6.1 Types of Clients
In which of the following business entities is an owner jointly and severally liable for the obligations of the business? A) A limited liability company (LLC). B) An S corporation. C) A general partnership. D) A sole proprietorship.
C) A general partnership. Joint and several liability is typical (and a drawback) of the general partnership, in which its partners/owners are jointly and severally liable for the obligations of the partnership. This means that each partner is liable for the wrongdoing of the other. A sole proprietorship is liable but not jointly or severally with anybody else.
A customer and his spouse own shares in the ABC Fund as joint tenants with rights of survivorship. If the customer dies, what happens to the shares in the account? A) The spouse would own all the shares. B) One-half of the shares would belong to the spouse, and the remaining half would be distributed to the customer's estate. C) Ownership of the shares must be determined by probate court. D) The account would be frozen until the estate was settled.
A) The spouse would own all the shares. In a JTWROS account, securities pass to the surviving owner. The account does not have to be frozen but can continue to enter orders.
If a new joint tenants with rights of survivorship account is opened, all of the following statements are true EXCEPT: A) checks may be drawn in the name of either party. B) orders may be given by either party. C) mail may be sent to either party (with the permission of each party). D) in the event of death, the decedent's interest in the account goes to the other party.
A) checks may be drawn in the name of either party. While either party may enter an order, any money or securities delivered out of the account must be in the names of both owners.
If three individuals have a tenants in common account with your firm and one individual dies, then: A) the two survivors continue as co-tenants with the decedent's estate. B) the account must be liquidated and the proceeds split evenly between the two survivors and the decedent's estate. C) trading is discontinued until the executor names a replacement for the deceased. D) account is converted to joint tenants with rights of survivorship.
A) the two survivors continue as co-tenants with the decedent's estate. The decedent's estate becomes a tenant in common with the survivors. The account is frozen until the decedent's portion is disposed of.
*A man is planning to start his own glass sculpturing business. He wants to be able to deduct his anticipated losses for the first two years. He anticipates that the enterprise will borrow money from lenders and is willing to personally guarantee the debt. He also wants to attract other investors but does not want to give up control of the day-to-day business decisions. What business form do you recommend? A) C corporation. B) S corporation. C) Limited partnership. D) General partnership.
C) Limited partnership. A limited partnership with him as general partner would allow for additional investment capital without giving up management control. C corporations do not allow deductibility of losses; S corporations do not allow guaranteed debt to be included in the taxpayer's basis. General partnerships could allow the other partners to more easily control the day-to-day operations than a limited partnership, in which the other investors (presumably limited partners) would not be permitted to take a role in the running of the business.
In a trust account, the person who makes the account management decisions is the: A) trustee. B) nontrustee custodian. C) investment adviser representative. D) beneficiary.
A) trustee. A trust is a legal entity that designates a person (the trustee) to manage the trust's assets for the benefit of another person (the beneficiary or beneficial owner).
Which of the following statements regarding an S corporation owner and an owner of an LLC are TRUE? Creditors have the very limited recourse rights to the owners. They may not be nonresident aliens. They both are considered stockholders. Both are taxable as flow-through entities. A) II and IV. B) I and IV. C) I and III. D) II and III.
B) I and IV. Creditors don't have recourse to the owners of either entity unless the owners have specifically allowed it. Both are flow-through or conduit entities. Owners of S corporations are stockholders, whereas those in an LLC are members. Nonresident aliens may not own an S corporation.
An S corporation is characterized by: A) limited lifetime. B) flow-through tax treatment. C) unlimited personal liability. D) more than 100 shareholders.
B) flow-through tax treatment. Shareholders of an S corporation have limited liability, are limited to no more than 100 shareholders, and receive flow-through tax treatment.
If 150 investors want to form a corporation to limit their financial liability to the amount of money they invest and do not want to be responsible for any debt that the corporation incurs, they would most likely form a(n): A) C corporation. B) S corporation. C) general partnership. D) proprietorship.
A) C corporation. The investors would form a C corporation. The advantages of the C corporation are stockholders are not liable for corporate debt; it is easier to raise money by issuing stock; it is easier to transfer ownership; and unlike a partnership or proprietorship, a C corporation has a continuous life because it does not terminate on the death of shareholders, officers, or directors. An S corporation is limited to 100 investors.
An estate account must be managed at the direction of the: A) estate's executor or administrator. B) investment adviser. C) general estate creditors. D) attorney with guardianship over the surviving children.
A) estate's executor or administrator. Only the estate's administrator or executor can make investment management and distribution decisions. This does not mean that the executor must manage the account, only that decisions as to who will do the management are within his purview. A guardian with authority over the children does not necessarily have power over the estate unless the guardian is also the administrator or the executor of the estate.
*A professional tennis player comes to you seeking advice on setting up a trust. She is interested in giving to charity and also wants discretion as to when income is distributed to the beneficiaries, her parents. Which trust do you advise she use? A) Charitable lead trust. B) Complex trust. C) Simple trust. D) Charitable remainder trust.
B) Complex trust. Only a complex trust allows the two features which she demands. Simple trusts may not make charitable contributions, and provide no discretion on income distribution. The two types of charitable trusts mentioned provide no ongoing discretion as to when income is distributed or who the beneficiaries are.
An investment policy statement would likely include: I. expected returns of the recommended strategy and the expected range of these returns. II. recommended allocations among differing asset classes. III. strategies used for selecting specific stocks in the equity portion of the portfolio. IV. disclosure of the fees that the adviser will earn for implementing the recommended strategy. A) II, III and IV. B) I, II and III. C) I only. D) I and II.
B) I, II and III. An investment policy statement prepared for clients delineates the allocation percentages for each asset class and the expected returns from each class, and outlines strategies that may be used for timing the market and choosing specific investments within each class, but fees the adviser may earn are not included in the policy statement; they are disclosed separately.
If the Smiths want to open a joint account at AAA Securities Corporation and have their securities transferred to their three daughters upon the death of the last surviving account holder, their agent should recommend that the Smiths open: A) a joint tenancy account with right of survivorship. B) a joint tenancy account with right of survivorship and execute a transfer on death (TOD) registration form. C) individual accounts in the name of each daughter. D) a tenants in common account.
B) a joint tenancy account with right of survivorship and execute a transfer on death (TOD) registration form. The agent should recommend that the Smiths open a joint account with right of survivorship and complete a transfer of death registration form. The joint tenancy account gives the Smiths joint ownership in the securities in the account. The surviving joint tenant immediately becomes the owner of the whole property upon the death of the other joint tenant (right of survivorship). The transfer upon death registration identifies the beneficiaries to receive the securities upon the death of the last joint tenant. Only individual and JTWROS accounts may be opened with a TOD provision.
Tax considerations are frequently an important factor when determining appropriate recommendations for advisory clients. In which of the following accounts is the tax status of the individual a critical factor? An account opened in the name of the XYZ Corporation, organized as a C corporation, by their chief investment officer. An account opened by a sole proprietor in the name of the company. An account opened in the name of ABC Corporation, an S corporation by one of its shareholders. An account opened in the name of the GHI fund, a Regulated investment company, by the fund's portfolio manager. A) I and IV. B) III and IV. C) II and III. D) I and II.
C) II and III. Sole proprietorships and S corporations have their income and losses pass through to the owners. Therefore, an account opened in the name of the business will create tax consequences for the owners. Regular, or C corporations, pay taxes on their earnings and, even though a Regulated investment company passes through at least 90% of its earnings to shareholders, the tax situation of each individual shareholder of the fund is of no consideration when making recommendations to the fund's portfolio manager.
An agent taking which of the following actions would be committing a violation? A) Buying securities in a joint account at the request of one party only. B) Selling securities from a corporate account by using limited power of attorney trading authority for the account. C) Selling securities from a minor's custodial account without the custodian's consent but with the beneficial owner's consent. D) Buying securities in a cash account with the consent of the customer.
C) Selling securities from a minor's custodial account without the custodian's consent but with the beneficial owner's consent. The custodian, not the beneficial owner (minor), is the person who has the authority to make investment decisions for an account. Any tenant in a joint account may give instructions for the account.
If 3 individuals open a joint account with your firm and one of the parties has written authorization from the other parties granting him authority to make all trading decisions, the new account form must contain information on: A) the individual with the highest net worth. B) any two of the three individuals. C) all three individuals. D) the individual granted trading authority.
C) all three individuals. Information is needed on all three individuals because they all have ownership in the account.
An agent may open a joint account for which of the following? Lee and his 13-year-old son, Tom. Mary and Kelley, two adult college roommates. Jerry and Mark, friends and partners in business for more than 20 years. Melinda and her minor nephew, John, for whom she is guardian. A) I and III. B) I and IV. C) II and IV. D) II and III.
D) II and III. Mary and Kelley, two adult college roommates. Jerry and Mark, friends and partners in business for more than 20 years. *JT Accts cannot be opened for minors Joint account owners share ownership of the account and must be adults. A minor may not legally exercise control over an account and may not be an owner of record of an account.
A wealthy individual has set up a GRAT. During the term of the trust, how is the income taxed? A) To the beneficiaries. B) Deferred until the termination of the trust. C) Only to the extent that the actual earnings exceed the amount of the annuity payout. D) To the grantor.
D) To the grantor. Even though the Grantor Retained Annuity Trust (GRAT) is technically an irrevocable trust, because of the retained interest by the grantor, tax liability on the trust's income remains with him.
A limited liability company is: A) an insurance company. B) traded on major exchanges. C) a company with tax consequences similar to a partnership. D) a limited partnership.
C) a company with tax consequences similar to a partnership. A limited liability company is a form of business entity in which the shareholders (called members) are taxed individually at their respective tax rates as is the case in a partnership.
*A complex trust has the following income for the year: $1,500 in taxable interest, $2,000 in dividends (reinvested in the stock), and $3,000 in tax-exempt interest. In addition, the portfolio realized $3,500 in capital gains that were reinvested in the corpus. What is the distributable net income (DNI) for the trust? A) $6,500. B) $1,500. C) $4,500. D) $10,000.
A) $6,500 All investment income, regardless of source, will be considered DNI and will be included in the taxable income calculation to the trust unless distributed. Reinvested capital gains are not part of a trust's DNI.
Which of the following types of business organizations do not protect owners' personal assets from losses incurred by the business? General partnership. Sole proprietorship. S corporation. C corporation. A) III and IV. B) I and II. C) I only. D) II and III.
B) I and II. Corporations, whether organized as C or S corporations, afford their owners limited liability which is the protection of their personal assets from losses incurred by the businesses. General partnerships and sole proprietorships subject their owners to personal liability for losses of the business.
In administering a joint account, a member firm's responsibilities concerning suitability determination and information disclosure apply to: A) the person with trading authority for the account. B) the person whose Social Security number is on the account. C) all persons who jointly own the account. D) the person with the greatest capital contribution.
C) all persons who jointly own the account. Suitability rules apply to all owners in a joint account.
**Which of the following statements about S corporations are CORRECT? S corporation status offers greater opportunity for raising additional capital than do other forms of business structure. Stockholders of S corporations are taxed on the net profits of the corporation, even if they do not receive taxable dividends. An S corporation may have no more than 50 shareholders. An S corporation may have only one class of stock. A) I and III. B) III and IV. C) II and IV. D) I and II.
D) II and IV. S corporations are flow-through vehicles, so any earnings are taxable to shareholders, whether or not they are paid out as dividends. An S corporation may have no more than 100 shareholders and may issue only one class of stock so its ability to raise large amounts of capital is rather limited.
Which of the following individuals may not open a joint account? A) Two spouses. B) Three sisters. C) Business colleagues. D) Parent and a minor.
D) Parent and a minor. Any two or more persons can have a joint account, but a minor is specifically excluded from the definition of a person.
Which of the following statements relating to trusts is CORRECT? A) A simple trust is required to distribute all of its income in the year earned. B) A complex trust is required to distribute all of its income in the year earned. C) A simple trust may distribute principal during the year. D) A complex trust may only distribute principal during the year in which the trust terminates.
A) A simple trust is required to distribute all of its income in the year earned. A simple trust is one that is required to distribute all accounting income in the year earned, has no charitable beneficiaries, and does not distribute principal in the current year. A complex trust is one that is allowed to accumulate income, has a charitable beneficiary, or distributes principal. All trusts are complex in their final year because all principal must be distributed when the trust terminates.
Several entrepreneurs form an S corporation. Under which of the following circumstances will the entrepreneurs risk losing their tax benefits? 150 new investors buy into the corporation during the year. 1 new member is a nonresident alien. 50% of the corporation's income is derived from passive investments in limited partnerships. The corporation issues several classes of stock. A) I, II, III and IV. B) I only. C) I and II. D) I, II and III.
A) I, II, III and IV. S corporations must not have more than 100 stockholders and each stockholder must be a citizen or resident of the United States. The corporation can only have one class of stock, and no more than 25% of the corporation's income can come from passive activities. If you were not sure of this last fact, a useful test-taking technique is recognizing that all of the other choices are correct and there is no way to select them without this one.
Carol is opening an investment account with her agent and will be expected to disclose all of the following items of financial or personal information EXCEPT her: A) educational background. B) age. C) annual income. D) investment experience.
A) educational background. When an agent opens accounts on behalf of a broker/dealer, she is required to ask each applicant to disclose date of birth, and will request annual income, and net worth, as well as investment experience. Disclosure of educational background is not typically sought.
Which of the following is among the most important reasons to form an S corporation? A) Ability to retain and reinvest earnings in a growing business. B) Avoid the double taxation of dividends. C) Ability to enjoy corporate tax rates. D) Enjoy the same legal status of a general partner in a partnership.
B) Avoid the double taxation of dividends. One of the most beneficial features of the S corporation is that the earnings pass through to the shareholders in proportion to their share of ownership and are taxed at the individual level (as opposed to the corporate level). Dividend distributions are not taxed twice as with the regular form of corporate ownership.
Alvin's spouse is a trustee of a trust established by Henrietta Flood, which directs income from the trust be paid to Alvin, for as long as he lives. Alvin's son, Floyd, will receive the principal upon Alvin's death. Floyd would like to receive some of the principal before Alvin's death and Alvin does not object. How should his spouse, the trustee, act in this situation? A) Distribute part of the income to Floyd. B) Follow the trust terms, continuing to distribute the income to Alvin and the principal to Floyd upon Alvin's death. C) Distribute part of the principal to Floyd. D) Distribute all of the principal to Floyd.
B) Follow the trust terms, continuing to distribute the income to Alvin and the principal to Floyd upon Alvin's death. A trustee must follow the terms of the trust. Nothing in the question implies that the trustee has any discretionary powers.
A wealthy individual has established a trust and named you as the trustee. If you wish to establish an account that permits the trust to engage in margin transactions, which of the following statements regarding margin trading is TRUE? A) It is permitted if the fiduciary shares in the profits or losses. B) It is permitted if provided for in the underlying documentation. C) It is not permitted. D) It is permitted if the fiduciary observes the prudent investor rule.
B) It is permitted if provided for in the underlying documentation. Margin trading in a trust account is permitted only if it is specifically provided for in the trust agreement.
*A wealthy individual has set up a GRAT. Should he die during the time the trust is active, how are the remaining assets in the trust taxed? A) The original value plus any appreciation passes to the beneficiaries, but is subject to gift tax. B) The original value plus any appreciation passes to the beneficiaries and is taxed as ordinary income. C) No tax is due if the grantor should die during the term of the trust. D) The original value plus any appreciation is taxed as part of the grantor's estate.
D) The original value plus any appreciation is taxed as part of the grantor's estate. One of the risks in setting up a GRAT is that if the grantor dies during the term of the trust (usually 2-10 years), the assets put in the GRAT, plus any appreciation, are included in his or her estate.
**Which of the following is NOT a characteristic of a C corporation? A) Double taxation of dividends. B) Limited liability. C) Retains and reinvests earnings. D) Generally not liable for federal income tax.
D) Generally not liable for federal income tax. Regular corporations are subject to federal income taxation because the earnings are not passed to the shareholders, as is the case in an S corporation or a partnership. Dividends are taxed twice: first at the corporate level and then at the individual level. Limited liability is a basic characteristic of all corporations. A regular corporation retains and reinvests earnings that are not distributed to shareholders as dividends.
If a trust has been established under which the father is to receive income for life, and his son is to receive the trust principal on the father's death, which of the following statements is TRUE? A) The trustee must notify the son each time an income distribution is made to the father. B) The trustee does not need to keep records of the income distribution to the father. C) The trustee can withhold income distributions to the father to preserve principal to the son. D) The trustee is not required to notify the son when an income distribution is made to the father.
D) The trustee is not required to notify the son when an income distribution is made to the father. It is not required that the trust's remainder beneficiary be notified when income is distributed from the trust. The trustee must report distributions from the trust for federal income tax purposes. The trustee must follow the terms of the trust, making distributions as required by the trust instrument.
In an account opened by two individuals as joint tenants with rights of survivorship, all of the following are true EXCEPT: A) orders may be entered by either party. B) mail may be directed to the joint owner agreed upon by both parties to the account. C) in the event of death, the other party assumes full ownership of the account. D) stock certificates may be delivered in the name of either party.
D) stock certificates may be delivered in the name of either party. In a JTWROS account, each party has an equal, undivided interest in the account. Upon the death of one party in a two-party account, the other party assumes full ownership of the account. Orders may be entered by either party, and mail may be directed to either party. However, disbursements of cash or securities must be in the name of all parties to the account.
