Unit 15

A taxpayer's marginal tax rate is the rate of taxation on any additional taxable income received. generally lower than the effective tax rate. the rate of tax paid on total taxable income. the rate of tax paid on margin account interest.

A

Clients have reached the age where they are contemplating selling their homes & moving into an assisted living facility. The profit made on the sale of their homes will be used to defray the costs of their new home. Under current tax laws, which of the following are true? A single person pays no tax on the first $250k of net profit realized on the sale of a prim. residence thats been occupied for at least 2 of the past 5 years. A single person pays no tax on the first $500k of net profit realized on the sale of a prim. residence thats been occupied for at least 2 of the past 5 years. A married couple pays no tax on the first $250k of net profit realized on the sale of a pri. residence thats been occupied for at least 2 of the past 5 years. A married couple pays no tax on the first $500k net profit realized on the sale of a pri. residence thats been occupied for at least 2 of the past 5 years. I,IV II,III I,III II,IV

A

For tax purposes, the sale of an investment at a profit will result in: A cap gain Alternative minimum tax liability Ordinary income Passive income

A

Investors looking to minimize the effects of taxation on their investments would probably receive the least benefit from a corporate bond. a growth stock. an S&P 500 Index fund. an apartment building.

A

The main purpose of dividend reinvestment in a mutual fund accumulation plan is to: compound the growth of a mutual fund investment. Avoid taxes avoid commissions or sales charges. protect against capital loss.

A

An investor would have to pay the alternative minimum tax when it exceeds the investor's regular income tax. the investor's capital gains exceed 10% of total income. there are tax-preference items reported on the tax return. the investor has received income from a limited partnership.

A. A taxpayer must pay the alternative minimum tax (AMT) in any year that it exceeds regular tax liability. Tax-preference items are re-input in figuring the AMT, but the AMT is paid only if that amount is higher than the regular income tax.

An investor purchases 1,000 shares of ABC at $42 per share. One year later, the stock is trading at $50 per share and the investor receives 50 shares of ABC as a stock dividend. How will this dividend be currently taxed? The shares are not subject to taxation As $2,500 ordinary income As a $2,100 capital gain As a $2,500 capital gain

A. They haven't been realized.

tax-swapping

An investor could sell an ABC 8% bond that matures in 2030 at a loss and buy back an XYZ 8% bond that matures in 2031 and claim the loss

A loss derived from a limited partnership may be offset against income from capital gains from municipal bonds. other limited partnerships. bonuses received in addition to a regular salary. dividends received from common stocks.

B

A married couple has lived in the same home for 40 years and now, with the children all gone, they've decided to sell and move to a retirement village. They purchased the home for $80,000 and have accepted a contract for $800,000. The tax consequence of this sale is a $470,000 capital gain. a $220,000 capital gain. a $720,000 capital gain. a $0 capital gain.

B. As long as a homeowner has lived in the primary residence at least two of the previous five years, the first $250,000 of profit on a home sale is excluded from tax. In the event it is a married couple, as in this question, the exclusion is doubled to $500,000. The profit on the sale was $720,000 ($800,000 minus the cost of $80,000) and the exclusion of $500,000 reduces the reportable gain to $220,000.

An investor purchases 100 shares of DERP common stock @ $50 per share and elects to have all cash dividends reinvested through the DRIP being offered by DERP. After holding the stock for 5 years, the investor has reinvested $1,200 and acquired 20 additional shares. If the market price of DERP is $55 per share and the investor liquidates the position, the tax consequences will be a loss of $700. a gain of $400. a gain of $600. a gain of $1,600.

B. The investor establishes the position at a cost of $5,000. To that, we add the $1,200 cost of the reinvested dividends, bringing the investor's tax cost basis to $6,200. When all of the shares are sold, the proceeds are $6,600 (120 shares x $55). Subtracting the $6,200 cost from the $6,600 proceeds results in a capital gain of $400.

An investor who would like to increase current income from investments and, at the same time, pay taxes on that income at less than her marginal tax rate, would probably find which of the following to be most suitable? U.S. Treasury bonds Public utility stock Growth stock Money market mutual fund

B. The key to this question is that dividends paid on stock issued by American companies (and certain qualified foreign corporations) generally qualify for a reduced tax rate (maximum 15 to 20%). No such benefit accrues to money market funds (their dividends are generated from interest income), and government bond interest is always taxed as ordinary income (although state income tax free). The dividends on a growth stock would also qualify, but, because the question deals with increasing current income, public utility is a more sensible approach. This is an example of how the test might present you with two answer choices that could be correct, and you must choose the one that is more correct.

A U.S. citizen owns stock in a Canadian company and receives dividends. The Canadian government withholds 15% of the dividends as a tax. As a result, the investor reports a reduction in the investor's ordinary income. a nonrecoverable loss on the investor's U.S. tax return. a tax credit on the investor's U.S. tax return. a tax credit on the investor's Canadian tax return.

C

One of your customers received a $5,000 year-end bonus. You explain that the bonus is really worth $3,250 in after-tax funds. This is because: the customer's effective tax rate is 35%. the customer's marginal tax rate is 65%. the customer's marginal tax rate is 35%. the customer's median tax rate is 35%.

C

The alternative minimum tax (AMT) is designed to ensure that certain high-income taxpayers do not avoid all income tax. This is done by adding back to the taxpayer's ordinary income, items such as accelerated depreciation and excess intangible drilling costs. The term used to describe these items used to arrive at the taxpayer's alternative minimum taxable income (AMTI) is Form 6231 Items AMT taxable items Tax preference items Tax preferred items

C

Which of the following is considered a tax preference item for the purposes of calculating the alternative minimum tax? Tax-exempt interest on general purpose municipal bonds issued after August 7, 1986 Intangible drilling costs to a limited partnership program Incentive stock options (ISOs) to the extent that the fair market value of the employer's stock is in excess of the strike price of the option Depreciation on property placed in service after 1986

C. The excess of the fair market value of the strike price of an ISO, known as the bargain element, is included as a tax preference item for the AMT. It is accelerated depreciation, excess intangible drilling costs, and interest on private purpose municipal bonds that are all tax preference items.

A taxpayer has realized short-term capital gains of $50,000 and long-term capital gains of $75,000 during the taxable year. Over the same period, the individual realized short-term capital losses of $40,000 and long-term capital losses of $100,000. The tax consequences of these transactions are a. a net short-term capital gain of $10,000 and a net long-term capital loss of $25,000. b. a net long-term capital loss of $15,000 and no gain carryover. c. a $3,000 deduction from income and a long-term capital loss carryover of $12,000. d. a $3,000 deduction from income and a long-term capital loss carryover of $3,000.

C. This investor has a $10,000 short-term capital gain ($50,000 minus $40,000) and a $25,000 long-term capital loss ($75,000 minus $100,000). Why isn't that choice the correct answer? Because the exam will always want the choice that most completely answers the question. In this case, the net of the gain and the loss is a $15,000 long-term capital loss. Why isn't that correct? Same reason—it is not the most complete answer: $3,000 of that $15,000 loss is deductible against earned income and the balance of $12,000 is a carryover to the next year. This is a very common type of question on the actual exam, where you must select the choice that covers all of the details. By the way, there is no such thing as a carryover of a gain; all net gains are taxed.

The alternative minimum tax is designed to ensure that certain high-income taxpayers do not avoid all income tax through the use of various tax preference items. Those preference items are added back to the taxpayer's ordinary income on IRS Form 6251 and would include long-term capital gains in excess of $3,000 annually. straight-line depreciation taken on investment real estate. intangible drilling costs in connection with an oil drilling program. interest received from specified private-purpose municipal revenue bonds.

D

Which of the following is an example of a regressive tax? (A regressive tax is a type of tax that is assessed regardless of income, in which low- and high-income earners pay the same dollar amount.) Estate tax Gift tax Income tax Federal fuel excise tax

D

In most cases, the tax filing status that results in the highest income tax is head of household. married filing jointly. qualifying widower with a dependent child. single.

D. In general, for the same amount of income, filing single will result in the highest income tax while married filing jointly, the lowest. Head of household is usually the best for those who are not married but do have children.

Your customer in the 24% federal income tax bracket would probably pay the most tax on a $5,000 investment into dividends received on domestic common stock interest received on municipal bonds. Dividends received on domestic preferred stock interest received on U.S. Treasury bonds.

D. Interest received on Treasuries will be fully taxable on a federal basis. That means 24% to this customer. Unless stated to the contrary, you can assume that dividends paid on stock (common and preferred) issued by domestic corporations are qualified. That means the tax rate will be 15%. Interest received on municipal bonds will be tax free.

Portfolio income

Includes dividends, interest, and net capital gains derived from the sale of securities. No matter what the source of the income, it is taxed in the year in which it is earned.

A lower cost basis results in a (smaller/larger) capital gain. It's is determined by comparing the sales proceeds with the cost basis.

NOTE

For purposes of an IRA contribution, alimony from pre-2019 is considered eligible income while alimony from a divorce after 2018 is not. Child support is never eligible income (T/F)?

T

Passive income and passive losses

come from rental property, limited partnerships, and enterprises (regardless of business structure) in which an individual does not actively participate. For the general partner, income from a limited partnership is earned income; for the limited partner, the income is passive

alternative minimum tax (AMT)

ensure that high-income taxpayers do not escape federal income taxes.

Earned income

includes salary, bonuses, tips, and income derived from active participation in a trade or business.

Alimony

payment made under a (divorce) court order (or under a legal separation agreement) to an ex-spouse. Alimony may be paid directly to the ex-spouse or to a third party on the ex-spouse's behalf (e.g., to pay premiums on the ex-spouse's life insurance or contribute to the ex-spouse's IRA).

marginal tax rate

the highest rate paid on income