ch. 5 and 6

Sheila earned $100,000 during the year. She elected to defer $4,000 of her earnings into her employer's 401(k) plan and her employer matched this deferral dollar-for-dollar. In this year, what amount of Sheila's earnings was subject to payroll taxes? Question 8 options: a) $104,000. b) $96,000. c) $100,000. d) $92,000.

c) $100,000. Sheila's earnings of $96,000 that were not deferred to the 401(k) plan would be subject to payroll taxes plus her deferrals of $4,000 to the 401(k) plan would be subject to payroll taxes. The employer's matching contributions are not subject to payroll taxes. The amount subject to payroll taxes would be $100,000 ($96,000 + $4,000).

Which of the following qualified plans would allocate a higher percentage of the plan's current contributions to a certain class or group of eligible employees?1. A profit-sharing plan that uses permitted disparity.2. An age-based profit-sharing plan.3. A defined benefit pension plan.4. A target benefit pension plan. Question 1 options: a) 1 only. b) 2 and 4. c) 1 and 3. d) 1, 2, 3, and 4.

d) 1, 2, 3, and 4.

Which of the following is/are correct regarding the net unrealized appreciation (NUA) for stock distributed from a stock bonus plan? Question 9 options: a) NUA is not taxed at the time of the lump-sum distribution. b) NUA is the appreciation of the stock while held in the plan. c) NUA is not taxed as a long-term capital gain when the stock is ultimately sold. d) Both a and b.

d) Both a and b.

Lennox, age 63, is a participant in the stock bonus plan of XYZ, Inc., a closely held corporation. Lennox received contributions in shares of XYZ stock to the stock bonus plan and XYZ, Inc. had the following income tax deductions: Years # of Shares Value per Share Lennox terminates employment in year 6 and takes a distribution from the plan of 975 shares of XYZ, Inc., having a fair market value of $24,000. Which of the following correctly describes Lennox's tax consequences for year 6 from this distribution if Lennox does not sell the XYZ stock until year 8? Question 6 options: a) Lennox has ordinary income of $15,875 and long-term capital gain of $8,125 in year 6. b) Lennox has long term capital gain of $24,000 in year 6. c) Lennox has a long-term capital gain of $8,125 in year 6. d) Lennox has ordinary income of $15,875 in year 6.

d) Lennox has ordinary income of $15,875 in year 6. Lennox's ordinary income is exactly equal to XYZ, Inc.'s deduction at the time of contribution, $15,875 (see chart below) and this will be taxable as ordinary income in the year of the distribution. Lennox's net unrealized appreciation is $8,125 ($24,000 - $15,875) and will be taxed as a long-term capital gain when the stock is sold in year 8.

Going Higher Construction sponsors a 401(k)-profit-sharing plan. In the current year, Going Higher Construction contributed 25% of each employees' compensation to the profit-sharing plan. The ADP of the 401(k) plan for the NHCs was 3.5%. If Kendra, age 57, earns $100,000 and is a 6% owner, what is the maximum amount that she may defer into the 401(k) plan for 2023? Question 2 options: a) $13,000. b) $30,000. c) $5,500. d) $7,500.

a) $13,000. Kendra is highly compensated because she is more than a 5% owner, so the maximum that she can defer to satisfy the ADP test requirements is 5.5% (3.5% + 2%) and because she is over 50, she can defer the additional $7,500 (2023) as a catch-up contribution. Kendra can defer $5,500 (5.5% x $100,000) and $7,500 (the catch-up) for a total of $13,000.

Emily, age 58, has been a participant in the Icon, Inc. ESOP for fifteen years. She plans to retire at 65. At the end of this year, Emily's entire account balance is comprised of Icon stock valued at $1,000,000. Emily believes that Icon has a bumpy future ahead and would like to diversify some of her ESOP investments. (She has not diversified any interest in ICON prior to this time.) How much must Icon allow Emily to diversify this year? Question 1 options: a) $250,000. b) $1,000,000. c) $750,000. d) $500,000.

a) $250,000.

Which of the following is true regarding negative elections?1. A negative election is a provision whereby the employee is deemed to have elected a specific deferral unless the employee specifically elects out of such election in writing.2. Negative elections are no longer approved by the IRS.3. When an employer includes a negative election in its qualified plan, the employer must also provide 100% immediate vesting. Question 9 options: a) 1 only. b) 1, 2, and 3. c) 1 and 3.

a) 1 only.

Alicia owns Advertising Solutions, Inc. (ASI) and sells 100% of the company stock on January 2 of this year to an ESOP for $2,000,000. Alicia had an adjusted basis in the ASI stock of $150,000. She purchased the stock on July 3, 2001. Which of the following statement(s) are true? Alicia will not recognize long-term capital gain or ordinary income this year if she reinvests the proceeds of the sale in qualified replacement securities within 12 months. Alicia must recognize $1,850,000 of long-term capital gain at the time of the sale to the ESOP. If Alicia dies before selling the qualified replacement securities when the fair market value of those qualified replacement securities is $4,000,000, her heirs will have an adjusted basis in the qualified replacement securities of $2,150,000. Question 5 options: a) 1 only. b) 2 only. c) 1 and 3. d) None of these statements are true.

a) 1 only. A major advantage for an ESOP is the ability of the owner to diversify their interest in a closely held corporation. In this case, if Alicia reinvests in qualified replacement securities within 12 months of the sale to the ESOP, she will not recognize capital gain or ordinary income on the sale to the ESOP. If Alicia dies before selling the qualified replacement securities when the fair market value of the qualified replacement securities is $4,000,000, her heirs will receive the securities with an adjusted basis equal to the fair market value at her date of death, $4,000,000.

Which of the following statements are correct?1. ESOP trustees are held to a standard of a fiduciary.2. ESOP trustees hold funds "in trust" for the benefit of the employees, participants, and their beneficiaries. 3. ESOP trustees can be individuals, committees, or entities. 4. Some conflicts of interests among employees, the corporation, and management of the corporation do not require the ESOP trustee to resign. Question 2 options: a) 1, 2, 3, and 4. b) 2 and 3. c) 1, 2 and 3. d) 1 and 2.

a) 1, 2, 3, and 4.

Which of the following vesting schedules may a top-heavy qualified profit-sharing plan use? Question 2 options: a) 1-to-5-year graduated. b) 3-to-7-year graduated. c) 5-year cliff. d) 4-to-8-year graduated.

a) 1-to-5-year graduated. As a result of the PPA 2006, qualified profit-sharing plans must use a vesting schedule that provides participants with vested benefits at least as rapidly as either a 2- to 6-year graduated vesting schedule or a 3-year cliff vesting schedule.

Which of the following statements regarding an age-based profit-sharing plan is correct? Question 1 options: a) An age-based profit-sharing plan provides greater benefits to the older plan participants. b) An age-based profit-sharing plan only provides a benefit to those plan participants whose age is within 10 years of the age of the owner of the plan sponsor. c) Younger plan participants in an age-based profit-sharing plan usually receive most of the profit-sharing plan allocation. d) An age-based profit-sharing plan provides a greater benefit to those plan participants whose earnings exceed the Social Security wage base and who are over fifty years old.

a) An age-based profit-sharing plan provides greater benefits to the older plan participants

A non-safe harbor 401(k) plan allows plan participants the opportunity to defer taxation on a portion of regular salary simply by electing to have such amounts contributed to the plan instead of receiving them in cash. Which of the following statements apply to 401(k) salary deferrals?1. Salary deferral into the 401(k) plan is limited to $22,500 for individuals younger than 50 for 2023.2. A non-discrimination test called the actual deferral percentage test applies to salary deferral amounts. Question 9 options: a) Both 1 and 2. b) Neither 1 nor 2. c) 2 only. d) 1 only.

a) Both 1 and 2.

Mario, age 61, is a participant in a stock bonus plan. The value of the employer stock contributions to the plan over the course of his participation totaled $165,000. On December 1st of last year, Mario takes a full distribution of the employer stock from the plan at a value of $550,000. Fourteen months later, Mario sells all the stock for $400,000. Which of the following statements is true? Question 9 options: a) Mario has ordinary income of $165,000 for last year. b) Mario has a long-term capital gain of $385,000 for last year. c) Mario has ordinary income of $165,000 and long-term capital gain of $385,000 for last year. d) Mario has a long-term capital loss of $150,000 in the current year.

a) Mario has ordinary income of $165,000 for last year. Because Mario is taking a lump-sum distribution from a qualified plan of employer stock, he will not have to recognize the net unrealized appreciation until he disposes of the employer stock. However, at the time of the distribution, the value of the stock, as of the date of contribution to the plan, will be taxable as ordinary income. Any gain on the subsequent sale of the stock will be taxable as long-term capital gain. In this case, Mario will recognize $165,000 of ordinary income at the date of the distribution and long-term capital gain of $235,000 ($400,000 - $165,000) at the date of sale.

A profit-sharing plan that uses permitted disparity allocates a higher percentage of the plan contribution to those participants whose earnings are in excess of the Social Security wage base.

a) True

One disadvantage of an ESOP is that it may place an unnecessary cash-flow burden on the plan sponsor. Question 8 options:a) Trueb) False

a) True

Participants of a stock bonus plan sponsored by a C corporation must be given pass-through voting rights for the employer stock held by the plan. Question 10 options:a) Trueb) Falsea) 1 only.

a) True

Toni, an executive vice-president, terminates her employment with Kerry Oil and Gas after three years of service. Her account balance in the company profit-sharing plan was $21,000 at the time of termination. The plan follows the least generous graduated vesting schedule permitted under PPA 2006, so Toni's vested benefit in the profit-sharing plan is $8,400. Question 3 options:a) Trueb) False

a) True A profit-sharing plan which follows the least generous graduated vesting schedule permitted under PPA 2006 must follow a 2-6 year graduated vesting schedule. In such a case, after three years of service, Toni would be 40% vested in the $21,000 profit-sharing plan account balance, and her vested account balance would be $8,400 ($21,000 x 40%).

Elizabeth, who turns age 60 this year, has been a participant in the ADM, Inc. ESOP for 22 years. The normal retirement age for the participants of the ESOP is 65. If Elizabeth's ESOP account balance is comprised of ADM stock valued at $4,000,000 and considering that Elizabeth has not elected to diversify any amount prior to the current year, ADM must allow Elizabeth to diversify at least $1,000,000 (the value of 25% of the total shares contributed) of her ESOP account balance. Question 3 options:a) Trueb) False

a) True When a participant attains the age of 55 and has 10 years of participation with the ESOP, the plan sponsor must allow the participant to diversify at least 25% of the total number of shares of employer stock contributed to the plan. In the final year of the 6-year qualified election period, the participant must be allowed to diversify an aggregate amount of at least 50% of the total number of shares contributed. In this case, since Melissa is not in the final year of the election period but considering that she is older than 55 and has been a participant for greater than 10 years, she can only compel ADM to diversify 25% of the total number of shares contributed, which is currently valued at $1,000,000.

Several years ago, Mona retired from Fox, Inc., a national plastics supplier. When Mona retired, she had 1,000 shares of Fox, Inc. stock in her stock bonus plan. Fox, Inc. took deductions equal to $20 per share for the contributions made on Mona's behalf. At retirement, Mona took a lump-sum distribution of the employer stock. The fair market value of the stock at distribution was $35 per share. On July 15th of this year, Mona sold the stock for $40 per share. Which of the following will Mona report on her tax return at the date she sells the Fox, Inc. stock? Question 1 options: a) $35,000 of ordinary income, $5,000 long-term capital gain. b) $0 of ordinary income, $0 of short-term capital gain, $20,000 of long-term capital gain. c) $20,000 of ordinary income, $20,000 of short-term capital gain. d) $40,000 of ordinary income.

b) $0 of ordinary income, $0 of short-term capital gain, $20,000 of long-term capital gain. Mona will not be subject to ordinary income at the date the stock is sold. $20,000 ($20 x 1,000; the basis amount contributed) would have been subject to ordinary income tax at the date the stock was distributed to Mona. At the date of sale Mona would have had $0 of short-term capital gain and $20,000 of long-term capital gain (the $15,000 net unrealized appreciation plus $5,000 additional gain between the distribution and sale dates).

Jared, age 54, earns $300,000 per year and is a participant in his employer's 401(k) plan. Ignoring the ADP test requirements, what is the maximum amount that Jared can defer under the 401(k) plan in 2023? Question 4 options: a) $22,500. b) $30,000. c) $66,000. d) $73,500.

b) $30,000. The deferral limitation for 2023 is $22,500 and Jared can defer an additional $7,500 (2023) as a catch-up contribution because he is age 50 or older

Preston, age 63, is a participant in a stock bonus plan sponsored by XYZ, Inc., a closely held corporation. Preston's account was credited with contributions in shares of XYZ stock to the stock bonus plan and XYZ Inc. had the following income tax deductions: Preston terminates employment in August of year 6 and takes a distribution from the plan consisting of 975 shares of XYZ, Inc., having a fair market value of $24,000. If Preston sells the stock for $40,000 six months after receiving the distribution, which of the following statements are true? 1. Preston has ordinary income of $14,382 in year 6.2. Preston has long-term capital gain of $24,000 in year 6.3. Preston has long-term capital gain of $8,125 in year 6.4. Preston has a short-term capital gain of $16,000 in year 7. Question 2 options: a) 2 and 4. b) 4 only. c) 1 only. d) 3 and 4.

b) 4 only.

Which of the following clauses in a 401(k) plan can assist the plan in meeting the requirements of the ADP test?

b) Negative election clause.

Which of the following is not a requirement for the owner of corporate stock who sells to an ESOP to qualify for the nonrecognition of gain treatment? Question 4 options: a) The ESOP may not sell the stock within three years of the transaction unless the corporation is sold. b) The ESOP must own at least 55% of the corporation's stock immediately after the sale. c) The owner must not receive any allocation of the stock through the ESOP. d) The owner must reinvest the proceeds from the sale into qualified replacement securities within 12 months after the sale.

b) The ESOP must own at least 55% of the corporation's stock immediately after the sale.

Rank-and-file employees who are beneficiaries of an ESOP are protected with the put option because: Question 1 options: a) The employee may force the corporation to sell the stock at a premium price. b) The employee may force the corporation to "buy back" the stock at fair market value. c) The employee may force the corporation to "buy back" the stock at a minimum price of 25 percent over the par value. d) None of the above are correct.

b) The employee may force the corporation to "buy back" the stock at fair market value. Beneficiaries are protected with the put option in ESOP's because the employee may force the corporation to "buy back" the stock at fair market value when there otherwise would be no market for the stock

All 401(k) plans must pass the ADP test.

b) False A 401(k) plan that elects safe harbor status is not required to comply with the ADP test.

Duff is the sole shareholder of Cupcake Surprises, Inc. (CSI) and sells 25% of the company stock to an ESOP for $550,000. Duff had an adjusted basis in the CSI stock of $100,000. Provided Duff reinvests the $550,000 in qualified replacement securities, he will not be required to recognize any capital gain. Question 6 options:a) Trueb) False

b) False Duff would be required to recognize capital gain of $450,000 on the transaction because to benefit from the nonrecognition of gain treatment, the ESOP must own at least 30% of the corporation's stock immediately after the sale. In this example, Duff only sold 25% of the stock to the ESOP.

If ICE Electronics, Inc. (ICE) established a profit-sharing plan for the current year, ICE is required to make contributions to the profit-sharing plan for the current plan year. Question 7 options:a) Trueb) False

b) False ICE is not required to make contributions to a profit-sharing plan each year. ICE can make contributions at its discretion.

Robert, age 54, is a participant in a noncontributory qualified profit-sharing plan sponsored by his employer. The maximum that may be contributed to Robert's account by the employer for the 2023 plan year is $73,500.

b) False The maximum contribution to a qualified profit-sharing plan for 2023 is $66,000. The catch-up contribution can only be contributed as a deferral contribution from employees who are age 50 and over. Since Robert's employer's qualified profit-sharing plan is noncontributory (all contributions are made by the employer), Robert would not have the availability to make deferral contributions to the noncontributory profit-sharing plan to meet the catch-up availability.

The plan sponsor of a 401(k) plan can require its employees to attain the age of 21 and complete 2 years of service to be eligible for participation in the 401(k) plan. Question 5 options:a) Trueb) False

b) False The standard eligibility rules require the plan sponsor of a qualified plan (including a 401(k) plan) to consider all employees who have attained the age of 21 and who have completed one year of service (1,000 hours) for eligibility in the plan. The exception to the standard rule allows the plan sponsor to only consider those employees who have attained the age of 21 and who have completed 2 years of service for eligibility in the plan, but the plan must provide 100% vesting after the completion of the 2 year period. However, the plan sponsor of a 401(k) plan is not eligible to utilize this exception.

Monarch Machines sponsors a 16.5% money purchase pension plan and 401(k) profit-sharing plan in which the employees are permitted to defer up to 75% of their compensation. Monarch Machines matches employee deferral contributions 100% up to 6% of deferred compensation. If James, age 31, is a highly compensated employee who earns $250,000, what is the maximum he could receive as an employer match from Monarch if the ADP of the NHC is 4% in 2023? Question 10 options: a) $20,500. b) $8,800. c) $12,350. d) $13,200.

c) $12,350. The maximum amount that may be contributed to qualified plans on James' behalf is $66,000 (2023). If James receives an allocation from Monarch's money purchase pension plan of $41,250 ($250,000 x 16.5%), he can only receive an additional $24,750 from other sources. The ADP of the NHC is 4%, so James, as a HC employee could, based upon the ADP test, defer up to 6% of his compensation and Monarch will match him 100%. However, $15,000 employee deferral and $15,000 match would put him over the max limit. Therefore, James would defer $12,375 of his compensation and Monarch would match $12,375. In this case, James will have received total annual additions of $66,000 ($41,250 + $12,375 + $12,375).

Lamont, age 55, is employed by BB Trucking Company as a tire repair specialist. He earns $120,000 per year and received an allocation of $45,000 to his employer-provided profit-sharing plan for the year. If BB Trucking does not match employee deferrals, what is the maximum amount Lamont can defer to his 401(k) plan for the 2023 plan year?

c) $28,500. The maximum deferral to a 401(k) plan for a participant who is 50 years old or over in 2023 is $30,000 ($22,500 plus catch-up of $7,500). The deferral is also included in the maximum defined contribution limit of $66,000 ($73,500 if 50 and over with catch-up). Since Lamont has received an allocation from the profit-sharing plan of $45,000, he is able to defer $21,000 ($66,000 - $45,000) plus the $7,500 catch-up deferral for participants who are 50 years and older to maximize his defined contribution plan limit for the year of $28,500.

One of the disadvantages of an ESOP is that the stock is in an undiversified investment portfolio. Which of the following statements is correct about ESOPs? An employee, age 55 or older, who has completed 10 years of participation in an ESOP may require that 25 percent of the total number of shares of employer stock contributed to the account be diversified. An employee who receives corporate stock as a distribution from an ESOP may enjoy net unrealized appreciation treatment at the time of distribution. Question 7 options: a) Neither 1 nor 2 b) 1 Only c) 1 and 2 d) 2 Only

c) 1 and 2

Which of the following vesting schedules may a non-top-heavy profit-sharing plan use?1. 2-to-6-year graduated.2. 3-year cliff.3. 1-to-4-year graduated.4. 3-to-7-year cliff. Question 7 options: a) 1, 2, 3, and 4. b) 1 only. c) 1, 2, and 3. d) 2 and 3.

c) 1, 2, and 3.

Bobby owns Advertising Solutions, Inc. (ASI) and sells 100% of the company stock on July 1 of the current year to an ESOP for $3,000,000. Bobby had an adjusted basis in the ASI stock of $450,000. If Bobby reinvests in qualified replacement securities before the end of the current year, which of the following statements is true? Question 3 options: a) Bobby must recognize $450,000 of ordinary income in the current year. b) Bobby must recognize $2,550,000 of long-term capital gain in the current year. c) Bobby will not recognize long-term capital gain or ordinary income in the current year. d) If Bobby dies before selling the qualified replacement securities, his heirs will have an adjusted taxable basis in the qualified replacement securities of $450,000, Bobby's carryover adjusted basis.

c) Bobby will not recognize long-term capital gain or ordinary income in the current year. A major advantage for an ESOP is the ability of the owner to diversify their interest in a closely held corporation. In this case, if Bobby reinvests in qualified replacement securities within 12 months of the sale to the ESOP, he will not recognize capital gain or ordinary income on the sale to the ESOP. If Bobby dies, the heirs will receive the securities with an adjusted taxable basis equal to the FMV at Bobby's date of death or the alternate valuation date.

Which of the following statements concerning stock bonus plans and ESOPs is(are) true? They both give employees a stake in the company through stock ownership and allow taxes to be delayed on stock appreciation gains. They both limit availability of retirement funds to employees if an employer's stock falls drastically in value and create an administrative and cash-flow problem for employers by requiring them to offer a repurchase option (a.k.a. put option) if their stock is not readily tradable on an established market. Question 7 options: a) 2 only. b) Neither 1 nor 2. c) Both 1 and 2. d) 1 only.

c) Both 1 and 2.

All the following are advantages of profit-sharing plans to businesses and business owners except: Question 6 options: a) May provide legal discrimination in favor of older owner-employees. b) Allows discretionary contributions. c) Must limit withdrawal flexibility. d) Controls benefit costs.

c) Must limit withdrawal flexibility.

Which of the following are correct for a leveraged ESOP, one in which the employer stock is obtained by virtue of a loan? Question 2 options: a) Contributions are subject to the 20 percent limit of covered compensation. b) There is no limit of contributions to the plan. c) The employer is permitted to deduct all interest paid on the ESOP loan. d) None of the above are correct.

c) The employer is permitted to deduct all interest paid on the ESOP loan. The employer is permitted to deduct all interest paid on the ESOP loan over and above the 25 percent deduction of total eligible payroll for plan participants.