Tax II - Exam 1
(B) property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, (C) a copyright, a literary, musical, or artistic composition, a letter or memorandum, or similar property, held by a taxpayer described in paragraph (3) of section 1221 (a), or (D) a publication of the United States Government (including the Congressional Record) which is received from the United States Government, or any agency thereof, other than by purchase at the price at which it is offered for sale to the public, and which is held by a taxpayer described in paragraph (5) of section 1221 (a).
(2) Timber, coal, or domestic iron ore Such term includes timber, coal, and iron ore with respect to which section 631 applies. (3) Livestock Such term includes—
(b) Exceptions and limitations (1) Gifts Subsection (a) shall not apply to a disposition by gift. (2) Transfers at death Except as provided in section 691 (relating to income in respect of a decedent), subsection (a) shall not apply to a transfer at death.
(3) Certain tax-free transactions If the basis of property in the hands of a transferee is determined by reference to its basis in the hands of the transferor by reason of the application of section 332, 351, 361, 721, or 731, then the amount of gain taken into account by the transferor under subsection (a)(1) shall not exceed the amount of gain recognized to the transferor on the transfer of such property (determined without regard to this section). Except as provided in paragraph (6), this paragraph shall not apply to a disposition to an organization (other than a cooperative described in section 521) which is exempt from the tax imposed by this chapter.
(2) Exception This subsection shall not apply to any exchange of— (A) stock in trade or other property held primarily for sale, (B) stocks, bonds, or notes, (C) other securities or evidences of indebtedness or interest, (D) interests in a partnership, (E) certificates of trust or beneficial interests, or (F) choses in action. For purposes of this section, an interest in a partnership which has in effect a valid election under section 761 (a) to be excluded from the application of all of subchapter K shall be treated as an interest in each of the assets of such partnership and not as an interest in a partnership.
(3) Requirement that property be identified and that exchange be completed not more than 180 days after transfer of exchanged property For purposes of this subsection, any property received by the taxpayer shall be treated as property which is not like-kind property if— (A) such property is not identified as property to be received in the exchange on or before the day which is 45 days after the date on which the taxpayer transfers the property relinquished in the exchange, or (B) such property is received after the earlier of— (i) the day which is 180 days after the date on which the taxpayer transfers the property relinquished in the exchange, or (ii) the due date (determined with regard to extension) for the transferor's return of the tax imposed by this chapter for the taxable year in which the transfer of the relinquished property occurs.
(2) Gains do not exceed losses If— (A) the section 1231 gains for any taxable year, do not exceed (B) the section 1231 losses for such taxable year, such gains and losses shall not be treated as gains and losses from sales or exchanges of capital assets.
(3) Section 1231 gains and losses For purposes of this subsection— (A) Section 1231 gain The term "section 1231 gain" means— (i) any recognized gain on the sale or exchange of property used in the trade or business, and
(3) Net section 1231 gain For purposes of this subsection, the term "net section 1231 gain" means the excess of— (A) the section 1231 gains, over (B) the section 1231 losses.
(4) Net section 1231 loss For purposes of this subsection, the term "net section 1231 loss" means the excess of— (A) the section 1231 losses, over (B) the section 1231 gains. (5) Special rules For purposes of determining the amount of the net section 1231 gain or loss for any taxable year, the rules of paragraph (4) of subsection (a) shall apply.
(A) cattle and horses, regardless of age, held by the taxpayer for draft, breeding, dairy, or sporting purposes, and held by him for 24 months or more from the date of acquisition, and (B) other livestock, regardless of age, held by the taxpayer for draft, breeding, dairy, or sporting purposes, and held by him for 12 months or more from the date of acquisition. Such term does not include poultry.
(4) Unharvested crop In the case of an unharvested crop on land used in the trade or business and held for more than 1 year, if the crop and the land are sold or exchanged (or compulsorily or involuntarily converted) at the same time and to the same person, the crop shall be considered as "property used in the trade or business."
(7) Timber property In determining, under subsection (a)(2), the recomputed basis of property with respect to which a deduction under section 194 was allowed for any taxable year, the taxpayer shall not take into account adjustments under section 194 to the extent such adjustments are attributable to the amortizable basis of the taxpayer acquired before the 10th taxable year preceding the taxable year in which gain with respect to the property is recognized.
(8) Disposition of amortizable section 197 intangibles (A) In general If a taxpayer disposes of more than 1 amortizable section 197 intangible (as defined in section 197 (c)) in a transaction or a series of related transactions, all such amortizable 197 intangibles shall be treated as 1 section 1245 property for purposes of this section. (B) Exception Subparagraph (A) shall not apply to any amortizable section 197 intangible (as so defined) with respect to which the adjusted basis exceeds the fair market value.
(c) Recapture of net ordinary losses (1) In general The net section 1231 gain for any taxable year shall be treated as ordinary income to the extent such gain does not exceed the non-recaptured net section 1231 losses. (2) Non-recaptured net section 1231 losses For purposes of this subsection, the term "non-recaptured net section 1231 losses" means the excess of—
(A) the aggregate amount of the net section 1231 losses for the 5 most recent preceding taxable years beginning after December 31, 1981, over (B) the portion of such losses taken into account under paragraph (1) for such preceding taxable years.
(4) Like kind exchanges; involuntary conversions, etc. If property is disposed of and gain (determined without regard to this section) is not recognized in whole or in part under section 1031 or 1033, then the amount of gain taken into account by the transferor under subsection (a)(1) shall not exceed the sum of—
(A) the amount of gain recognized on such disposition (determined without regard to this section), plus (B) the fair market value of property acquired which is not section 1245 property and which is not taken into account under subparagraph (A).
(5) Property distributed by a partnership to a partner (A) In general For purposes of this section, the basis of section 1245 property distributed by a partnership to a partner shall be deemed to be determined by reference to the adjusted basis of such property to the partnership.
(B) Adjustments added back In the case of any property described in subparagraph (A), for purposes of computing the recomputed basis of such property the amount of the adjustments added back for periods before the distribution by the partnership shall be— (i) the amount of the gain to which subsection (a) would have applied if such property had been sold by the partnership immediately before the distribution at its fair market value at such time, reduced by (ii) the amount of such gain to which section 751 (b) applied.
(6) Transfers to tax-exempt organization where property will be used in unrelated business (A) In general The second sentence of paragraph (3) shall not apply to a disposition of section 1245 property to an organization described in section 511 (a)(2) or 511 (b)(2) if, immediately after such disposition, such organization uses such property in an unrelated trade or business (as defined in section 513).
(B) Later change in use If any property with respect to the disposition of which gain is not recognized by reason of subparagraph (A) ceases to be used in an unrelated trade or business of the organization acquiring such property, such organization shall be treated for purposes of this section as having disposed of such property on the date of such cessation.
(4) Special rules For purposes of this subsection— (A) In determining under this subsection whether gains exceed losses— (i) the section 1231 gains shall be included only if and to the extent taken into account in computing gross income, and (ii) the section 1231 losses shall be included only if and to the extent taken into account in computing taxable income, except that section 1211 shall not apply.
(B) Losses (including losses not compensated for by insurance or otherwise) on the destruction, in whole or in part, theft or seizure, or requisition or condemnation of— (i) property used in the trade or business, or (ii) capital assets which are held for more than 1 year and are held in connection with a trade or business or a transaction entered into for profit, shall be treated as losses from a compulsory or involuntary conversion.
(ii) any recognized gain from the compulsory or involuntary conversion (as a result of destruction in whole or in part, theft or seizure, or an exercise of the power of requisition or condemnation or the threat or imminence thereof) into other property or money of— (I) property used in the trade or business, or (II) any capital asset which is held for more than 1 year and is held in connection with a trade or business or a transaction entered into for profit.
(B) Section 1231 loss The term "section 1231 loss" means any recognized loss from a sale or exchange or conversion described in subparagraph (A).
(2) Recomputed basis For purposes of this section— (A) In general The term "recomputed basis" means, with respect to any property, its adjusted basis recomputed by adding thereto all adjustments reflected in such adjusted basis on account of deductions (whether in respect of the same or other property) allowed or allowable to the taxpayer or to any other person for depreciation or amortization.
(B) Taxpayer may establish amount allowed For purposes of subparagraph (A), if the taxpayer can establish by adequate records or other sufficient evidence that the amount allowed for depreciation or amortization for any period was less than the amount allowable, the amount added for such period shall be the amount allowed. (C) Certain deductions treated as amortization Any deduction allowable under section 179, 179A, 179B, 179C, 179D, 179E, 181, 190, 193, or 194 shall be treated as if it were a deduction allowable for amortization.
(C) so much of any real property (other than any property described in subparagraph (B)) which has an adjusted basis in which there are reflected adjustments for amortization under section 169, 179, 179A, 179B, 179C, 179D, 179E, 185, [1] 188 (as in effect before its repeal by the Revenue Reconciliation Act of 1990), 190, 193, or 194, [2] (D) a single purpose agricultural or horticultural structure (as defined in section 168 (i)(13)),
(E) a storage facility (not including a building or its structural components) used in connection with the distribution of petroleum or any primary product of petroleum, or (F) any railroad grading or tunnel bore (as defined in section 168 (e)(4)).
26 U.S. Code § 1231 - Property used in the trade or business and involuntary conversions
(a) General rule (1) Gains exceed losses If— (A) the section 1231 gains for any taxable year, exceed (B) the section 1231 losses for such taxable year, such gains and losses shall be treated as long-term capital gains or long-term capital losses, as the case may be.
26 U.S. Code § 1245 - Gain from dispositions of certain depreciable property
(a) General rule (1) Ordinary income Except as otherwise provided in this section, if section 1245 property is disposed of the amount by which the lower of— (A) the recomputed basis of the property, or (B) (i) in the case of a sale, exchange, or involuntary conversion, the amount realized, or (ii) in the case of any other disposition, the fair market value of such property, exceeds the adjusted basis of such property shall be treated as ordinary income. Such gain shall be recognized notwithstanding any other provision of this subtitle.
(C) In the case of any involuntary conversion (subject to the provisions of this subsection but for this sentence) arising from fire, storm, shipwreck, or other casualty, or from theft, of any— (i) property used in the trade or business, or (ii) any capital asset which is held for more than 1 year and is held in connection with a trade or business or a transaction entered into for profit, this subsection shall not apply to such conversion (whether resulting in gain or loss) if during the taxable year the recognized losses from such conversions exceed the recognized gains from such conversions.
(b) Definition of property used in the trade or business For purposes of this section— (1) General rule The term "property used in the trade or business" means property used in the trade or business, of a character which is subject to the allowance for depreciation provided in section 167, held for more than 1 year, and real property used in the trade or business, held for more than 1 year, which is not— (A) property of a kind which would properly be includible in the inventory of the taxpayer if on hand at the close of the taxable year,
(c) Adjustments to basis The Secretary shall prescribe such regulations as he may deem necessary to provide for adjustments to the basis of property to reflect gain recognized under subsection (a).
(d) Application of section This section shall apply notwithstanding any other provision of this subtitle.
(b) Gain from exchanges not solely in kind If an exchange would be within the provisions of subsection (a), ofsection 1035(a), of section 1036(a), or of section 1037(a), if it were not for the fact that the property received in exchange consists not only of property permitted by such provisions to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property. (c) Loss from exchanges not solely in kind If an exchange would be within the provisions of subsection (a), ofsection 1035(a), of section 1036(a), or of section 1037(a), if it were not for the fact that the property received in exchange consists not only of property permitted by such provisions to be received without the recognition of gain or loss, but also of other property or money, then no loss from the exchange shall be recognized.
(d) Basis If property was acquired on an exchange described in this section, section 1035 (a), section 1036(a), or section 1037 (a), then the basis shall be the same as that of the property exchanged, decreased in the amount of any money received by the taxpayer and increased in the amount of gain or decreased in the amount of loss to the taxpayer that was recognized on such exchange. If the property so acquired consisted in part of the type of property permitted by this section, section 1035 (a), section 1036(a), or section 1037 (a), to be received without the recognition of gain or loss, and in part of other property, the basis provided in this subsection shall be allocated between the properties (other than money) received, and for the purpose of the allocation there shall be assigned to such other property an amount equivalent to its fair market value at the date of the exchange. For purposes of this section, section 1035 (a), andsection 1036 (a), where as part of the consideration to the taxpayer another party to the exchange assumed (as determined under section 357 (d)) a liability of the taxpayer, such assumption shall be considered as money received by the taxpayer on the exchange.
(3) Section 1245 property For purposes of this section, the term "section 1245 property" means any property which is or has been property of a character subject to the allowance for depreciation provided in section 167 and is either— (A) personal property, (B) other property (not including a building or its structural components) but only if such other property is tangible and has an adjusted basis in which there are reflected adjustments described in paragraph (2) for a period in which such property (or other property)—
(i) was used as an integral part of manufacturing, production, or extraction or of furnishing transportation, communications, electrical energy, gas, water, or sewage disposal services, (ii) constituted a research facility used in connection with any of the activities referred to in clause (i), or (iii) constituted a facility used in connection with any of the activities referred to in clause (i) for the bulk storage of fungible commodities (including commodities in a liquid or gaseous state),
the tax rules for determining the timing and amount of interest income from corporate and U.S. Treasury bonds are as follows.
-taxpayers include the actual interest payments they receive in gross income. - if the bond was issued at a discount, special original issue discount (OID) rules of the current year amortization in gross income in addition to any interest payments the taxpayer actually receives. in the case of corporate zero-coupon bonds, this means taxpayers must report and pay taxes on income related to the bonds even though they did not receive any payments from the bonds.
When should investors consider making an election to amortize market discount on a bond into income annually? [Hint: see §1278(b)]
A taxpayer may elect under §1278(b) to amortize market discount on a bond into income currently (as ordinary income) rather than wait to recognize the accrued market discount as ordinary income when the bond is sold or matures. Generally, this election makes sense when the taxpayer's current marginal tax rate is expected to be significantly lower than the future marginal rate when the bond is sold or matures.
Do after-tax rates of return for investments in either interest or dividend paying securities increase with the length of the investment? Why or why not?
After-tax rates of return do not increase for interest or dividend paying securities with the length of the investment period because they are both taxed annually.
Describe how interest income and dividend income are taxed. What are the similarities and differences in their tax treatment?
Because they are cash method taxpayers, individual investors typically are taxed on interest and dividends when they receive them. However, interest income is taxed using ordinary rates while qualified dividends are taxed at lower capital gains rates.
Compare and contrast the tax treatment of interest from a Treasury bond and qualified dividends from corporate stock.
Both the interest from Treasury bonds and dividends are taxed by cash method taxpayers in the year they are received. However, interest is taxed using ordinary rates while qualified dividends are taxed at lower capital gains rates. An additional difference between these types of income relates to their state income tax treatment. The interest from Treasury bonds is exempt from state income taxes while dividends are subject to state income taxes.
Dividends
Company's share profits to the shareholders based on the corporation's performance.
How are Treasury notes and Treasury bonds treated for federal and state income tax purposes?
Generally, interest from Treasury bonds and notes is taxed annually as it is received at ordinary rates for federal income tax purposes. However, interest from Treasury bonds and Treasury notes is exempt from state income taxes.
IRS Publication 550
IRS Publication 550 indicates that "if you borrow money for personal purposes as well as for investment, you must allocate the debt among those purposes." This means that only interest expense paid on the portion of debt that was used for the investment in the stocks can be deducted as investment interest. The interest paid on the loan allocated to the personal portion isn't deductible to the taxpayer.
This year, David, a taxpayer in the highest tax rate bracket, has the option to purchase either stock in a Fortune 500 company or qualified small business stock in his friend‟s corporation. All else equal, which of the two will he prefer from a tax perspective if he intends to hold the stock for six years? Which would he prefer if he only plans to hold the stock for two years?
If David holds the stock in his friend's corporation for more than five years, 100% of his gain will be excluded. In contrast, gains from the sale of stock in the Fortune 500 company would be taxed at the prevailing maximum capital gains rate (maximum of 20% currently). Thus, David would prefer to purchase stock in his friend's corporation if taxes are the only consideration. If the stocks are only held for two years, the stock in his friend's corporation would not be treated as qualified small business stock and he would be indifferent, from a tax perspective, between purchasing the two stocks.
Treasury bonds and Treasury notes are issued at maturity value, at a discount, or at a premium, depending on prevailing interest rates. Treasury bonds and Treasury notes pay a stated rate of interest semiannually. When Treasury bonds and Treasury notes are either issued or subsequently purchased at either a premium or discount, special rules apply. Specifically, taxpayers may elect to amortize the premium to reduce the amount of interest currently reported. To the extent taxpayers amortize the premium, they reduce the tax basis in the related bond or note.
If a portion of the premium is unamortized (either because the election to amortize the premium was not made or because the bond is sold prior to maturity), the unamortized premium remains part of the tax basis of the bond or note and affects the amount of capital gain or loss taxpayers recognize when the bond or note is sold or when it matures.
What is the definition of a capital asset? Give three examples of capital assets.
In general, a capital asset is any asset other than an asset used in a trade or business (i.e., equipment, buildings, inventory, etc.), or accounts or notes receivable generated from the sale of services or property by a trade or business. Also, any property that is used for personal rather than business purposes is a capital asset. Examples of capital assets include investment assets such as corporate or governmental bonds, corporate stock, stocks in mutual funds, and land held for investment. Personal assets such as automobiles, personal residences, golf clubs, book collections, and televisions are also capital assets.
Investment Income
Includes taxable and tax-exempt interest, dividends, capital gains net income, certain rent and royalty income, and net passive activity income.
What happens to capital losses that are not deductible in the current year?
Individual capital losses that are not deducted in the current year are carried forward indefinitely and treated as though they were incurred in the subsequent year.
What limitations are placed on the deductibility of capital losses for individual taxpayers?
Individual taxpayers with a net capital loss for the year may deduct up to $3,000 of the capital loss against ordinary income. Taxpayers can deduct up to $3,000 ($1,500 if married filing separately) of net capital losses against ordinary income. Net capital losses in excess of $3,000 ($1,500 if married filing separately) retain their short or long-term character and are carried forward.
What is the underlying policy rationale for the current tax rules applicable to interest income and dividend income?
Interest and dividends are typically taxed annually when received because taxpayers have the wherewithal to pay the tax at that time. Interest income is taxed at ordinary rates because it is viewed as a less risky type of income compared to other more risky forms of income such as the expected appreciation in capital assets. Qualified dividends are taxed at capital gains rates to mitigate the effect of double taxation on corporate earnings.
Operating Income
Is always taxed annually at ordinary rates
Are all long-term capital gains taxable at the same maximum rate? If not, what rates may apply to long-term capital gains?
Long-term capital gains may be taxed at one of five different rates (0, 15, 20, 25, or 28 percent). Unrecaptured §1250 gains from the sale of depreciable real estate investments are taxed at a 25% maximum rate, gains from collectibles held for more than one year are taxed at a 28% maximum rate, and recognized gains from the sale of qualified small business stock held for more than five years is taxable at a 28% maximum rate. The remaining long-term capital gains are taxed at 0, 15, or 20 percent depending on the taxpayer's ordinary income tax rate as follows:
What tax rate applies to net short-term capital gains?
Net short- term capital gains are taxed at the taxpayer's ordinary tax rates.
Why might investors purchase interest-paying securities rather than dividend- paying stocks?
Non-tax considerations may play a role. For example, investors may be willing to give up the tax rate benefit from receiving qualified dividend income in exchange for the certainty of receiving predicable interest payments. In addition, risk preferences might cause investors to prefer one investment over another. FDIC insurance guarantees the security of an investment in savings accounts and certificates of deposit up to a threshold amount; whereas, no guarantees exist for stock investments.
Why does the tax law provide preferential rates on certain capital gains?
Preferential tax rates apply to gains on the sale of certain capital assets (e.g., capital assets held for more than one year). Among other things, these preferential rates are meant to encourage taxpayers to invest in those assets and to hold those assets for the long term. The government believes this will help the national economy by stimulating the demand for risky investments.
Compare and contrast the tax treatment of dividend-paying stocks and growth stocks.
Qualified dividends from dividend paying stocks and long-term capital gains from growth stocks are both taxed at favorable capital gains rates. However, dividends are taxed when received in contrast to the appreciation in growth stocks which is taxed only when growth stocks are sold. All else equal, growth stocks will have a higher after-tax rate of return because the tax is deferred into the future while dividend paying stocks are taxed annually.
Why does the tax law allow a taxpayer to defer gains accrued on a capital asset until the taxpayer actually sells the asset?
Taxpayers are allowed to defer accrued gains on capital assets until the date of sale because the investment doesn't provide the wherewithal (i.e., cash) to pay the tax on the accrued gains until after it is sold. When the taxpayer sells the asset, the investment should provide the cash necessary to pay the taxes due on the gain.
What methods may taxpayers use to determine the adjusted basis of stock they have sold?
Taxpayers can use the FIFO method to determine basis in the stock. That is, the first stock purchased (i.e., the stock the taxpayer has held for the longest time) is treated as though it is the first stock sold. Taxpayers can also use the specific identification method of determining the basis of the stock sold.
Why would taxpayers generally prefer the tax treatment of market discount to the treatment of original issue discount on corporate bonds?
Taxpayers generally would prefer market discount to original issue discount on bonds because the ordinary income related to market discount is deferred until bonds are sold or until they mature. In contrast, taxpayers must report ordinary income from the amortization of original issue discount yearly until the bonds are sold or until they mature.
Maturity Value
The amount that is due on the maturity date of a note
What is the deciding factor in determining whether a capital gain is a short-term or long-term capital gain?
The deciding factor is the amount of time an asset has been held by the taxpayer. When a capital asset that has been held for more than one year is sold, it generates a long-term capital gain. When it has been held for one year or less it generates a short term capital gain when sold.
Cameron purchases stock in Corporation X and in Corporation Y. Neither corporation pays dividends. The stocks both earn an identical before-tax rate of return. Cameron sells stock in Corporation X after three years and he sells the stock in Corporation Y after five years. Which investment likely earned a greater after-tax return? Why?
The gain from the sale of the Corporation Y stock should earn a greater after-tax return because the tax was deferred for 5 years while the tax on the gain from the sale of Corporation X stock was deferred for 3 years. The longer the tax is deferred, the less it costs on an after-tax basis. The lower the tax cost, the higher the after-tax return, all else equal.
Face Value
The payment to the bondholder at the maturity of the bond. (same thing as maturity value)
certificates of deposit
Time deposits that state the amount of the deposit, maturity, and rate of intrest being paid
Portfolio Investments
Transfers of money to buy stocks, bonds, and so on.
In what ways are U.S. savings bonds treated more favorably for tax purposes than corporate bonds?
U.S. Savings Bonds compare favorably with corporate bonds because any interest related to the original issue discount on savings bonds is deferred until the savings bonds are cashed in. In comparison, any original issue discount on corporate bonds must be amortized and included in the investor's annual tax returns. Also, interest from savings bonds used to pay for qualifying educational expenses may be excluded entirely from income whereas interest from corporate bonds must eventually be reported.
26 USC 1001
a) Nonrecognition of gain or loss from exchanges solely in kind (1) In general No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.
a. What is Grayson's net short-term capital gain or loss from these transactions? b. What is Grayson's net long-term gain or loss from these transactions? c. What is Grayson's overall net gain or loss from these transactions? d. What amount of the gain, if any, is subject to the preferential rate for certain capital gains?
a. Grayson's net short-term capital loss is $300, which is the net of the short-term gains and losses for the year. This $300 loss is the short-term capital gain of $3,500 from Stock B (i.e. $17,500 - 14,000) less the short-term capital loss of $3,800 from Stock E (i.e. $3,500 - 7,300).
76. Ben recently made a one-time investment of $20,000 in the Florida 529 educational savings plan for his three-year-old son, Mitch. Assume the plan yields a constant 6 percent return for the next 15 years.
a. How much money will be available for Mitch after taxes when he begins college at age 18? b. Assume, instead, that when Mitch turns 18, he decides to forego college and spend his time as a traveling artist. If Mitch's parents give him the amount in the 529 plan to pursue his dreams, how much will he keep after taxes if his marginal tax rate is 10 percent?
At the beginning of his current tax year David invests $12,000 in original issue U.S. Treasury bonds with a $10,000 face value that mature in exactly 10 years. David receives $700 in interest ($350 every six months) from the Treasury bonds during the current year and the yield to maturity on the bonds is 5 percent. a. How much interest income will he report this year if he elects to amortize the bond premium? b. How much interest will he report this year if he does not elect to amortize the bond premium?
a. If David elects to amortize the $2,000 bond premium, he will use the constant yield method (similar to the effective interest method used to amortize bond premium under GAAP) to amortize the bond premium semiannually. Ultimately, he will report $599 of interest income from the bond. The amortization table below reflects the required calculations:
John bought 1,000 shares of Intel stock on October 18, 2010 for $30 per share plus a $750 commission he paid to his broker. On December 12, 2013, he sells the shares for $42.50 per share. He also incurs a $1,000 fee for this transaction. c. What is John's adjusted basis in the 1,000 shares of Intel stock? d. What amount does John realize when he sells the 1,000 shares? e. What is the gain/loss for John on the sale of his Intel stock? What is the character of the gain/loss?
a. John's basis in the 1,000 shares of Intel stock is $30,750. This is the purchase price of $30,000 (i.e., 30 × $1,000) plus the $750 commission paid to the broker. b. On the sale, John realizes $41,500. This is the sales price of $42,500 (i.e., 1,000 × $42.50) minus the transaction fee of $1,000. c. John's gain on the sale is $10,750 which is the amount realized minus his adjusted basis (i.e., $41,500 - 30,750). The gain is a long-term capital gain because John held the stock for more than a year before selling.
77. Rich and Shauna Nielson file a joint tax return, and they itemize deductions. Assume their marginal tax rate on ordinary income is 25 percent. The Nielsons incur $2,000 in miscellaneous itemized deductions, excluding investment expenses. They also incur $1,000 in noninterest investment expenses during the year. What tax savings do they receive from the investment expenses under the following assumptions:
a. Their AGI is $90,000. b. Their AGI is $130,000.
74. The Johnsons recently decided to invest in municipal bonds because their marginal tax rate is 40 percent. The return on municipal bonds is currently 3.5 percent and the return on similar taxable bonds is 5 percent. Compare the after-tax returns of the municipal and taxable bonds.
a. Which type of bond should the Johnsons select? b. What type of bond should the Johnsons select if their marginal tax rate was 20 percent? c. At what marginal tax rate would the Johnsons be indifferent between investing in either taxable or municipal bonds?
Operating Losses
are either deducted annually at ordinary rates or deferred and deducted later at ordinary rates depending on the investors' circumstances
Treasury bonds and treasury notes
are issued at maturity value, at a discount, or at a premium, depending on prevailing interest rates. treasury bonds and treasury notes pay a stated rate of interest semiannually. However, corporate bonds may pay interest at a stated "coupon" rate of they may not provide any periodic interest payments.
a. The Nielsons have $3,000 of miscellaneous itemized deductions including investment expenses. These deduction are only deductible to the extent they exceed 2 percent of AGI. If AGI is $90,000, 2 percent of AGI is $1,800 and $1,200 of the $3,000 is deductible. The deductible portion is first treated as investment expense and then noninvestment miscellaneous itemized deductions. In this situation, all $1,000 of the investment expenses are deductible ($200 of the other miscellaneous itemized deductions are deductible). The tax benefit of the investment expenses is $250 (i.e., $1,000 deduction × 25 percent marginal tax rate).
b. If AGI is $130,000, 2 percent of AGI is $2,600. In this case only $400 of the miscellaneous itemized deductions are deductible. Because the deductible portion is first considered to be the investment expenses, all $400 of the deductible miscellaneous itemized deductions are considered to be investment expenses. The tax benefit from the $400 deductible investment expense is $100 (i.e., $400 × 25 percent).
a. Because earnings inside a 529 plan compound tax free, the 529 plan Ben set up for Mitch will be worth $47,931 or $20,000 × (1+.06)15 after fifteen years. If this amount is distributed to Mitch and he uses it to pay for qualified higher education expenses, neither he nor Ben will owe any tax on the distribution.
b. If Mitch becomes a traveling artist, he will pay taxes and penalties on the earnings portion of the $47,931 distribution. Because the original investment in the account was $20,000, the earnings portion of the $47,931 distribution would be $27,931. This amount will be subject to Mitch's ordinary 10 percent tax rate plus a 10 percent penalty rate. Thus, Mitch will pay $5,586 or $27,931 x 20 percent in taxes and penalties leaving him with $42,345 to pursue his dreams as a traveling artist.
a. Assuming the Johnson's marginal rate is 40 percent, their after-tax rate of return from taxable bonds would be 3 percent or 5 percent x (1-.40). Because this is less than the 3.5 percent rate of return from municipal bonds, they should purchase municipal bonds.
b. If the Johnson's marginal rate is 20 percent the after-tax rate of return from taxable bonds would be 4 percent or 5 percent x (1-.20). Under this assumption, the Johnsons should buy taxable bonds.
Bond Premium
bonds are issued at an amount above the maturity value
Bond Discount
bonds are issued at an amount below the maturity value
b. Grayson's net long-term capital gain is $8,970, which is the net long-term gain less the long-term loss for the year. This is the net of the long-term capital gain of $11,720 (i.e. $4,550 from Stock C ($15,300 - 10,750) and $7,170 from Stock D ($12,400 - 5,230)) less the long-term capital loss of $2,750 from Stock A ($4,500 - 7,250).
c. Grayson's net capital gain is $8,670, which is the net short-term loss offset against the net long-term capital gain for the year because the signs are opposite. This $300 short-term capital loss (from part a) is netted against the $8,970 net long-term capital loss (from part b). d. Grayson's entire net capital gain of $8,670 will be taxed at a preferential 15 percent tax rate.
Zero-coupon bonds
corporate consequences of holding corporate or treasury bonds that are very similar. (1) interest from treasury bonds is exempt from state tax while interest from corporate bonds are not and (2) treasury bonds always pay interest periodically while corporate bonds may or may not.
Passive Investments
generate operating income and operating losses
-if the bond was issued at a premium, taxpayers may elect to amortize the premium. taxpayers or their advisors are responsible for determining the yearly amortization of bond premium is the election to amortize the premium has been made. the amount of the current year amortization offsets a portion of the actual interest payments that taxpayers must include in the gross income. the original tax basis of the bond include the premium and is reduced by any amortization of bond premium over the life of the bond.
if the bond is purchased in the secondary bond market at a discount, the taxpayer treats some of or all of the market discount as interest income when she sells the bond of the bond matures. if the bond is sold prior to maturity, a ratable amount of the market discount (based on the number of days the bond is held over the number of days until maturity when the bond is purchased), called accrued market discount, is treated as interest income of the date of sale. if the bond is held to maturity, the entire bond discount is treated as interest income at maturity.