Chapter 21 Quiz: Tax COnsiderations

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

Wash Sale

A sale of securities at a loss with the subsequent disallowance of the loss by the IRS. If an individual sells a security at a loss and within 30 days, repurchases substantially the same security, the IRS will consider it a wash sale and will disallow the loss

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) A loan is taken equal to 95% of the policy's cash value B) The policy is surrendered C) The death benefit is paid D) There is a cash withdrawal in excess of the cost basis

A) 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.

Which of the following offers the opportunity to realize a capital gain rather than ordinary income? A) Cash dividends B) Stock dividends C) Section 529 plans D) Deferred annuities

B) 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.

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 excess of the alternative tax over the regular tax is added to the regular tax. C) The alternative minimum tax is added to the regular tax. D) The lesser of the regular tax or the alternative tax is paid.

B) The excess of the alternative tax over the regular tax is added to the regular tax

Which of the following statements regarding grantor trusts is NOT correct? A) If the grantor has the power to revoke the trust, he is treated as the owner of the trust. B) If the grantor can control the beneficial enjoyment of the trust, he is treated as the owner of the trust. C) The grantor may be taxed on trust income only if the grantor actually received the income. D) If the grantor can receive income from the trust, he is treated as the owner of the trust.

C) The grantor may be taxed on trust income only if the grantor actually received the income. As long as the grantor has the power directly or indirectly to control the trust, he is treated as the owner. The grantor may be taxed on trust income if the grantor either actually or constructively receives the income.

Distributable Net Income (DNI)

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.

Adjusted Gross Income

Gross income less adjustments

501(c)3 organization

Not-for-profit designation by government for no taxes and can accept charity but cannot give out dividends

Cost Basis

The cost used to determine a capital gain or loss on an investment

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

A highly compensated customer owns 200 shares of Datawaq. He bought it 20 years ago, and it is now trading at 90. If he donates the stock to a 501(c)(3) charity, how much can he claim as a tax deduction for this donation?

$18,000 Securities can be gifted to charity and deducted at their fair market value, as long as they have been held more than one year. The fair market value of the deduction allowed for 200 shares is 200 multiplied by the current market price of the stock, or $18,000.

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 that year?

$3,000.00 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.

Section 529 Plans

- state provided - can be funded by after tax dollars - can pay prepaid tuition - All earnings exempt from federal taxes - If withdrawn for unqualified withdrawl, 10% penalty

If 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 Interspousal gifts to citizens of the United States, regardless of amount, are not subject to gift taxes.

Holding period for long term capital gains is...

12 months

alternative minimum tax

A taxpayer must pay the alternative minimum tax in any year that it exceeds regular tax liability. Tax-preference items are re-input in figuring AMT, but the AMT is paid only if that amount is higher than the regular income tax.

Investors who buy shares in state-specific municipal bond funds may be subject to

Capital gains tax Interest received from municipal bonds and municipal bond funds 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 investors' cost.

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.

Jean owns a $1 million life insurance policy on her mother, Clara. Jean is named as sole beneficiary, and so far she has paid $150,000 in premiums. If Clara dies, which of the following will occur? I.The proceeds will be exempt from income tax. II. $850,000 of the proceeds will be subject to income tax. III. The proceeds will be included in Clara's estate for estate tax purposes. IV.The proceeds will not be included in Clara's estate.

I. and IV. Life insurance proceeds are generally free from income taxes and will be free from estate taxes, if the insured possesses no incidence of ownership. In other words, a beneficiary other than the deceased's estate has been named, and the owner is someone other than the insured.

Gross Estate

all property owned by the decedent that might be subject to federal estate taxes upon a person's death (DOES NOT INCLUDE DEBTS OWED)

Stepped-up basis

value of property which is inherited is "stepped up" to its fair market value as of the date of death rather than at the date of purchase.

Which of the following is (are) advantages of irrevocable insurance trusts? I. Provide estate liquidity. II. Insurance proceeds are removed from the estate of the insured for tax purposes. III. The insured has the flexibility to alter the trust arrangements. IV. Once set up, no changes may be made.

1. and 2. 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.

Howard is the owner of 4 different insurance policies. Which of the following policies have death benefits proceeds that are NOT subject to income tax upon death of the insured? Policy 1; his wife is the insured. Policy 2; his business partner is the insured. Policy 3; his daughter is the insured. Policy 4; he is the insured.

All of them are NOT subject to income tax upon death of Howard? The question is asking for income tax treatment of insurance proceeds, not estate tax treatment. Life insurance proceeds are not income taxable to an original human owner of the policy.

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?

C) $1,100,000.00 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.

Which of the following is federally tax exempt for a corporation? A) Capital gains B) Preferred stock dividends C) Municipal bond interest D) Foreign corporate stock dividends

C) Municipal Bond Interest Municipal bonds are tax exempt for corporations, as well as for individuals. Preferred stock dividends are taxable but at a reduced rate for corporations due to the 50% dividend exclusion. That break does not apply to the dividends on foreign securities. Regardless of the security, capital gains are taxable.

alternative minimum tax

the personal income rate that applies whenever the amount of taxes paid falls below some designated level

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

use the original cost on the ring Regardless of the nature of the asset, the cost basis of any asset acquired as a gift is that of the donor. Although not tested, the maximum rate on capital gains from collectibles, such as a gold ring, is 28% (higher than the rate for securities).

One of your new clients has only been working for 3 years but is already interested in retirement planning. In order to be fully eligible for Social Security, the client must

Have a minimum of 40 quarters of work Current Social Security requirements are a minimum of 40 covered quarters of employment (10 years). A covered quarter is a calendar quarter during which the worker earned a minimum amount ($1,300 in 2017) which is indexed and, therefore, would never be tested. Reduced retirement benefits may begin as early as age 62, but disability payments can begin much, much earlier, as long as there have been 40 covered quarters. There is no minimum annual earnings limit.

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?

It wont be! 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.

An individual purchased a variable life insurance policy 10 years ago with a guaranteed death benefit of $100,000. The annual premium for this policy was $2,000 per year. The individual dies and, due to outstanding performance of the separate account, leaves a death benefit to the beneficiary of $121,000. What are the income tax consequences to that beneficiary?

One of the nice things about life insurance proceeds is that even when the death benefit is increased due to separate account performance, it is still free of income tax.

marginal tax rate

the extra taxes paid on an additional dollar of income Marginal tax rate is defined as the rate of taxation on any additional taxable income received. It is sometimes referred to as the tax on the "next" dollar or the "last" dollar of income. The effective tax rate is the overall rate paid on the total taxable income.

The basis of an asset received from a decedent's estate is referred to as a stepped-up basis. This means that the asset's basis is generally

the fair market value of the asset on the day the decedent died

There are number of potential sources of income to a client that would have to be reported on their Form 1040 tax return. Among them could be all of these EXCEPT A) operation of a sole proprietorship B) death benefit received from a life insurance policy C) interests in a DPP D) ownership of stock in an S corporation

B) death benefit received from a life insurance policy An 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). And, if units of a DPP throw off income, that would be reported as well. Of course, taxable income can be generated by investments in the form of dividends, interest, and capital gains from any source. The death benefit is from a life insurance policy and those, unlike the death benefit from an annuity, are not subject to income tax. Depending on how the ownership is structured, the death benefit could be subject to estate tax, but that would be reported on the Form 706 and is generally not considered income.

An investor purchases 500 shares of stock on January 10 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 BE CAREFUL HERE AND READ THE QUESTION CAREFULLY. THEY"VE HELD IT FOR A YEaR and A HALF Not 7 Months

Long term capital loss

An investor inherits 1,000 shares of the ABC Global Growth 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?

Long-term capital gain of $4,750 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).

An advisory client of yours dies in 2019, and you transfer the $1.4 million of securities in the individual's name to the estate account. You will A) tell the executor that he will be receiving a Form 1099 for tax purposes, representing the transfer of account over to the estate account B) inform the executor that you need to keep sufficient liquid funds in the account because estate taxes will be due in 6 months C) continue to manage the account unless the advisory contract called for termination upon death or informed otherwise by the executor D) notify the executor of the estate that he is able to do any trades to rebalance the account, and that taxes will be of no consideration

C) Continue to manage the account unless the advisory contract called for temination upon death or informed otherwise by the executor Unless the advisory contract has a termination upon death provision or the executor wishes to assume management of the account, the investor adviser may continue to manage the account of the estate. Trades made in the account must take into consideration tax implications as with any other account. Estate taxes are due 9 months after death, and unless there are other assets not listed here, no tax is due because this estate is less than $11.4 million (the amount exempt from taxation for 2019).

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? I. For gift-tax purposes, the value of the gift is $3,000. II. For gift-tax purposes, the value of the gift is $7,000. III. The son's cost basis on the stock is $3,000. IV. The son's cost basis on the stock is $7,000.

II. III. 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.

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) a $240 long-term capital gain and a $60 short-term capital gain B) a $300 short-term capital gain C) a $60 short-term capital gain D) a $240 long-term capital gain B) 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.

Dr. Howard dies. Which of the following life insurance policies will be included in his gross estate? Policy I—owned by Dr. Howard; he is the insured and his wife is the beneficiary. Policy II—owned by Mrs. Howard; she is the beneficiary. Policy III—originally owned by Dr. Howard; Mrs. Howard is the insured and he gave the policy to his daughter 5 years ago. Policy IV—owned by Dr. Howard; Mrs. Howard is the insured and he is the beneficiary.

Policy 1 & 4 The question asks which will be included in the gross estate, not which policies will be part of the taxable estate. Any policies that are owned by the decedent at the date of death will be included in the decedent's gross estate. Of course, there may be a deduction from the gross estate for anything left to a spouse. Policy II was never owned by the decedent, therefore it is not included. Policy III is not included because it was given away more than 3 years before Dr. Howard's death.

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

$3,000 The $11,000 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.

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) Wages and tips C) Stock dividends D) Income from a sole proprietorship

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.

​Oscar and Hilda, a married couple, are collecting Social Security. They speak to their financial planner for advice on taxation of those benefits. At what level do their benefits become subject to income tax?​

When 50% of their benefits added to all their other income, including tax-exempt interest, exceeds $32,000 These are the current numbers used by the IRS to determine if Social Security benefits are taxable. It is interesting that the computation indirectly can cause tax-exempt interest to become taxable. Once the couple's income under this computation exceeds $44,000, 85% of it is taxable. If the question dealt with a single person, the limit would be $25,000 rather than $32,000.