) given to any donee in any calendar year is excluded from the donor's total gifts as "free" from tax. Cumulative taxable gifts are simply the sum of the taxable gifts given.

Dividend reinvestment plans are popular because A)dividends must purchase shares in whole numbers. B)dividends are not currently taxable, thereby achieving tax deferral. C)dividends can be used for discounted stock purchases. D)basis calculations are simplified.

C)dividends can be used for discounted stock purchases. The biggest benefit of a dividend reinvestment plan is the ability to purchase additional shares of stock at a discount. Even though the dividends are reinvested, they are currently taxable. Remember that when determining basis, the taxpayer must keep meticulous records of all stock purchased and reinvested dividends. Dividend reinvestment plans usually allow purchases out to three decimal places.

Which one of the following statements regarding the applicable credit amount is not correct? A)The applicable credit amount will increase as the applicable exclusion amount increases in future years. B)It is the amount of taxable transfers that a person can make without having to actually pay gift or estate tax. C)Use of the applicable credit is voluntary. D)It is a dollar-for-dollar offset against gift and estate tax liability.

B)It is the amount of taxable transfers that a person can make without having to actually pay gift or estate tax. The applicable exclusion amount is a dollar-for-dollar offset against gift and/or estate tax liability. The applicable credit amount represents the amount of gift and estate tax liability that a person can incur without having to actually pay gift or estate tax. It is applied directly against a tax owed. The two amounts will increase together in future years because the applicable credit amount is the corresponding tax liability for the applicable exclusion amount. Use of the applicable credit is not voluntary. It must be taken. There is no option to pay cash instead of using the applicable credit.

Which one of the following assets is not held in will substitute form? A)joint property with right of survivorship B)property held as community property C)property held in a revocable inter vivos trust D)property held as tenants by the entirety

B)property held as community property Unlike tenants by the entirety and joint property with right of survivorship, traditional community property is not a will substitute because this form of property does not have a right of survivorship feature. In other words, the deceased can will his or her portion of community property to anyone he or she wishes; the surviving spouse does not automatically inherit the property. Property in a revocable inter vivos trust is held in will substitute form because its disposition upon the death of the grantor will be controlled by the trust rather than the grantor's will or the state laws of intestacy.

Which one of the following is the most common method for investors to use in determining the cost basis of mutual fund shares? A)Last-in, first-out B)First-in, first-out C)Average cost D)Specific identification

C)Average cost The average cost method is the most widely used as fund companies provide this information, thus making it simple for fund shareholders. The first-in, first-out method requires the taxpayer to reconstruct his or her purchases in determining gain or loss, and results in greater gains during a rising market. Thus, it is not as widely used as the average cost method. The specific identification method results in the lowest tax liability, although it requires meticulous record keeping that most taxpayers will not adhere to. Also, the shares sold would have to be specifically identified to the mutual fund when the sale is made. This is practically impossible.

Which of the following is not a possible subtraction from total gifts for the year? A)Annual exclusion B)Charitable deduction C)Unused applicable credit amount D)Marital deduction

C)Unused applicable credit amount The unused applicable credit amount is a subtraction from the current tentative tax. The marital and charitable deductions and the annual exclusion are all possible subtractions from a donor's total gifts for the year.

Charlie contributed $2,000 to Roth IRA 1 last year, when he was age 24, and $2,000 to Roth IRA 2 this year. Two years from now, Roth IRA 1 will have a balance of $2,650, and Roth IRA 2 will have a balance of $2,590. Charlie closes Roth IRA 1 two years from now, receiving the balance of $2,650. Which one of the following statements best describes his tax and penalty status for that year? A)He cannot make any withdrawals, because the money has not been in the Roth IRA for five years or longer. B)He only pays income taxes, because Roth IRA distributions are not subject to a penalty. C)He will pay neither taxes nor a penalty. D)He must pay taxes and a penalty on the full distribution.

C)He will pay neither taxes nor a penalty. None of the withdrawal is included in Charlie's taxable income, because the $2,650 is less than the aggregate total of his contributions ($4,000). Remember that contributions are treated as the first dollars distributed no matter when they were actually contributed. No penalty applies since the withdrawal is not taxable. The distribution, however, is not considered a qualified distribution because Charlie's Roth IRA has not passed the five-year holding period test. Also, the question does not address why he withdrew the Roth money. He is not dead, age 59 1/2, buying, building or rebuilding a first-home (up to $10,000), or disabled.

Which one of the following techniques will result in tax deferral? A)Exchanging stocks on a regular basis by selling and reinvesting the proceeds B)Moving funds from one brokerage account into another C)Investing in high-growth stocks D)Reinvesting mutual fund dividends into more shares of the fund

C)Investing in high-growth stocks Investing in high-growth, low-dividend-paying stock is one form of deferring tax liability. The constant sale and repurchase of stocks will generate a tax liability with each sale, thus not offering any tax deferral.

Which one of the following statements regarding the uses of life insurance in estate planning is false? A)Life insurance can be used to provide estate liquidity. B)Life insurance can be used to facilitate the transfer of a business. C)Life insurance benefits will always be in that person's taxable estate if the deceased is the person insured. D)Life insurance can be used to pay estate taxes.

C)Life insurance benefits will always be in that person's taxable estate if the deceased is the person insured. Life insurance benefits when the deceased is the insured person will not always be the decedent's taxable estate. First, the deceased might not be the owner of the life insurance policy. For example, the owner of the policy could always have been the decedent's spouse or child. Also, the policy might have been given away more than three years before the death. In these cases, the life insurance policy would not be in the decedent's gross estate in the first place. Thus, the policy could not be in the taxable estate. Also, if the deceased owned the life insurance policy and the beneficiary of the policy was a spouse or charity, then the death benefits would not be estate taxed due to the marital or charitable dedcution. Life insurance is often used to provide estate liquidity needed to pay funeral expenses, medical expenses of a final illness, probate costs, living expenses of survivors, and estate taxes when the applicable credit will not cover the taxes due. Insurance can also facilitate the transfer of a business by providing the funding mechanism for business buy-sell agreements. Cash from a life insurance policy is always a welcome asset to the beneficiaries.

Which one of the following assets would not be included in a decedent's probate estate? A)Real estate received by a contingent beneficiary named in the decedent's will B)Personal property given to the decedent's children by a provision in the intestacy statutes C)Life insurance proceeds received by a named beneficiary from a policy on the decedent's life D)A retirement asset in which only the primary beneficiary is named and that person has predeceased the owner.

C)Life insurance proceeds received by a named beneficiary from a policy on the decedent's life Life insurance proceeds paid to a designated beneficiary pass by virtue of contract provisions in the policy that act as a will substitute. Therefore, probate is avoided. Any property received by a will provision or a provision of the intestacy statutes would be considered probate property. If there is no living primary or secondary/contingent beneficiary of a retirement account or life insurance policy, then the assets are in the deceased owner's probate. There is no other way to determine who the new owner of the asset would be.

Which one of the following statements regarding property held in tenancy in common is not correct? A)Each tenant has the right to transfer his or her interest without the consent of the other tenants. B)Property held in this form will be included in the probate estate. C)Property held in this form will pass by right of survivorship. D)More than two people can own the same property in this manner.

C)Property held in this form will pass by right of survivorship. Property held in tenancy in common does not have a right of survivorship feature. It will therefore be a probate asset and will be disposed of by will or the laws of intestacy. Any number of persons can take title to the same property as tenants in common and each tenant in common has the legal right to transfer his or her interest without the consent of the other tenants, although it may be difficult to find a buyer for a partial interest.

Which one of the following represents the basis of stock acquired by gift, if the fair market value on the date of gift is less than the donor's basis? A)Donor's basis B)Fair market value at the date of the gift C)The basis is not known until the stock is sold D)The mid-point between the high and the low on the date of the gift

C)The basis is not known until the stock is sold Normally, the basis of an asset acquired by a gift will be the donor's adjusted basis. However, if the fair market value on the date of the gift is less than the donor's basis, it is not possible to know the donor's basis until the asset is sold. If the asset is sold for less than the value on the date of the gift, the loss is determined from the value on the date of the gift and the holding period is determined from the date of the gift. If the asset is sold for a value above the donor's basis, the gain is determined from the donor's basis and the holding period began when the donor purchased the asset. If the asset is sold for a price between the donor's basis and the fair market value on the date of the gift, there is no taxable gain or loss, so the holding period is irrelevant.

Which one of the following describes the taxability of tax-exempt market discount bonds? A)The market discount is subject to capital gains upon the sale or redemption of the bond. B)They are exempt from taxation. C)The market discount is taxed as ordinary income upon the sale or redemption of the bond. D)They are tax-free from all state and local income tax regardless of where the taxpayer resides.

C)The market discount is taxed as ordinary income upon the sale or redemption of the bond. Any market discount is taxed as ordinary income upon the sale or redemption of the bond.

Which one of the following is not an example of a gift subject to the federal gift tax? A)Forgiving a legal debt of $19,000 owed by a friend B)Paying a friend's legal fees of $16,000 C)Exchanging property worth $25,000 for property worth $11,000 D)Paying a niece's hospital bill of $25,000

D)Paying a niece's hospital bill of $25,000 Paying an amount (other than for medical or tuition expenses) that you are not legally obligated to pay constitutes a gift because it is tantamount to giving the friend the money to pay the amount themselves. This includes the forgiveness of a debt. In an exchange of property where one value is more than double that of the other, a gift has clearly taken place.

Which one of the following is not a possible purpose of probate? A)The determination that a person has died with a valid will B)The determination that a person has died without a valid will C)The determination that a person has died D)The determination that a surviving spouse is entitled to property owned by both spouses as joint tenants with right of survivorship

D)The determination that a surviving spouse is entitled to property owned by both spouses as joint tenants with right of survivorship

Which one of the following is not a characteristic of a gift subject to the federal gift tax? A)The donee does not get a stepped-up basis in the gifted asset. B)The donor must give up control over the property. C)The donor must receive less than full value for the property transferred to the donee. D)The donor must intend to give a gift.

D)The donor must intend to give a gift. Intent is not necessary for a gift to be subject to the federal gift tax. When the donor receives full value, a sale, not a gift, has occurred and if the donor can still control the asset, he or she still owns it. The stepped-up basis is available for transfers at death, not for gifted assets.

Which one of the following is a requirement or rule related to the Section 121 exclusion? A)The taxpayer must have owned and lived in the home five years before the sale. B)Capital gains on the sale may be excluded for up to $250,000 for married taxpayers who file jointly. C)The taxpayer must be living in the home at the time of the sale. D)The exclusion may not be used more than once within a two-year period unless an exception applies.

D)The exclusion may not be used more than once within a two-year period unless an exception applies. Unless the taxpayer moves because of a new job, for health reasons, or due to other unforeseen circumstances, only one exclusion is allowed within any two-year period. The taxpayer must have owned and lived in the home for at least two of the previous five years before the sale. This does not require the taxpayer to have owned the home for five years. Single taxpayers are allowed an exclusion of up to $250,000, while married taxpayers who file jointly are allowed an exclusion of up to $500,000.

Which one of the following statements regarding wills is not correct? A)They are revocable until death if competent. B)They may specify how debts should be paid. C)They may designate individuals to administer the will and care for minor children. D)They may change the beneficiary on a life insurance policy.

D)They may change the beneficiary on a life insurance policy. A will cannot unilaterally change a life insurance policy beneficiary, which is a contract between the policy owner and the insurance company. The will can, however, appoint a personal representative to administer the will and be a guardian for minor children, and can state the portion of the estate from which the debts of the decedent are to be paid. Finally, a testator can change the will until death as long as he or she is competent.

Which one of the following statements regarding intestate succession statutes is false? A)If the decedent had a surviving spouse, he or she will receive some part of the intestate estate. B)They are controlled by state law. C)They cannot give property to friends of the decedent or to charity. D)They may give some individuals the income or use of property for a specified period of time with title to the property going to another person.

D)They may give some individuals the income or use of property for a specified period of time with title to the property going to another person. Property distributed in this manner (where some some individuals get the income or use of property for a specified period of time with title to the property going to another person) must be placed in a trust. Intestacy laws distribute only outright title to property, with no provisions for trusts. Each state determines its own intestate distribution scheme, but all give some property to a surviving spouse to prevent his or her total disinheritance. They cannot give property to friends of the decedent or to charity as there is no way to determine which friends or charities the decedent might have desired to receive his or her property.