Unit 21
If an employed client has $12,000 of capital gains and $15,000 of capital losses in the most recent taxable year, how much unused loss, if any, is carried forward by the client to the following tax year?
$0.00 In this question, the client had $12,000 of capital gains and $15,000 of capital losses. Step 1: Offset the capital gains with the capital losses ($15,000 - $12,000). This leaves $3,000 remaining in capital losses. Step 2: Note that the client can apply up to a maximum of $3,000 of any remaining losses against ordinary income. Once all $3,000 in remaining losses is used to reduce ordinary income, this would leave $0 to carry forward to the next year. Therefore, the reason you would not carry $3,000 to the next year is that it would be used to reduce ordinary income for the current year.
f a husband makes a gift of $100,000 to his wife, a U.S. citizen, how much of the gift is subject to gift taxes?
$0.00 Interspousal gifts to citizens of the United States, regardless of amount, are not subject to gift taxes.
A customer in the 25% tax bracket bought 200 shares of ABC at $93 per share plus commission of $50. Considering the customer's cost basis, when she sold 100 shares six months later at $96 per share, less commission of $50, her after-tax net was
$168.75. Because the purchase and sale were of different lots, you must compute the net proceeds on a per share basis. Dividing the cost of $93 + commission of .25 ($50 ÷ 200 shares) gives you a total per share cost of $93.25. Selling for $96.00 - 0.50 ($50 ÷ 100 shares) = $95.50 proceeds per share. $95.50 - $93.25 = $2.25. $2.25 multiplied by 100 shares sold = $225.00. In a 25% tax bracket, this is a taxable short-term gain and 25% of $225.00 = $56.25. Therefore, her after-tax net was $168.75 ($225 - 56.25).
During the previous fiscal year, The Kaplan Family Trust received $24,000 in dividends and $35,000 in interest from corporate bonds. Securities transactions during the year resulted in long-term capital gains of $48,000, $20,000 of which were reinvested in the corpus. The DNI for the Kaplan Family Trust is
$87,000 Distributable Net Income (DNI) is dividends and interest plus capital gains that have not been reinvested back into the trust. In this case, $24,000 + $35,000 + $28,000 = $87,000.
Three years ago, a customer bought 200 shares of ABC for $60.50 per share. Upon her death, she left the shares to her husband when ABC was trading at $98.25. If her husband sells the shares for $99.25, what is his cost basis for tax purposes?
$98.25 The cost basis to the recipient of inherited securities is the fair market value on the date of the owner's death. In this case the fair value is the market value of $98.25.
In order for an individual to receive Social Security benefits based on the earnings of the ex-spouse, the couple must have been married for at least
10 years. If a couple has been married for at least 10 years prior to divorcing, an ex-spouse may claim benefits. There are other requirements including unmarried status for the claimant.
A customer who sold a bond at a loss must wait how long before he can buy back a substantially identical bond and not have the sale classified as a wash sale?
31 days When a customer sells a security at a loss, he may not buy back the same (or substantially identical) security from 30 days before to 30 days after the sale that established the loss, without having the loss disallowed.
A customer is selling inherited stock. The decedent originally paid $50 per share and on the date of the decedent's death, the stock was worth $60 per share. On the day the customer sells the stock, the price per share is $62. What is the investor's cost basis in the stock?
60 The IRS allows a step-up in basis for inherited stock. The customer's cost basis is the fair market value of the stock on the date that the decedent died.
When are estate taxes due?
9 months after death Estate taxes are due 9 months after death. The taxes are based on either the value at death or the alternative valuation 6 months after death.
The Wrights live in Texas, where Maria Wright has had an extremely successful cattle business for a number of years. As a very generous person, how much money can Maria give to her spouse, a Canadian citizen, in 2019 without incurring gift tax consequences?
A limited amount because her spouse is not a U.S. citizen Under current tax regulations, there is a limit to the amount of a gift that may be made to a noncitizen spouse. For 2019, that limit is $155,000, (the amount is never tested).
The separate account subaccounts chosen by the purchaser of a variable life insurance policy have had outstanding performance over the past 15 years. There would generally be no tax implications in which of the following situations?
A loan is taken equal to 95% of the policy's cash value Funds obtained from a policy loan are not considered taxable income (same as any loan - you owe the money). If the amount received at policy surrender is greater than the cost basis, the excess is taxed as ordinary income. The same is true with the withdrawal. Although the death benefit will always be free of income tax, it could be subject to estate tax.
Part of the information-gathering role of an investment adviser representative is preparing a family balance sheet and family income statement, both of which are essential for determining suitability. Which of the following would be entries on the income statement rather than the balance sheet?
Alimony Please note that the question is not asking about taxation of the alimony. An income statement includes both income and expenses. What is important here is that in a profile for a client, regardless of the taxation, alimony is money received by your client who is the payee and an expense to your client who is making the payments.
Which of the following would generally NOT result in any income tax liability?
Death benefit proceeds from a life insurance policy As a rule, profits from flow-through businesses like S corporations and earnings from a sole proprietorship are subject to income tax. Qualified dividends are taxed at a lower rate than nonqualified ones; in fact, for taxpayers in the 10% or 15% tax bracket, the rate on these dividends is 0%. But don't choose that answer in a question like this (unless the question specifies the lowest tax bracket investors), because that is an exceptional case (there are not many people buying securities in those low tax brackets). Death benefits from life insurance policies are invariably tax free.
If an investor is in the highest federal income tax bracket and is subject to the alternative minimum tax, which of the following securities should an agent recommend?
General obligation bond Municipal bonds are suitable for the portfolio of an investor who is in a high tax bracket because the interest is exempt from federal income tax. A general obligation (GO) bond is a better recommendation than an industrial revenue bond because the interest on industrial revenue bonds is likely subject to the AMT.v
Last year, an investor had a $5,000 loss after netting all realized capital gains and losses. This year the investor has a $1,000 capital gain. After netting his gains and losses, what will be his tax situation this year?
He will offset $1,000 ordinary income this year. Only $3,000 of last year's loss can be deducted against that year's income. Therefore, the losses carried forward from the previous year are the remaining $2,000. These losses are netted against the gain of $1,000 for a net loss of $1,000. That loss can be used to offset $1,000 of ordinary income. There are now no longer any losses to carry forward.
You are working with a client who received her divorce earlier this year. She has 2 young children, ages 4 and 7, who both live with her. In general, it would be most advantageous for her to file her federal income tax claiming what status?
Head of Household Taxpayers claiming the Head of Household filing status benefit from a higher standard deduction and lower tax rates than single taxpayers. There are several requirements that must be met to qualify for HOH status. Some of them include the following: You are unmarried or "considered unmarried" on the last day of the year. A "qualifying person" lived with you in the home for more than half the year (except for temporary absences, such as school). This is generally your children. Because she is divorced, she can't claim married or joint and, as stated above, filing as HOH offers many tax advantages over single.
One of your customers purchased a variable life insurance contract through your firm. After 14 years, he had deposited $15,000 in premiums, and his death benefit had grown to $80,000. Shortly after taking out a loan against cash value of $10,000, he was killed in an automobile accident. What will be the tax consequences of this situation to the death benefit?
His beneficiary need not pay taxes on the death benefit. A death benefit payable on a life insurance policy or contract is not subject to taxation. The insurance company will deduct the balance of the $10,000 loan before it releases the death benefit to the beneficiary, but that does not affect the tax consequences.
Which of the following is (are) advantages of irrevocable insurance trusts? Provide estate liquidity. Insurance proceeds are removed from the estate of the insured for tax purposes. The insured has the flexibility to alter the trust arrangements. Once set up, no changes may be made.
I and II As with all life insurance, the proceeds are available almost immediately upon death providing estate liquidity. When done properly, the proceeds of the policy are not included in the deceased's estate, thereby saving estate taxes. The trust is irrevocable—no changes can be made, and this is one of the few disadvantages.
Under current federal tax law, which of the following would have an effect on the amount of taxes your client would pay? Age Citizenship Marital status as of the last day of the year Residency
I, II, III, and IV Each of these can affect your tax rate. Taxpayers age 65 and older get an extra exemption, so that lowers their tax. If you are not a U.S. citizen, and are considered a nonresident alien, you are taxed somewhat differently than others. Only married persons can file a joint return, which usually, but not always, results in lower taxes. Residency determines if you will also have to pay a state income tax and receive deductions for that (or a state sales tax) on your federal income tax.
Which of the following statement(s) regarding gift taxes for a gift made in 2019 are TRUE? Gifts of $15,000 per person per year can be given without a tax liability. Gifts in excess of $15,000 per person per year may be subject to tax. The donor, not the recipient, is responsible for any tax liability. The tax rate increases with the size of the gift.
I, II, III, and IV In accordance with current gift tax regulations, an individual may give a gift of up to $15,000 per person in 1 year with no gift tax liability. If the gift exceeds $15,000, it is the donor who is responsible for any tax. The gift tax is a progressive tax, which means that as the size of the gift increases, the percentage of applicable tax will also increase.
A U.S. citizen purchases a bond issued by the government of Sweden. The interest payments received are taxed at which of the following levels? Federal State Local
I, II, and III Interest on foreign bonds is taxed in the United States by federal, state, and local governments.
If a high-income taxpayer is subject to AMT, which of the following preference items must be added to adjusted gross income to calculate his tax liability?
Interest on a private purpose municipal bond The interest received on private purpose municipal bonds is considered a tax preference item for the AMT. The interest on GO bonds and income received on corporate securities are never considered preference items under the AMT. In the real world, it is not only those with high incomes that are caught by the AMT, but the exam is not likely to go that deep.
A deceased client's trust account has over 90% of its value invested in a single common stock whose recent performance has been outstanding, resulting in a very large unrealized capital gain at the time of death. What action would most likely be taken by the investment adviser handling this account?
Liquidating a portion of that stock to take advantage of the tax savings offered by the stepped-up basis at death Under current tax law, a beneficiary inherits assets at their fair market value as of the time of death. This is known as a stepped-up basis (probably because these assets are generally at a higher price than when originally purchased). In this question, we are told that there is a large unrealized gain. Therefore, with a portfolio that is overconcentrated in 1 security, it would make sense to diversify while, at the same time, avoiding or minimizing capital gains taxes. It would be against the provisions of the UPIA for a fiduciary to ever engage in trading from his own account.
An investor purchases 100 shares of ABCE common stock at $70 per share. Thirteen months later, the stock is sold when the market price is $50 per share. Which of the following activities made 20 days after the sale of the stock at $50 per share, would NOT violate the wash sale rule?
Purchasing an ABCE put option The wash sale rule applies when the same or substantially identical security as a stock sold at a loss is acquired within the 30 day period prior to and after the sale. Buying a put is not a problem because the put only allows the holder to sell the stock, not buy it. Please note that a bond convertible at $50 is convertible into 20 shares, so 5 bonds will enable the investor to convert into 100 shares.
A Schedule K-1 would NOT be used for tax reporting to the owners by which of the following business entities?
Sole proprietorship Sole proprietorships generally complete Schedule C of the individual Form 1040. Legal entities that pass through income or loss use the Schedule K-1 to indicate the amount of that income or loss attributable to the individual shareholder/member/partner.
A client buys 100 shares of a mutual fund on December 28, 2016, for $4,000 and receives a capital gains distribution of $2.40 per share on March 6, 2017, which is taken in cash. He sells his 100 shares for $4,300 on June 19, 2017. For tax purposes, this transaction will result in
a $300 short-term capital gain The June sale of the shares purchased in December results in a short-term capital gain of $300. The distribution represents a long-term gain of $240, but this question only deals with the client's transaction.
Which of the following is not included in adjusted gross income on an individual's federal income tax return?
Stock dividends Stock dividends (dividends paid as additional shares of stock rather than in cash) adjust the investor's cost basis and don't come into play until the stock is sold.
Which of the following offers the opportunity to realize a capital gain rather than ordinary income?
Stock dividends Stock dividends, unlike cash dividends, are not taxable in the year of receipt. Instead, they reduce the owner's cost basis and, when sold at a price above that cost basis, are treated as capital gain rather than ordinary income. Deferred annuities never generate anything but ordinary income, and qualified withdrawals from Section 529 plans result in no taxation on the earnings. If they are not qualified, there is ordinary income tax plus a penalty.
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 Shares received per a stock dividend are not currently taxable. Instead, shareholders who receive stock dividends must adjust their cost basis in the shares downward. The total number of new shares, multiplied by their new adjusted basis, must equal the shareholder's total interest before the stock dividend was received.
A number of corporations offer dividend reinvestment plans (DRIPs) where the client's dividends are automatically reinvested in additional shares of the issuer. In the case of a company that pays dividends with some degree of regularity, if the market price per share has declined over the year, an investor participating in one of these plans would find which of the following to be TRUE (assume no splits)?
There are more shares in the investor's account. With the dividends reinvested, there will be more shares. Although the market price per share has declined, we don't know the aggregate account value (with the additional shares) so we don't have enough information to tell if the overall value has risen or declined.
An investor purchases 500 shares of stock on January 10, 2020, at $50 per share and sells it on August 4 of the following year for $40 per share. As a result, the investor has realized
a long-term capital loss Buying stock at $50 per share and selling it for $40 per share creates a capital loss of $10 per share. In this case, because the holding period was more than a year and a half, the loss is long term. If the purchase is in January 2020 and the sale is in August of the following year, that must be August 2021.
Benefits of structuring a business as a general partnership would include
avoidance of taxation at the entity level so the partners are not taxed twice General partnerships file a Form 1065 and pay no tax. Instead, each partner's share of the income is reported on Schedule K-1 making for a single rather than double layer of tax.
An estate planning tool that may be used to take advantage of the lifetime estate tax exclusion is the
bypass trust The bypass trust is most commonly used to maximize estate tax savings by having the first to die of a married couple leave the lifetime exclusion ($11.4 million for 2019) to their children with the balance taken against the unlimited marital deduction. This results in saving estate taxes on that $11.4 million. With the "portability" provisions of the tax law signed on December 17, 2010, this is of limited value.
The amount of federal income tax a U.S. citizen residing in the country will pay is dependent on all of these EXCEPT
gender Tax rates are not dependent upon one's gender. Age has an impact because there is an extra exemption for those at age 65. State of residence is a factor because certain state taxes are deductible on your Form 1040. Filing status is very important because in most cases, married filing jointly results in the lowest taxes.
You have a client who was divorced 3 years ago, maintains a home, and has custody of the children. More than likely, the most advantageous tax filing status for your client is
head of household. When qualifying for head of household status (the technical qualifications are beyond the exam), the individual has the lowest tax burden. There is no such status as "divorced parent" and one cannot file jointly unless married. Filing as a single carries the highest tax burden.
Many different investments offer the opportunity to reinvest income. If one were to compare the difference between interest-on-interest reinvestment plans and dividend and capital gain reinvestment plans,
in both plans, all income is taxable in the year received, whether reinvested or not Regardless of the type of plan, any income, whether reinvested or not, is always taxed in the current year. Think of an interest-on-interest plan as a passbook savings account where the interest is credited and compounded. Whether taken out or not, the earnings are reported on an annual basis. On the exam, the question may ask for a difference as we have here, but, as you can see, there is no difference.
The alternative minimum tax becomes a consideration when a taxpayer has so-called tax preference items. Included in that definition is
interest from private activity bonds When an individual has tax preference items, AMT becomes an issue. One of the securities that generates preference income is a private activity bond, a revenue bond that is issued to benefit certain facilities such as airports, sports facilities and hospitals. Interest on Treasury securities is never a preference item and earned income, such as wages, salary, and tips, is not considered a preference item.
An example of an interest-on-interest reinvestment program is
interest left to compound on a bank-insured certificate of deposit Interest-on-interest reinvestment is, as the term implies, the practice of compounding earnings by reinvesting them. This is traditionally the way a bank savings account or certificate of deposit builds in value. Reinvesting the dividends on a bond fund is dividend reinvestment, even though most, if not all, of the fund's income is generated by interest. Same with the UIT and there is no program for reinvesting bond interest similar to a DRIP for reinvesting dividends
Each of the following could cause an investor to be subject to the alternative minimum tax EXCEPT
interest received on school district GO bonds General obligation GO bonds are not subject to the AMT.
The alternative minimum tax (AMT)
is assessed against high annual income earners and disallows some deductions and exemptions used to calculate adjusted gross income. The alternative minimum tax (AMT) is assessed against high annual income earners. When calculating adjusted gross income, some deductions and exemptions are disallowed resulting in a higher taxable adjusted gross income (AGI). In the real world, it is not only those with high incomes that are caught by the AMT, but the exam is not likely to go that deep.
Tax preference items are used for the purpose of computing the alternative minimum tax. They include all of the following except
straight-line depreciation. Straight-line depreciation is not a preference item. All of the other choices are included in the IRS listing of tax preference items. In the case of the ISO, it is a preference item to the extent that the fair market value of the employer's stock is in excess of the strike price of the option. As a test-taking tip, when you see two opposites as answer choices, it is likely that one of them is the correct answer. In this case, we have straight-line and accelerated depreciation, only one of which is a preference item.
Investors who are subject to the alternative minimum tax (AMT) will lose the tax benefits normally associated with
tax preference items. Certain items receive favorable tax treatment from the IRS. One example is tax-exempt interest on private purpose municipal revenue bonds. Another example is accelerated depreciation. These types of items are known as tax preference items. For investors who are subject to the alternative minimum tax (AMT), the benefits normally associated with tax preference items are lost, because these items must be added back into the investor's taxable income.
When comparing the tax treatment of C corporations, S corporations, and LLCs, it would be CORRECT to state that
the C corporation is the only one that pays taxes Only the C corporation is a separately taxed entity; the income (or loss) from an S corporation or LLC flows-through to the shareholders/members. The tax filing dates for the 2 flow-through entities is the same, generally March 15, while that for the C corporation is the 15th day of the 4th month after the end of the fiscal year (April 15 for a calendar year filer). The suitability for the S corporation and the LLC generally looks through to the individual owners where that is not the case with the C corporation.
Using industry jargon, the tax on the last dollar of income is at
the marginal rate The IRS defines marginal tax rate as "the highest rate that you will pay on your income." Basically, as you make more money, you pay tax at a higher rate incrementally. The effective tax rate is the average that you pay on all of your income.
If a customer of your firm receives stock from the estate of her mother, the stock's cost basis in the hands of the customer is
the market value at date of death When securities are inherited, the heir receives a cost basis calculated as of the deceased party's date of death.
Regarding the treatment of estates by the IRS, it would not be correct to state any of the following EXCEPT
the maximum tax rate on estates is the same as that on gifts The maximum tax rate on estates and gifts is 40% (the number is not tested; only that the rates are the same). The alternative valuation date is 6 months after death; 9 months after death is when the tax is due. Dead people can't make gifts and any income received by the estate before it is liquidated is reported on Form 1041.
An investor has made the following purchases, all in the same calendar year: 100 ABC at $20 on January 15; 200 ABC at $25 on April 4; and 100 ABC at $30 on July 23. With ABC currently selling at $22, if this investor needed to sell 200 ABC, the best decision from a tax standpoint would probably be to
use LIFO The best decision from a tax standpoint is to arrange things to show the largest loss. Remember, losses can be used against gains and, if there are more losses than gains, up to $3,000 of that loss can reduce taxable income. Using a form of share identification known as LIFO (last in first out), enables the investor to designate the 100 shares purchased at $30 in July and 100 of the shares purchased at $25 in April. That will result in a short-term capital loss of $1,100 ($800 on the July shares purchased at $30 plus $300 on the April shares purchased at $25.) That loss may be used either against realized gains or, if this is the investor's only transactions, deducted in full against ordinary income. The average cost method is only available for mutual funds. If this investor used FIFO, the sale would be of the 100 shares bought in January at $20 per share and 100 of the shares bought in April at $25 per share. The sale of the January purchase results in a $200 gain ($22 - $20 × 100 shares). The sale of the April purchase results in a $300 loss ($22 - $25) = -$3 times 100 shares. Combining them generates a net loss of $100. From a tax standpoint, declaring a loss of $1,100 is preferable to a loss of $100.
