Unit 15 Testing (All)
The proper term is tax preference items. Those would include the following: Deductions taken for accelerated (but not straight-line) depreciation Excess intangible drilling costs Capital gains on incentive stock options Otherwise tax-exempt interest from specified private activity bonds
AMT
An advisory client of yours discusses a business project she is involved with where the partnership is using accelerated depreciation to maximize losses in the early years. It would be prudent of you to inform the client that A) accelerated depreciation could trigger the alternative minimum tax. B) accelerated depreciation leads to a reduction in the partnership's cash flow. C) a maximum of $3,000 in losses can be taken against passive income in any year. D) a maximum of $3,000 in losses can be taken against ordinary income in any year.
Answer: A)
An investor would have to pay the alternative minimum tax when A) it exceeds the investor's regular income tax. B) the investor's capital gains exceed 10% of total income. C) there are tax-preference items reported on the tax return. D) the investor has received income from a limited partnership.
Answer: A)
One of your clients invested $10,000 into a mutual fund. The client elected to reinvest all dividends. As a consequence of this, A) the investor's cost basis is increased by the amount of the reinvested dividends. B) the reinvestments will purchase shares at a discount from the NAV. C) the dividends will be taxed as capital gains once the shares are liquidated. D) taxes are deferred until those shares are redeemed.
Answer: A) Explanation Because the reported dividends are taxed each year, when the shares are ultimately liquidated, they have already been taxed. So, the investor's cost basis is increased by the amount of the reinvestment. Reinvested dividends are purchased at the NAV; mutual fund shares are never purchased below the NAV.
Tax preference items are used for the purpose of computing the alternative minimum tax. They include all of the following except A) straight-line depreciation. B) excess intangible drilling costs. C) accelerated depreciation. D) certain incentive stock options.
Answer: A) Explanation 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.
An investor in the 28% tax bracket has a $5,000 loss after netting all capital gains and losses realized. How much may the investor deduct from income for the year? A) $3,000 B) $0 C) $2,500 D) $5,000
Answer: A) Explanation The maximum deduction of net capital losses against other income in any one year is $3,000; any remaining loss can be carried forward into the next year.
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? I. Federal II. State III. Local A) I, II, and III B) II and III C) I only D) II only
Answer: A) Interest on freign bonds is taxed in the United States by federal, state, and local governments ...of course...
One of your clients buys 300 shares of RIF common stock in March at $25 per share. Three months later, the client purchases 200 shares of RIF at $30 per share. One month later, RIF pays a dividend of $1 per share. Then, five months later, another purchase of RIF is made—this time 400 shares at $35 per share. If the client were to sell all RIF at $30 per share, what is the client's capital gain or loss? A) $500 loss B) $400 gain C) $500 gain D) No gain or loss
Answer: A) The investor's total cost is $27,500 for the 900 shares purchased. The proceeds of the sale are $27,000 (900 × $30). That results in a capital loss of $500. The cash dividend has nothing to do with capital gain or loss.
A U.S. citizen owns stock in a Canadian company and receives dividends. The Canadian government withholds 15% of the dividends as a tax. As a result, the investor reports A) a reduction in the investor's ordinary income. B) a tax credit on the investor's U.S. tax return. C) a nonrecoverable loss on the investor's U.S. tax return. D) a tax credit on the investor's Canadian tax return.
Answer: B)
Investors who are subject to the alternative minimum tax (AMT) will lose the tax benefits normally associated with A) gains associated with variable annuity portfolios. B) tax preference items. C) capital losses. D) losses on options positions.
Answer: B)
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 A) $300.00. B) $168.75. C) $150.00. D) $56.25.
Answer: B) 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 $0.25 ($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 ($225.00 - 56.25).
Which of the following statements regarding taxation is not true? A) Passive income is derived from rental property, limited partnerships, and enterprises in which an individual is not actively involved. B) Earned income includes salary, bonus, and income as an owner of a limited partnership. C) Portfolio income includes dividends, interest, and net capital gains derived from the sale of securities. D) Items that must be added back into taxable income for calculation of the alternative minimum tax (AMT) include accelerated depreciation on property placed in service after 1986; local taxes and interest on investments that do not generate income; and incentive stock options exceeding the fair market value of the employer's stock.
Answer: B) Earned income includes salary and bonus but not income as an owner of a limited partnership. Passive income is derived from rental property, limited partnerships, and enterprises in which an individual is not actively involved. Each of the other choices is true.
An investor purchased 500 shares of stock on January 10, 2020, at $50 per share and sold it on August 4 of the following year for $40 per share. As a result, the investor realized A) a long-term capital gain. B) a long-term capital loss. C) a short-term capital loss. D) a short-term capital gain.
Answer: B) Explanation 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 was in January 2020 and the sale was in August of the following year, that must be August 2021.
A client owns a taxable bond with a coupon rate of 5%. His marginal tax rate is 28%. What is the after-tax yield he will receive on this investment? A) 6.94% B) 3.60% C) 6.40% D) 1.40%
Answer: B) Explanation The client will earn an after-tax yield of 3.60%, or 5% × (1 − 0.28). Or, you could simply take off the 28% tax from 5% (1.40%) and subtract that from the 5% to arrive at 3.60%.
Taxation is an important part of investment planning. In general, it is correct to state that a taxpayer's effective tax rate A) is more important than the marginal tax rate when considering tax-deductible contributions. B) is lower than the marginal tax rate. C) and the marginal tax rate are the same. D) is based on a different tax table than the marginal tax rate.
Answer: B) Explanation The marginal tax rate is the rate you pay on each additional dollar you receive as income. The effective tax rate, however, is the overall rate of tax you pay on your total taxable income. Because income tax in the U.S. is progressive, as your earnings increase, so does the tax rate. Because the effective tax rate is the average rate, with very rare exceptions, it will always be lower than the marginal rate. Only the marginal tax rates are shown in the IRS tables. When money is spent on a tax-deductible basis, whether it is a donation to a charity or a contribution to a retirement plan, it is the marginal rate that is used to calculate the tax savings.
Investors looking to minimize the effects of taxation on their investments would probably receive the least benefit from A) an S&P 500 Index fund. B) a corporate bond. C) an apartment building. D) a growth stock.
Answer: B) Investors receive interest income from corporate bonds. That income is fully taxable at ordinary income rates. Real estate ownership has certain tax benefits, such as depreciation and a deduction for operating expenses. Index funds are known for their high tax efficiency, and investors in growth stocks anticipate long-term capital gains, which are taxed at a lower rate than ordinary income.
There are many sources of taxable income to an individual. Included might be money received from which of the following? Sole proprietorship Subchapter S corporation Investments Life insurance death benefit A) I and II B) I, II, and III C) II and III D) I, II, III, and IV
Answer: B) individual can generate income from running a sole proprietorship or being a shareholder in an S corporation (the exam will possibly use the obsolete term Subchapter S). Of course, taxable income can be generated by investments in the form of dividends, interest, and capital gains. The death benefit from a life insurance policy is not subject to income tax.
You have a client who was divorced three years ago, maintains a home, and has custody of the children. More than likely, the most advantageous tax filing status for your client is A) single. B) head of household. C) joint. D) divorced parent.
Answer: B) 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.
The main purpose of dividend reinvestment in a mutual fund accumulation plan is to A) avoid taxes. B) avoid commissions or sales charges. C) compound the growth of a mutual fund investment. D) protect against capital loss.
Answer: C) Explanation Reinvesting dividends compounds the growth of the fund with periodic purchases of new shares. Taxes are due on dividends whether or not they are reinvested. Capital gains or losses will occur whether or not dividends are reinvested. The purchase of additional shares with reinvested dividends may increase the capital gain or loss in proportion to the dividends reinvested. Avoiding commissions or sales charges is not the main rationale for reinvesting dividends, even though sales charges are not applied to reinvested dividends.
Sally Sherman purchased 100 shares of Chocolate Manufacturers Corporation (CMC) for $19 per share on February 12. She received a 10% stock dividend on May 18. She sold all of her CMC at $13 per share in June of the same year. What were her tax results? A) $575 short-term loss; $105 long-term gain B) $575 long-term loss C) $470 short-term loss D) $575 long-term gain, $105 short-term loss
Answer: C) Explanation Sally paid $1,900 for 100 shares and sold 110 shares for $1,430 (13 at 110). Because the transactions all took place in less than a year, the transaction was a short-term loss.
The alternative minimum tax is designed to ensure that certain high-income taxpayers do not avoid all income tax through the use of various tax preference items. Those preference items are added back to the taxpayer's ordinary income on IRS Form 6251 and would include A) intangible drilling costs in connection with an oil drilling program. B) straight-line depreciation taken on investment real estate. C) interest received from specified private-purpose municipal revenue bonds. D) long-term capital gains in excess of $3,000 annually.
Answer: C) Explanation The Internal Revenue Code provides that interest on specified private activity bonds is an item of tax preference. Therefore, this interest must be added to a taxpayer's regular taxable income in order to compute the taxpayer's AMT income. Read the choices carefully. It is accelerated (not straight line) depreciation and excess intangible drilling costs that are preference items. 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.
The alternative minimum tax (AMT) is assessed against A) low annual income earners and allows special deductions for them to be taken. B) high annual income earners and gives them special deductions to take that lower income earners do not get. C) high annual income earners and disallows some deductions and exemptions used to calculate adjusted gross income. D) all self-employed individuals.
Answer: C) Explanation The alternative minimum tax (AMT) is assessed against high annual income earners. When calculating adjusted gross income (AGI), some deductions and exemptions are disallowed, resulting in a higher taxable 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.
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? A) $12,000 B) $3,000 C) $0 D) $15,000
Answer: C) 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. It can be safely assumed than an employed client of a broker-dealer makes at least $3,000 per year.
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? A) He will have a $1,000 loss to carry over to the next year. B) He will have a $1,000 gain. C) He will offset $1,000 ordinary income this year. D) There will be no tax consequences.
Answer: C) 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 carried forward.
It would be least likely for dividends paid on which of the following investments to meet the requirements to be considered qualified? A) Preferred stock B) Equity mutual funds C) Bond mutual funds D) Common stock
Answer: C) Qualified dividends are those eligible for reduced income tax rates. Those rates can be as low as 0% and as high as 23.8%, with most falling between 15-20%. We don't expect the exam to test on the requirements for a dividend to be considered qualified or how you reach that 23.8% rate. Dividends on bonds and MMFs are not qualified because the majority of those dividends represent interest earned by the fund and the tax break does not apply to earnings from interest.
You have a client whose income from a real estate limited partnership is $11,000. During the same year, your client has net capital losses of $2,000 and losses from an oil and gas drilling program of $6,000. The effect of this investment activity would be to increase the client's taxable income by A) $5,000. B) $9,000. C) $3,000. D) $11,000.
Answer: C) The $11,000 in passive income is offset by the $6,000 of passive loss, giving the client $5,000 of passive income. Because capital losses up to $3,000 are deductible from taxable income, we can deduct the $2,000 in net losses, giving a net increase to taxable income of $3,000.
A client bought 100 shares of a mutual fund on December 28, 2016, for $4,000 and received a capital gains distribution of $2.40 per share on March 6, 2017, which was taken in cash. He sold his 100 shares for $4,300 on June 19, 2017. For tax purposes, this transaction resulted in A) a $240 long-term capital gain and a $60 short-term capital gain. B) a $240 long-term capital gain. C) a $300 short-term capital gain. D) a $60 short-term capital gain.
Answer: C) The June sale of the shares purchased in December resulted 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.
A loss derived from a limited partnership may be offset against income from A) capital gains from municipal bonds. B) dividends received from common stocks. C) other limited partnerships. D) bonuses received in addition to a regular salary.
Answer: C) A limited partnership may use only passive income to offset the loss derived from a limited partnership. A passive loss cannot be used to offset dividends received from common stock. Passive loss from partnerships may be used to offset dividends received from common stock. Passive loss from partnerships may be used to offset passive gains from partnerships, not gains from municipal bonds.
Which of the following statements regarding the alternative minimum tax is true? A) The tax bracket will determine whether the regular tax or the alternative tax is paid. B) The alternative minimum tax is added to the regular tax. C) The lesser of the regular tax or the alternative tax is paid. D) The excess of the alternative tax over the regular tax is added to the regular tax.
Answer: D)
wners of private activity municipal bonds might find themselves A) in violation of MSRB rules if proper disclosures are not made. B) receiving less interest than with a similar GO bond. C) taking an extraordinarily high risk. D) subject to the alternative minimum tax.
Answer: D) AMT preference item
If a client has realized a capital gain from the sale of a municipal bond, to reduce tax liability, the capital gain can be offset against a capital loss in which of these? GOs Equity securities Corporate bonds REITs A) II and III B) I and II C) I only D) I, II, III, and IV
Answer: D) An realized capital gain on a security may be offset by a caital loss realized from the sale of any type of security, including municipal bonds, equities, corporate bonds, or REITs
Which of the following offers the opportunity to realize a capital gain rather than ordinary income? A) Cash dividends B) Deferred annuities C) Section 529 plans D) Stock dividends
Answer: D) Explanation 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 a 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.
Investors who buy shares in state-specific municipal bond funds may be subject to A) federal income tax. B) out-of-state property tax. C) no taxation. D) capital gains tax.
Answer: D) Interest received from municipal bond funds generally is generally income tax free on a federal basis but taxable in states other than the state of issue. State-specific funds avoid that problem. These investments are subject to capital gains taxes if sold at prices above the investors' cost.
The term earned income would include A) the death benefit from a variable annuity policy. B) alimony received as part of a divorce decree executed on January 15, 2019. C) the death benefit from a variable life insurance policy. D) a bonus paid as a result of your division exceeding its goals.
Answer: D) The IRS defines earned income as wages, salaries, tips, and other taxable employee pay, such as bonuses. The death benefit from a variable annuity policy is taxed as ordinary income but is not earned. The death benefit from a variable life insurance policy is generally free of income tax, so it cannot be earned income. Under the TCJA of 2017, alimony received from a divorce decree dated January 1, 2019 or later is not earned income.
Under the TCJA of 2017:
alimony received from a divorce decree dated January 1, 2019 or later is not earned income.
