6.5 Taxation

You have a client whose income from a real estate limited partnership is $11,000. During the same year, your client had 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) $11,000. D) $3,000.

Answer: D The $11,000 passive income is offset by the $6,000 of passive loss giving the client $5,000 of passive income. Since 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.

Under the gift tax marital deduction, how much can an individual give a spouse who is a U.S. citizen without incurring a gift tax? A) No more than $14,000 per year. B) No more than $28,000 per year. C) No more than $143,000 per year. D) An unlimited amount.

Answer: D The gift tax marital deduction permits an individual to give a spouse an unlimited amount of property without incurring a gift tax. However, if the spouse is not a U.S. citizen, the maximum marital gift is $145,000 (2014).

Frank and Joe Hardy have formed Hardy Investigative Services, (HIS), with each owning 50% of the stock in the company. HIS is organized as an S corporation. Unless receiving an extension, the Form 1120S is due A) March 15 B) January 15 C) April 15 D) 90 days after the end of their fiscal year

Answer: A All business returns, with the exception of sole proprietorships, partnerships, and LLC's (including multiple member LLCs that do not elect to be treated as corporations), are due 2½ months after the end of the year (always a calendar year for businesses other than a C corporation).

A US 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) tax credit on the investor's U.S. tax return. B) reduction in the investor's ordinary income. C) tax credit on the investor's Canadian tax return. D) non-recoverable loss on the investor's U.S. tax return.

Answer: A An investor receives a credit for taxes withheld on investments by countries with which the United States has diplomatic relations; the tax credit directly decreases the investor's American tax liability.

Which of the following business entities has an income tax filing due date (disregarding possible extensions) of March 15th? Sole proprietorship Single member LLC Multiple member LLC electing to be treated as a corporation​ S corporation A) III and IV B) I and II C) II, III and IV D) I and IV

Answer: A Filing of an income tax return for businesses is generally 2 ½ months after the end of the fiscal year. In the case of S corporations and LLC's with more than one member electing to be treated as a corporation​, that is always March 15. C corporations are able to choose their fiscal year so, if theirs ended June 30th, then the tax filing deadline would be September 15th. In the case of sole proprietorships, partnerships, and LLC's with only one member, the return dates are the same as for the individual tax return, April 15th.

At his death, on January 1, 2012, Morris owned shares of ABC Corporation common stock, with a fair market value of $50 per share, which he had purchased in 2001 for $25 per share. If Morris' executor elected to value the estate by using the alternate valuation date, but then sold the shares through a broker/dealer on May 15, 2012 at $40 per share, what is the estate's basis per share for estate tax purposes? A) $40. B) $15. C) $125. D) $50.

Answer: A If the executor elects to value the decedent's estate by using the alternate valuation date, the value per share is the value at the date six months after death, unless the property is sold prior. In this case, the value per share is the FMV on the date of sale, $40 in this example.

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 offset $1,000 ordinary income this year. B) He will have a $1,000 gain. C) He will have a $1,000 loss to carry over to the next year. D) There will be no tax consequences.

Answer: A 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.

William died in 2014 with the following assets and liabilities: $200,000 in securities left to his wife, $650,000 home left to his wife (the home cost $150,000), $250,000 life insurance policy with his daughter as beneficiary, $75,000 in debts and estate expenses. What is William's taxable estate? A) $175,000 B) $0; it is below the $5 million exemption equivalent C) $625,000 D) $750,000

Answer: A The question is asking for the taxable estate, not the amount of estate tax due. The market value of all assets which William has an incident of ownership in will be included in the gross estate. All assets left to the spouse and the debts/expenses are allowable reductions to arrive at the taxable estate. In this case, the $1.1 million gross estate is reduced by the $850,000 left to his wife and then by the $75,000 in debt and expenses. Technically, there is still a taxable estate. However, any estate tax due is reduced by a credit equivalent to $5.34 million in assets for 2014.

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: GOs. equity securities. corporate bonds. REITs.

Answer: B A realized capital gain on a security may be offset by a capital loss realized from the sale of any type of security, including municipal bonds, equities, corporate bonds, or REITs.

Investors looking to minimize the effects of taxation on their investments would probably receive the least benefit from A) a growth stock B) a corporate bond C) an apartment building D) an S&P 500 index fund

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.

A client has just finalized her divorce and intends to sell her gold wedding band. Because the price of gold has risen significantly since she married 20 years ago, she will be able to realize a profit on the sale, but she does not know what to use as the cost basis. You suggest she speak to a tax specialist who will tell her to A) obtain an appraisal from a qualified jeweler and use that as the cost basis B) use the original cost of the ring C) use a cost basis of zero because it was a gift D) ignore the profit for tax purposes because precious metals are not subject to capital gains taxation

Answer: B Regardless of the nature of the asset, the cost basis of any asset acquired as a gift is that of the donor.

Which of the following is not included in adjusted gross income on an individual's federal income tax return? A) State income tax refunds B) Stock dividends C) Wages and tips D) Income from a sole proprietorship

Answer: B 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.

Mr. Wright died with the following assets and liabilities: $200,000 in securities left to his wife, a $650,000 home left to his wife (the home cost $150,000), a $250,000 life insurance policy with his daughter as beneficiary, and $75,000 in debts and estate expenses. What is Mr. Wright's gross estate? A) $1,025,000.00 B) $1,100,000.00 C) $250,000.00 D) $600,000.00

Answer: B The question asks for the gross estate, not the adjusted gross estate or taxable estate. The market value of all assets in which Mr. Wright possessed an incident of ownership at the time of death are included in the gross estate. The amount is therefore $1,100,000. The adjusted gross estate would be less the $75,000 of debt and expenses.

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. Under the Uniform Prudent Investors Act, the investment adviser handling the account would be acting with proper fiduciary responsibility by A) exchanging a portion of that stock for a suitable security held in the adviser's trading account B) liquidating a portion of that stock to take advantage of the tax savings offered by the stepped-up basis at death C) continuing to hold that stock position if it is felt that it meets the objectives of the trust D) selling all of that stock in order to rebalance the trust's assets

Answer: B 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 over-concentrated in one 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.

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 2014 without incurring gift tax consequences? A) Unlimited. B) A limited amount because her spouse is not a U.S. citizen. C) $14,000. D) $100,000.

Answer: B Under current tax regulations, there is a limit to the amount of a gift that may be made to a noncitizen spouse. For 2014, that limit is $145,000.

Your customer redeemed 200 of her 500 Kapco common shares without designating which shares were redeemed. Which of the following methods does the IRS use to determine which shares she redeemed? A) LIFO. B) FIFO. C) Identified shares. D) Wash sale rules.

Answer: B When a customer does not choose a method, the IRS uses FIFO (first in, first out). This will likely result in shares with the lowest cost basis being redeemed first, which creates a greater taxable gain.

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? A) There is no waiting period. B) 31 days. C) 5 days. D) 20 days.

Answer: B 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.

Which of the following statements regarding taxation is NOT true? A) Portfolio income includes dividends, interest, and net capital gains derived from the sale of securities. B) 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. C) Earned income includes salary, bonus, and income as an owner of a limited partnership. D) Passive income is derived from rental property, limited partnerships, and enterprises in which an individual is not actively involved.

Answer: C Earned income includes salary and bonus, but income received as an owner of a limited partnership is considered passive income. Passive income is derived from rental property, limited partnerships, and enterprises in which an individual is not actively involved.

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. A) II only. B) II and III. C) I, II and III. D) I only.

Answer: C Interest on foreign bonds is taxed in the United States by federal, state, and local governments.

Sally Sherman purchased 100 shares of Chocolate Manufacturers Corporation 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 long-term loss. B) $575 long-term gain, $105 short-term loss. C) $470 short-term loss. D) $575 short-term loss; $105 long-term gain.

Answer: C 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.

Julie owns 100 shares of CCC at $25. CCC declares a 25% stock dividend. After the ex-date, what will she own? 125 shares. 100 shares. Cost basis of $25. Cost basis of $20.

Answer: C Stock dividends make the number of shares owned increase and the cost per share decrease. The overall value should remain unchanged. 125 shares × $20 = $2,500; 100 shares × $25 = $2,500.

Client inherits 1,000 shares of ABC mutual fund when NAV is 9.50 and POP is $10.00 and elects to receive all distributions in cash. Two years later, sells all when NAV is 14.25 and POP is 15.00. What are the tax consequences of this sale? A) Long-term capital gain of $5,000. B) Long-term capital gain of $5,500. C) Long-term capital gain of $4,750. D) Long-term capital gain of $4,250.

Answer: C Upon death, the beneficiary inherits mutual funds at their NAV ($9.50). Sale (redemption) takes place at the NAV ($14.25) for a profit of $4.75 per share (times 1,000 shares).

A customer buys 100 XYZ at $30. Two years later, with the stock trading at $70, the customer makes a gift of the securities to his son. Which of the following statements are TRUE? For gift-tax purposes, the value of the gift is $3,000. For gift-tax purposes, the value of the gift is $7,000. The son's cost basis on the stock is $3,000. The son's cost basis on the stock is $7,000. A) I and IV. B) II and IV. C) II and III. D) I and III.

Answer: C When making a gift of securities, the market value at date of gift is used to determine if any gift taxes are due. However, when making a noncharitable gift of securities, the donor's cost basis is passed to the recipient.

Most taxes in the U.S. fit into one of two categories. They are either progressive or regressive. Which of the following taxes are known as progressive taxes? Sales. Cigarette. Income. Estate. A) I and III. B) II and IV. C) III and IV. D) I and II.

Answer: C With a progressive tax, the percentage amount increases as the taxable amount increases such as income and estate taxes. Sales and cigarette taxes are regressive because all persons pay the same percentage tax regardless of their income.

If a client has $12,000 of capital gains and $15,000 of capital losses in any 1 taxable year, how much unused loss, if any, is carried forward by the client to the following tax year? A) $3,000.00 B) $12,000.00 C) $15,000.00 D) $0.00

Answer: D After netting the $12,000 capital gains and $15,000 capital losses, the client has a net capital loss of $3,000. Since this amount of capital loss may be used to offset ordinary income in any one taxable year, there is no amount of loss to carry forward.

If a father makes a gift of securities to his 10-year-old daughter, gift taxes would be based on the: A) cost of the securities. B) market value of the securities as of April 15 of the year in which the gift is made. C) market value of the securities as of December 31 of the year in which the gift is made. D) market value of the securities on the date of gift.

Answer: D If a gift tax is due, it is paid by the donor and based on the gift's value on the date it is given.

Which of the following statements about capital gains are TRUE? The minimum holding period required to qualify for long-term capital gains treatment is one day longer than 12 months. The highest federal income tax rate on long-term capital gains is less than the highest federal income tax rate on ordinary income. If an investor holds stock for 12 months or less and has no other transactions, any gain on the sale of the stock is taxed at the same rate as ordinary income. A) I and II. B) I and III. C) II and III. D) I, II and III.

Answer: D If an investor holds stock for more than 12 months and sells it for a gain, the gain will be treated as a long-term capital gain. The advantage of long-term capital gains is that the maximum tax rate on long-term capital gains is lower than the maximum rate on ordinary income. If an investor holds stock for 12 months or less, though, any gain will be considered a short-term capital gain and will be taxed at the same rate as ordinary income.

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? A) As a $2,100 capital gain. B) As a $2,500 capital gain. C) As $2,500 ordinary income. D) The shares are not subject to taxation.

Answer: D 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.