Series 7 - Taxes & Tax Shelters: Types of Taxable Income

A customer buys $20,000 of ABC stock in March of 20XX. On December 31, 20XX, the stock is valued at $16,000. The customer will be able to deduct how much on this year's tax return? A 0 B $1,000 C $3,000 D $4,000

The best answer is A. The loss is not "recognized" for tax purposes until the securities are sold. Thus, none of the loss is deductible on this year's tax return.

Under IRS regulations, a gain or loss upon current disposition of an asset is first considered to be long term if the asset has been held for: A 6 months or less B over 6 months C 1 year or less D over 1 year

The best answer is D. Under IRS rules, a security's holding period is short term if the security has been held for up to 1 year. Short term capital gains are taxed at 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%. (Note that this rate is raised to 20% for taxpayers in the highest tax bracket.)

A client account shows the following activity: Purchase Date Position Price 6/14/21 500 XIX $99 7/21/21 400 AON $82 8/4/21 200 MMM $74 Sale Date Position Price 10/28/21 300 AON $102 11/12/21 200 MMM $79 As of the current date, the market value of XIX is $122 per share; AON is at $98 per share and MMM is at $77 per share. Based on this activity, as of the current date, the customer has a: A realized gain of $7,000 and an unrealized gain of $13,100 B realized gain of $13,100 and an unrealized gain of $6,000 C realized gain of $3,000 and an unrealized gain of $3,400 D realized gain of $3,400 and an unrealized gain of $3,000

The best answer is A. The customer bought 500 shares of XIX at $99 and still holds the position. Since XIX is now valued at $122, there is an $23 per share unrealized gain x 500 shares = $11,500 unrealized gain on XIX. The customer bought 400 shares of AON at $82 per share. Then the customer sold 300 AON shares at $102, for a $20 per share realized gain x 300 shares = $6,000 realized gain on AON. The remaining 100 shares of AON are now valued at $98 per share, for a $16 per share unrealized gain x 100 shares = $1,600 unrealized gain on AON. The customer bought 200 shares of MMM at $74 per share. Then the customer sold those 200 MMM shares at $79, for a $5 per share realized gain x 200 shares = $1,000 realized gain. The customer has no remaining position in MMM. The total realized gain or loss is: $6,000 realized gain on AON + $1,000 realized gain on MMM = $7,000 realized gain. The total unrealized gain or loss is: $11,500 unrealized gain on XIX + $1,600 unrealized gain on AON = $13,100 unrealized gain.

An investor's securities portfolio has depreciated by $3,000 this year. How much of the loss can the investor deduct on this year's tax return? A 0 B $1,500 C $3,000 D $6,000

The best answer is A. An investor cannot deduct depreciation of an asset that is currently held as a capital loss. To take the loss, he or she must first sell those securities. Investors can only deduct $3,000 of net realized capital losses per year. Any losses above this amount are carried forward to future tax years.

Which statement is TRUE about taxation of capital gains? A Short term capital gains are taxed at higher rates than long term capital gains B Short term capital gains are taxed at lower rates than long term capital gains C Short term capital gains are taxed at the same rate as long term capital gains D Short term capital gains are taxed at ordinary income rates; long term capital gains are tax deferred

The best answer is A. The maximum tax rate on short term capital gains is 37% (the same as for earned (ordinary) income). For assets held over 12 months, the maximum tax rate drops to 15%. (Note that this rate is raised to 20% for individuals in the highest tax bracket.)

A customer has $3,000 of capital losses and $3,000 of capital gains in a tax year. On that year's tax return, the investor has: A no taxable capital gain or loss B a $3,000 capital gain with no capital loss deduction C a $3,000 capital loss with a $3,000 capital gain carryforward D a $3,000 capital gain and a $3,000 capital loss carryforward

The best answer is A. The tax law allows capital gains and losses to be netted each year. Net capital gains are fully taxable at the tax bracket. However, only $3,000 of net capital losses can be deducted in any year. Any losses above this amount can be carried forward to the next tax year. This customer has no net capital gain or loss. Here, the $3,000 loss is offset by the $3,000 capital gain, for no gain or loss.

Under IRS regulations, a gain or loss upon current disposition of an asset is considered to be short term if the asset has been held for: A 6 months or less B 1 year or less C 2 years or less D 5 years or less

The best answer is B. Under IRS rules, a security's holding period is short term if the security has been held for up to 1 year. Short term capital gains are taxed at 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%. (Note that this rate is raised to 20% for taxpayers in the highest tax bracket.)

In the same year, a customer has $14,000 of long-term capital losses on stock positions and $4,000 of short-term capital gains on options positions. Which statement is TRUE? A The capital losses can be netted against the capital gains and a $10,000 net capital loss is reported, all of which is deductible B The capital losses can be netted against the capital gains and a $10,000 net capital loss is reported, $3,000 of which is deductible C The $14,000 of capital losses on the stock positions must be reported separately from the $4,000 of capital gains on the options positions, with all $14,000 of capital losses being deductible and all $4,000 of capital gains being taxable D The $14,000 of capital losses on the stock positions must be reported separately from the $4,000 of capital gains on the options positions, with only $3,000 of capital losses being deductible and all $4,000 of capital gains being taxable

The best answer is B. Capital gains and capital losses on all assets are "netted" against each other. There is no segregation by type of asset. This customer had $14,000 of long term capital losses on stocks and $4,000 of short term capital gains on options. The customer has a net $10,000 long-term capital loss, of which only $3,000 is deductible in 1 year. The remaining $7,000 of unused net capital losses is carried forward to the next year.

Royalties received from an oil and gas program are: A partnership income B passive income C earned income D portfolio income

The best answer is B. Income received from partnership investments is characterized under the tax code as passive income. Passive losses can only be offset against other passive income - they cannot be offset against earned income or portfolio income.

Cash payments made to investors (except for extremely high earners) from which of the following investments are subject to the lower 15% maximum tax rate? I Common stocks II Preferred stocks III Convertible bonds IV Non-convertible bonds A I only B I and II C III and IV D I, II, III, IV

The best answer is B. Interest payments received from bond investments (whether the bonds are convertible or not) do not qualify for the lower 15% tax rate. Also note that this rate is raised to 20% for individuals in the highest tax bracket.

A customer has $20,000 in passive losses from a limited partnership investment. If the customer has $3,000 of passive income for that tax year, the customer may deduct: A 0 B $3,000 C $17,000 D $20,000

The best answer is B. Passive losses (which are derived from direct investments in real estate and limited partnership investments) can only be offset against other passive income. Since there is $3,000 of passive income for this tax year, only $3,000 of passive losses can be deducted. The unused $17,000 of passive losses are carried forward and can be offset in later years against passive income generated in those years.

A customer has $8,000 of capital losses and $3,000 of capital gains in a tax year. On that year's tax return, the investor has a(n): A $3,000 capital loss deduction with no loss carryforward B $3,000 capital loss deduction and a $2,000 loss carryforward C $3,000 capital loss deduction and a $5,000 loss carryforward D $8,000 capital loss deduction

The best answer is B. The tax law allows capital gains and losses to be netted each year. Net capital gains are fully taxable at the appropriate tax bracket. However, only $3,000 of net capital losses can be deducted in any year. Any losses above this amount can be carried forward to the next tax year. Here, the customer has a net capital loss of $5,000 of which $3,000 can be deducted this year with the unused $2,000 loss carried forward to the next tax year.

An investor in a limited partnership generating passive losses can offset these against: I passive income generated from other limited partnership investments II income generated from direct investments in real estate III dividends received from blue chip corporations IV capital gains generated from the sale of securities A I only B I and II only C III and IV only D I, II, III, IV

The best answer is B. Under the Tax Code, passive losses can only be offset against passive income. They cannot be offset against portfolio income (interest, dividends, capital gains) or earned income. Passive income and loss is defined as that derived from real estate investments and limited partnership interests.

Which of the following are defined as "portfolio income" under IRS guidelines? I Distributive share of income from limited partnership holdings II Proceeds from the sale of securities in excess of the tax basis of those securities III Interest income received from bond holdings IV Dividends received from preferred stock holdings A I and II only B III and IV only C II, III, IV D I, II, III, IV

The best answer is C. Income from partnership interests is defined as "passive income" under IRS rules. Passive income can only be offset by passive losses. Portfolio income consists of dividends, interest, and net capital gains on securities (except for direct participation program interests, which are considered to be passive investments). Portfolio gains can only be offset against portfolio losses.

Under Internal Revenue Code guidelines, a royalty received from writing a best selling diet book is defined as which type of income? A passive B investment C portfolio D earned

The best answer is D. Under the Internal Revenue Code, royalty income from books, plays, movie scripts, and magazine articles, are all reported on Schedule C as earned income. Any expenses associated with earning these royalties, may be deducted against any earned income.