Series 6: Taxation (Income Tax Consequences)
Robert Hall bought 500 shares of Snow White Mutual Fund at the Public Offering Price of $10.00 per share. This price included an 8.50% sales load. Mr. Hall chose not to have dividends and capital gains reinvested. In the first year, Mr. Hall received a dividend distribution of 35¢ per share, a capital gain distribution of 25¢ per share, and a return of capital of 30¢ per share. What is Mr. Hall's adjusted cost basis per share?
$9.70 per share
Which of the following statements concerning the requirements of Subchapter M of the Internal Revenue Code for a regulated investment company are correct? I The company must have 50% of its assets invested in diversified securities II The company must derive 50% of its income from dividends, interest, and gains on securities III The company must register under the Investment Company Act of 1940 IV The company must distribute at least 90% of its net investment income to shareholders
I, III & IV only Aside from the requirement to distribute at least 90% of Net Investment Income to shareholders, other requirements for conduit tax treatment under Subchapter M include: The company must file an election with the IRS; The company must register under the Investment Company Act of 1940; The company must derive at least 90% of its income from dividends, interest, and capital gains on portfolio securities; and The company must have at least 50% of its assets invested in diversified securities.
The IRS does not tax mutual fund distributions of which of the following income items?
Interest from municipal bonds Interest earned from municipal bonds and passed to investors is not taxable at the federal level. The interest keeps its tax-exempt character. The IRS taxes interest received from money market instruments and Treasury bonds at ordinary income tax rates. Dividends received from common stock are also taxable, but at a lower maximum 15% tax rate (the same rate as for long-term capital gains).
A customer buys 2000 shares of DEFF fund at $20.00 per share. The NAV per share is $19.00. The fund charges a 5% sales charge. The customer's cost basis per share is:
$20.00 The POP includes the 5% sales charge. The beginning cost basis is the amount paid by the customer, which is $20.00 per share. This includes $1.00 of sales charge per share. When the customer redeems the shares, this is the cost that is used to determine any resulting capital gain or loss.
A customer buys 500 shares of the ACME fund at $10.00 per share on January 3rd of this year. The fund has a 5% sales load. On July 20th of this year, the customer redeems the shares at $10.50 per share. The tax consequence is:
$250 short-term capital gain The customer bought 500 shares at $10 each and redeemed the shares for $10.50, 6 months later. The gain is $.50 per share x 500 shares = $250. The gain is a short-term capital gain since the customer held the shares for less than 1 year. The sales load of 5% is part of the purchase price, which is the cost basis. The gain or loss is simply the difference between the full purchase price and the redemption proceeds.
A customer in the 28% tax bracket has $9,000 of capital losses and $5,000 of capital gains. How much loss is deductible from this year's tax return?
$3,000 The customer has a capital gain of $5,000 and a capital loss of $9,000 for a net capital loss of $4,000. Of this amount, $3,000 can be deducted for this tax year, with a $1,000 loss carryforward.
A customer purchased 400 shares of XYA Corporation stock at $40 per share. After XYA pays a 25% stock dividend, what is the customer's cost basis in the stock?
$32 per share If there is a 25% stock dividend, the 400 share holding becomes 400 x 1.25 = 500 shares. The cost is adjusted to $40 / 1.25 = $32 per share adjusted cost basis. Note that the aggregate value of the customer's holding does not change. Before the stock dividend was paid, the customer had 400 shares at $40 = $16,000 aggregate holding value. After the stock dividend is paid, the customer has 500 shares at $32 = $16,000 aggregate holding value.
A customer has $7,000 of capital gains and $3,000 of capital losses in a tax year. On that year's tax return, the investor has a:
$4,000 taxable capital gain The tax law allows capital gains and losses to be netted each year. Any net capital gain is taxable; and net capital loss is tax deductible (with a maximum of $3,000 of net capital losses that can be deducted in any 1 year). Since there is $7,000 of capital gains and $3,000 of capital losses, this customer has a net $4,000 capital gain that is taxable.
Under IRS regulations, a gain or loss upon current disposition of an asset is long term if the asset has been held for over:
1 year Under IRS rules, a security's holding period is long term if it exceeds 1 year. Gains on assets held over 12 months are taxed at a maximum rate of 15%.
If a mutual fund distributes less than 90% of its net investment income, how much of its net investment income is subject to income tax?
100% of net investment income Unless an investment company distributes 90% or more of its net investment income, the IRS taxes all of its net income at corporate rates.
In order to qualify for Subchapter M treatment as a regulated investment company, what minimum amount of its assets must a mutual fund invest in diversified securities?
50% Aside from the requirement to distribute at least 90% of Net Investment Income to shareholders, other requirements for conduit tax treatment under Subchapter M include: The company must file an election with the IRS; The company must register under the Investment Company Act of 1940; The company must derive at least 90% of its income from dividends, interest, and capital gains on portfolio securities; and The company must have at least 50% of its assets invested in diversified securities.
For a mutual fund to be eligible for treatment as a regulated investment company, the fund's dividends, interest, and capital gains on portfolio securities must be what percentage of its income?
90% A regulated investment company must derive at least 90% of its income from dividends, interest, and capital gains on portfolio securities.
Which of the following statements concerning the tax treatment of mutual fund distributions is correct?
A distribution that is a "return of capital" is not taxable to the shareholder A shareholder must report for tax capital gains and dividend distributions in the year the fund makes the distributions. Whether the shareholder reinvests the money or not makes no difference in the tax treatment. A "return of capital" distribution is not income, dividends, or capital gain. This is reported in a separate box titled "Non-Dividend Distributions" on Form 1099-DIV because the distribution is not taxable.
If a customer calls about the tax treatment of a mutual fund distribution, the registered representative should advise the customer that the tax information will be sent on what IRS form?
Form 1099 Mutual fund dividend and capital gains distributions are reported to shareholders on Form 1099-DIV, which is sent by the fund to both the shareholders and the IRS.
Which of the following statements is NOT TRUE regarding reporting of short-term capital gains for tax purposes?
Gross short-term capital gains cannot be netted against capital losses shit's true: Short-term capital gains receive ordinary income tax treatment The net short-term capital gains amount is determined by deducting short-term losses from short-term gains Net long-term losses offset short-term gains Short-term capital gains are netted against any capital losses and only the net amount is taxable. Ordinary income tax rates apply to the net short-term capital gain. Lower long-term capital gains rates only apply to net gains on assets held over 1 year.
Which of the following statements concerning a mutual fund's capital gains distributions are correct? I Shareholders must report undistributed capital gains allocations for income tax purposes II Shareholders must report capital gains distributions for income taxes purposes III Funds generally must report short-term capital gains as long-term IV Funds must distribute appreciation of portfolio assets as capital gains
I and II only If a mutual fund does not distribute all of its capital gains to shareholders in that year (a very rare event), any undistributed portion of the capital gains is still reported to shareholders and is taxable. Capital gains distributions made by the fund to its shareholders are reported on Form 1099-DIV. Allocations of undistributed capital gains to shareholders are reported on Form 2439 - Notice to Shareholder of Undistributed Long-Term Capital Gains. Short-term capital gains are reported by mutual funds on Form 1099-DIV as non-qualified dividends and these are taxed at ordinary income tax rates of up to 37%. Funds do not distribute the unrealized appreciation - this shows as increased NAV in the fund. When appreciated securities are sold, the resulting capital gain is reported and is taxable.
Which of the following statements concerning a regulated investment company are correct? I It functions as a conduit for passing investment income to shareholders II It qualifies if it distributes at least 50% of its net investment income to shareholders III It pays no tax on income that it distributes as a dividend to shareholders IV Shareholders pay no tax on dividends received while the company qualifies under Subchapter M
I and III The IRS considers a regulated company a "conduit" or "pipeline" for passing investment income on to shareholders. A regulated investment company must distribute at least 90% of its net investment income. While the regulated investment company pays no tax on dividends it distributes, the shareholders receiving them report these for tax.
Which statements are true regarding the taxation of capital gains? I A capital gain is short term if a position is liquidated at a profit after being held for 1 year or less II A capital gain is short term if a position is liquidated at a profit after being held for over 1 year III For investors in the maximum tax bracket, any short term capital gains will be taxed at the same tax rate as that bracket IV For investors in the maximum tax bracket, any short term capital gains will be taxed at a lower rate than that bracket
I and III Under Internal Revenue rules, a capital gain (or loss) is short term if a position is liquidated after being held for 1 year or less. Short term capital gains are taxed at ordinary income rates with a maximum rate of 37% (the maximum individual tax rate). If the position is held for over 1 year (1 year and 1 day), then any gain or loss is long term. Gains on assets held over 12 months are taxed at a maximum rate of 15% or 20% (15% for individuals who are not in the maximum tax bracket; 20% for individuals who are in the maximum tax bracket).
Which of the following statements concerning the netting of short-term and long-term capital gains from sale of mutual fund shares are correct? I When a short-term gain exceeds a short-term loss, the investor reports a net short-term gain II When a short-term gain exceeds a long-term gain, the investor reports a net short-term gain III When a short term gain exceeds a long-term loss, the investor reports a net short-term gain IV When a long-term gain exceeds a short-term gain, the investor reports a net long-term gain
I and III only Capital gains and losses are "netted" against each other for tax purposes. When a short-term gain exceeds a short-term loss, the investor reports a net short-term gain. When a short term gain exceeds a long-term loss, the investor reports a net short-term gain. When an investor has both a short-term and a long-term capital gain, the investor reports both the long-term and the short-term gains separately, since they are both taxable, but at different tax rates. There is no netting of a gain against a gain; or netting of a loss against a loss. Only gains and losses are "netted."
Which of the following statements concerning the taxation of mutual fund earnings and capital gains are correct? I Earnings distributed by a regulated investment company will be taxed twice II A shareholder does not pay tax on capital gain distributions that are reinvested until the shares are sold III A regulated investment company must distribute at least 90% of its capital gains to shareholders IV Undistributed capital gains are taxed to the regulated investment company, but the investor must also report his or her own proportionate share of these gains
I and IV Subchapter M of the Tax Code allows a regulated investment company to serve as a "conduit" of income, so the income received on securities is not taxable to the investment company. The distributed income will be taxed twice (the company that earned it paid tax on the income from which the dividend was paid and the investor who received it had to include the dividend on his or her tax return and pay tax again). Subchapter M allows mutual funds to escape a third round of taxation on the same earnings. A regulated investment company is not required to distribute capital gains - the rule is that is must distribute at least 90% of Net Investment Income to be regulated. (However, a fund must distribute at least 98% of its capital gains to shareholders, otherwise, it will be subject to a 4% excise tax, but this has nothing to do with being a regulated investment company.) Any undistributed capital gains are reported by the fund to the shareholder on Form 2439 and these are taxable to the fund. The investor must report his or her proportionate share of these gains, with any tax paid by the fund being a credit against the shareholder's liability. A shareholder must pay tax on dividend and capital gains distributions - it makes no difference if they are reinvested.
Which statements are true regarding capital gains distributions made by mutual funds? I Securities held by the fund for 1 year or less and that are sold at a profit will result in a short-term capital gains distribution that is taxed at ordinary income rates II Securities held by the fund for 1 year or less and that are sold at a profit will result in a short-term capital gains distribution that is taxed at preferential rates III Securities held by the fund for over 1 year and that are sold at a profit will result in a long-term capital gains distribution that is taxed at ordinary income rates IV Securities held by the fund for over 1 year and that are sold at a profit will result in a long-term capital gains distribution that is taxed at preferential rates
I and IV The character of the capital gain distribution depends on how long the fund held the underlying security. If the fund held the underlying security for 1 year or less when it was sold at a profit, then any gain is short term. These are reported by the fund as a "non-qualified" ordinary dividend on Form 1099-DIV and are taxable at ordinary income tax rates of up to 37%. If a fund held the underlying security for more than 1 year when it was sold at a profit, any gain is long-term. These are reported by the fund on Form 1099-DIV in a separate box as long-term capital gains and are subject to a maximum tax rate of 15%or 20%. Note 15% for individuals who are not in the maximum tax bracket; 20% for individuals who are in the maximum tax bracket.
Which of the following statements is (are) TRUE about the tax treatment of distributions from a regulated investment company? I The tax laws consider a regulated investment company as a conduit or pipeline for passing investment income to investors II Investment income is not taxable for the corporation that earned the income III Investment income distributed to shareholders is not taxable at the investment company level as long as the investment company meets certain conditions IV Shareholders report the distributions they receive from the regulated investment company for tax purposes
I, III and IV only The IRS considers a regulated investment company to be a pipeline or conduit that passes investment income to investors without paying tax at the investment company level. The corporation that made the dividend payment to the investment company made that payment out of its "after-tax" income. The dividend then "passes-through" the "regulated fund" without being taxed at the fund level; instead it is taxable at the shareholder level only.
Which statements are true about regulated investment companies? I Any corporation that pays dividends to the fund is not liable for income tax on the earnings from which the dividends were distributed II Any corporation that pays dividends to the fund is liable for income tax on the earnings from which the dividends were distributed III The fund is not liable for income tax on any net investment income that it distributes to shareholders as a dividend IV The fund is liable for income tax on any net investment income that it distributes to shareholders as a dividend
II and III Dividends received by "regulated" mutual funds are paid by a corporation out of its "after-tax" income. These dividends received are part of the fund's Net Investment Income. When the fund distributes NII to the shareholders, it pays no income tax on the distributed NII. Taxation of the distribution occurs at the shareholder level only.
Which statement is true about taxation of distributions reported on Form 1099-DIV? I Distribution of dividends that come from interest payments on bonds held in a mutual fund portfolio are taxed at ordinary income tax rates of up to 15% or 20% II Distribution of dividends that come from interest payments on bonds held in a mutual fund portfolio are taxed at ordinary income tax rates of up to 37% III Distribution of dividends that come from dividend payments on stocks held in a mutual fund portfolio are taxed at tax rates of up to 15% or 20% IV Distribution of dividends that come from dividend payments on stocks held in a mutual fund portfolio are taxed at tax rates of up to 37%
II and III Dividends received from mutual funds invested in bonds are taxed as regular interest income. These are reported on Form 1099-DIV as "ordinary dividends" that are taxable at ordinary income tax rates of up to 37%. Dividends received from mutual funds invested in stocks qualify for the lower 15% or 20%. Note 15% for individuals who are not in the maximum tax bracket; 20% for individuals who are in the maximum tax bracket. These are reported on Form 1099-DIV as "qualified dividends" and are taxed at the lower rate.
Commissions paid when buying closed-end fund shares are: I deductible II non-deductible III included in the cost basis per share IV excluded from the cost basis per share
II and III The cost of purchasing shares, whether a sales charge or commission, is not deductible. It is included in the cost basis of the shares for tax purposes. For example, if a closed end fund share is purchased for $19 and a $1 per share commission is charged, the cost basis per share is $20. If the shares are later sold in the market for $31 per share, but there is a $1 per share commission charged to sell, then the "sales proceeds" to the customer are $30 per share. The taxable capital gain is the difference between the $30 sales proceeds and the $20 cost basis, or $10 per share capital gain.
What are the consequences for an investor who violates the wash sale rule? I Disallowance of the gain on the sale II Disallowance of the loss on the sale III Adjustment of the cost basis in the newly acquired security upwards by the amount disallowed IV Adjustment of the cost basis in the newly acquired security downwards by the amount disallowed
II and III only
Which of the following statements concerning capital gains are correct? I Gains on mutual fund shares held for up to two years are short-term II Capital gain distributions from mutual funds are long-term capital gains when the investor has held the shares for 6 months III Short-term capital gains are taxed at the individual rates for ordinary income IV Long-term capital gains are taxed at one-half the rates for ordinary income
II and III only Distributions reported by mutual funds as "capital gain" distributions are long-term capital gains regardless of the investor's holding period because the fund's holding period determines the treatment as long or short term. Short-term capital gains are reported on Form 1099-DIV as "ordinary dividends" and are taxed at rates of up to 37%. Gains on mutual fund shares held for up to one year are short-term. If a security is held for more than 1 year and sold at a profit, then the resulting long-term capital gain is taxed at a maximum rate of 15% or 20%. Note 15% for individuals who are not in the maximum tax bracket; 20% for individuals who are in the maximum tax bracket.
When a mutual fund shareholder elects automatic reinvestment of capital gains: I the capital gains tax is deferred until the shares are sold II the capital gains tax is owed for the year of the distribution III most funds require the shareholder to reinvest dividends as well IV most funds do not allow the shareholder to reinvest dividends as well
II and III only The shareholder must pay capital gains tax for the year of the distribution - it makes no difference if the distribution is reinvested in additional shares. Shareholders that elect automatic reinvestment must reinvest both dividend and capital gain distributions.
To qualify as a "regulated" investment company, a fund must: I distribute at least 75% of Net Investment Income to shareholders II distribute at least 90% of Net Investment Income to shareholders III derive at least 75% of its income from dividends, interest and capital gains IV derive at least 90% of its income from dividends, interest and capital gains
II and IV To be a regulated investment company, aside from having to distribute at least 90% of Net Investment Income to shareholders, at least 90% of the fund's income must be dividends, interest, or capital gains from sales of securities.
Which of the following statements concerning exchanges of shares among a family of mutual funds are correct? I If the NAV of the shares redeemed is above the NAV for the shares acquired, there is no taxable gain II The cost basis for the shares acquired will be the same as the cost basis for the shares traded in III The cost basis for the shares acquired will equal the total NAV of the shares traded in IV If the NAV of the shares redeemed is above the investor's cost basis for those shares, there will be a taxable gain
III & IV only Choice I is incorrect and Choice IV is correct because the IRS determines taxable gain by comparing the redemption price on the "old" fund shares to the cost basis of those shares. The NAV of the shares the investor acquires is not relevant for determining the gain. Choice (II) is incorrect and Choice III is correct because the NAV of the shares redeemed is the amount of money the investor uses to acquire new shares in another fund. This becomes the beginning cost basis in the new fund holding.
Which of the following statements concerning an open-end investment company "regulated" under Subchapter M is correct?
It qualifies for special tax treatment under IRS rules A "regulated" investment under Subchapter M of the Internal Revenue Code company qualifies for special "conduit" tax treatment if it distributes at least 90% of its Net Investment Income to shareholders. The fund pays no tax on the distributed net income; the distributions are only taxed at the shareholder level, so they flow through to the shareholder (as in a conduit or pipeline) without stopping at the corporate level to be taxed. An open-end investment company can always issue additional shares, whether it is regulated under Subchapter M or not. Open-end funds continuously issue and redeem their own shares. However, their shares cannot be traded - only shares of closed-end funds trade. FINRA "early warning" restrictions refer to rules not tested in Series 6 about broker-dealer capital requirements.
A customer sold some Snow White Mutual Fund shares that she bought over a period of several years. If the customer does not show the date of purchase and the cost of the mutual fund shares on her tax return, how will the IRS treat the sale?
It will apply the FIFO method of accounting When a taxpayer does not identify the date of purchase and cost when reporting sales (redemptions) of mutual fund shares, the IRS applies the FIFO method. If a taxpayer sells all his or her shares, the IRS uses the average price for all shares. Carryover basis rules apply to shares a taxpayer received as a gift during the lifetime of the donor.
What is the cost basis of mutual fund shares received as an inheritance?
NAV on the date of death For shares inherited from a decedent, the cost basis is the net asset value on the date of death. Upon death, the basis "steps-up" to the current market value per share. The estate will pay federal estate tax on the net asset value at the time of death. This includes any appreciation on the shares while they were held by the decedent. As of the date of inheritance, the holding period automatically becomes long term (regardless of how long the deceased person actually held the shares). When the beneficiary sells those shares, any resulting gain or loss is automatically long term.
Which of the following is NOT TRUE about capital gains reporting for tax purposes?
Net short-term gains offset net long-term gains shit's true: Net short-term gains offset net long-term losses An investor with both a net short-term gain and a net long-term gain must report both amounts The IRS taxes short-term capital gains at ordinary income rates Capital gains and losses can be offset against each other; one cannot offset a capital gain against another capital gain. Investors with both net long-term gains and net short-term gains must report both separately, since they are taxed at different rates (a maximum rate of 15% or 20% for long-term gains, depending upon income, and a maximum rate of 37% for short-term gains).
When a mutual fund shareholder calculates cost basis, which of the following will increase cost basis?
Reinvested dividends Aggregate cost basis is the valuation used to calculate resulting gain or loss if an entire mutual fund holding is redeemed. Cost basis must be adjusted upwards for reinvested dividends and capital gains; and downwards for returns of capital. For example, assume that a customer buys 100 shares of ACME fund at $20 per share, which includes any sales charge. The beginning aggregate cost basis is $2,000 (100 shares at $20 per share). There is no deduction or reduction for the sales charge paid. If the fund distributes $100 in dividends, these do not affect aggregate cost basis - they are taxable income. If the customer reinvests the $100 of dividends, these buy additional shares and the aggregate cost basis is increased from $2,000 to $2,100. If the fund distributes a return of capital (a very rare event), this is a reduction of cost basis. For example, if the fund distributed a $100 return of capital, the cost basis is reduced from $2,100 to $2,000. If the shares are now redeemed for $2,500, there is a $500 capital gain ($2,500 sales proceeds versus $2,000 adjusted cost basis).
ABC Corporation declares a 3-for-1 stock split. The current stock price is $45. Which of the following is NOT true regarding the stock split?
Shareholders incur a tax liability on the transaction Stock dividends and stock splits are not taxable events. Only cash dividends are taxable when received. If it is a 3:1 split, then for every 1 share, 2 additional shares will be issued, making a total of 3. Since there will be 3 shares outstanding where there was only 1 before, the shares price will be reduced to 1/3rd its original value. For example, assume this customer originally owned 100 shares at $45 per share, for a total value of $4,500. After the 3:1 split, the customer will own 300 shares (100 x 3) at $15 each (1/3rd of $45) for a total value of $4,500. The aggregate value does not change - however the cost per share is reduced and the number of shares increases.
ABC Corporation declares a 1-for-3 reverse stock split. The current stock price is $15. Which of the following is NOT true regarding the transaction?
Shareholders incur a tax liability on the transaction. No tax liability results from a reverse stock split because there is no cash payout. In a 1-for-3 reverse stock split, shareholders reduce their holdings to 1/3rd of the original amount and the stock price is increased to 3 times the original amount. Assume that a customer owns 300 shares at $15 per share, for an aggregate holding of $4,500. After the 1:3 reverse split, the customer will now have 100 shares (1/3rd of 300) at $45 (3 x $15), for an aggregate holding of $4,500. Note that the aggregate value does not change. Rather, the number of shares decreases and the price per share increases proportionately. A company will reverse split its stock if its market price has fallen too low (below $1 typically) and the exchange where the stock trades is threatening to delist the stock. By reverse splitting the stock, the market price per share is increased and the stock can stay listed on that exchange.
A customer died and left his mutual fund shares by will to his brother, who immediately redeems shares. What are the income tax consequences for the brother?
The brother takes a new cost basis of net asset value at the customer's death The brother receives the shares at a "stepped up" basis, which is the net asset value at the date of the customer's death. Any increase in value to that point is included in the decedent's estate, which is responsible for any estate tax due. Since the brother receives the shares at the "stepped up" NAV and immediately redeems them (at NAV), there will be no capital gain or loss on redemption.
A regulated investment company distributes 90% of its net income. Which of the following statements concerning the tax liability for net income for that year is correct?
The company pays tax on 10% of net income, and investors pay tax on 90% of net income When an investment company is "regulated" under Subchapter M, the fund pays no tax on the distributed income. The shareholders pay tax on this income; however, the fund still pays tax on any income it retains. In this case, the fund would pay tax on the 10% retained income. A "regulated" fund must distribute at least 90% of its Net Investment Income to shareholders.
In January, a customer invests $20,000 in an international fund. The fund has an extremely poor quarter, and the customer redeems her shares in May at an aggregate value of $16,000. She has no other gains or losses for this year. Which of the following statements describes the tax consequences of these transactions?
The customer has a $4,000 short-term capital loss, of which she can deduct $3,000 this year The customer had a short-term capital loss because she held the shares of the international fund for less than one year. Since she has no other gains, she can deduct up to $3,000 of the $4,000 loss against her other income. The remaining $1,000 of the loss is carried forward to the next tax year.
For income tax purposes, an investor who buys mutual fund shares before the ex-dividend date will report what amount of dividend income from the distribution?
The full amount distributed When a mutual fund makes a distribution of either dividends or capital gains, the Board of Directors of the fund sets the "ex" date. This is the first day that any new purchaser of the fund shares will not be on the shareholder list to receive the distribution. On this date, the price of each share is reduced for the value of the distribution made to the shareholder. Thus, there is no benefit in "rushing" to buy mutual fund shares prior to ex-date just to receive the distribution. If the shares are purchased on the ex-date or later, the customer does not get the distribution, but did not pay for it either, since the price per share was reduced. An investor who buys a mutual fund before the ex-dividend date will be on record to get the full distribution and the 1099-DIV will report this to the shareholder and the IRS. If the shares were purchased on the ex-date or after, then the shareholder would not get the dividend distribution and would not receive a 1099-DIV.
Which of the following statement concerning the tax rates for short-term and long-term capital gains is TRUE?
The maximum tax rate for long-term capital gains is 15% or 20%; while short-term capital gains is 37% The maximum rate for long-term capital gains is 15% or 20% (15% for individuals who are not in the maximum tax bracket; 20% for individuals who are in the maximum tax bracket). Short-term capital gains are taxed at the same rate as ordinary income, which is currently a maximum of 37%.
What is the cost basis for fund shares received as a gift?
The recipient must carry over the donor's cost basis The cost basis for shares received as a gift is the donor's original cost basis. This means that if the shares have appreciated, the recipient of the gift will be responsible for capital gains tax!
Why would a mutual fund make a supplemental distribution of capital gains to shareholders?
To avoid a penalty tax on the fund Mutual funds make supplemental distributions of capital gains to avoid a penalty or excise tax on undistributed capital gains. Under the tax code, if a fund does not distribute at least 98 percent of capital gains each year, it is subject to a 4 percent excise tax. The supplemental distribution may not exceed 10 percent of the total capital gain distribution for that year.
Which statement best describes the consequence to an investor of violating the wash sale rule?
Violation results in disallowance of the tax loss and the deduction on the investor's tax return If an investor violates the wash sale rule by buying the same securities, or substantially identical securities, within 30 days of a sale that resulted in a loss, the investor may not claim a loss for tax purposes. The disallowed loss is added to the cost of the newly purchased shares. In essence, this treatment defers the taking of the loss until the newly acquired security is sold.
All of the following statements concerning cost basis for federal income tax purposes are correct EXCEPT:
a beneficiary will have a carryover basis in inherited mutual fund shares Reinvested dividends increase the owner's cost basis in mutual fund shares. A beneficiary does not have a carryover basis in inherited mutual fund shares; rather, the beneficiary uses the date-of-death value as the cost basis. This is called a "stepped up" basis. For a purchaser of mutual fund shares, the cost basis includes the purchase price inclusive of the sales charge. A return of capital is considered to be a return of original investment and reduces the owner's cost basis in mutual fund shares.
All of the following statements concerning a mutual fund's reporting of capital gains to shareholders for income tax purposes are correct EXCEPT mutual funds must report:
appreciation of portfolio assets on Form 2439 shit's true: undistributed capital gains allocations on Form 2439 capital gains distributions on Form 1099-DIV short-term capital gains as "non qualified" dividend income on Form 1099-DIV If a mutual fund does not distribute all of its capital gains to shareholders in that year (a very rare event), any undistributed portion of the capital gains is still reported to shareholders and is taxable. Capital gains distributions made by the fund to its shareholders are reported on Form 1099-DIV. Allocations of undistributed capital gains to shareholders are reported on Form 2439 - Notice to Shareholder of Undistributed Long-Term Capital Gains. Short-term capital gains are reported by mutual funds on Form 1099-DIV as non-qualified dividends and these are taxed at ordinary income tax rates of up to 37%. Funds do not distribute the unrealized appreciation - this shows as increased NAV in the fund. When appreciated securities are sold, the resulting capital gain is reported and is taxable.
To qualify as a regulated investment company, a mutual fund must:
distribute at least 90% of net investment income to shareholders To qualify as a regulated investment company, a fund must distribute at least 90% of its net investment income. Note that the distribution requirement only applies to net investment income; there is no minimum distribution requirement for capital gains for a fund to be regulated. However, a fund must distribute at least 98% of its capital gains to shareholders, otherwise, it will be subject to a 4% excise tax, but this has nothing to do with being a regulated investment company.
An investor will likely be subject to the AMT if he or she has:
high reported gross income and large tax deductions The Alternative Minimum Tax (AMT) is a portion of the tax code that attempts to ensure that high income taxpayers that rely on a large amount of tax deductions to reduce their taxable income still pay a "fair" amount of tax. Under the AMT, large tax deductions that reduce reported taxable income are "added back" and the resulting "AMT income" is taxed at a flat rate of 26-28%. The law requires that the higher of regular income tax or AMT tax be paid. The AMT only hits higher-income taxpayers because the first $51,900 of income for an individual ($80,800 for a couple) is excluded from the tax.
When an investor sells mutual fund shares, any realized capital gains are long-term or short-term according to the:
length of time the customer owned the shares The length of time that the client owned the redeemed mutual fund shares determines whether any gains are long-term or short-term. Form 1099-DIV reports distribution information, not redemption information. When the shares are redeemed, the brokerage firm or fund company will send the customer a year-end Form 1099-B, which shows the sales proceeds from the redemption of the shares.
On January 1st, a customer buys 1,000 shares of ACME Fund, an open-end investment company. On February 1st, the investment manager of ACME Fund liquidates the fund's holding of Apple common shares for a profit. ACME Fund has held the Apple stock for 2 years. On February 20th, the ACME Fund makes its annual capital gain distribution to shareholders. The entire gain is attributable to the sale of the Apple shares. The distribution is taxable to the customer as:
long-term capital gain The character of the gain depends on how long the fund held that security, not how long an individual held shares of the fund. The fund held the Apple stock for over two years before selling it at a profit. This is a long-term capital gain to the fund. Fund shareholders at the time of the gain distribution receive the gain as long-term, whether they held the fund's shares for one day or ten years!
All of the following statements concerning the tax consequences of liquidating an investment in mutual fund shares are correct EXCEPT:
regardless of holding period, an investor who sells fund shares will report any capital gains as long-term An investor only reports a long-term capital gain if he or she holds shares for more than 12 months as of the date of sale. If the shares have been held for 12 months or less as of the sale date, the holding period is short-term. Mutual funds must pay tax each year on any undistributed capital gains, so these gains do not accumulate. Investors will receive a tax credit for their portion of the undistributed capital gain. An exchange of fund shares is a sale and new purchase for tax purposes. Investors may deduct net capital losses of up to $3,000 per year against income and any excess unused losses are carried over to the next tax year, when they can be used to offset capital gains for that year, and if there is a net loss, another $3,000 can be deducted - and so on.
An investment company that distributes at least 90% of its net investment income to shareholders is as a(n):
regulated fund Under the Internal Revenue Code, an investment company that distributes at least 90% of its net investment income to shareholders is a regulated company. A regulated company pays no tax on net income that it distributes to shareholders. The shareholders pay tax on the distributions they receive. Thus, net income passes through to the shareholders and they must report it for taxation. This is called "conduit tax treatment." Please note that any net income retained by the fund is still taxable to the fund. For example, if a fund distributes 99% of its net investment income to shareholders and retains 1%, it must pay income tax on the 1% retained. The 99% distribution is taxed only at the shareholder level and not at the fund level.
A customer receives dividends from his fixed income mutual fund, which is invested exclusively in bonds of U.S. corporations. Each year, the customer receives a Form 1099-DIV from the fund that will:
report these dividends as "non-qualified" and these will be taxed as ordinary income at his current rate If the source of distributions paid by a mutual fund to its shareholders is interest income these are "non-qualified" dividends that will be taxed at ordinary income tax rates of up to 37%. In contrast, if the source of distributions paid by a mutual fund to its shareholders is cash dividend income, these are "qualified" dividends that will be taxed at a maximum rate of 15% or 20% (the same rate as for long term capital gains). Note 15% for individuals who are not in the maximum tax bracket; 20% for individuals who are in the maximum tax bracket. Mutual funds are subject to "conduit tax treatment" as long as they follow IRS rules (which they all do). This means that the funds pay no tax on distributed earnings. The earnings are passed-through to the fund shareholders and are taxed only to the fund shareholder. Distributed earnings are not taxable to the fund. Thus, Choice D is incorrect.
A "qualified dividend" distributed by a corporate issuer to its shareholders qualifies for:
taxation at the same rate as for long term capital gains Mutual fund dividend distributions are either classified as "qualified" or "non-qualified." A "qualified" distribution is one that qualifies for the lower 15% or 20% maximum tax rate given to cash dividends received from stock investments. The source of these distributions is cash dividends received by the fund on stock investments held in its portfolio. Note that this is the same tax rate as for long term capital gains. A "non-qualified" distribution is one that does not qualify for the lower 15% maximum tax rate given to cash dividends received from stock investments. The source of these distributions is interest received by the fund on bond investments held in its portfolio. Interest income received (with the exception of municipal bond interest, which is exempt from Federal taxation) is taxed at ordinary income tax rates of up to 37%, so any fund distributions made from this interest income are "non-qualified" and are taxed at ordinary income tax rates.
