Basic Tax Rules for Equities Flashcards
In January, 20XX a customer buys 100 shares of ABC stock at $50 per share and pays a $2 commission per share. The customer receives $2 in cash dividends during the year. The customer’s cost basis in the stock is:
A. $48 per share
B. $50 per share
C. $52 per share
D. $54 per share
The best answer is C.
When the stock is purchased, any commission paid is not deductible - it is part of the cost basis of the shares. Thus, the cost basis for tax purposes is $50 + $2 commission = $52 per share. The $2 dividend received is included in taxable income for this year, and is not part of the stock’s cost basis.
In January, 20XX a customer buys 100 shares of ABC stock at $30 per share and pays a $2 commission per share. The customer receives $1 in cash dividends during the year. The customer’s cost basis in the stock is:
A. $28 per share
B. $30 per share
C. $31 per share
D. $32 per share
The best answer is D.
When the stock is purchased, any commission paid is not deductible - it is part of the cost basis of the shares. Thus, the cost basis for tax purposes is $30 + $2 commission = $32 per share. The $1 dividend received is included in taxable income for this year, and is not part of the stock’s cost basis.
A customer buys a NASDAQ stock in a principal transaction at $79 plus a $1 mark-up. Which statement is TRUE?
A. The cost basis for tax purposes is $78 per share
B. The cost basis for tax purposes is $79 per share
C. The cost basis for tax purposes is $80 per share
D. The trade will be reported to the tape at $80 per share
The best answer is C.
For tax purposes, any commissions or mark-ups charged to buy stock are considered to be part of the cost basis (therefore, they are not deductible). The cost basis is $79 plus $1 mark-up = $80 per share.
The trade is reported to the tape exclusive of commissions or mark-ups, which are added well after the trade occurs. Remember, all trades are reported within 10 seconds, and the trade is reported at $79 per share.
A corporation declares a dividend of $3.00 on Tuesday, December 6th. The record date is set at Friday, December 30th, with the dividend payable on January 6th. Based on this information, the ex date is set at December 28th. For the recipient of the dividend, the “tax event” occurs on:
A. December 6th
B. December 26th
C. December 30th
D. January 6th
The best answer is D.
For tax purposes, payments by issuers to securities holders are considered to be received as of the date the issuer sends the check. In this case, the check is sent on January 6th (payable date), therefore the income is taxable as of this date.
A corporation declares a cash dividend on Wednesday, December 1st. The record date is set at Tuesday, December 21st, with the dividend payable on Friday, December 31st. Based on this information, the ex date is set at Friday, December 17th. The “tax event” occurs on:
A. Wednesday, December 1st
B. Friday, December 17th
C. Tuesday, December 21st
D. Friday, December 31st
The best answer is D.
For tax purposes, payments by issuers to securities holders are considered to be received as of the date the issuer sends the check. In this case, the check is sent on Friday, December 31st (payable date), therefore the income is taxable as of this date.
A customer holds 1,000 shares of ABC stock valued at 80 in a margin account. The debit balance in the account is $35,000. ABC declares and pays a 20% stock dividend. The tax consequence of the distribution to the investor will be:
A. portfolio income when received
B. capital gain when received
C. reduction of cost basis per share
D. passive income at time received
The best answer is C.
Under IRS rules, stock dividends are not taxable at the time of receipt. This is true, because, in essence, the shareholder received nothing from the company, except for the possibility of increased future share price appreciation. The stock dividend results in the cost basis per share being reduced, with the number of shares held increased proportionately. In aggregate, the customer’s cost basis remains the same.
An investor holds shares of a stock that declares a 10% stock dividend. Which statement is TRUE regarding the stock position after the dividend is paid?
A. The cost basis per share is adjusted upward and is taxable
B. The cost basis per share is adjusted downward and is not taxable
C. The cost basis per share is adjusted downward and is taxable
D. The cost basis per share is adjusted upward and is not taxable
The best answer is B.
Under IRS rules, stock dividends are not taxable at the time of receipt. The stock dividend results in the cost basis per share being reduced, with the number of shares held increased proportionately. In aggregate, the customer’s cost basis remains the same.
A customer has purchased 1,000 shares of ABC stock at $44 per share, paying a commission of $1.00 per share for the transaction. ABC stock declares a 20% stock dividend. When the dividend is paid, the tax status of the investment is:
A. 1,000 shares held at a cost basis of $44 per share
B. 1,000 shares held at a cost basis of $45 per share
C. 1,200 shares held at a cost basis of $36.66 per share
D. 1,200 shares held at a cost basis of $37.50 per share
The best answer is D.
The payment of a stock dividend increases the number of shares held by the investor and the cost basis must be reduced accordingly, since each share is theoretically worth less after the stock dividend is paid. The customer will have 1,000 shares x 1.20 = 1,200 shares after the dividend. Each share originally had a cost basis of $45 ($44 price plus $1 commission). After the dividend is paid, the cost basis is adjusted to $45/1.20 = $37.50.
A customer has purchased 1,000 shares of ABC stock at $30 per share, paying a commission of $1 per share for the transaction. ABC stock declares a 5% stock dividend. When the dividend is paid, the tax status of the investment is:
A. 1,000 shares held at a cost basis of $30 per share
B. 1,000 shares held at a cost basis of $31 per share
C. 1,050 shares held at a cost basis of $29.52 per share
D. 1,050 shares held at a cost basis of $30 per share
The best answer is C.
There is no tax due when a stock dividend is paid; instead the investor gets more shares; with each share worth proportionately less. The payment of a stock dividend increases the number of shares held by the investor and the cost basis must be reduced accordingly, since each share is theoretically worth less after the stock dividend is paid. The customer will have 1,000 shares x 1.05 = 1,050 shares after the dividend. Each share originally had a cost basis of $31 ($30 price plus $1 commission). After the dividend is paid, the cost basis is adjusted to $31/1.05 = $29.52.
A customer has made the following purchases of XYZ stock:
Year 1: 300 shares @ $62 Year 2: 400 shares @ $66 Year 3: 100 shares @ $63 Year 4: 500 shares @ $69 Year 5: 200 shares @ $68
It is now Year 6 and the stock is trading at $70. The customer wishes to sell 1,000 shares. To minimize tax liability, the customer should use which tax valuation method for the shares that are sold?
A. Last In First Out
B. First In First Out
C. Average Cost
D. Specific Identification
The best answer is D.
A customer that has purchased stock over many years and that sells part of the position can choose to use “specific identification” to identify the specific shares being sold. In this case, the customer will lower his or her tax bill by choosing the highest cost shares. These would be the 500 shares purchased at $69 in Year 4; the 200 shares purchased at $68 in Year 5; and 300 of the 400 shares purchased at $66 in Year 2 as the 1,000 shares sold for $70. These are the highest cost shares and this will reduce the capital gain.
If the customer does not use specific identification, the IRS mandates FIFO accounting for shares sold. Average cost accounting can only be used for mutual fund shares; not for individual stocks.
A customer has accumulated a stock position over a period of years at different stock prices. The stock has appreciated in the last year and the customer places an order to sell part of the position. Regarding the customer’s cost basis of the shares being sold, which statement is TRUE?
A. The customer may specify which shares are sold so that the highest cost shares are sold first
B. The lowest price shares must be sold first
C. The customer must use a weighted average price per share as the cost basis
D. LIFO accounting is required for any shares sold
The best answer is A.
The Tax Code allows the use of “specific identification” when selling securities. Thus, a customer with a large holding of appreciated stock can “choose” the more expensive shares as the ones that were sold, reducing any potential capital gain. If specific identification is not used, then the IRS requires FIFO (First In / First Out) accounting.
Which of the following is reported on Form 1099-DIV?
A. Cash dividends
B. Taxable interest
C. Tax-free interest
D. All of the above
The best answer is A.
Form 1099-DIV is the report to the IRS by issuers of cash dividends paid and capital gains distributions made by mutual funds. Interest paid on taxable bonds and tax-free bonds is reported on Form 1099-INT.
If a customer does not give a broker his or her instructions, cost basis reporting on Form 1099-B for a stock holding where there have been multiple purchases at different times is done on a:
A. FIFO basis
B. LIFO basis
C. Specific identification basis
D. Random selection basis
The best answer is A.
Cost basis reporting to the IRS is required on Form 1099-B. The Form includes the cost basis of the security, the sale proceeds, and whether the holding period is short term or long term. If there are multiple purchases of the stock position, absent customer instructions, FIFO is used to report cost basis. If the customer gives instructions to the broker, then specific identification can be used - which is beneficial if higher cost shares are selected to either reduce capital gains or increase reported capital losses.
Under IRS rules, if a customer selling shares of stock wishes to use specific identification instead of FIFO for cost basis reporting, the broker-dealer effecting the trade must be notified of this no later than:
A. Trade Date
B. Confirmation Date
C. Settlement Date
D. Statement Date
The best answer is C.
If a customer says nothing at the time of a stock sale, IRS rules requires that FIFO be used to determine which shares are sold. If the customer wishes to use specific identification instead, this must be chosen by the customer no later than settlement date.
What is the cost basis to the recipient of an inherited mutual fund position?
A. The cost basis of the deceased person
B. The net asset value as of the date of death of the deceased person
C. The market value as of the date the recipient liquidates the position
D. The greater of the cost basis of the deceased person or the net asset value as of the date of death
The best answer is B.
One benefit built into the tax code is that inherited securities are given a new cost basis to the recipient, using the date of death to value the securities. Thus, if the securities have appreciated, there is no capital gains tax due on death. This is called a “stepped up” basis.
