09 Taxation and Retirement Plans

Question 1

Within her IRA, Maria Mathers purchased 1,000 shares of ABC @14 on January 12th, 2009. The next day, she also purchased 1,000 shares of XYZ @15. On January 11th 2010, she sells all her ABC stock for $19 per share and all her XYZ stock for $7 per share. Therefore, which of the following accurately describes the tax implications?

A. The amount of the capital loss depends on Maria’s marginal tax rate
B. There will be no effect on taxation of this account
C The purchase of XYZ within 30 days of the ABC purchase triggers wash sale rules
D. Maria may reduce her ordinary income by $3,000

Answer 1

B. There will be no effect on taxation of this account

Rationale:
The retirement plan makes all income come out at ordinary income rates. So, there are no wash sales, no tax loss selling, etc. within a retirement plan.

Question 2

Janice Myer purchased 1,000 shares of MMM on January 1st, 2010. On December 30th, 2010, Janice sells the shares for a $900 capital gain. If the trade settles on January 3rd, 2011, which of the following accurately describes the tax consequences?

A. Janice will report the gain or loss for tax year 2011
B. The gain will be considered long-term
C. The gain will be considered short-term
D. The gain will be treated as dividend income

Answer 2

C. The gain will be considered short-term

Rationale:
To make sure it’s a long-term capital gain, sell it on the day after the one-year anniversary. Janice bought the stock on January 1st. To make it a long-term gain, she needed to sell it the following year on January 2nd or later. Also, it’s when she sells, not when the transaction settles, that her holding period stops.

Question 3

If the owner of a variable annuity contract dies during the accumulation phase:

A. The beneficiary receives proceeds tax-free.
B. The beneficiary must pay tax on the proceeds.
C. The beneficiary must pay tax at her ordinary income rate on the excess above cost basis.
D. The surrender value is maintained in the separate account in order to offset miscalculations of mortality risk on the part of the actuary.

Answer 3

C. The beneficiary must pay tax at her ordinary income rate on the excess above cost basis.

Rationale:
Somebody always pays ordinary income rates on the excess over cost basis.

Question 4

Jill originally invested $9,000 into the Excelsior Fund. She has since reinvested dividend distributions of $1,000 and
capital gains distributions of $500. If Jill currently holds 1,000 shares of the fund, her cost basis is:

A. $10.50 per share
B. $11.50 per share plus commissions
C. $10.00 per share plus sales charges
D. Indeterminable

Answer 4

A. $10.50 per share

Rationale:
Dividend and capital gains distributions are taxed whether the investor buys a car or more shares of the fund. So, they are added to the cost basis.

Question 5

Which of the following statements accurately describes the taxation of capital gains?

A. Commissions are subtracted from the purchase price and added to the sales price of stock to determine cost basis and proceeds
B. A loss realized on a bond held for 13 months is treated as a long-term capital gain
C. Investors offset long-term gains with short-term losses, and short-term gains with long-term losses
D. A profit realized on a stock held for 11 months is currently taxed at the investor’s ordinary income rate

Answer 5

D. A profit realized on a stock held for 11 months is currently taxed at the investor’s ordinary income rate

Rationale:
Clearly, a loss can not be treated as a gain. Commissions are added to cost basis when you buy and subtracted from the proceeds when you sell. Match up short- term with short-term and long- term with long-term.

Question 6

Which of the following statements accurately describe(s) the tax implications of insurance contracts?

A. Loans against the policy are charged interest, and both the principal and interest reduce the contract values
B. All choices listed
C. The policyholder may surrender the part of cash value representing net premiums paid into the contract tax-free
D. Death benefits are not taxable to the beneficiary, but are includable in the insured’s estate taxes

Answer 6

B. All choices listed

Rationale:
Three good things to know about taxation of insurance.

Question 7

Mary held 1,000 shares of ABC for 13 months before selling them for a loss of $1,000. If Mary repurchases shares of
ABC 23 days later, which of the following accurately describes the tax implications?

A. Mary can be fined by the SEC
B. The loss is disallowed
C. Mary can be sued for tax fraud by the IRS and/or FINRA
D. The loss is disallowed but is added to the cost basis of the new purchase

Answer 7

D. The loss is disallowed but is added to the cost basis of the new purchase

Rationale:
That’s a wash sale, so she will add the loss to the cost basis on the new purchase, rather than making use of the loss currently.

Question 8

Which of the following items would be included in the gross estate for purposes of federal estate tax liability?

l. Life insurance policy
II. Value of the decedent’s primary residence
III. A house transferred to an irrevocable trust 24 months prior to death
IV. A house transferred to a revocable trust

A. I
B. I, II, III, IV
C. II, III
D. I, IV

Answer 8

B. I, II, III, IV

Rationale:
Normally, assets placed in an irrevocable trust aren’t included in the estate’s value. But, if the asset is suddenly placed in an irrevocable trust within 3 years of death, it is often included. Also note that the death benefit is not taxable to the beneficiary, but the insurance policy is included in the value of the estate.

Question 9

Which of the following items would reduce the amount of the gross estate for purposes of figuring the taxable estate?

I.Funeral and administrative expenses
II. Market value of municipal bonds
III. Charitable gifts made after death
IV. Marital Deduction

A. I, III
B. I, III, IV
C. I, II, IV
D. Ill, IV

Answer 9

B. I, III, IV

Rationale:
No reason to deduct the market value of municipal bonds, is there?

Question 10

Mr. Jeffries sets up a trust for the benefit of his adult daughter, Amber, from which his wife may withdraw only if necessary. Therefore, income on the trust will be taxed to:

A. Mrs. Jeffries as the contingent beneficiary
B. The trust because it is a separate legal entity
C. Mr. Jeffries as the donor
D. Amber as the primary beneficiary

Answer 10

C. Mr. Jeffries as the donor

Rationale:
If his wife can withdraw money, he has an economic interest in the trust. Therefore, it’s still taxable to him. Husbands and wives are one economic unit.

Question 11

Harold Quick had the following results on four stock sales this year:

• $15,000 in long-term gains
• $5,000 in long-term losses
• $5,000 in short-term gains
• $13,000 in short-term losses

Therefore, the tax implications are:

A. Short-term capital gain of $2,000
B. Long-term capital gain of $2,000
C. Short-term capital gain of $8,000
D. Long-term capital gain of $15,000

Answer 11

B. Long-term capital gain of $2,000

Rationale:
Match up long-term with long- term, and short-term with short-term. He ended up with a $10,000 long-term gain, offset by an $8,000 short-term loss. That’s a $2,000 gain, treated as long-term.

Question 12

Jarod Stevens had the following results on four stock sales this year

• $15,000 in long-term gains
• $23,000 in long-term losses
• $15,000 in short-term gains
• $5,000 in short-term losses

Therefore, the tax implications are:

A. Short-term capital gain of $2,000 taxed at ordinary income rates
B. Long-term capital loss of $8,000, short-term capital gain of $8,000
C. No net gains or losses
D. Short-term capital gain taxed at a maximum of 15%

Answer 12

A. Short-term capital gain of $2,000 taxed at ordinary income rates

Rationale:
He has an $8,000 long term loss, and a $10,000 short-term gain. That makes it a total gain of $2,000, treated as short- term.

Question 13

Aunt Mildred purchased 392 shares of the XLT Value Fund in 1983, with the NAV at $9.92 and the POP at $10. Aunt Mildred dies and wills all shares to you. On the date of death the NAV is $12. If you redeem the shares 4 months later with the NAV at $13.00 and the POP at $13.25, your capital gain will be:

A. Long-term gain of $1.00 per share
B. Short-term gain of $1.00 per share
C. Short-term gain of $3.33 per share
D. Short-term gain of $3.00 per share

Answer 13

A. Long-term gain of $1.00 per share

Rationale:
For inherited shares, take the fair market value on the date of death as the cost basis, and consider all gains to be long-term.

Question 14

Which of the following statement(s) is/are accurate concerning wash sale rules?

I. It is illegal to sell common stock at a loss and then repurchase it within 30 days
II. If a loss is disallowed due to wash sale rules, the investor adds the loss to the cost basis on the re-purchase
III. An investor may sell MSFT common stock at a loss and purchase MSFT preferred stock within 30 days and still claim the loss on the common stock
IV. Wash sale rules do not apply to a Traditional IRA or Roth IRA

A. II, III, IV
B. I, IV
C. I
D. II, IV

Answer 14

A. II, III, IV

Rationale:
Nothing illegal about repurchasing the stock within 30 days of selling it at a loss. You just have to know how to treat that for tax purposes. Common and preferred stock are two different things.

Question 15

If an investor elects to receive dividend and capital gains distributions from a mutual fund in cash, rather than reinvesting into new shares, within a 401 (k) or Traditional IRA plan, which of the following best describes the tax ramifications of this decision?

A. Dividends will grow tax-deferred, but capital gains will be taxed annually
B. The dividends will be taxed as long- term capital gains
C. The decision will have no ramifications
D. The long-term capital gains will be taxed as long-term capital gains

Answer 15

C. The decision will have no ramifications

Rationale:
She’s not taking distributions of cash. She’s just selling securities and letting the cash sit in the account until she decides what to purchase next.

Question 16

Your 58-year-old client has invested a total of $30,000 into a non-qualified variable annuity. The value of the separate account is now $68,000. If your client takes a lump-sum payout, what will be the result?

A. 10% of growth taxed at ordinary Income
B. Growth taxed at ordinary income, plus 10% penalty on growth portion
C. 10% taxed at long-term capital gains rate
D. 10% taxed at short-term capital gains rate

Answer 16

B. Growth taxed at ordinary income, plus 10% penalty on growth portion

Rationale:
Withdrawals before age 59 ½ are not just taxed at ordinary
income rates; they are also penalized 10%.

Question 17

An investor bought an 8% bond at a basis of 9.10. Three years later, he sells the bond at a 6.95 basis. In this example he realizes a:

A. Long-term loss
B. Short-term gain
C. Short-term loss
D. Long-term gain

Answer 17

D. Long-term gain

Rationale:
The yield went down, so the price at which he later sold was higher. It was three years later, so it had to be long-term.

Question 18

XYZ Equity Income Fund reports net income of $1,000,000 and distributes $880,000 directly to investors. Therefore, the fund will be taxed on what amount?

A. As stipulated in the prospectus
B. $1,000,000
C. $20,000
D. $120,000

Answer 18

B. $1,000,000

Rationale:
The fund has to distribute at least 90% of net income to qualify for special tax treatment.

Question 19

Jocelyn purchases an XYZ call option in February, exercising the contract in May. After holding the stock, she sells it the following April. What is true of the tax implications of Jocelyn’s activity

I. The gain or loss on the stock is short- term
II. The gain or loss on the stock is long-term
III. The premium paid is subtracted from the strike price to determine Jocelyn’s cost basis
IV. The premium paid is added to the strike price to determine Jocelyn’s cost basis

A. II, III
B. I, IV
C. I, III
D. II, IV

Answer 19

B. I, IV

Rationale:
She did not start holding the stock until May, so the gain or loss is short-term. The premium paid for the right to buy the stock at the strike price is added to the strike price to determine her cost basis. If she paid $2 for an Oct 50 call, her cost basis on the stock would be $52, for example.

Question 20

All of the following would be taxable to a mutual fund investor except:

A. Reinvested capital gains distributions
B. Reinvested dividend distributions
C. Appreciation in fund shares that are exchanged for shares within the fund family
D. Unrealized capital gains

Answer 20

D. Unrealized capital gains

Rationale:
Nobody pays tax on unrealized capital gains, ever.

Question 21

This year one of your clients reports capital gains of $7,000 and capital losses of $13,000 Therefore:

A. He may take a deduction of $3,000 and carry forward $4,000
B. He may take a deduction of $3,000 and carry forward $3,000
C. He may take a deduction of $13,000
D. He may take a deduction of $6,000

Answer 21

B. He may take a deduction of $3,000 and carry forward $3,000

Rationale:
Currently, $3,000 is the most that can be deducted against income, but the remainder is carried forward for future years indefinitely. The net loss of $6,000 allows the investor to reduce his taxable income by $3,000 and carry $3,000 forward for future years.

Question 22

One of your customers sold 300 shares of LMNO for a loss of $4 per share on May 10th of this
year. If the customer purchases 2 LMNO calls on July 5th, how much of the loss can be claimed
for tax purposes?

A. $800
B. $400
C. All of it
D. None of it

Answer 22

C. All of it

Rationale:
The calls were purchased more than 30 days after the sale, so all of the loss can be used that year.

Question 23

A 51-year-old orthodontist with a Keogh plan has contributed $50,000 to the plan. If he liquidates the account at $85,000, which of the following accurately explains the tax consequences?

A. $35,000 will be taxable at long-term capital gains rates
B. $85,000 will be taxable as ordinary income, plus a penalty of $8,500
C. $35,000 will be taxable as ordinary income
D. $85,000 will be taxable as ordinary income

Answer 23

B. $85,000 will be taxable as ordinary income, plus a penalty of $8,500

Rationale:
The money went in pre-tax, so all $85,000 is taxable. Retirement money is never taxed at capital gains rates-it’s ordinary income. Plus a 10% penalty, since he’s not even close to 59 1/4 . Are there ways he could avoid the penalty? Not in this question.

Question 24

Qualified dividends earned on common stock is considered to be what kind of income for tax
purposes?

A. Earned
B. Phantom
C. Portfolio
D. Passive

Answer 24

C. Portfolio

Rationale:
Portfolio income includes dividends, bond interest, and capital gains. It is not earned income, so it doesn’t count toward an IRA contribution, for example. Passive income is received through limited partnerships (DPP’s) and rental1 income, for example.

Question 25

The writer of an equity put option would account for the premium collected on a put contract that was exercised how?

A. Adding the premium to the strike price to find the cost basis
B. Adding the premium to the strike price to find the proceeds
C. Subtracting the premium from the strike price to find the proceeds
D. Subtracting the premium from the strike price to find the cost basis

Answer 25

D. Subtracting the premium from the strike price to find the cost basis

Rationale:
The writer of a put ends up buying stock when the put contract is exercised, so the premium affects his cost basis on the stock he has to purchase when the owner puts/sells it to him at the strike price. If the strike price is 50 and the premium collected was 3, the cost basis on the stock is $47. The premium is subtracted from the strike price to find his cost basis.

Question 26

Sonny purchased a $50,000 par value T-note paying 4% interest. If Sonny is in the 30% federal and 7% state income tax brackets, he will pay how much in taxes on the interest from the T-note?

A. $740
B. $600
C. $120
D. None, as T-notes are not taxable instruments

Answer 26

B. $600

Rationale:
He receives 4% of $50,000, which is $2,000 in annual interest. He pays no state tax on that income, only 30% of $2,000, which is $600.

Question 27

Margie Miskowitz is a divorcee. Which of the following are included when determining her maximum IRA contribution for the year?

A. Child support received
B. Alimony received
C T-bond interest
D. Capital gains distributions from any taxable mutual funds

Answer 27

B. Alimony received

Rationale:
Portfolio income is not “earned income.” Alimony is, child support isn’t.

Question 28

Investors seeking tax-exempt income should be advised to invest:

A. In high-yield bond funds within a 401 (k)
B. Municipal bonds within a taxable account
C. In high-yield bonds within an IRA
D. Direct participation programs

Answer 28

B. Municipal bonds within a taxable account

Rationale:
The only good place to buy a tax-exempt muni is within a “taxable account.” If you put it into a tax-deferred account, it will come out as ordinary income . . . unless a tricky question brought up the ROTH IRA.

Question 29

Many investors have recently considered converting a Traditional IRA to a Roth IRA. Which of the following is an accurate statement of this maneuver?

A. It makes sense only if the account value exceeds all contributions to the account
B. It makes sense if the account value is below the amount contributed
C. It is not available to high-income investors for Tax Year 2010
D. It is allowed for Tax Year 2010 only

Answer 29

B. It makes sense if the account value is below the amount contributed

Rationale:
If the account value has gone down, the individual pays tax on less money than he contributed-lucky Devil. This maneuver is available for 2010 even for people who earn too much money to CONTRIBUTE
to a Roth IRA

Question 30

Five years ago Jimmy Johns purchased shares of the ABC income fund for $10,000 and has since reinvested $2,000 in dividends. If he sells his shares this year for $8,000 and has no other sales of securities to report, he will:

A. Be able to offset ordinary income by $2,000
B. Have no gains or losses to report
C. Be deemed to have engaged in a wash sale
D. Be able to offset ordinary income by $3,000, with $1,000 for future years

Answer 30

D. Be able to offset ordinary income by $3,000, with $1,000 for future years

Rationale:
His basis is $12,000, so he has a $4,000 loss. This year, he can use $3,000 of it, carrying the rest forward.

Question 31

All of the following are taxable in relation to a mutual fund investment except:

A. Capital gains distributions from a tax-exempt municipal bond fund
B. Reinvested capital gains distributions
C. Undistributed capital gains
D. Unrealized capital gains

Answer 31

D. Unrealized capital gains

Rationale:
If a capital gain is realized by the shareholder or the portfolio manager, it is taxable. Whether the capital gain is distributed by the fund or reinvested by the shareholder… no relevance to the tax treatment.

Question 32

Joey bought 300 shares of ABC @45 on January 10th last year. This year, on January 12th, he sold all 300 shares @20. On February 1st, he purchased 100 ABC @22. Therefore:

A. The sale of 200 shares is treated as a wash sale
B. The sale of 300 shares is treated as a wash sale
C. No wash sale was triggered
D. The sale of 100 shares is treated as a wash sale

Answer 32

D. The sale of 100 shares is treated as a wash sale

Rationale:
He only screwed up on 100 shares by purchasing that amount within 30 days of the sale at a loss.

Question 33

Jennifer Leigh sold 100 ABC at a loss of $11.35 per share on April 30th of this year. Which of
the following would not trigger a wash sale treatment of the disposition?

A. Buying ABC Aug 35 puts
B. Purchasing an ABC warrant
C. Buying ABC Aug 40 calls
D. Purchasing an ABC convertible debenture

Answer 33

A. Buying ABC Aug 35 puts

Rationale:
Having the right to sell (buying puts) would not be a proxy for buying the stock. Buying calls, warrants, or convertible debentures all give the holder the right to buy the stock, which the IRS treats as actually holding the stock again, right after trying to sell it for a deductible loss.

Question 34

Which of the following represents an incorrect statement concerning the tax implications of “short selling?”

A. Short sellers do not establish a “holding period”
B. Gains and losses on short sales are treated as short-term
C. Losses on short sales are non-deductible
D. Gains and losses on short sales are realized when the position is covered

Answer 34

C. Losses on short sales are non-deductible

Rationale:
There is no holding period, so there’s no way to distinguish short-term from long-term . . . they’re all short-term gains and losses, and realized only when the position is covered or bought and replaced. Losses are deductible on both short and long positions.

Question 35

An inaccurate statement concerning gifts of securities is that:

A. If the gift exceeds the annual exclusion, the recipient may be liable for gift taxes
B. The annual amount that be gifted tax-free is limited
C. The recipient assumes the donor’s cost basis on the securities gifted
D. There is no limit on gifts between spouses

Answer 35

A. If the gift exceeds the annual exclusion, the recipient may be liable for gift taxes

Rationale:
If there is gift tax to pay, it’s paid by the donor.

Question 36

Westchester Holdings owns 10% of Coca-Cola’s outstanding common stock. Therefore, when
Westchester receives dividends, they are taxed on what amount?

A. 30%
B. 80%
C. 70%
D. 20%

Answer 36

A. 30%

Rationale:
If the company owns under 20% of the other company, they exclude 70% of the dividends and are taxed on the remaining 30%.

Question 37

One of your customers invests $50,000 into a limited partnership interest and signs a recourse note for $20,000. Therefore, your investor’s tax basis is:

A. $70,000
B. $50,000
C. $10,000
D. $30,000

Answer 37

A. $70,000

Rationale:
The LP’s can lose what they put in and what they agree to contribute later. This LP is on the hook for $20,000 and could also lose his initial $50,000 investment. $70,000 tax/cost basis.

Question 38

Which of the following is an accurate statement concerning the taxation of DPP’s?

A. Gains are taxable to the partners, not the partnership
B. Profits are taxable to the partnership, not the partners
C. Long-term capital gains are taxable to the partnership
D. An LP’s share of losses are deductible against passive and portfolio income only

Answer 38

A. Gains are taxable to the partners, not the partnership

Rationale:
The flow-through of the DPP means that the LP’s get a share of income, losses, and long-term gains. Any losses an LP receives can be deducted against passive income only— not earned or portfolio income. The partnership is not taxed as an entity, unlike a C-Corporation.

Question 39

Melody owns an ADR of a company headquartered overseas. If the company withholds 15% of her dividends, Melody:

A. Will do nothing
B. Will receive a tax credit on taxes due to the foreign government
C. Must adjust her cost basis
D. Will receive a tax credit on her US taxes

Answer 39

D. Will receive a tax credit on her US taxes

Rationale:
She only pays taxes to the US. If the foreign government withholds part of her dividends, she can claim a tax credit on her US taxes.

Question 40

Interest income paid on bonds issued by which of the following is exempt from federal, state, and local taxes?

A. Washington, DC
B. New York City
C. Hawaii
D. Puerto Rico

Answer 40

D. Puerto Rico

Rationale:
Territorial possession bonds like those issued by Puerto Rico are exempt from taxation at all three levels.

Question 41

Fixed-income investors who sell bonds at a loss should either wait 30 days before buying another bond, or alter any of the following features when purchasing a substitute except:

A. Coupon rate
B. Denomination
C. Maturity dates
D. Yield

Answer 41

B. Denomination

Wether the bonds are denominate in $1,000’s or $5,000’s is not important. To avoid having the capital loss declared unusuable, alter the other features, which truly make the new bond a different species from the one the investor just sold at a loss to reap some tax benefits.

Question 42

Cameron Callseller purchased 100 ABC @55 and simultaneously wrote 1 ABC Oct 50 call @6. When ABC trades @63, the call is exercised. Therefore, Cameron should report his proceeds on the stock as:

A. $600
B. $5,700
C. $5,600
D. $6,300

Answer 42

C. $5,600

Rationale:
He sold the stock for $5,000 and also took in $600 in premiums to write that call, which led to the sale at that strike price. $5,600. His cost basis, btw, is $5,500.

Question 43

Cameron Callseller purchased 100 ABC 0)55 and simultaneously wrote 1 ABC Oct 50 call @6. When ABC trades @63, the call is exercised. Therefore:

A. Cameron should report a short-term capital gain of $600
B. Cameron should report a long-term capital loss of $200
C. Cameron should report a capital loss of $100
D. Cameron should report a capital gain of $100

Answer 43

D. Cameron should report a capital gain of $100

Rationale:
His proceeds when selling the stock are $5,600 (strike price plus the premium taken in). He paid $5,500 for the stock. Capital gain of $100. There isn’t enough information given to discern between short-term and long-term capital gains.

Question 44

A. Dempsey Danforth sold 500 shares of XYZ for a loss of $5 per-share on March 17th of this year. Unable to control his impulses, he then purchased 500 shares of XYZ on April 7th for $39 per-share. Therefore:

A. He may be pursued for tax fraud by the IRS
B. A. Dempsey Danforth may not use the $5 per-share loss to his benefit in any way
C. The cost basis on the new purchase is $44
D. The cost basis on the new purchase is $34

Answer 44

C. The cost basis on the new purchase is $44

Rationale:
It’s a wash sale because he didn’t wait a full 30 days to repurchase shares of XYZ. He can’t use the loss now, but he can benefit by adding it to his new cost basis, which is $44. Also note, that if he’d only repurchased, say, 300, shares there would only be a wash sale on those 300, not the full 500. The test has been known to go there.

Question 45

A good friend of yours sold 10 ABC Apr 50 calls $1.50 last November. If the calls expire
this April:

A. Your friend will report a long-term capital gain of $1,500 for last year
B. Your friend will report a long-term capital gain of $150
C. Your friend will report a short-term capital gain of $1,500 for this year
D. Your friend will report a short-term capital gain of $150

Answer 45

C. Your friend will report a short-term capital gain of $1,500 for this year

Rationale:
Ordinary options lead to short- term gains and losses, as they expire within 9 months. He took in $1,500 short-term. The position didn’t go away until this year, so this is the tax year to report the gain.

Question 46

Pauline wrote a PNC Nov 50 put @3 back in September. The put is exercised in October with PNC trading for $41 per share. Therefore, the tax implications of Pauline’s put play are:

A. Proceeds of $12 per share
B. Cost basis of $47 per share
C. Proceeds of $44 per share
D. Cost basis of $53 per share

Answer 46

B. Cost basis of $47 per share

Rationale:
She’d like to tell the IRS she had to pay $50 per share, but, actually, she only paid $47 per share. Her proceeds aren’t determined until and unless she sells the stock she just reluctantly acquired.

Question 47

Mrs. Witherspoon purchased a Youngstown, Ohio 4% general obligation bond from the syndicate at a reoffering yield of 5.5%. In ten years, the bond matures. Mrs. Witherspoon’s tax implications are which of the following?

A. Mrs. Witherspoon realizes no gain or loss at maturity
B. Mrs. Witherspoon may take the loss to offset other portfolio income for the year
C. The accreted amount of the bond will be taxed at ordinary income rates
D. The accreted amount of the bond will be taxed at long-term capital gains rates

Answer 47

A. Mrs. Witherspoon realizes no gain or loss at maturity

Rationale:
She bought the bond at an original issue discount, which was only implied but clearly in the question. For an OID, there is no gain or loss if the bond is held at maturity. If somebody buys a bond on the secondary market at a discount-whole different ballgame.

Question 48

What are the tax implications if an investor holds 500 shares of ABC @40 from January to November and then purchases 5 ABC Feb 40 put options?

A. The investor has initiated a wash sale against the box
B. The investor will realize either a long-term capital gain or loss when disposing of the shares
C. There are no implications of either transaction
D. The investor’s holding period on the stock is interrupted until the puts expire

Answer 48

D. The investor’s holding period on the stock is interrupted until the puts expire

Rationale:
He’s only held the stock short- term (Jan-Nov), so when he buys the put to shield his downside risk, his holding period is halted and won’t start up again until the puts go away. If he exercises the puts in February, he’d realize a short-term capital gain or loss on the stock.

Question 49

A municipal bond investor purchases a newly issued municipal bond with a 6% coupon on a re-offered basis of 6.80. If held to maturity, the investor’s yield will actually be:

A. 6.8%
B. Negative
C. Between 6% and 6.8%
D. 6%

Answer 49

A. 6.8%

Rationale:
If she’d bought the bond at a discount from another investor (secondary market), she’d get taxed at maturity on the difference, making her yield something less than 6.8%. This is an OID, so there’s no catch at maturity–her yield is 6.8%.

Question 50

A municipal bond investor purchases a municipal bond with a 6% coupon on a basis of 6.80 on the secondary market. If held to maturity, the investor’s yield will actually be:

A. Between 6 and 6.8%
B. Lower than 6%
C. Higher than 6.8%
D. Negative

Answer 50

A. Between 6 and 6.8%

Rationale:
In this question, the difference between her discounted purchase price and par will be taxed as ordinary income, making her effective yield less than 6.8%. It’s not a huge discount, but it does knock down the yield-to-maturity of 6.8%.

Question 51

Which of the following sources of income may be counted to determine an individual’s maximum Roth IRA contribution for the year?

I. Alimony received
II. Child support payments received
III. Municipal bond interest received
IV. Corporate bond interest received

A. I
B. I, II, IV
C. II, IV
D. II, III, IV

Answer 51

A. I

Rationale:
Portfolio income doesn’t count as “earned income.” The only thing that counts as earned income here is alimony.

Question 52

An investor holds 400 shares of XYZ common stock that he purchased at an average basis of $54 per share. This year XYZ’s board of directors declare a 10% stock dividend. Therefore, the investor’s tax situation will be affected in which of the following ways?

A. There will be no effect
B. He will be taxed on $5.40 per share after the dividend is paid
C. He will be taxed at a maximum rate of 15%
D. He will be taxed at a maximum rate of 1.5%

Answer 52

A. There will be no effect

Rationale:
Stock dividends do not lead to tax implications-the investor just needs to increase the number of shares owned to 440 and lower the per-share cost basis accordingly.

Question 53

If an American investor holds an American Depository Receipt in a corporation headquartered in Italy and the darned Italian government witholds 15% of the dividend income, the investor may:

A. Sue the Italian government for fraud and negligence
B. Claim a tax credit on his US tax forms
C. Do nothing about this unfortunate situation other than sing a few verses of Que Sera, Sera.
D. Sue the bank who issued the ADR for negligence

Answer 53

B. Claim a tax credit on his US tax forms

Rationale:
This is a good question to memorize rather than ponder. A tax credit on his US taxes may be claimed-don’t let the test think he files taxes with the Italians.

Question 54

Ordinary income rates would apply to income received in which of the following forms?

A. All choices listed
B. Long-term capital gain realized on a corporate bond position
C. Dividend distribution from a municipal bond fund
D. Dividends paid by a Real Estate Investment Trust to a non-accredited investor

Answer 54

D. Dividends paid by a Real Estate Investment Trust to a non-accredited investor

Rationale:
The dividend from the municipal bond fund should be tax-exempt. Long-term capital gains are taxed at a lower rate than ordinary income. REITS pay ordinary dividends.