Unit 15
If an investor is in the highest federal income tax bracket and is subject to the alternative minimum tax, which of the following securities should an agent recommend? A) Industrial revenue bond B) Corporate bond C) Treasury bond D) General obligation bond
D) General obligation bond Municipal bonds are suitable for the portfolio of an investor who is in a high tax bracket because the interest is exempt from federal income tax. A general obligation (GO) bond is a better recommendation than an industrial revenue bond because the interest on industrial revenue bonds is likely subject to the AMT.
A number of corporations offer dividend reinvestment plans (DRIPs) where the client's dividends are automatically reinvested in additional shares of the issuer. In the case of a company that pays dividends with some degree of regularity, if the market price per share has declined over the year, an investor participating in one of these plans would find which of the following to be true (assume no splits)? A) There are more shares in the investor's account. B) The value of the investor's account has gone up. C) The value of the investor's account has gone down. D) There are fewer shares in the investor's account.
A) There are more shares in the investor's account. With the dividends reinvested, there will be more shares. Although the market price per share has declined, we don't know the aggregate account value (with the additional shares) so we don't have enough information to tell if the overall value has risen or declined.
The amount of federal income tax a U.S. citizen residing in the country will pay is dependent on all of these except A) gender. B) state of residence. C) filing status. D) age.
A) gender. Tax rates are not dependent upon one's gender. Age has an impact because there is an extra exemption for those at age 65. State of residence is a factor because certain state taxes are deductible on your Form 1040. Filing status is very important because in most cases, married filing jointly results in the lowest taxes.
An example of an interest-on-interest reinvestment program is A) interest left to compound on a bank-insured certificate of deposit. B) reinvesting the interest received on a bond. C) reinvesting the earnings on a bond UIT. D) reinvesting the dividends distributed on a bond fund.
A) interest left to compound on a bank-insured certificate of deposit. Interest-on-interest reinvestment is, as the term implies, the practice of compounding earnings by reinvesting them. This is traditionally the way a bank savings account or certificate of deposit builds in value. Reinvesting the dividends on a bond fund is dividend reinvestment, even though most, if not all, of the fund's income is generated by interest. Same with the UIT and there is no program for reinvesting bond interest similar to a DRIP for reinvesting dividends.
Using industry jargon, the tax on the last dollar of income is at A) the marginal rate. B) the effective rate. C) the final rate. D) the average rate.
A) the marginal rate. The IRS defines marginal tax rate as "the highest rate that you will pay on your income." Basically, as you make more money, you pay tax at a higher rate incrementally. The effective tax rate is the average that you pay on all of your income.
Many corporations make available dividend reinvestment plans for their shareholders. Among the benefits of using DRIPS are I. allowing the investment to compound. II. discounts from the current market price. III. reduced taxation. IV. the ability to accept the dividend in cash or in additional shares of stock. A) I and III B) I and II C) I and IV D) II and IV
B) I and II DRIPs, like any other plan involving dividend reinvestment, offer the opportunity to have the investment compound. In most cases, shares are available at a slight discount from the current market and/or reduced or eliminated commissions. Many plans allow investors to add thousands of dollars to the reinvested dividend, taking advantage of the previous two benefits. However, there is no tax advantage and this is merely reinvesting a cash dividend, not receiving a stock dividend.
An investor purchases 100 shares of ABCE common stock at $70 per share. Thirteen months later, the stock is sold when the market price is $50 per share. Which of the following activities made 20 days after the sale of the stock at $50 per share, would not violate the wash sale rule? A) Purchasing 100 shares of ABCE common stock B) Purchasing an ABCE call option C) Purchasing 5 ABCE convertible bonds with a conversion price of $50 D) Purchasing an ABCE put option
D) Purchasing an ABCE put option The wash sale rule applies when the same or substantially identical security as a stock sold at a loss is acquired within the 30 day period prior to and after the sale. Buying a put is not a problem because the put only allows the holder to sell the stock, not buy it. Please note that a bond convertible at $50 is convertible into 20 shares, so 5 bonds will enable the investor to convert into 100 shares.
Each of the following could cause an investor to be subject to the alternative minimum tax except A) interest received on private activity municipal bonds. B) accelerated depreciation taken on certain property. C) interest received on school district GO bonds. D) excess intangible drilling costs.
C) interest received on school district GO bonds. General obligation GO bonds are not subject to the AMT.
An investor has made the following purchases, all in the same calendar year: 100 ABC at $20 on January 15; 200 ABC at $25 on April 4; and 100 ABC at $30 on July 23. With ABC currently selling at $22, if this investor needed to sell 200 ABC, the best decision from a tax standpoint would probably be to A) use FIFO. B) use LIFO. C) use average cost. D) hold the stock until the price reaches $25.
B) use LIFO. The best decision from a tax standpoint is to arrange things to show the largest loss. Remember, losses can be used against gains and, if there are more losses than gains, up to $3,000 of that loss can reduce taxable income. Using a form of share identification known as LIFO (last in first out), enables the investor to designate the 100 shares purchased at $30 in July and 100 of the shares purchased at $25 in April. That will result in a short-term capital loss of $1,100 ($800 on the July shares purchased at $30 plus $300 on the April shares purchased at $25.) That loss may be used either against realized gains or, if this is the investor's only transactions, deducted in full against ordinary income. The average cost method is only available for mutual funds. If this investor used FIFO, the sale would be of the 100 shares bought in January at $20 per share and 100 of the shares bought in April at $25 per share. The sale of the January purchase results in a $200 gain ($22 - $20 × 100 shares). The sale of the April purchase results in a $300 loss ($22 - $25) = -$3 times 100 shares. Combining them generates a net loss of $100. From a tax standpoint, declaring a loss of $1,100 is preferable to a loss of $100.
Many different investments offer the opportunity to reinvest income. If one were to compare the difference between interest-on-interest reinvestment plans and dividend and capital gain reinvestment plans, A) in both cases, all income is deferred until liquidation. B) in the case of dividend and capital gains reinvestment plans, taxes are deferred until liquidation. C) in both plans, all income is taxable in the year received, whether reinvested or not. D) in the case of interest on interest plans, taxes are deferred until liquidation.
C) in both plans, all income is taxable in the year received, whether reinvested or not. Regardless of the type of plan, any income, whether reinvested or not, is always taxed in the current year. Think of an interest-on-interest plan as a passbook savings account where the interest is credited and compounded. Whether taken out or not, the earnings are reported on an annual basis. On the exam, the question may ask for a difference as we have here, but, as you can see, there is no difference.
The alternative minimum tax becomes a consideration when a taxpayer has so-called tax preference items. Included in that definition is A) overtime pay from a job. B) tips received while working at a restaurant. C) interest from private activity bonds. D) interest from U.S. Treasury bonds.
C) interest from private activity bonds. When an individual has tax preference items, AMT becomes an issue. One of the securities that generates preference income is a private activity bond, a revenue bond that is issued to benefit certain facilities such as airports, sports facilities and hospitals. Interest on Treasury securities is never a preference item and earned income, such as wages, salary, and tips, is not considered a preference item.
You are working with a client who received her divorce earlier this year. She has two young children, ages four and seven, who both live with her. In general, it would be most advantageous for her to file her federal income tax claiming what status? A) Single B) Married, but separated C) Joint D) Head of Household
D) Head of Household Taxpayers claiming the head-of-household (HOH) filing status benefit from a higher standard deduction and lower tax rates than single taxpayers. There are several requirements that must be met to qualify for HOH status. Some of them include the following: You are unmarried or considered unmarried on the last day of the year. A "qualifying person" lived with you in the home for more than half the year (except for temporary absences, such as school). This is generally your children. Because she is divorced, she can't claim married or joint and, as stated above, filing as HOH offers many tax advantages over single.
