Analysis - Basic Tax Rules: Intro to taxation

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

A. 0 (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.)

For investors who are not extremely high earners, the maximum tax rate on cash dividends received is: A. 15% B. 25% C. 35% D. 50%

A. 15% (A lower tax rate, 15%, is imposed on cash dividends received from both common and preferred stocks. The intent of this tax benefit is to promote long term equity investment. Note that this rate is raised to 20% for individuals in the highest tax bracket.)

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

D. earned (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.)

Which of the following would be defined as "portfolio income" under IRS regulations? A. Long term capital gains B. Alimony payments C. Royalty payments D. Bonus payments

A. Long term capital gains (Capital gains (long or short term) are defined as portfolio income. Earned income is basically defined as income from one's regular employment, but also includes alimony payments, royalties received (such as royalties earned for writing a book), and bonuses. Also note that starting in 2019, alimony payments will no longer be taxable to the recipient, nor will they be deductible to the payer - but don't expect to see this on the exam until 2019!)

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

A. short term capital gains are taxed at higher rates than long term capital gains (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 $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

B. $3,000 capital loss deduction and a $2,000 loss carry forward (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.)

All of the following would be taxable at "earned income" rates under IRS regulations EXCEPT: A. Social Security payments B. Alimony payments C. Royalty payments D. Bonus payments

B. Alimony Payments (Earned income, under the tax code, has different definitions, depending on the regulation involved. The income items that are taxed at "earned income" rates (currently a maximum of 37%) includes wages, bonuses, social security payments, and royalties received (such as royalties earned for writing a book). Note that starting in 2019, alimony payments received are no longer taxable earned income, nor are they deductible to the person making the alimony payment.)

A customer has invested in a real estate business that is being managed by a third party. Any income from the investment would be characterized for tax purposes as: A. portfolio income B. passive income C. earned income D. alternative income

B. Passive Income (Passive income and loss is defined as that derived from real estate investments and limited partnership investments. Passive losses can only be offset against passive income. Passive losses cannot be offset against investment income or earned income.)

n 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

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 (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.)

A customer in the 28% tax bracket has $4,000 of capital gains and $12,000 of capital losses. How much unused loss is carried forward to the next tax year? A. 0 B. $3,000 C. $5,000 D. $8,000

C. $5,000 ( The customer has a capital gain of $4,000 and a capital loss of $12,000 for a net capital loss of $8,000. Since only $3,000 of net capital losses can be deducted in a tax year, $5,000 of the loss cannot be deducted. This $5,000 loss is carried forward to the next tax year.)

All of the following items are included as deductible passive losses on the income tax returns of limited partnership investors EXCEPT: A. depletion allowances B. intangible drilling costs C. principal payments on secured debt D. interest payments on secured debt

C. principal payments on secured debt (Interest payments on loans, intangible drilling costs (the cost of drilling for oil and gas), and depletion allowances (the recovery of monies paid to buy the oil or gas reserve) are all tax deductible items under the Internal Revenue Code since they are "ordinary and necessary business expenses." Repayment of principal on a loan is not tax deductible.)

Which statements are TRUE regarding the taxation of capital gains? I A capital gain is considered to be short term if a position is liquidated at a profit after being held for 1 year or less II A capital gain is considered to be short term if a position is liquidated at a profit after being held for over 1 year III For investors in the maximum tax bracket, any short term capital gains will be taxed at the same tax rate as that bracket IV For investors in the maximum tax bracket, any short term capital gains will be taxed at a lower rate than that bracket

I and III (Under Internal Revenue rules, a capital gain (or loss) is considered to be short term if a position is liquidated after being held for 1 year or less. Short term capital gains are taxed at ordinary income rates with 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.)

Which of the following statements are TRUE about capital gains taxes for investors who are not extremely high earners? I The maximum tax rate on a short term capital gain is 15% II The maximum tax rate on a short term capital gain is 37% III The maximum tax rate on a long term capital gain is 15% IV The maximum tax rate on a long term capital gain is 37%

II and III (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 taxpayers in the highest tax bracket.)

Which of the following securities transactions would result in a long term capital gain? I Purchase 100 shares of ABC stock at $50 on January 2, 2018; Sell 100 shares of ABC stock at $60 on July 2, 2018 II Purchase 100 shares of ABC stock at $50 on January 2, 2018; Sell 100 shares of XYZ stock at $60 on July 2, 2018 III Purchase 100 shares of ABC stock at $50 on January 2, 2018; Sell 100 shares of ABC stock at $60 on January 3, 2019 IV Purchase 100 shares of ABC stock at $50 on January 2, 2018; Sell 100 shares of XYZ stock at $60 on January 2, 2019

III only (Under Internal Revenue rules, a profit (or loss) is considered to be long term if a position is liquidated after being held for more than 1 year (1 year and 1 day or more). Short term capital gains are taxed at a maximum rate of 37% (the maximum individual tax rate). 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.) Also note that to have a taxable gain or loss, the same security must have been purchased and subsequently sold (or vice versa).