CFP Flashcards
ALWAYS Bar List
felony theft/embezzlement/finance based crimes
felony tax fraud
revocation of financial professional license UNLESS d/t fee not being paid
felony murder or rape
felony any other violent crime w/in last 5 years
Presumed Bar List
STORY, bar unless petitioned
2 or more personal/business bankruptcies, felony conviction violent crimes (besides murder/rape) more than 5 years ago, felony nonviolent crimes including perjury w/in last 5 years, revocation or suspension of non-financial professional license, suspension financial professional license (unless not paying fee for renewal)
Exceptions to Registration: RIA
(Incidental TABLE) = need not register & generally NOT regulated by Advisers Act; banks/bank holders loans & deposits only, BD primary business is trades only, LATE for profession (Lawyers/Accountants/Teachers/Engineers), publisher newspaper/magazine periodical regular circulation, advisers only related strictly to securities guaranteed by U.S., person not w/in intent of laws as SEC
Exemptions to Registration: RIA
(VIPs are SaFE from exemptions) = meet definition but no registration but subject to anti-fraud provisions of act; all intrastate services, no securities traded on national exchange, only clients are insurance companies, solely to venture capital funds, solely to private funds less than $150 million, foreign advisors w/out place of business in U.S.
Accredited Investor
$1 million, or $200k income if single, $300k of spousal income
FINRA (Series 6 & 7)
S6 = MFs, UITs, Variables (life insurance/annuities); things that settle in price @ end of day;
S7 = everything except commodities & futures; to sell variable life/annuities must also have state insurance license;
KNOW SERIES 6 & 7 FOR EXAM!
The Brochure Rule
(Tested Frequently) = written disclosure to every client of advisory services/fees, types of securities, education/business standards, participation/interest in securities transactions, conditions for managing accounts, must be given to client at or before time of entering into contract; compliance w/ brochure rule accomplished by providing client w/ ADV Part 2 (outlines fees)
Fiduciary Duty
Duty of Loyalty, Care, & to Follow Client Instructions
Financial Planning Definition
a collaborative process that helps maximize a Client’s potential for meeting life goals through Financial Advice that integrates relevant elements of the Client’s personal & financial circumstances
Orally or in Writing
For Financial Advice, only Privacy Policy must be in writing, everything else orally OR writing
For Financial Planning only Material Conflicts of interest orally OR writing, everything else writing
Debt NOT discharged in bankruptcy (NOT ALLEVIATED)
student & government loans
3 years of back taxes
alimony & child support
monies owed d/t malicious acts, drunk driving, criminal fines & penalties, embezzlement
Assets exempt from creditors
homestead, life insurance, qualified plans
Traditional/Roth IRAs up to $1MM
No protection for inherited IRAs if non spousal beneficiary
Monetary Policy (Tools - 4)
Reserve Requirement
Discount Rate = overnight interest banks borrow from federal reserve
Open Market Operations (Treasuries buy/sell)
Excess Reserve Rate = interest on reserves over reserve requirement
- maintain long-term economic growth
- maintain price levels supported by the economy
- maintain full employment
Fiscal Policy (Tools - 3)
Taxation or Tax Rates
Government spending (Congress) - cutting spending increases interest rates
Debt Management (deficit spending) - increased deficit spending = decreased money supply = increasing interest rates
- maintain long-term economic growth
- maintain price levels supported by the economy
- maintain full employment
Financial Aid Programs
Federal Pell Grant: NEED based; subsidized = need based; unsubsidized = NOT need based
Parent Loans for Undergrad Students (PLUS): loans for parents; NOT need based
Grad PLUS loan for Grad Students (PLUS Direct): dependent on STUDENT credit score
Federal Perkins Loan Program: NEED based
LLC (Lifetime Learning Credit)
tuition/fees undergrad, grad, or professional programs
20% of up to $10K in qualified expenses per year
maximum per family is $2K per year
unlimited # of years
AGI phaseouts
AOTC (American Opportunity Tax Credit)
tuition & fees for 4 years of postsecondary education (includes universities/colleges)
100% of first $2K in qualified expenses
25% of next $2K in qualified expenses
maximum PER STUDENT = $2,500 per year
refundable up to 40% or $1,000
AGI phaseouts
Insurable Risks are CHAD
Not catastrophic
Homogeneous exposure units (large # of similar units)
Accidental
Measurable & Determinable
A Legal Contract requires COALL!
Elements of a Valid Contract
Competent Parties
Offer & Acceptance
Legal Consideration
Lawful Purpose
Contract of Indemnity
an insured cannot make a profit from an insurance contract; only entitled to compensation to extent of insured’s financial loss
Subrogation Clause
insured cannot receive compensation from both the insurer & a 3rd party for the same claim
Contract of Adhesion
take it or leave it, no negotiations over terms & conditions
any ambiguities found in favor of the insured
Aleatory
unequal exchange of money (cumulative premium vs DB paid out)
Executive or State Insurance Commissioner
administers, interprets, & enforces insurance laws
the State Insurance Commissioner does NOT make law!
Goals of State Insurance Regulation
protect the insured
maintain & promote competition
maintain solvency of insurers
NAIC
provides watch list of insurance companies based upon financial ratio analysis
NO regulatory power over insurance industry
involved in accrediting state insurance regulatory offices
issues “model legislation” that state legislatures may or may not adopt
Permanent Insurance Dividend Options: CRAP-O
Cash
Accumulate at interest = dividends invested by company, tax free up to basis, interest pad on dividends IS taxable
Reduce Premiums
Paid-up Additions
One-year term insurance additions (purchase of)
HSA (Health Savings Account)
age 55 & older catch up
$1,000 catch up
distributions for NQ medical expenses are subject to income tax & a 20% penalty if taken before age 65; income tax only at 65 or older
Permitted Expenses: (same as those expenses qualifying as medical expenses for purposes of the itemized deduction) (tax free)
- dental/orthodontics/vision
- COBRA & LTC premiums
- healthcare premiums while receiving unemployment
- Medicare & other health care coverage (65 or older)
- OTC (medical use, pain relief, cold relief etc)
NOT PERMITTED EXPENSES = cosmetic surgery
COBRA
EXAM TIP: to be offered COBRA there must be 20+ EEs, ER offers group health & the EE is already participating in the group health plan
NOT required to offer COBRA under 20 EEs
EXTENSION TO FAMILY MEMBERS:
E:
18 months reduction in hours or normal termination
D:
36 months death, divorce, medicare eligibility, loss of dependency status by children of EE
E:
29 months if EE meets SS definition of disabled
EEs have 60 days to make a COBRA election
**an EE terminated d/t “gross misconduct” is NOT eligible for COBRA
Demand Curve Impacts
price change = movement along demand curve
curve shift = income, taxes, savings rates, disposable income
Supply Curve Impacts
price change = movement along curve
prices down = supply down; prices up = supply up
curve shift = technology, competition, anything other than price
Financial Planning Process
Uber Is A Drunk Person’s Immediate Motor Vehicle – UIADPIMV
- Understand client’s personal & financial circumstances
- Identifying & Selecting Goals
- Analyze current course of action & potential alternatives
- Develop Financial Plan Recommendations
- Presenting the Financial Planning Recommendations
- Implementing the Financial Plan Recommendations
- Monitoring the Plan
A CFP must complete all steps unless specifically stated in engagement letter
HO Basic Coverage - 12
Losses w/ 12 named perils
Fire
Vehicles (damage caused by vehicles)
Lightning
Smoke
Windstorm
Vandalism or malicious mischief
Hail
Explosions
Riots or civil commotion
Theft
Aircraft
Volcanic eruptions
S-L-W & F-V-V-V-H-E-A-R-T (Pronounced Slow Favorite)
HO Broad Coverage - 18
12 basic perils plus 6 additional named perils
Falling objects
Weight of ice/snow/sleet
Accidental discharge/overflow of water or steam
Sudden & accidental cracking, burning, bulging of appliances
Freezing of plumbing, heating, air conditioning, fire sprinkler system, or appliance
Sudden & accidental damage from artificially generated electrical currents
Basic + FAS-FWD (Pronounced Fast Forward)
HO Open Perils Coverage
protection from losses associated w/ all perils except those specifically excluded
provides more comprehensive coverage than the basic & broad policies
Exclusions include neglect (termite damage), flood & earthquakes
HO Section I Coverages - 4
Coverage A = Dwelling
Coverage B = Other Structures
Coverage C = Personal Property
Coverage D = Loss of use
HO Section II Coverages - 2
Liability & Medical payment coverage
Coverage E = Personal Liability
Coverage F = Medical payments to others
Automobile Insurance - 6
Part A = Liability coverage
Part B = Medical payments coverage
Part C = Uninsured motorist coverage
Part D = Coverage for damage to the insured’s automobile
Part E = Duties after accident or loss
Part F = General Provisions
Part A 50/100/50
50K bodily injury per person; 100K bodily injury per accident; 50K property damage
Social Security Benefits Reduction for Early Retirement
Reduced by:
5/9 of 1% for each month for first 3 years
Then 5/12 of 1% for each month beyond 3 years
Social Security Benefits Increase for Delaying Retirement
8% SIMPLE interest increase for each year the retiree delays their benefit
What is NOT covered by Medicare Part B? - 4
dental care, dentures
cosmetic surgeries
hearing aids
eye exams
Research Reports - 2
Value Line = ranks stocks; 1 = highest = buy; 5 = lowest = sell
Morningstar = ranks mutual funds, stocks, & bonds; 1 = lowest; 5 = highest
Ex-Dividend Date
1 day before date of record
if stock purchased on or after ex-dividend date then you will NOT receive the dividend
to receive the dividend an investor must purchase the stock prior to the ex dividend date
Commercial Paper
money market security
short term loans b/t corporations
maturities of 270 days or less & does NOT have to register w/ SEC
denominations of $100,000 & are sold at a discount
Bankers Acceptance
money market security
facilitates imports/exports
maturities of 9 months or less
can be held until maturity or traded
Eurodollars
money market security
deposits in foreign banks that are denominated in US dollars
Price Weighted Avg vs Value Weighted Index
Price Weighted = avg of price, does NOT take into account % allocation of the position w/in portfolio; examples = DJIA (dow jones industrial average)
Value Weighted = incorporates market capitalization of individual stocks into average; examples = S&P 500, Russell 2000 (smallest market cap), Wilshire 5000, EAFE (Europe, Asia, Australia, Far East)
Affect Heuristic
judging whether good or bad
do they like or dislike some company based on non-financial issues
Anchoring
attaching or anchoring one’s thoughts to a reference point even though there may be no logical relevance or is not pertinent to the issue in question
anchoring is also known as conservatism or belief perseverance
Availability Heuristic
relies upon knowledge that is readily available in memory, cognitive heuristic known as “availability” is involved; this may cause investors to overweight recent events or patterns while paying little attention to longer term trends
Bounded Rationality
when individuals make decisions, their rationality is limited by the available information, the tractability of the decision problem, the cognitive limitations of their minds, & the time available to make the decision
decision makers in this view act as “satisficers” seeking satisfactory solution rather than optimal one
one consequence of this concept is that having additional information does not lead to an improvement in decision making d/t the inability of investors to consider significant amounts of information
3 Forms Efficient Market Hypothesis
Weak = price reflects historical price data, advantage through fundamental analysis & inside information; rejects technical analysis
Semi-Strong = price reflects public information, advantage through inside information; rejects both technical & fundamental analysis
Strong = price reflects all information, no advantages to gain, no insider info; diversify stocks randomly or merely go w/ an index
Cognitive Dissonance
tending to misinterpret info that is contrary to an existing opinion or only pay attention to info that supports an existing opinion
Disposition Effect
also known as regret avoidance or “faulty framing” where normal investors do NOT mark their stocks to market prices
investors create mental accounts when they purchase stocks & continue to mark their value to purchase prices even after market prices have changed
Gambler’s Fallacy
investors often have incorrect understanding of probabilities which can lead to faulty predictions
investors may sell stock when it has been successful in consecutive trading sessions because they may not believe the stock is going to continue its upward trend
Prospect Theory
people value gains & losses differently & will base their decisions on perceived gains rather than perceived losses
investors are “loss averse” & have an asymmetric attitude to gains & losses
getting less utility from gaining $100 then would lose if they lost $100
explains why investors may avoid higher risk investments even if they offer strong risk adjusted returns
also explains why they over insure against risks through low deductibles
Self-Attribution Bias
you give yourself credit for all the good outcomes & any bad outcomes are d/t outside factors
Similarity Heuristic
used when a decision or judgement is made when an apparently similar situation occurs even though the situations may have very different outcomes
Representativeness
thinking a good company is a good investment w/out regard to an analysis of the investment
familiarity causes investment in companies that are familiar, such as an employer
Loss Aversion
investors prefer avoiding losses more than experiencing gains
an unwillingness to sell a losing investment in the hopes it will turn around
in other words, investors feel more pain from losses, then enjoying gains
Leptokurtic vs Platykurtic
Leptokurtic = high peak, flat tails; higher chance of extreme events
Platykurtic = low peak, thin tails; lower chance extreme events
Systematic Risk
nondiversifiable risk, market risk, economy based risk
PRIME
Purchasing Power risk*
Reinvestment Rate risk*
Interest Rate risk*
Market risk
Exchange Rate risk
- = most likely to be tested
Unsystematic Risk
diversifiable risk, unique risk, company specific risk
ABCDEFG
Accounting risk
Business risk*
Country risk*
Default risk*
Executive risk
Financial risk*
Government/Regulation risk*
- = most likely to be tested
Arbitrage Pricing Theory (APT) Factors/Keywords
multi factor model
pricing imbalances cannot exist for any significant period of time
explains returns based on factors, if a factor is 0 then it has no impact on returns
APT attempts to take advantage of pricing imbalances
SD & BETA are NOT inputs/variables
inputs are factors = inflation, risk premium & expected returns & their sensitivity(b) to those factors
- If the required rate of return decreases, the stock price will?
- If the dividend is expected to increase, the stock price will?
- If the required rate of return increases, the stock price will?
- If the dividend is expected to decrease, the stock price will?
- increase
- increase
- decrease
- decrease
Price to Earnings (P/E) ratio
how much an investor is willing to pay for each dollar of earnings; measure of relationship b/t a stock’s price & its earnings; stock price as a multiple of company earnings
used to value a stock if the firm pays no dividends
the relationship of price to earnings is known as the P/E multiplier
P/E = Expected Price per share / EPS
OR
Expected Price per Share = P/E x EPS
P/E ratio = P/E multiplier
example if P/E = 3 then trading at 3 times its value
Dividend Payout Ratio
relationship b/t the amount of earnings paid to shareholders in the form of a dividend, relative to earnings per share
typically the higher the dividend payout ratio, the more mature the company
a high DPR may also indicate the possibility of the dividend being reduced
a low DPR may indicate that the dividend may increase, thereby increasing the stock price
DPR = common stock dividend / EPS
Retention Ratio = 1 - DPR
Return on Equity (ROE)
measures the overall profitability of a company; there is a direct relationship b/t ROE, earnings & dividend growth
ROE = EPS / Stockholders Equity per Share
Stockholders Equity per share = total equity / shares outstanding
Dividend Yield Formula
= Dividend Per Share / Stock price
states the annual dividend as a percentage of the stock price
Fundamental Analysis
ratio analysis on balance sheet & income statement to determine future performance
looking at economic data
Fundamental analysts believe that a stock price performance is largely driven by the financial performance of the firm
Fundamental analysis assumes:
1. investors can determine reliable estimates of a stock’s future price behavior
2. some securities may be mispriced & through fundamental analysis it can be determined which securities are mispriced
Technical Analysis
charting & plotting a stock’s trading volume & price movements to predict future direction
does NOT involve ratio analysis or analysis of financial statements
analysts believe supply & demand drive a stock price
Efficient Market Hypothesis (EMH)
investors cannot consistently achieve above-average market returns
prices reflect all information that is available & change very quickly to new information
stock prices will follow a “random walk”
investors who believe in the EMH believe a passive investment strategy is appropriate such as buy & hold an index
Random Walk Theory
the behavior of stock prices closely resembles a random walk
prices of stocks are unpredictable but NOT arbitrary
impossible to consistently achieve above-average market returns
at any given moment prices that exist on securities are the best incorporation of all available information & a true reflection of the value of that security
prices are in equilibrium
changes in price & volume of trading are generated by changing needs of investors
Market Anomalies (4)
- January Effect = January tends to be a better month d/t tax loss selling in November & December followed by investors getting back into the market in January
- Small Firm Effect = small caps tends to outperform large caps; easier for them to grow revenues & earnings faster than a large cap
- Value Line Effect = stocks that receive Value Line’s highest ranking (1) outperform stocks that receive the lowest ranking (5)
- P/E Effect = stocks w/ a low P/E ratio tend to outperform stocks w/ a high P/E ratio
Strategic vs Tactical Asset Allocation
Strategic = involves assessing the likely outcomes for various allocation mixes b/t asset classes; buy & hold strategy
Tactical = investor determines expected returns for asset class, then rebalances the portfolio to take advantage of the expected returns; pricing anomalies or strong sectors; active management strategy
BOTH are active allocation strategies
US Treasury Securities Taxation
all US Treasury securities are nontaxable at the state & local level
Nonmarketable US Treasury Issues - 3
not easily bought or sold
- Series EE/Series E Bonds
- Series HH/Series H Bonds
- Series I Bonds (inflation-indexed)
Marketable US Treasury Issues - 3
- T-Bills (sold at discount, no interest)
- T-Notes (semi-annual interest)
- T-Bonds (semi-annual interest
All bills, notes, & bonds are sold in denominations of $100 or more
treasury securities are sold on an “auction” basis w/ the lowest yield winning the auction
Original Issue Discount (OID)
issued at discount from par value; example = zero coupon bonds
zero coupon bond sold at deep discount; bond will increase in value over term of bond until matures at par value
no interest paid until maturity
bond holder must recognize income each year even though no interest is received; known as imputed or “phantom income” because bond holder doesn’t receive interest, but still must pay taxes on the increase in value of the zero-coupon bond
particularly suited to accounts w/ benefit of tax deferral (ex IRA) d/t not having to recognize phantom interest
Treasury Inflation Protected Securities (TIPS)
inflation & purchasing power protection
principal/par value adjusts for inflation, coupon rate applied to new principal amount
coupon rate does NOT change as is the case w/ I Bonds (important!)
Separate Trading of Registered Interest and Principal Securities (STRIPS)
periodic coupon payments separated from bond & each coupon payment including the par value trade separately
essentially treasury STRIPS create zero-coupon bonds
highly liquid & appropriate for investors looking for a low risk, highly liquid investment & w/ a specific time horizon
Corporate Bonds - Secured Bonds (2)
Mortgage Backed Securities (MBS) - backed by pool of mortgages, biggest risk is prepayment risk & default risk
Collateral Trust Bonds - backed by an asset owned by the company issuing the bonds; asset held in trust by third party
Corporate Bonds - Collateralized Mortgage Obligations (CMOs)
divided into “tranches” which determine which investors receive principal repayment; A-Z; short, intermediate, & LT tranches
interest distributed pro-rata & principal repayments used to retire tranches sequentially
investors in ST tranche receive principal repayment before intermediate & LT tranch
meant to mitigate against prepayment risk associated w/ mortgage-backed securities
Corporate Bonds - Unsecured Corporate Bonds (3)
Debentures - unsecured debt not backed by any asset; backed on belief of creditworthiness that the issuing company (or government) will repay the debt
Subordinated Debentures - lower claim on assets than other unsecured debt; more risk d/t lower claim on assets if company defaults on bond repayments
Income Bonds - interest only paid when a specific level of income is attained
Guaranteed Investment Contract (GIC)
issued by insurance companies w/ guaranteed ROR
insurance company agrees to repay the principal & guaranteed rate of return for a period of time
yield is higher than treasury securities
General Obligation Bonds
backed by full faith/credit & taxing authority of the municipality that issued the bond
Revenue Bonds
backed by the revenue of a specific project
NOT backed by full faith/credit & taxing authority of the entity that issued the bond
Private Activity Bonds
used to finance construction of stadiums
What companies insure municipal bonds?
American Municipal Bond Assurance Corp (AMBAC)
Municipal Bond Insurance Association Corp (MBIA)
Current Yield Formula
= Annual Coupon Payment in dollars / Current Price of the Bond
Yield Ladder - Discount Bonds (highest to lowest)
YTC
YTM
CY
CR or Nominal Yield
**Remember when shopping if you see a Discount “Call Mom’s Cell Now! = Discounts from highest to lowest is yield to CALL, yield to Maturity, Current yield, & Nominal yield
Yield Curve Theories - 3
Liquidity Preference Theory = yield curve results in lower yields for shorter maturities since some investors prefer liquidity, paying for liquidity means lower price
Market Segmentation Theory = curve depends on supply & demand at any given maturity; when supply > demand rates are low; if supply < demand rates are high
Expectations Theory = curve reflects investors’ inflation expectations; since investors believe inflation will be higher in future, LT yields are higher than ST yields
Bond Duration
Duration = weighted average maturity of all cash flows
the bigger the duration, the more price sensitive or volatile the bond is to interest rate changes
duration is the moment in time the investor is immunized from interest rate risk & reinvestment rate risk
Modified Duration is a bond’s price sensitivity to changes in interest rates
a bond portfolio should have a duration equal to the investor’s time horizon to be effectively immunized
the higher the coupon rate, the lower duration
the lower the coupon rate, the higher duration
zero coupon bond always w/ highest duration; zero coupon bond always have a duration equal to its maturity
higher the term of the bond the higher the duration & vice-versa
as YTM increases, duration decreases
as YTM decreases, duration increases
coupon rate & YTM are INterest rates & there is an INverse relationship; the IN should help keep it straight
Bond Strategies - 4
- Tax Swap = selling a bond w/ gain & a bond w/ loss which offset each other; OR selling a bond w/ loss & just buying a new bond
- Barbells = owning both ST & LT bonds; when interest rates move only one set of positions needs to be sold & restructured
- Laddered Bonds = purchasing bonds w/ varying maturities; helps reduce interest rate risk d/t bonds being held until maturity
- Bullets = very little payments during interim period then lump-sum at some specified date in the future; most bonds mature in or around same time period; zero-coupon/treasures/corporates most likely candidates; used when the investor has a balloon payment due on a liability at some future date
Preferred Stock
both equity & debt features
debt features = stated par value; stated dividend rate as a percentage of par
equity features = price of a bond may generally move w/ price of common stock
dividend does NOT fluctuate like a common stock dividend; NO maturity date like a bond
price of preferred stock more closely tied to interest rates than common stock
Tax Advantage = corporations receive a 50 or 65% deduction of dividends (preferred & common stock) based on percentage of ownership of the company paying the dividends (covered in tax)
65% for 20% or more owned corporations
same deduction applies to common stock dividends as well
Convertible Bonds & Conversion Value
conversion value (CV) is value of convertible bond in terms of stock into which it can be converted
CV = (Par / CP) x Ps
Ps = price of the common stock
CP = conversion price
(Par Value / CP) is the conversion ratio or the # of shares the convertible can be converted into
Property Valuation Formula
to determine how much an investor is willing to pay for a piece of property
Capitalized Value = Net Operating Income (NOI) / Capitalization Rate
Capitalized Rate = NOI / Cost
NOI = Gross Rental Receipts + non-rental income - vacancy & collection losses - total expenses
NOT including depreciation or mortgage payment
OR
NOI = Net Income + depreciation + financing activities
Closed End Fund
fixed initial market capitalization
specific # of shares initially sold to public
those shares then traded on an organized exchange; NO new shares issued by fund
shares may trade at a premium or discount to NAV
Open End Fund
unlimited # of shares
as long as fund receives contributions, fund family will continue to offer shares
shares bought/redeemed directly from fund family
shares trade at NAV
NAV = (Assets - Liabilities) / Shares Outstanding
Unit Investment Trust
managed by trustee
self liquidating, passive management, NO trading of assets w/in the trust
issues units, NOT shares
units can be sold back to the UIT at NAV; very thinly traded secondary market
Exchange Traded Funds (ETFs)
portfolio of stocks representing an index
traded on exchange similar to stocks & can be traded intra-day unlike mutual funds
investors do NOT have to buy/sell blindly
low cost of ownership d/t passive investments
trading only occurs when stocks are added or removed from an index
Most ETFs are tax efficient investments d/t low asset turnover & passive investment strategy
ETFs structured to track an index but can also be actively managed to track an investment manager’s top picks, or mimic an existing mutual fund
Real Estate Investment Trusts (REITs)
low correlation w/ stock market & diversification benefit provided to portfolios
real estate is a hedge against inflation
REITs MUST distribute 90% of investment income to shareholders to maintain tax-exempt status
Equity REIT
invest in real estate for capital appreciation
income generated from rental income & appreciation
Mortgage REIT
invest mostly in mortgages & construction loans
make the spread b/t the lending & borrowing rate
American Depository Receipts (ADRs)
foreign stock held in domestic banks’ foreign branch
dividends & capital gains (capital gains in ADRs include currency fluctuation)
trade on US exchanges, denominated in US dollars, trade in US dollars
dividends paid in US dollars
ADRs do NOT eliminate exchange rate risk ** MUST KNOW
Time Value Options Contracts
= premium - intrinsic value
Black/Scholes
KNOW THE VARIABLES
used to determine the value of a CALL option
Variables = current price of underlying asset, time until expiration, risk-free ROR, volatility of underlying asset, strike (exercise) price
all variables have a DIRECT relationship on the price of the option except the strike price; as the strike price increases, the option decreases in value
Put/Call Parity
attempts to value a PUT option based on the value of a corresponding call option
MUST KNOW
Binomial Pricing Model
attempts to value an option based on the assumption that a stock can only move in one of two directions
MUST KNOW
Taxability of Call Options
two potential tax consequences
- if contract expires: premium paid = ST loss, premium received = ST gain
- if contract exercised: premium added to stock price to increase basis in underlying stock; if underlying stock held for more than 12 months = LTCG or LTCL; if underlying stock held less than or equal to 12 months = ST gain or loss
Warrants
essentially LT call options issued by the corporation
expiration period much longer than options, usually 5-10 years
terms are NOT standardized
ex = call option contracts are standardized in terms of expiration month & # of shares controlled
Futures Contracts
Two types = commodity futures & financial futures
options give holder right to do something; futures obligate holder to make or take delivery
futures contracts do NOT state the per unit price of the underlying asset which is determined by supply & demand
two primary players in futures are hedgers & speculators
futures contracts are “marked to market” = gain or loss (in cash) is credited/debited to your account on a daily basis
Using Futures Contracts to Hedge a Position
Position 1 = long the commodity, short the contract (orange grove owner, long the commodity oranges in the trees & short the futures contract to lock in his sale price)
Position 2 = short the commodity, long the contract (manufacturer of orange juice user of oranges, long in futures contract & short position in manufacturing costs of juice in the future)
4 Main Areas of GDP
consumer spending
government spending
business investing
net imports/exports
FDIC Insurance
each depositor $250K insurance PER TYPE OF ACCOUNT OWNERSHIP including IRAs up to $250K; 3 types of ownership = individual, joint & trust accounts; retirement accounts also separate but cov depends on type of asset; each person deemed to own 50% of a joint account; money market mutual fund NOT covered; stocks/bonds/mutual funds NOT covered; any deposit payable in US IS covered; any deposit only payable outside of the US is NOT covered
Chapter 7 Bankruptcy
relief through liquidation
Chapter 11 Bankruptcy
relief through adjusting debts
“means test”
Protected Assets in Chapter 7 Bankruptcy
rollover IRAs have unlimited protection
IRA & Roth exempt up to about $1.3 million (as indexed)
alimony & child support
pensions, life insurance & annuities
INHERITED IRAs DO NOT HAVE ANY PROTECTION
Worker Protection Laws - 2
- Workers Compensation - absolute form of liability (doesn’t matter who was at fault), regardless of fault if injured at work EE collects benefits, benefits NOT subject to income taxation
- Unemployment compensation - collects if EE loses job, funded by tax on ER, benefits INCLUDED in gross income
Categories of Ratios - 3
- Liquidity Ratio = ability to meet ST or current liabilities
- Debt Ratios & Debt Analysis = indicates how well a person manages their debt
- Performance Ratios = assesses the financial flexibility of the client as well as progress towards goals
Current Ratio
Liquidity Ratio
ability to meet ST obligations
CL = credit cards, ST debt less than 12 months
Current Ratio = Current Assets / Current Liabilities
balance sheet
Emergency Fund & EF Ratio
liquidity ratio
need 3-6 months in nondiscretionary expenses (expenses that do NOT go away if you lose your job, debt/utilities/food)
EF Ratio = Current Assets / MONTHLY Nondiscretionary Expenses
Housing Ratio 1
debt ratio
also known as FRONT Ratio
should be less than or equal to 28% of GROSS income
= MONTHLY Housing Costs (P+I+T+I) / MONTHLY GROSS income
P =Principal
I = Interest
T = Taxes (Property)
I = Homeowners Insurance
Housing Ratio 2
debt ratio
also known as BACK Ratio
housing plus all other recurring debt should be less than or equal to 36% of GROSS income
= [MONTHLY Housing Costs (P+I+T+I) + ALL Other Recurring Debt] / MONTHLY GROSS Income
P =Principal
I = Interest
T = Taxes (Property)
I = Homeowners Insurance
All other recurring debt includes auto, student loans, boat, credit card & any other type of monthly debt
Buying vs. Renting (Leasing)
primary driver is TIME
Rent/Lease = time in property short (1-3 years)
Buy = time in property long (> 3 years), build equity, high marginal tax bracket
Savings Ratio
performance ratio
= Annual Savings (EE + ER Contributions) / ANNUAL GROSS Income
target 10-12% depending on age starting saving
could be 20-25% if saving later in 40s or 50s
important to include employer contributions to 401k, profit sharing plans etc
Savings Plan or 529 Savings Plan
***529 Savings plan default answer for best education savings plan unless given data/info making 529 impossible/unavailable/disadvantage
Qualified State Tuition Plan
invests in diversified portfolio stocks/bonds based on child’s age
appreciation tax free if used for qualified education expenses
contributions made pro ratably over 5 year period
up to $90K in one year w/out gift tax consequences
a couple that elects gift splitting can contribute $180K (18K x 2 x 5) in one year 2024
significant for grandparents want to reduce their gross estate
considered a PARENTAL asset for financial aid purposes
distributions from plans owned by someone other than the parents for education expenses are NO LONGER considered income of the child for FASFA purposes
Savings Plan or 529 Savings Plan Advantages & Disadvantages
Advantages:
possible state income tax deduction for contributions
no phase out for who can participate
owner controls the account
can change beneficiary anytime
contributor can remove assets from gross estate
SECURE 2.0 Act changes after 12/31/23:
beneficiaries permitted to rollover up to $35k over course of lifetime from any 529 account in their name to their Roth IRA
these rollovers are also subject to Roth IRA annual contribution limits, & the 529 account must have been open for more than 15 years
Disadvantages:
10% penalty & included in gross income if NOT used for qualified education expenses
Exceptions to 10% penalty include death, disability & scholarship for beneficiary
Consumer Debt Payment Ratio
Debt Ratio
consumer debt payments should NOT exceed 20% of NET income
Capital Assets - ACID
all assets are capital assets EXCEPT ACID:
Accounts/notes receivable
Copyrights & creative works
Inventory
Depreciable property used in a trade or business
3 Types of Assets
- Capital Assets - most personal use assets & most investment assets
- Section 1231 Assets - section 1245 & section 1250 depreciable business property used in a trade or business
- Ordinary Income Assets - assets that are not capital assets & not section 1231 assets
Section 1231 Assets
assets used in a trade or business
do NOT include = inventory, property held by the taxpayer primarily for sale to customers in the ordinary course of their trade or business, copyrights or creative works
Section 1231 specifically includes certain property such as:
Timber
Coal
Iron Ore
Certain Livestock
Unharvested crops (under certain conditions)
Increases to Basis (CB)
capital improvements that extend the life of the asset
NOT repairs/maintenance
Decreases to Basis (CB)
Section 179 deduction
depreciation
Adjusted Taxable Basis - Property Acquired by Nontaxable Exchange
when property acquired in exchange, newly acquired property has carryover basis if property exchanged for property of equal value (no boot is paid)
if property exchanged for MORE valuable asset (thus boot is paid), new asset has carryover basis (CB of the exchanged property) plus any boot paid
if property exchanged for LESS valuable asset (thus boot is received), new asset has carryover basis reduced by any boot received that was greater than the gain
Basis of Gifted Property - General Rule & 2 Exceptions
General Rule = donee’s basis in gifted property is the SAME as the donor’s basis in the gifted property
Exception 1 = FMV of gifted ass is less than donor’s basis (loss property); Double Basis Rule must be used
- for gains only, basis of donor is adjusted basis of donee
- for losses only, basis to donee is FMV of property on date of gift
- if asset later sold by donee & amount realized is b/t FMV at time of gift & adjusted basis of donor, NO gain or loss is recognized; donee’s basis = sales price
Exception 2 = when gift tax has been paid & asset appreciated in hands of donor, portion of tax which is associated w/ the appreciation is added to the donor’s basis to determine the donee’s basis
Donee’s Basis = Donor’s Basis + [(Net Appreciation in Value of Gift / Value of Taxable Gift) x Gift Tax Paid]
Holding Period for Gifted Property
General Rule = holding period in the hands of the donee includes the HP of the donor
If double basis asset (gifted asset where FMV is less than donor’s basis at time of gift) is sold for a loss, then the holding period for the donee starts on the date of the gift
Related Party Transactions Rule (Section 267 - Sale to a related Party)
ONLY AFFECTS TRANSACTIONS WHERE THERE IS A LOSS
Transferor’s loss is forever lost; DISALLOWED LOSS
transferee takes asset w/ DOUBLE BASIS RULE (FMV for losses, transferor’s basis for gains)
holding period ALWAYS begins at the date of the sale
related parties include siblings (include half but NOT step), lineal descendants (children/grandchildren), ancestors (parents/grandparents), spouse
EXAM TIP: NEVER gift or sell an asset to a related party when the donor’s basis is greater than the FMV of the asset
Bargain Sales to Charity
if a taxpayer sells property to a charity for less than its FMV, the basis of the property must be allocated b/t the portion of the property sold & the portion given to charity
Basis for Sale Purposes = (Amount Realized / FMV) x Basis of Property
Holding Period
LTCG maximum rate 20%; STCG taxed as ordinary income
LTCG = asset held MORE than one year
day of disposition is included in HP but day of acquisition NOT included in HP
Realization & Recognition
gains on capital assets are taxed only when there has been BOTH (1) a realization event AND (2) a recognition event
gains must be realized BEFORE they can be recognized
realization occurs when there is a disposition of property (sale/exchange) OR segregation of the gain
Recognition occurs when a realized gain is taxed
as a general rule realized gains are recognized (taxed) unless an exception to this rule can be found in the Internal Revenue Code; an exception will generally provide that the gain is exempt from taxation OR the gain is deferred to a future time
Calculation of Gain or Loss
Section 1001
Realized Gain/Loss = Amount Realized - Adjusted Basis
Adjusted Basis = Cost of Property + Capital Additions - Cost Recovery
ordinary gains are fully taxable, ordinary losses are fully deductible
capital gains/loss subject to special tax treatment
Calculation of Amount Realized
Amount Realized = Cash received + FMV of property received in exchange + Liabilities Shed
the party that is giving up or “shedding” the debt will be deemed to have an additional amount realized
conversely the party assuming the debt will be deemed to be paying that amount in the exchange
Wash Sale Rule
losses on wash sales are disallowed
occurs when a taxpayer disposes of securities at a loss & acquires substantially identical securities w/in 30 days before or after the date of the loss sale
the disallowed loss is ADDED to the cost of the new stock or security to determine the new basis of the substantially identical securities
EXAM TIP:
Index fund for Index fund = wash sale rule APPLIES
Index fund for managed large cap fund = wash sale rule does NOT apply
Personal Use Property - losses disallowed
= losses generated on the sale or exchange of property that is used for personal purposes is disallowed for income tax purposes
Section 121 Exclusion of gains from sale of principal residence
property must have been owned & occupied as a principal residence for 2 of the last 5 years; exclusion can only be used once every 2 years
single taxpayers may exclude up to $250K of gain from sale of principal residence
MFJ may exclude up to $500K of gain from the sale of their principal residence
if married both MUST meet the use requirement & not have utilized the exclusion w/in the last 2 years but either may meet the ownership requirement
a reduced exclusion is available if sale of personal residence is d/t change in employment, change of health, or other unforeseen circumstances
Exclusion Allowed = (# of months met / 24) x Available Exclusion
Worthless Securities
a loss resulting from worthless securities is deductible in the year in which the securities become completely worthless
Section 165 sets the artificial sale date for the securities as the last day of the year in which the securities became worthless
Always 12/31 for Calendar year taxpayers!
3 Types of Assets
- Capital Assets = most personal use assets & most investment assets
- Section 1231 Assets = Section 1245 & Section 1250 Depreciable Business Property used in a trade or business
- Ordinary Income Assets = assets that are not capital assets & not Section 1231 assets
Section 1244 Limitations on Losses
single deduct up to $50K ($100K MFJ) on loss on small business stock as ordinary loss if following requirements met:
1. stock represents ownership in domestic corporation
2. corporation was a small business corporation (less than $1MM total capital contributions plus paid-in capital
3. loss was sustained by the original owner of the stock
loss in excess of per year limit is treated as capital loss
any gains associated w/ Section 1244 stock treated as capital gains
Section 1231
assets must have holding period more than 1 year
gains = capital gains
losses = ordinary losses
Depreciation Recapture:
gain on the disposition of Section 1245 property treated as ordinary income to extent of depreciation allowed/allowable on property
any gain beyond that which must be treated as ordinary income is treated as a Section 1231 gain
Section 1245 property = property subject to an allowance for depreciation or amortization, tangible personal property used in a trade or business & includes depreciable property (equipment), patents, copyrights & other intangibles
Real Property (land & buildings) is NOT Section 1245 property
EXAM TIP:
the ONLY way to have a section 1231 gain on a section 1245 property is to sell it for more than it was originally purchased for
EXAM TIP:
Note - ANY sale amount in excess of the original purchase price of a Section 1245 asset is a Section 1231 gain
Section 1250 governs the recapture of depreciation on real Section 1231 assets (business realty such as buildings & real estate)
- lesser of gain or difference b/t depreciation taken & straight line depreciation taxed as ordinary income (recapture of excess depreciation)
- if gain exceeds amount, lesser of the remaining gain or the SL depreciation taken on the property will be taxed at 25% (un-recaptured Section 1250 depreciation)
- any gain in excess taxed at capital gains rates
ALL Section 1250 losses are ordinary losses
Nontaxable Exchanges - Involuntary Conversions Section 1033
deferral of gain on an involuntary conversion of property d/t destruction/theft/seizure/condemnation
defer gains to extent proceeds received reinvested in replacement property w/in appropriate time period
time period starts at date of realization of involuntary conversion or threat of condemnation; time period ends 2 years (3 years for condemnation of realty) from the year-end of year that gain is realized
to extent proceeds are not reinvested gain must be recognized
Like-Kind Exchanges Section 1031
deferred taxation of gains only for real property transactions held for either productive use in a trade or business or as an investment; only applys to U.S. realty, NOT foreign
1031 does NOT apply to = tangible personal property (since TCJA), personal assets, inventory, stocks, bonds, notes, interests in partnerships, certificates of trust or beneficial interests
anything considered not like-kind in the exchange is called “boot”
party trading up recognizes no gain & adds to their old basis any boot/cash given to other party
party trading down (receiving less like-kind property than given up) recognize gain to extent of boot received; if boot exceeds gain the amount of boot in excess of gain is treated as return of capital & reduces the basis in the new asset
FMV of new asset - gain NOT recognized + loss NOT recognized = basis in new asset
basis in boot received is FMV of property
IRC Approach (BEWARE OF USING IRC APPROACH!)
Adjusted Basis of Like-kind asset Given + Adjusted Basis of Boot Given + Gain Recognized - FMV of Boot Received - Loss Recognized = Basis in New Asset
TIP: mortgage relief is boot, so is forgiveness of debt, the one receiving debt relief think of as the one receiving cash
Bottom-Up Equity Managers
Value Managers
Technicians
looking for the next big, but as yet, undiscovered stock that will break onto the scene
start w/ the company then the industry then finally the economic climate
Top-Down Managers
Group rotation managers
Market timers
starts w/ the economic climate, moves to the industry then the company
R-Squared
R-Squared = correlation coefficient squared
R-Squared measures the percentage of return d/t the market
greater than or equal to 0.7 means beta is appropriate
When is standard deviation the best measure of a portfolio’s risk level?
when a portfolio is not well diversified
Basic Tax Formula
Gross Income
AGI
Taxable Income
Tax Due (or Refund Due)
Gross Income = Income (broadly conceived) - exclusions from income
AGI = Gross Income - deductions FOR AGI (ATL)
Taxable Income = AGI - (the greater of total itemized deductions (BTL) OR standard deduction) - any QBI x 20% deduction
Tax Due (or Refund Due) = Tax on Taxable Income - tax credits (including federal income tax withheld & other prepayments of federal income taxes)
Doctrine of Constructive Receipt
income is taxable when it is:
1. Readily available to the taxpayer, AND
2. that income is NOT subject to substantial limitations or restrictions
Qualifying Child (NOT for $2,000 credit)
Meets all of the following tests:
1. Relationship Test = taxpayer’s child, grandchild, step brother/sister, half brother/sister
2. Support Test = child does NOT provide more than 1/2 of their own support
3. Age Test = child is under age 19 or student under age 24
4. Abode Test = child lived w/ taxpayer more than 1/2 of the year
Qualifying Relative
Meets all of the following tests:
1. Relationship (or household member) Test = children, grandchildren, siblings, parents, grandparents, parent’s siblings OR anyone that lives w/ you all year even if they are not related
2. Support Test = provide more than 1/2 of the support of a dependent
3. Gross Income Test = dependent’s gross income must be less than $5,050 (2024)
4. Not a Qualifying Child Test = a dependent cannot be a qualifying child of any taxpayer for the tax year
EXAM TIP = no cousins unless in the same household!
Items Specifically Included in Gross Income
Compensation for services (including certain fringe benefits)
Gross income derived from business
Gains derived from dealings in property
Interest & Dividends
Rents & Royalties
Income from life insurance & endowment contracts
Pensions
Discharge of indebtedness (unless under bankruptcy)
Distributive share of partnership gross income
Unemployment benefits
Income in respect of a decedent (IRD)
Income from an interest in an estate or trust
Annuity payments
Alimony & separate maintenance payments (dated PRIOR to 2019)
Below Market Rate Loans (Imputed Interest)
Social Security Benefits Taxation
up to 85% of SS benefits may be taxable; dependent on taxpayer’s MAGI
MAGI + 1/2 of SS benefits must be compared to hurdle amounts (not on tax table)
1st hurdle: MFJ = $32K; MFS = $0; All Other Taxpayers = $25K
2nd Hurdle: MFJ = $44K; MFS = $0; All Other Taxpayers = $34K
- If MAGI + 1/2 SS Benefits exceeds first hurdle but not the second; taxable amount of SS Benefits is LESSER OF:
- 50% SS Benefits OR
- 50% [MAGI + (1/2 SS Benefits) - Hurdle 1] - If MAGI + 1/2 SS Benefits exceeds second hurdle; taxable amount of SS Benefits is LESSER OF:
- 85% SS Benefits OR
- 85% [MAGI + (1/2 SS Benefits) - Hurdle 2] + LESSER OF:
(a) $6K MFJ, $4,500 all other taxpayers OR
(b) taxable amount calculated under the 50% formula & only considering Hurdle 1
Below Market Rate Loans (Imputed Interest)
imputed interest included in income of lender (phantom interest income); also is the amount of the gift from the donor (lender) to the donee (borrower); gift may be eligible for annual gift tax exclusion
if loan less than or equal to $10,000 = NO imputed interest
loan greater than $10K but less than or equal to $100K = imputed interest is LESSER of NII or interest calculated using AFR less interest calculated using stated rate of the loan (if borrower’s NII less than or equal to $1,000 then $0 imputed interest)
if loan greater than $100,000 = imputed interest calculated using AFR less interest calculated using stated rate of the loan
AFR = Applicable Federal Rate
Items Specifically Excluded from Gross Income
Gifts & Inheritances
Life Insurance Proceeds
Scholarships (tuition, fees, books)
Gain on Sale of Personal Residence
Qualifying Distributions from Roth IRAs & Roth 401(K)/403(b) Plans
Compensation for Injuries & Sickness (workers comp?)
Employer sponsored accident & health plans
Child support payments received
Gross Income Exclusions - Employee Benefits
meals & lodging; lodging must be condition of employment
Employer sponsored Accident & Health Plans
- Medical
- Group Term Life Insurance
– cost of first $50K of coverage NOT taxable to employee; cost of excess coverage taxable determined by Uniform Premium Table I
Other Employee Fringe Benefits:
- Athletic Facilities (on employer premises)
- Educational Assistance Programs (limited to $5,250/year)
- Flexible spending Accounts permitted $3,200 (2024) per year whereas Dependent Care Spending Accounts permitted $5,000 maximum contribution per year
Classes of Nontaxable Employee Benefits:
- No-additional-cost-services
- Qualified employee discounts (service -20%; products - profit %)
- Working condition fringe benefits
- De Minimis fringe benefits
Functions of AGI (4)
- limiting measure (floor) for medical expenses (7.5%)
- limiting measure (ceiling) for charitable deductions
- determines deductibility of IRA contributions
- determines phaseout of other tax benefits
Above the Line Deductions (FOR AGI) ATL
deductions from losses on sale or exchange of property
deductions from rental & royalty property
1/2 self-employment tax paid
100% health insurance premiums paid by a self-employed individual
contributions to pension, profit sharing, annuity plans, IRAs, etc
penalty on premature withdrawals from time savings accounts or deposits
interest on student loans = $2,500 deduction regardless of filing status; may be used for higher education expenses related to tuition, fees, room & board, necessary fees for people at least half time; phaseout single 80-90K, MFJ 165-195K 2024
Health Savings Accounts
Trade or business expenses
Alimony payments = divorced before 2019 & NOT materially modified
ATL Deductions - Trade or Business Expense
in order for expenses to be deductible, they MUST be:
1. Ordinary = normal/usual/customary for others in similar business & not capital in nature
2. Necessary = prudent businessperson would incur same expense
3. Reasonable = question of fact
Other Ordinary & Necessary:
- Business Gifts = limited to $25 each plus shipping
- Entertainment Expenses = deductions except for meals are eliminated for years after 2017; 50% limit on meals, 100% of transportation costs; entertainment expenses are NO longer deductible
ATL Deductions - Alimony
for alimony paid under an agreement signed on or before 12/31/2018
alimony paid is a deduction FOR AGI ATL; payment for support, payments in cash that do NOT extend beyond death of payee
CHILD SUPPORT IS NOT ALIMONY
alimony received is earned income (provides for IRA funding) if divorced on or before 12/31/2018
alimony cannot be property settlement; no deduction is available for property transferred among spouses
for agreements signed (or significantly modified w/ an election to follow the new tax treatment) after 12/31/2018 = alimony is no longer deductible or taxable
ATL Deductions - Moving
Changes since TCJA:
- under TCJA, moving expenses are NO longer deductible except for armed services relocating to a permanent duty station
- if employer pays or reimburses moving expenses then employer must include the amounts paid in the employees gross income
Below the Line Deductions (FROM AGI) BTL
greater of sum of itemized deductions or standard deduction
standard deduction = given amount for tax year
itemized deductions (aka Sch A & BTL)
charitable contributions
limited casualty losses
medical expenses in excess of 7.5% of AGI (made permanent)
limited miscellaneous itemized deductions
interest on mortgage & investments, subject to limitations
taxes (state/sales & use, local, US property) capped at $10,000
***Qualified Business Income Deduction - applies to both standard & itemized
BTL Deductions (Itemized) - Casualty Losses
only available for Federally declared disaster areas; sudden & unexpected loss; not available for erosion or termite damage
loss equal to LESSER of decline in FMV or Adjusted Taxable Basis
less $100 per incident; subject to 10% of AGI floor
Estate Administration losses & Business casualty losses still exist; not subject to same restrictions
BTL Deductions (Itemized) - Misc Itemized Deductions
NOT subject to 2% AGI threshold:
- Income in respect of decedent (IRD)
- Gambling losses to extent of gambling winnings
- Impairment related work expenses for handicapped
- Annuity losses for decedent annuitant
*ABSOLUTELY need to know the deductions not subject to 2% floor
miscellaneous deductions previously subject to the 2% AGI limit are no longer deductible
BTL Deductions (Itemized) - Interest
Mortgage Interest:
- interest on up to $1MM of indebtedness on primary residence & one other property for property financed prior to 12/15/2017
- interest on up to $750K of indebtedness on primary residence & one other property for property financed after 12/15/2017
- NO home equity interest is deductible unless used to improve the property
- calculated by dividing the qualified mortgage over the total mortgage times the interest paid
Investment Interest:
- to the extent of net investment income (NII)
- NOT including qualified dividends & LTCG
- special election to tax these at ordinary income tax rate will include in net investment income (NII)
BTL Deductions (Itemized) - Taxes
state income taxes OR sales & use tax
city income taxes
ad valorem taxes (property taxes (house/vehicles etc) for US property
deduction when paid (cash basis)
no foreign taxes are deductible
deductible only by tax bill recipient
Capped at $10,000
BTL Deductions (Itemized) - Qualified Charity Contributions
overall the total deductible contributions for the tax year cannot exceed 50% of the donor’s AGI when both cash & property are donated in the same tax year
Adoption Expense Credit
credit for adoption expenses incurred up to $16,810 (2024)
phased-out ratably for MAGI b/t $252,150-$292,150 (2024)
an eligible child is one that is less than 18 years of age OR physically or mentally handicapped
Child Tax Credit
partially refundable child tax credit of $2,000 available to individual taxpayer for each qualifying child under the age of 17
Qualifying Child =
- is son/daughter/stepchild/foster child/brother/sister/stepbrother/stepsister/halfbrother/halfsister/or a descendant of any of them (ex grandchild)
- under age 17 @ end of tax year
- did NOT provide over half of their support for the tax year
- lived w/ taxpayer for more than half the year
- was a U.S. citizen, U.S. national, or a resident of the United States
under TCJA up to $,1700 each qualifying child credit may be refundable
phaseout AGI $200k/$400k
Qualifying Dependent Tax Credit (Family Credit)
qualifying dependent credit for years after 12/31/17
$500 nonrefundable credit
qualifying dependents includes dependents as defined under present law except for qualifying children under age 17; so assume qualifying relatives AND qualifying children age 17 & over are eligible
Child & Dependent Care Credit
credit of 20% of expenses paid (limited) for the care of dependent under age 13 or spouse or dependent w/ a handicap
lesser of actual costs or $3,000 for one qualified individual & $6,000 for two or more qualified individuals and the earned income of the lower earning spouse
EXAM TIP: most likely to be tested is 20% x eligible costs; $3,00 for one child or $6,000 for two children
Kiddie Tax
applies to unearned income of dependent children under age 19 living w/ parent or under age 24 & a full-time student
unearned income in excess of $2,600 taxed at parent’s rate
unearned income b/t $1,300 & $2,600 taxable @ child’s rate
earned income above the standard deduction taxed @ child’s rate
apply standard deduction for a dependent = greater of $1,300 or earned income plus $450 (limited to $14,600)
EXAM TIP: the kiddie tax only applies to UNEARNED INCOME in excess of $2,600
AMT
taxpayer liable for greater of regular tax liability or the AMT
AMT = regular taxable income +- adjustments + preferences less AMT exemptions (2024) $133,300 MFJ, $85,700 single/HoH, $66,650 MFS
preferences = permanent changes (private activity bonds)
AMT Adjustments
positives or negatives
accelerated depreciation for real & personal property that is allowable for regular tax purposes (added back)
the standard deduction if itemized deductions are NOT used (added back)
taxes (state/local/property) (added back, capped at $10k)
Incentive Stock Option bargain element (positive @ exercise, negative @ sale)
AMT Preference Items
Percentage depletion
Intangible drilling costs
Interest on private activity bonds
EXAM TIP: make sure to know the three preference items!
permanent increases; always added back, NEVER subtracted
Hobby Losses
all ordinary, necessary, & reasonable business expenses are deductible against income; to be classified as a business activity the taxpayer must have a profit motive
when there is no profit motive & the activity is classified as a hobby = ALL of the hobby income must be included in gross income
TCJA hobby expenses are NOT deductible
no profit in 3 years out of 5 years = presumed a hobby
hobby activities cannot generate deductible losses
the hobby rules may still be tested as it relates to when an activity is deemed a hobby & as it relates to mixed use real estate rentals
Rental Use Classification
- Is the property rented for less than 15 days?
- YES = nontaxable activity = income realized, NOT recognized, no expenses may be claimed
- NO = see next step - Is the property used by the owner for more than the greater of 14 days or 10% of the rental days?
- YES = Mixed Use Activity = income recognized, allocable expenses deductible to extent of income, 2% floor does NOT apply, expenses deducted ATL, unused expenses can be carried forward
- NO = Rental Activity = income recognized, all allocable expenses deductible even if rental activity results in loss, ability to claim loss may be limited by passive-activity rules
Tax Deductions for Pass Through Entities
20% deduction based on QBI; deduction reduces taxable income, NOT AGI
Taxable Income Flow Through Entities
At Risk Rules & Passive Activity Treatment:
- three types of income = active, passive, portfolio
- under the at risk rules, apply before passive activity rules, losses can only be deducted to the extent of property/money that is at risk
passive losses can only offset passive income &/or gains
At-risk = amount of a taxpayer’s economic investment in an activity, amount of cash & adjusted basis of property contributed to activity plus amounts borrowed for which taxpayer is personally liable (recourse debt)
Passive Activity = NO material participation, rental activities even w/ material participation; exception = real estate dealers are NOT considered a passive activity
if the real estate is actively managed then taxpayer can deduct up to $25K from ordinary income subject to phase-out of $1 for every $2 AGI exceeds $100K
Material Participation = greater than 500 hours per year OR greater than 100 hours & the most of any participant
Suspended Losses at Risk = if suspended losses are from “At Risk” activity they are NOT deductible until the at risk amount is positive from additions or income; if losses are suspended under passive activity rules the losses are deductible upon disposition
Publicly Traded Partnershps must be treated separately; income/losses can only be used for that partnership
losses from a limited partnership cannot be used to offset income from a master limited partnership (MLP)
Election to Expense Assets - Section 179
can elect to immediately expense up to $1,220,000 of business tangible property placed in service during the year
expense limitation reduced by amount of Section 179 property placed in service during year that exceeds $3,050,000; dollar-for-dollar reduction
election to expense cannot exceed taxable income (before section 179) of taxpayer’s trades or business (taxpayer cannot create a loss using Section 179)
- excess of limitation over taxable income limitation may be carried over to subsequent years, amount carried over still reduces basis currently
Section 179 applies BEFORE MACRS
Industries More Affected by Recession as employment & production are concerned:
- Capital goods
- Consumer durable goods
- Consumer nondurable goods
- Services
Capital Goods & Consumer durable goods are cyclical & fluctuate directly w/ the economy & GDP
Holding Period Return Formula
(SP - PP +- CF) / PP or equity invested
% of return available from a given investment
CF includes margin interest
SP = selling price
PP = purchase price
CF = cash flow
Conversion Value Formula
CV = (PAR / CP) x Ps
values a convertible bond in terms of its conversion value rather than its market price
CV = conversion value
PAR = face value of bond
CP = conversion price to convert the bond to shares of common stock
Ps = sale (or market) price of the stock
Jensen Model (alpha)
measures performance of portfolio manager to the market on a risk adjusted basis
+alpha = good
-alpha = bad
absolute measure
Margin Position
MP = Equity / FMV
current equity position of the investor
Equity = Stock Price - Loan
Required Equity = Current Price x Maintenance
Market Risk Premium in CAPM
(Rm - Rf)
Margin Call Formula
Margin Call = Loan / (1 - Maintenance Margin)
the lowest price at which the price can fall before an investor will receive a margin call
***at what price does an investor receive a margin call price
Tax Exempt Yield
not on formula sheet
= corporate rate x (1 - Marginal Tax Rate)
after tax ROR a taxable corporate bond pays
Taxable Equivalent Yield
on formula sheet
TEY = r / (1 - t)
r = tax exempt yield
t = investor’s marginal tax rate
the equivalent yield of a taxable security
Exam Tip = if I am given the taXable rate, I need to multiple (X) in the formula
Tax Equivalent = think pre-tax
Information Ratio
on formula sheet
IR = (Rp - Rb) / SDa
Rp = return of portfolio
Rb = return of a benchmark
SDa = tracking error of active return
measures return above benchmark divided by SD
measures the excess return & consistency provided by a fund manager relative to a benchmark
Expected ROR formula
on formula sheet
r = (D1 / p) + g
D1 = next expected dividend
p = market price paid for a security
g = dividend growth rate or the company growth rate
the rate an investor should expect based on price paid for a security
Property Valuation Formula
Value = Net Operating Income (NOI) / Capitalization Rate
the value of income producing property
cap rate = opportunity cost of capital
Net Present Value Formula
NPV = PV of CF - Cost
value of a stream of future cash flows discounted at the opportunity cost of capital
Exam Tip = if NPV = 0 then yes make the investment
a positve NPV the investor would make the investment
a negative NPV & the investor would NOT make the investment
Coefficient of Variation formula
CV = SD / x
x = mean expected (average) return
standardizes the measure of risk per unit of return
useful when comparing two assets w/ different average returns
Exam Tip = the asset w/ lower CV (risk/return) has the higher risk asjusted return (return/risk)
the higher the CV the more risky an investment & the less likely an investor is to achieve the average return
The estimated value of a real estate asset in a financial statement prepared by a CFP certificant should be based upon the:
value that a well informed buyer is willing to accept from a well informed seller where neither is compelled to buy or sell
Supply Demand Graph
x axis = quantity
y axis = price
top left to bottom right = Demand
bottom left to top right = Supply
Comparing HMOs & PPOs
HMO = cheaper, in-network only
PPO = more expensive, more flexibility
similarities = no paperwork if in-network?
Long Term Care (LTC)
must be chronically ill or suffer from substantial cognitive impairment
chronically ill = unable to perform 2 of 6 ADLs for at least 90 days
substantial cognitive impairment = behavior threatens own/others health & safety
ADLs = eating, bathing, dressing, transferring from bed to chair, toileting, continence
BEDTC
EXAM TIP: walking is NOT a current ADL
premiums tax deductible & benefits tax free if policy is qualified
maximum deduction if over 70 = $5,880 (likely to be tested)
EXAM TIP: a portion of LTC premiums are tax deductible subject to medical deduction of 7.5% of AGI
qualified requirements = no surrender value, limited to qualified LTC services, dividends to reduce future premiums or increase benefits, meet consumer protection laws, does NOT pay for expenses covered under Medicare
General Exclusions for all HO Policies
Movement of ground (earthquake/landslide)
Ordinance or Law (regulations construction/demolition)
Damage from water (floods, water from underground, sewer backup)
War or nuclear hazard (nuclear power plant)
Power failure (power plant failure that causes a loss)
Intentional act (burning down your own house)
Neglect (must take reasonable means to save property & mitigate loss)
Homeowners Insurance Forms Available
HO-1 = Basic Form, basic named perils
HO-2 = Broad Form, basic & broad perils
HO-3 = Special Form, coverage on dwelling & other structures on an open peril basis resulting in coverage against all physical loss other than those specifically excluded; personal property covered on a named peril basis (memorize HO-3)
HO-4 = Contents Broad Form (renters)
HO-5 = Comprehensive Form
HO-6 = Unit Owners Form (CONDO OWNERS)
HO-8 = Modified Form (old homes)
Collision
Part D
protects against an accident involving another car, running off the road, into a creek or lake, tree, wall
Comprehensive or Other Than Collision (comprehensive = animate object always (rock animal, if inanimate (run into a wall) then collision if behind the wheel & comprehensive if not behind the wheel)
Part D
covers the following perils:
falling objects
fire
theft
explosion
earthquake
windstorm
hail
water
flood
mischief
vandalism
riot
contact w/ a bird or animal
breakage of glass
Personal Liability Umbrella Policy (PLUP)
protection against legal obligations that arise from negligent acts
pays the costs up to the face of the policy that result in a liability
usually provides defense for the insured in the event of a lawsuit
requires higher liability limits on underlying auto & homeowner policies
the coverage includes exposure at the premises of the residence or away from the residence
EXAM TIP: if a client doesn’t have a PLUP THEY NEED IT; a PLUP is always the right answer; look for $1 million in coverage
Social Security Percentages & Payroll taxes
OASDI 6.2% (both ER & EE) up to wage base $168,600 (single, rest on formula sheet)
Medicare 1.45% (both ER & EE) unlimited amount of wages
Additional Medicare tax of 0.9% (EE) on income in excess of $200,000 if single or $250,000 for MFJ unlimited amount of wages
Social Security Definition of Disability
disability is expected to last for 12 months or disability will result in your death & cannot perform the duties of any occupation
severe physical or mental impairment that is expected to prevent worker from performing substantial work for at least one year or result in death
Social Security Retirement Eligibility (Medicare)
to qualify for retirement benefits a worker must be “fully insured”
must earn 40 quarters of coverage
1 quarter = $1,730 in wages subject to social security
Social Security Disability Eligibility (Medicare)
covered for disability if age 31 & greater, fully insured (40 quarters) & earned 20 quarters in the last 40 quarters
24-31; 1/2 of calendar quarters elapsed since worker reached age 21
if ages 21-24; 6 quarters earned
currently insured has NO spousal benefit
Social Security Beneficiaries
Most Important:
Disabled insured worker under age 65
A retired insured worker under age 62
Spouse of a retired or disabled worker who is at least 62 OR is caring for a child under age 16 or disabled
Divorced spouse of a covered worker if age 62 & married to the worker for at least 10 years & did not remarry
Widow at age 60, care of child under age 16
*watchout for blackout period
Medicare
provides hospital & medical insurance
must have attained age 65 years OR disabled for 2 years
Social Security Beneficiaries Chart
Like Kind Exchange Steps
ISO vs NQSO
AMT does NOT apply to NQSO
Credit Summary and Kiddie Tax
Hints on ISOs
Defined Contribution Plan Vesting Schedules
Defined Benefit Plan Vesting Schedules
Highly Compensated vs Key Employee
Top-Heavy Plan Characteristics & Requirements (Definition, Funding, Vesting, DB & DC differences)
QP Plan Limits - Covered Compensation & Maximum Benefit
Defined Benefit Pension Plan Funding Formulas
Roth IRA vs Roth 401(k) Account
an employee could contribute up to $23,000 to a Roth 401(k) account or to a pretax account but NOT to both
Profit Sharing Plans CODA - ADP Test
Actual Deferral Percentage Test (ADP Test) - limits the employee elective deferrals for the HC based on the elective deferrals of the NHC; test ensures that HC aren’t taking too much more advantage of the plan than NHC
**If ADP for NHCEs is 2% then 2 times; technically second row is over 2% & less than 8%
**if the HC are higher, employer failed the ADP test
Stock Bonus Plans vs Profit Sharing Plans
Advantages & Disadvantages of ESOPs
Stock Bonus Plans vs ESOPs
Distributions Due to Death SECURE Act distributions based on beneficiary type
Designated Beneficiary based on owner’s death rules
Characteristics of all qualified plans
Selecting Qualified Plan Flowchart
Characteristics of a Disqualified Person
Prohibited Transactions
generally include actions by a disqualified person that potentially could have adverse consequences to the plan or participants, including:
EXAM TIP = be able to recognize prohibited transactions
Earned Income vs NOT Earned Income (IRA Eligibility)
IRAs - Roth IRA Nonqualified Distributions
contribtutions first then conversions then earnings finally
*think “best out 1st”
Roth 401(k) vs Roth IRA
457 Plans - Public vs Private Plans
457 Plans - Flowchart
457(f) Plans
457 Plan Comparison Chart
457 Plan General Characteristics Chart
Characteristics of Alternative Deferred Compensation Arrangements Table
ISO v NQSO Chart
Employee Benefits: Fringe Benefits - Important Numbers 2024
COBRA Qualifying Events
Contingent Legatee Clause
determines how the proceeds will be divided w/ relation to the deceased heirs & their descendants
Per Stirpes (By Representation or By the Roots):
- grandchildren stand in for their deceased parent & get that share to split among themselves
Per Capita (By the Head):
- equal shares based upon # of living beneficiaries; heirs of the same generation get an equal share IF they are the only heirs
Per Capita At Each Generation:
- heirs of the same generation ALWAYS get an equal share; typically one of the more preferred methods of leaving assets to heirs
Power of Attorney
stand-alone document, allows an agent to act for the principal & may include power to appoint assets
power to act
ends at the death of the principal
may be general or limited
may be revoked at anytime by the principal
used for health care or property management
Limited used in a non-marital trust
General may be used in a marital trust
Power of Appointment
a power, usually included in a trust or power of attorney, allowing power holder to direct assets to another (eg pay bills)
power to transfer assets
may survive the death of the grantor
may be general or limited to an ascertainable standard or limited in some other way
may be revoked at anytime by principal
Probate Process
assets may transfer & be retitled through the probate process, by contract, by state titling law, or by state trust law
5/5 Lapse Rule
if a trust has more than one beneficiary, the 5/5 Lapse Rule must be applied to determine i the lapse causes a taxable gift from the beneficiary holding the Crummey power to the other beneficiaries of the trust
such a taxable gift is a gift of future interest & is NOT qualified for the annual exclusion
a taxable gift is deemed to have been made when a power to withdraw an amount in excess of the GREATER of $5,000 or 5% of the trust assets has lapsed, or not been used by a beneficiary
Lifetime Gifting Techniques to Achieve a Lower Gross Estate at Death
EXAM TIP = know this chart!
Gross Estate Formula
value of a decedent’s gross estate = the FMV of all interests owned by the decedent at their time of death
SCIN vs Private Annuity
Revocable Trusts vs Irrevocable Trusts Chart
Charitable Remainder Trusts - Summary Characteristic Table
Lineal Descendants
Unrelated Parties
