Unit 21 - Tax Considerations
One of your ultra-high net worth clients has extensive real estate holdings and is concerned about his children being forced to liquidate some of them in order to pay the estate taxes after his death. One tool that could be suggested to solve this problem would be A) registering the properties as JTWROS. B) placing the properties into a living trust. C) purchasing a life insurance policy using an ILIT. D) using a TOD account.
C) purchasing a life insurance policy using an ILIT.
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 the RIF at $30 per share. One month later, RIF pays a dividend of $1 per share. Then, 5 months later, another purchase of the RIF is made—this time 400 shares at $35 per share. If the client were to sell all the 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
A) $500 loss
If a high-income taxpayer is subject to AMT, which of the following preference items must be added to adjusted gross income to calculate his tax liability? A) Dividends paid on preferred stock B) Interest on a private purpose municipal bond C) Distributions from a corporate bond mutual fund D) Interest on a general obligation municipal bond
B) Interest on a private purpose municipal bond
Which of the following is federally tax exempt for a corporation? A) Foreign corporate stock dividends B) Municipal bond interest C) Preferred stock dividends D) Capital gains
B) Municipal bond interest
Your daughter is getting married and, to celebrate, you give her fiancé a beautiful watch that you purchased for $5,575. What are the tax consequences of this gift? A) The fiancé would have to report this as ordinary income. B) No tax C) Because they are not yet married, the fiancé is not actually a family member, so a gift tax would be levied. D) Anything over the FINRA gift limit of $100 per person per year would be considered taxable.
B) No tax
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) There will be no tax consequences. B) He will have a $1,000 gain. C) He will offset $1,000 ordinary income this year. D) He will have a $1,000 loss to carry over to the next year.
C) He will offset $1,000 ordinary income this year.
Your client purchased 1,000 shares of ABC common stock on February 28, 2017. When would that purchase qualify for long-term capital gain or loss treatment? A) February 28, 2018 B) March 1, 2017 C) March 1, 2018 D) February 29, 2018
C) March 1, 2018
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 gain, $105 short-term loss B) $575 short-term loss; $105 long-term gain C) $575 long-term loss D) $470 short-term loss
D) $470 short-term loss
If a married couple establishes a JTWROS account with a balance of $25 million and the wife dies, what is the husband's estate tax liability? A) He pays federal estate taxes on $12.5 million. B) He pays federal estate taxes only on the amount that exceeds the estate tax credit. C) He pays federal estate taxes on the entire balance. D) He pays no estate tax.
D) He pays no estate tax.
Grandma has decided to give her grandson some stock that she bought many years ago. When the grandson sells the stock, how is the tax liability figured? A) Her date of purchase is used, but the cost basis is from the date of the gift. B) Her cost basis is used, but the holding period begins on the date of the gift. C) Both the cost basis and holding period are determined from the date of the gift. D) Her cost basis and date of purchase is used.
D) Her cost basis and date of purchase is used. When stock is given as a gift, the donee (recipient) takes over the cost basis and the holding period of the donor.
There are many sources of taxable income to an individual. Included might be money received from which of the following? I. Sole proprietorship II. Subchapter S corporation III. Investments IV. Life insurance death benefit A) II and III B) I, II, III, and IV C) I and II D) I, II, and III
D) I, II, and III
Which of the following entities would issue a Schedule K-1? A) REIT B) Sole proprietorship C) C corporation D) Limited partnership
D) Limited partnership
There are a number of different ways in which a business may be structured. For tax purposes, which form is taxed on its income? A) General partnership B) S corporation C) LLC D) Sole proprietorship
D) Sole proprietorship
One of your very generous clients has used up her lifetime gift exclusion. Continuing to make gifts, she gives $50,000 to a grandchild and $18,000 to the child of a friend. What are the tax consequences of these gifts? A) Only the gift to the child of the friend will be taxed because one can make unlimited gifts to grandchildren. B) The tax rate on both gifts will be the same. C) If the children use the money for tuition at a tax-qualified educational institution, there is no tax. D) The tax rate on the $50,000 gift will be higher than that on the $18,000 gift.
D) The tax rate on the $50,000 gift will be higher than that on the $18,000 gift.
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) I only C) II and III D) II only
A) I, II, and III
A high net worth individual wishes to know when a gift can be made this year without being obligated to pay gift tax. You would respond that there is no gift tax when the gift is made to A) a non-citizen spouse. B) the American Red Cross. C) a sibling of the donor. D) a grandchild of the donor.
B) the American Red Cross.
Which of the following vehicles make use of the unified estate tax credit? I. Bypass trust II. Generation-skipping trust III. Living trust IV. Simple trust A) I and IV B) III and IV C) I and II D) II and III
C) I and II
Three years ago, a customer bought 200 shares of ABC for $60.50 per share. Upon her death, she left the shares to her husband when ABC was trading at $98.25. If her husband sells the shares for $99.25, what is his cost basis for tax purposes? A) $79.38 B) $60.5 C) $99.25 D) $98.25
D) $98.25 The cost basis to the recipient of inherited securities is the fair market value on the date of the owner's death. In this case the fair value is the market value of $98.25.
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 A) the amount the decedent originally paid for the asset B) the fair market value of the asset on the day the decedent acquired it C) the amount the recipient ultimately sells the asset for D) the fair market value of the asset on the day the decedent died
D) the fair market value of the asset on the day the decedent died
If a customer of your firm receives stock from the estate of her mother, the stock's cost basis in the hands of the customer is A) the original cost of the stock adjusted for any estate taxes paid B) the market value at date of distribution to the customer C) the original cost of the stock D) the market value at date of death
D) the market value at date of death When securities are inherited, the heir receives a cost basis calculated as of the deceased party's date of death.
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. A) II and III B) II and IV C) I and III D) I and IV
A) II and III
Which of the following business entities has an income tax filing due date (disregarding possible extensions) of March 15? I. Sole proprietorship II. Single-member LLC III. Multiple-member LLC electing to be treated as a corporation IV. S corporation A) III and IV B) I and II C) II, III, and IV D) I and IV
A) III and IV
The gain on the sale of a security held as an investment will be treated as a long-term capital gain if the security was held for A) more than 6 months B) more than 12 months C) more than 1 month D) more than 3 months
B) more than 12 months
Using industry jargon, the tax on the last dollar of income is at A) the effective rate B) the marginal rate C) the average rate D) the final rate
B) the marginal rate
One of your ultra-high net worth clients would like to give some low cost basis stock as gifts to her adult grandchildren. It would be prudent for you to tell her that A) for purposes of the gift tax, her cost basis will be used. B) unlike an inheritance, there is no stepped-up cost basis. C) making the gift under the Uniform Transfer to Minors Act is generally the most advantageous for the child. D) it would be wise for her to use a TOD account to avoid probate.
B) unlike an inheritance, there is no stepped-up cost basis.
In order for an individual to receive Social Security benefits based on the earnings of the ex-spouse, the couple must have been married for at least A) 2 years. B) 5 years. C) 1 year. D) 10 years
D) 10 years
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) Income from a sole proprietorship D) Stock dividends
D) Stock dividends
The main purpose of dividend reinvestment in a mutual fund accumulation plan is to A) compound the growth of a mutual fund investment B) avoid commissions or sales charges C) avoid taxes D) protect against capital loss
A) compound the growth of a mutual fund investment
The gain on the sale of a security held as an investment will be treated as a long-term capital gain if the security was held for A) more than 12 months B) more than 3 months C) more than 6 months D) more than 1 month
A) more than 12 months
All of the following are progressive taxes except A) estate taxes. B) gift taxes. C) excise taxes on cigarettes. D) personal income taxes.
C) excise taxes on cigarettes.
Which of the following would generally NOT result in any income tax liability? A) Profits generated by a sole proprietorship B) Death benefit proceeds from a life insurance policy C) Qualified dividends from common stock D) Profits generated by an S corporation
B) Death benefit proceeds from a life insurance policy
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? I. Policy 1; his wife is the insured. II. Policy 2; his business partner is the insured. III. Policy 3; his daughter is the insured. IV. Policy 4; he is the insured. A) II and IV B) I, II, III, and IV C) II and III D) I, II, and II
B) I, II, III, and IV
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 B) a $300 short-term capital gain C) a $60 short-term capital gain D) a $240 long-term capital gain and a $60 short-term capital gain
B) a $300 short-term capital gain
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 A) have minimum credited earnings of at least $20,000 per year. B) have a minimum of 40 covered quarters of employment. C) have at least 40 years of employment. D) be at least age 62.
B) have a minimum of 40 covered quarters of employment.
A loss derived from a limited partnership may be offset against income from A) dividends received from common stocks B) other limited partnerships C) bonuses received in addition to regular salary D) capital gains from municipal bonds
B) other limited partnerships A limited partner 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 stocks. Passive loss from partnerships may be used to offset passive gains from partnerships, not gains from municipal bonds.
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) ignore the profit for tax purposes because precious metals are not subject to capital gains taxation D) use a cost basis of zero because it was a gift
B) use the original cost of 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).
Which of the following statements regarding grantor trusts is NOT correct? A) If the grantor can control the beneficial enjoyment of the trust, he is treated as the owner of the trust. B) If the grantor has the power to revoke 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.
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 growth stock C) a corporate bond D) an apartment building
C) a corporate bond 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.
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 reinvestments will purchase shares at a discount from the NAV B) taxes are deferred until those shares are redeemed C) the investor's basis is increased by the amount of the reinvested dividends D) the dividends will be taxed as capital gains once the shares are liquidated
C) the investor's basis is increased by the amount of the reinvested dividends Because the reported dividends are taxed each year, when the shares are ultimately liquidated, they have already been taxed. So, the investors cost basis is increased by the amount of the reinvestment.
William died in 2019 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 named as beneficiary, and $75,000 in debts and estate expenses. What is William's net estate? A) $175,000 B) $0; it is below the $11.4 million exemption equivalent C) $750,000 D) $625,000
D) $625,000 The question is asking for the net estate, not the amount of estate tax due. The market value of all assets that 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 net or taxable estate. The math goes like this. The $1.1 million gross estate (add together the assets ($200,000 + $650,000 + $250,000) is reduced by the $850,000 left to his wife. That brings the net estate down to $250,000 ($1,100,000 minus $850,000). The net estate is further reduced by the $75,000 in debt and expenses. Subtracting $75,000 from $250,000 leaves a net estate of $175,000. That is well below the estate tax exemption of $11.4 million in assets for 2019.
Ebony sets up a revocable trust, naming her daughter, Sylvia, as the sole beneficiary. Ebony has appointed the Pacific Atlantic Trust Institution (PATI) as the trustee. Any distributed income will be taxable to A) the beneficiary B) the trustee C) the trust D) the grantor
D) the grantor In almost all cases, income received into a revocable (grantor) trust, whether distributed or not, is taxable to the grantor. Things are different when the trust is irrevocable, but much more complicated and not likely to be tested.
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 reinvestments will purchase shares at a discount from the NAV B) the dividends will be taxed as capital gains once the shares are liquidated C) taxes are deferred until those shares are redeemed D) the investor's basis is increased by the amount of the reinvested dividend
D) the investor's basis is increased by the amount of the reinvested dividend
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) $11,000 B) $5,000 C) $9,000 D) $3,000
D) $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.
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) ownership of stock in an S corporation B) operation of a sole proprietorship C) interests in a DPP D) death benefit received from a life insurance policy
D) death benefit received from a life insurance policy
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) ignore the profit for tax purposes because precious metals are not subject to capital gains taxation C) use the original cost of the ring D) use a cost basis of zero because it was a gift
C) use the original cost of 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).
If a father makes a gift of securities to his 10-year-old daughter, gift taxes would be based on A) the market value of the securities as of April 15 of the year in which the gift is made B) the market value of the securities as of December 31 of the year in which the gift is made C) the market value of the securities on the date of gift D) the cost of the securities
C) the market value of the securities on the date of gift
Investors who buy shares in state-specific municipal bond funds may be subject to A) no taxation B) out-of-state property tax C) federal income tax D) capital gains tax
D) 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.
If a father makes a gift of securities to his 10-year-old daughter, gift taxes would be based on A) the market value of the securities as of April 15 of the year in which the gift is made B) the market value of the securities as of December 31 of the year in which the gift is made C) the cost of the securities D) the market value of the securities on the date of gift
D) the market value of the securities on the date of gift 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.
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) $3,000.00 B) $15,000.00 C) $0.00 D) $12,000.00
C) $0.00 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.
An investor inherits 1,000 shares of the ABC Global Growth Fund when the NAV is $9.50, the bid price is $9.00, and the ask price is $9.15. Two years later, the investor sells all shares when the NAV is $14.25, the bid is $14.50, and the ask is $14.60. What are the tax consequences of this sale? A) Long-term capital gain of $5,450 B) Long-term capital gain of $5,500 C) Long-term capital gain of $5,350 D) Long-term capital gain of $4,750
B) Long-term capital gain of $5,500 Upon death, the beneficiary inherits closed-end funds at their bid price (what the estate could have sold them for), or $9.00 per share. The sale two years later takes place at the bid ($14.50) for a profit of $5.50 per share (times 1,000 shares). Remember, in the case of a closed-end fund, the NAV does not figure into any computations; prices are based on supply and demand and have a bid and ask price, the same as any stock. How did you know this was a closed-end company? Only in the case of a closed-end company can the ask price be lower than the NAV (ask = $9.15, NAV = $9.50).
Which of the following statements about capital gains are TRUE? I. The minimum holding period required to qualify for long-term capital gains treatment is 1 day longer than 12 months. II. The highest federal income tax rate on long-term capital gains is less than the highest federal income tax rate on ordinary income. III. 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 III B) II and III C) I, II, and III D) I and II
C) I, II, and III 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.
Grandpa bought 100 shares of XYZ common stock 10 years ago for $10 per share. The stock split 2 for 1 several years ago and grandpa gave all of the stock to his grandson when the price per share was $20. Three months ago, grandpa passed away and left the grandson another 100 shares of XYZ that had been purchased one month earlier at $25 per share. At the date of death, the XYZ stock had already climbed to $30 per share. If the grandson sells the XYZ stock for $35 per share, the taxable consequences would be A) $6,000 long-term capital gain plus $500 short-term capital gain. B) $2,500 long-term capital gain plus $1,000 short-term capital gain. C) $4,000 long-term capital gain. D) $6,500 long-term capital gain.
D) $6,500 long-term capital gain. Gifted stock carries the donor's cost basis. In this case, 100 shares at $10 per share is $1,000. The stock split means there are now 200 shares, but that doesn't change the total cost basis. When that stock is sold at $35 per shares, the proceeds of $7,000 exceed the cost basis by $6,000, all of which is long-term capital gain. Inherited stock receives a stepped-up basis. That is, the cost basis is at date of death. In this case, the cost per share is $30. When that 100 shares is sold at $35 per share, a $500 profit is realized. In one of the quirks in the Internal Revenue Code, stock received as an inheritance always has a long-term holding period, even when, as in this question, the actual holding period was short-term. Adding the $6,000 of gain from the gift and the $500 of gain from the inheritance gives a total of $6,500 long-term capital gain.
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) The death benefit is paid B) The policy is surrendered C) There is a cash withdrawal in excess of the cost basis D) A loan is taken equal to 95% of the policy's cash value
D) A loan is taken equal to 95% of the policy's cash value 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.
A married couple has lived in the same home for 40 years and now, with the children all gone, they've decided to sell and move to a retirement village. They purchased the home for $80,000 and have accepted a contract for $800,000. The tax consequences of this sale is A) $220,000 capital gain. B) $0 capital gain. C) $470,000 capital gain. D) $720,000 capital gain.
A) $220,000 capital gain. As long as a homeowner has lived in the primary residence at least 2 of the previous 5 years, the first $250,000 of profit on a home sale is excluded from tax. In the event it is a married couple, as in this question, the exclusion is doubled to $500,000. The profit on the sale was $720,000 ($800,000 minus the cost of $80,000) and the exclusion of $500,000 reduces the reportable gain to $220,000.
XYZ, Inc. is a C corporation in the 21% federal income tax bracket. Which of the following investments offers the company the highest after-tax return? A) ABCD, Inc. preferred stock paying a 6% dividend B) Municipal bond with a 5% coupon rate C) Corporate bond with a 6.75% coupon D) REIT paying a 6.5% dividend
A) ABCD, Inc. preferred stock paying a 6% dividend The key to this answer is that corporations have a 50% dividend exclusion on dividends received from other companies. The math looks like this: Only half of the 6% dividend is taxable. That means 3% per year is tax free and the other 3% is subject to tax at the 21% rate. So, we have 3% + 79% of the taxable 3% = 3% + 2.37% = 5.37% after-tax return. The municipal bond is not taxed, but that only produces 5% after tax. The corporate bond is subject to 21% tax so the corporation gets to retain the other 79%. That computes to 6.75 x 79% = 5.33%, just a bit less than the preferred stock. In most cases, dividends paid to corporations by REITs are fully taxable. That makes the after-tax return on the 6.5% dividend only 5.14%.
Grandpa bought 100 shares of XYZ common stock 10 years ago for $10 per share. The stock split 2 for 1 several years ago and grandpa gave all of the stock to his grandson when the price per share was $20. Three months ago, grandpa passed away and left the grandson another 100 shares of XYZ that had been purchased one month earlier at $25 per share. At the date of death, the XYZ stock had already climbed to $30 per share. If the grandson sells the XYZ stock for $35 per share, the taxable consequences would be A) $6,000 long-term capital gain plus $500 short-term capital gain. B) $4,000 long-term capital gain. C) $6,500 long-term capital gain. D) $2,500 long-term capital gain plus $1,000 short-term capital gain.
C) $6,500 long-term capital gain. Gifted stock carries the donor's cost basis. In this case, 100 shares at $10 per share is $1,000. The stock split means there are now 200 shares, but that doesn't change the total cost basis. When that stock is sold at $35 per shares, the proceeds of $7,000 exceed the cost basis by $6,000, all of which is long-term capital gain. Inherited stock receives a stepped-up basis. That is, the cost basis is at date of death. In this case, the cost per share is $30. When that 100 shares is sold at $35 per share, a $500 profit is realized. In one of the quirks in the Internal Revenue Code, stock received as an inheritance always has a long-term holding period, even when, as in this question, the actual holding period was short-term. Adding the $6,000 of gain from the gift and the $500 of gain from the inheritance gives a total of $6,500 long-term capital gain.
