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
Interest & Penalties for Noncompliance (Filing Taxes)
Failure to File = Five %
Failure to Pay = Point five %
Annual Depreciation Deduction Formula
Adjusted Basis - Salvage Value = Depreciable Amount
Depreciable Amount / Estimated Useful Life = Annual Depreciation Deduction
Property Classes & Depreciation
3 Year = Tractors, rent-to-own property
**5 Year = Autos, computers, office equipment
**7 Year = office furniture & fixtures
27.5 Year = rental home
39 Year = office building
** = the two categories most likely to be tested
Which property uses mid-month convention depreciation?
nonresidential real property & residential rental property
Sole Proprietorships Advantages & Disadvantages
Advantages:
- easy to form
- simple to operate
- easy to sell business assets
- few administrative burdens
- income generally passed through to the owner on Schedule C of Form 1040
Disadvantages:
- generally have limited sources of capital
- unlimited liability
- no guarantee of continuity beyond the proprietor
- business income is subject to self-employment tax
General Partnerships Advantages & Disadvantages
Advantages:
- more sources of initial capital than proprietorships
- usually have more management resources available than proprietorships
- have fewer administrative burdens than corporations
- income & losses generally passed through to the partners for tax purposes
Disadvantages:
- transfer of interests more difficult than for proprietorships
- unlimited liability (each partner liable for partnership debts & obligations)
- partnership income tax & basis adjustment rules can be complex
- business net income subject to self-employment tax
- partners entitled to few tax-free fringe benefits that are generally available to all employees
Limited Partnerships Advantages & Disadvantages
Advantages:
- favorable pass-through partnership taxation status
- flexibility in structuring ownership interests
- limited partners are not personally liable for the debts & obligations of the limited partnership as long as they do not engage in management
Disadvantages:
- must file w/ the state to register
- in most states, general partners are liable for debts & other obligations of the limited partnership
- losses for limited partners are generally passive losses
Limited Liability Partnerships (LLP) Advantages & Disadvantages
Advantages:
- favorable pass-through partnership taxation available
- flexibility in structuring ownership interests
- partners can insulate themselves from the acts of other partners
Disadvantages:
- required to file w/ the state to register
- unlimited liability for own acts of malpractice
Family Limited Partnerships (FLP) Advantages & Disadvantages
Advantages:
- control retained by senior family member
- valuation discounts are available for minority interests
- annual exclusion gifts generally used to transfer interests to family members
- some creditor protection
- restrictions can be placed on transferability of limited partnership interests of junior family members
- FLP is commonly used as an estate planning strategy
Disadvantages:
- attorney setup fees & costs
- periodic valuation costs
- operational requirements
- potential IRS challenges regarding valuations & discounts
Limited Liability Companies (LLC) Advantages & Disadvantages
Advantages:
- members have limited liability
- # of members unlimited but single member LLC is disregarded entity for tax purposes (file form 1040 schedule C)
- members may be individuals, corporations, trusts, other LLCs & other entities
- income passed through to members usually on Schedule K-1
- double taxation affecting most C corporations avoided if partnership tax status elected
- members can participate in managing the LLC
- distributions to members do not have to be directly proportional to the members’ ownership interests as they do for S corporation
- can have multiple classes of ownership
- entity may elect to be taxed as a partnership, an S corporation, or a C corporation
Disadvantages:
- may have limited life (often by the termination on the death or bankruptcy of a member)
- transfer of interests is difficult & sometimes limited by operating agreement
- some industries or professions may not be permitted to use LLC status
- laws vary from state to state regarding LLCs
- laws are relatively new for LLCs therefore precedent from prior court cases are limited
- for tax purposes the complex partnership rules generally apply
- members not meeting exceptions are subject to self-employment tax on all earned income if partnership status is elected
C Corporation Dividend-Received Deductions based on ownership percentages
ownership less than 20% = 50% DRD
ownership at least 20% & less than 80% = 65% DRD
ownership at least 80% (affiliated corporations) = 100% DRD
C Corporations Advantages & Disadvantages
Advantages:
- relative ease raising capital
- limited liability of shareholders
- unlimited life of entry
- ease of transfer o ownership interests
- generally more management resources
- shareholder/employees may receive the full array of employer-provided tax-free fringe benefits
Disadvantages:
- potential for double taxation d/t entity level taxation
- administrative burdens (filings)
- more difficult to form & dissolution can cause taxable gains
- borrowing may be difficult w/out stockholder personal guarantees which negates part of the advantage of limited liability
- requires a registered agent
- requires a federal tax ID #
S Corporation Requirements
must meet all following requirements at all times for “S” election to be initially & continually valid
- no more than 100 eligible shareholders
- ownership of S corp stock restricted to individuals who are US citizens or US residents, estates, certain trusts, & charitable organizations; an ESBT (Electing Small Business Trust) is one of the trusts that an own an S Corporation
- the corporation must be an eligible corporation created under the laws of the United States or of any state
- Insurance companies, Domestic International Sales Corporations (DISCs), & certain financial institutions are NOT eligible for S corp status
- the corporation is allowed only one class of outstanding stock however the one class of stock may have shares w/ voting rights & shares w/ no voting rights
S Corporation Advantages & Disadvantages
Advantages:
- income passed through to shareholders for federal income tax purposes
- income taxed at individual level which may be lower tax rate than applicable corporate rate
- shareholders have limited liability
- distributions from S corporations are exempt from the payroll tax system assuming the corporation provides adequate compensation to those shareholders who are employees of the corporation
Disadvantages:
- limited to 100 shareholders
- only one class of stock permitted
- cannot have corporate, partnership, certain trust, or nonresident alien shareholders
- shareholder employees owning more than 2% of the company must pay taxes on a range of employee fringe benefits that would be tax-free to a shareholder/employee of a C corporation
- the tax rate of the individual shareholder may be higher than the corporate tax rate
- borrowing may be difficult w/out stockholder personal guarantees, which negates part of the advantage of the limited liability
Personal Holding Company
both requirements to be met:
- Personal Holding Company Income Test = at least 60% of the corporation’s adjusted ordinary gross income for the tax year is from dividends, interest, rent & royalties
- Stock Ownership Requirement = at any time during the last half of the tax year more than 50% in value of the corporation’s outstanding stock is owned, directly or indirectly, by 5 or fewer individuals
Odd Lot Theory
small investors are always wrong
if odd lot purchases are falling d/t relative odd lot sales, it indicates the little guy thinks the market will fall
according to theory this would indicate rally is coming
Dow Theory
deals in three levels of market activity over time
DB Taxable Amount to Purchaser in Viatical Settlement
Taxable Amount = Death Benefit - Purchase Price of Policy - Premiums Paid by Purchaser after Purchase
3 Risks of Mortgage-Backed Securities
purchasing power risk
interest rate risk
prepayment risk
the duration of a bond is a function of its:
current price
time to maturity
yield to maturity
coupon rate
3 Authority Levels
- Implied Authority = actions assumed to be part of an agent’s repertoire w/in their rights; authority to write a policy etc; this level takes place b/t the agent & the company (as stated in the facts of the question)
- Express Authority = written in the contract
- Apparent Authority = when a 3rd party believes there is authority (signage, business cards) but NONE EXISTS
Note:
when a client sees letter head, they assume you can conduct business; that is based on one of two things:
1. you have expressed authority which means you have implied authority
OR
2. you do not have expressed authority which means you have apparent authority
Dividends
Cash Dividends:
- qualified dividends receive capital gains treatment
- Qualified Dividend = paid by american company or qualifying foreign company, not listed as a dividend that doesn’t qualify by IRS, held the stock for more than 60 days during the 121 day period that begins 60 days before the ex-dividend date
Stock Dividends are NOT taxable to the shareholder
Beta
measure of systematic risk or market risk whereas standard deviation is a measure of total risk
beta is an appropriate measure of risk for a well diversified portfolio
beta of the market is 1
beta greater than 1 will have greater fluctuation & vice versa
Coefficient of Determination
R-Squared
measure of how much return is d/t the market
R-squared tells the investor if beta is an appropriate measure of risk
greater than or equal to 0.7 indicates beta is an appropriate measure
tells us diversification & benchmark
Modern Portfolio Theory
acceptance by an investor of a given level of risk while maximizing their expected return objectives
Optimal Portfolio is the one selected from all efficient portfolios
1. investors seek the highest return attainable at any level of risk
2. investors want the lowest level of risk at any level of return
3. the assumption is also made that investors are risk averse
Serial bonds
issued in series & mature in series
Registered bonds
paid interest based on to whom the bonds are registered
Bearer bonds
pay interest to the holder of the bond
Reset bonds
interest rates can be reset on reset bonds & U.S. government issues Treasury bonds, both are registered
Substitution Swaps
take advantage of anticipated & potential yield differentials b/t bonds that are similar w/ regard to coupons, rating, maturities, & industry
Rate Anticipation Swaps
utilize forecasts of general interest rate changes
Yield Pickup Swaps
designed to alter the cash flow of the portfolio by exchanging similar bonds having different coupon rates
Tax Swaps
replaces bonds w/ offsetting capital gains & losses
Minimum Tax Amount to Pay in Estimates to meet safe harbor
90% of current year, 100% of prior year, OR 110% of prior year
If AGI from year prior is greater than $150K then safe harbor is 90% of current year tax or 110% of prior year tax
110% for prior year tax safe harbor ONLY applies if AGI is over $150K this year
Effective Income Tax Rate
the average rate a taxpayer pays based on taxable income
determined by dividing the tax liability by the taxable income
Items NOT allowed when figuring an NOL
any deduction for personal exemptions
capital losses in excess of capital gains
the section 1202 exclusion
nonbusiness deductions in excess of nonbusiness income
net operating loss deduction
the domestic production activities deduction
Like Kind Exchange Steps
ISO vs NQSO
AMT does NOT apply to NQSO
Credit Summary and Kiddie Tax
Hints on ISOs
Pension Plan Characteristics
legal promise of the plan = paying a pension at retirement
NO in-service withdrawals permitted (under Pension Protection Act of 2006 defined benefit pension plans can provide for in-service distributions to participants age 59.5 or older)
mandatory funding standards (for plan years beginning in 2008 the funding rules under IRC Section 412 have been amended by the Pension Protection Act of 2006)
10% of plan assets available to be invested in employer securities
plan must provide qualified joint & survivor annuity & qualified presurvivor annuity
Profit Sharing Plan Characteristics
legal promise of the plan = deferral of compensation & taxation
in-service withdrawals permitted after two years if plan document permits
NO mandatory funding standards
up to 100% of plan assets available to be invested in employer securities
plan does NOT have to provide qualified joint & survivor annuity & qualified presurvivor annuity
Defined Benefit Plan Characteristics
annual contribution limit = not less than the unfunded current liability
Employer assumes investment risk
forfeitures allocated to reduce plan costs
subject to Pension Benefit Guaranty Corporation (PBGC) coverage EXCEPT professional firms w/ less than 25 employees
investment accounts are commingled (NOT SEPARATE ACCOUNTS); participants have accrued benefits; accrued benefit roughly equal to the present value of the expected future payments at retirement
credit CAN be given for prior service for the purpose of benefits
favors older employees
Defined Contribution Plan Characteristics
annual contribution limit = 25% of total employee covered compensation
Employee assumes investment risk
forfeitures allocated to reduce plan costs or allocate to other participants
plan NOT subject to PBGC coverage
investment accounts are usually separate (separate accounts); participants have account balances
credit CAN NOT be given for prior service for the purpose of benefits
favors younger employees (usually)
Advantages of Qualified Plans
Advantages to the Employer:
- Employer contributions currently tax deductible
- Employer contributions to the plan are NOT subject to payroll taxes; no avoidance for employee elective deferrals
Advantages to the Employee:
- Availability of pretax contributions for employees
- Tax deferral of earnings on contributions
- ERISA protection (Anti-Alienation prohibits any action that may cause the plan assets to be assigned, garnished, levied, or subject to bankruptcy proceedings; protection from employers)
- Lump-sum distribution options (ten year averaging only for those born prior to 1936, NUA, Pre-1974 capital gain treatment)
Disadvantages of Qualified Plans
limited contribution amounts
contributions cannot be made after money is received
plans usually have limited investment options
no or limited access to money while an active employee
distributions usually taxed as ordinary income (basis = $0)
early withdrawal penalties may apply
mandatory distributions at age 73
only ownership permitted is by the account holder
cannot assign or pledge as collateral
cannot gift to charity before age 70.5 w/out income tax consequences (charitable gifts from IRAs post age 70.5 & pre age 73 will NOT count towards RMDs for those turning 70.5 after 12/31/19 or for those turning 73 after 12/31/22)
any year a deductible contribution is made to an IRA & a charitable distribution is made from an IRA the allowable charitable deduction will be reduced by deductible contributions made after age 70.5
limited enrollment periods
considered to be an Income in Respect of a Decedent (IRD) asset, subjecting distributions to both income & estate taxes w/ no step-up in basis
costs of operating the plan
QP Qualification Requirements
Plan Document - in writing by end of tax year; funding doesn’t have to occur until tax return filing plus extension
Eligibility - 21 years old & 1 year of service or 2 years of service w/ 100% vesting (does NOT apply to 401(k) plans)
Coverage
Vesting - 2 to 6 years graduated or 3-year cliff
Special Qualification Requirements apply to Top-Heavy Plans & Cash or Deferred Arrangements (CODAs) 2 to 6 years graduated or 3-year cliff
Limitation on Benefits & Contributions
QP Eligibility & Plan Entrance Dates
Eligibility:
- Age 21 & one year of service (1,000 hours worked during one plan year)
- special election to require two years of service - 100% vesting requirement; NOT available for 401(k) plans
- Tax-exempt educational institutions can require age 26
- Plan Entrance Date - MUST have at least 2 per year
QP Eligibility Long Term PT (Part-Time) Employees
for plan years beginning after 12/31/20:
- 401(k) must allow LT PT Employees to participate in 401(k) (SECURE Act) upon the completion of: 500 hours per year, 3 continuous years, years completed after 12/31/20 will count; eligibility would begin in 2024 (after the completion of 3 continuous years)
Highly Compensated Employees (Very Important Definition)
Two Classifications = Highly Compensated (HC) & Non-Highly Compensated (NHC)
Highly Compensated = an employee who is either:
1. a more than 5% owner at any time during the plan year OR preceding plan year (owns more than 5% of a company’s stock or capital (if an EE owned 5% of their employer’s stock that EE would NOT be considered highly compensated); don’t forget in addition to direct ownership the family attribution rules consider shares of stock owned by certain relatives including spouse, children, grandchildren, or parents as if owned by one owner
- an EE w/ compensation in excess of $155,000 2024 for current plan year; if special employer election is made add “and in top 20% of employees ranked by salary”
- an EE w/ compensation in excess of $150,000 2023 for the prior plan year; $135,000 2022 look-back
QP Coverage Tests - 3
Plan must be nondiscriminatory; all qualified plans must pass at least ONE of the following tests:
- Safe Harbor Test = greater than or equal to 70% of NHC covered
- Ratio % Test = % NHC Covered / % HC Covered ratio greater than or equal to 70%
- Average Benefits Test (Both Tests AB % Test & Nondiscriminatory test) (Nondiscriminatory test rule not likely to be tested) = AB % NHC Covered / AB % of HC Covered ratio greater than or equal to 70 % AND Nondiscriminatory test
50/40 Test
Defined Benefit Plans must additionally pass the 50/40 test
Plan must cover the LESSER of 50 employees (eligible) or 40% of employees (eligible) w/ a minimum of 2 our of 3 employees (unless there is only one EE in which case only 1 participant is required)
EXAM TIP: to remember that it’s 50 employees or 40%, remember ‘people come first’; EMPLOYEES COME FIRST!
QP Vesting
Defined Contribution Plan:
- Noncontributory = 2-6 year graduated OR 3 year cliff
- Deferral (Contributory) = 100% vested
Defined Benefit Plan:
- 3-7 year graduated OR 5 year cliff
***In any case ER can always be more generous
Defined Contribution Plan Vesting Schedules
Defined Benefit Plan Vesting Schedules
Top Heavy & Key Employee
Special Plan Requirements for Top-Heavy Plans:
Top-Heavy:
- Defined Contribution: greater than 60% of account balance attributable to key employees
- Defined Benefit: greater than 60% of accrued benefits attributable to key employees
Key Employee:
- greater than 5% owner OR
- greater than 1% owner w/ compensation in excess of $150,000 (not indexed) OR
- an officer w/ compensation in excess of $220,000 for 2024; officer determined based on all facts
Highly Compensated vs Key Employee
Top-Heavy Plan Characteristics & Requirements (Definition, Funding, Vesting, DB & DC differences)
QP Plan Limits - Covered Compensation & Maximum Benefit
Rules for Material Participation
- More than 500 hours of participation
- Taxpayer is the only one who substantially participates
- Taxpayer spends greater than 100 hours in the tax year & no one else spend more
- Taxpayer has materially participated in any 5 of the previous 10 years
- The activity is a personal services activity & the individual has materially participated in any 3 prior years
- Taxpayer participates 100 or more hours in this activity & total participation in all such activities exceeds 500 hours
1231 5-Year Look Back
Section 1231 gains offset by most previous 5 years
amount of most recent 5 years of losses is amount taxed at ordinary income & remaining 1231 gain taxed as section 1231 capital gain
Traditional Pension Plans Defined Benefit Annual Pension Benefit Amount Calculation Formula
Annual Pension Benefit Amount = percent per year x # of years of service x Average of the 3 highest consecutive years salary (salary used can vary based on plan documents)
Life Insurance in Qualified Plans
Limited Investment in Life Insurance; any QP may purchase life insurance as long as life insurance is not the primary focus of the plan
premiums paid by ER taxable to EE at time of payment to extent of the Table I cost of insurance
to maintain its qualified plan status a QP that includes life insurance must pass EITHER the 25% test OR the 100-to-1 ratio test
25 Percent Test: consists of two tests depending on type of life insurance 25% or 50%
- Term/Universal Life = aggregate premiums paid for the life insurance policy CANNOT exceed 25% of the employer’s aggregate contributions to the participant’s account
- Whole Life = aggregate premiums paid for the whole life insurance policy CANNOT exceed 50% of the employer’s aggregate contributions to the participant’s account
100-to-1 Ratio Test:
- limits the amount of the death benefit of life insurance coverage purchased to 100 times the monthly-accrued retirement benefit provided under the same qualified plan’s defined benefit formula
Pension Plans - Actuary
Actuary = determine required plan funding range, assumptions, costly (drive up costs of the plan)
Required Annually for Defined Benefit Pension Plan & Cash Balance Pension Plan
Required ONLY at Inception for Target Benefit pension plan
money purchase pension plan has no need for actuarial services because the annual contribution is predefined in the plan documents
EXAM TIP = NO other plans require an actuary
Pension Plans - Social Security Integration (2)
Excess Method = provides an excess benefit to those participants whose earnings are in excess of the Social Security wage base; used by both Defined Benefit & Defined Contribution Plans
Offset Method = reduces the benefit to those employees whose earnings are below the Social Security wage base; used ONLY by Defined Benefit Plans
Defined Benefit Pension Plan Funding Formulas
Pension Plans - Defined Benefit Pension Plan
mandatory funding
pension benefit based on defined funding formula
- Flat Amount Formula = equal dollar benefit
- Flat Percentage Formula = % of salary
- Unit Credit Formula = YOS x % x salary
commingled accounts
favors older plan entrants
all plans must meet eligibility/coverage/vesting rules
Pension Plans - Cash Balance Pension Plans
DB pension plan
mandatory funding
pension benefit based on an annual guaranteed contribution rate & guaranteed earnings on the contributions
Quasi-Separate Accounts = participant sees hypothetical account w/ hypothetical earnings; actuarially determined
favors younger plan entrants
all plans must meet eligibility/coverage/vesting rules
uses 3 year cliff vesting; employer can be more generous in vesting schedule
EXAM TIP = cash balance plans are a popular choice to get rid of old expensive DB plans!
Pension Plans - Money Purchase Pension Plans
DC pension plan
mandatory annual funding of a fixed percentage of total employer covered up to 25%
participant bears investment risk
separate accounts
favors younger plan entrants
eligibility/coverage/vesting
not likely to be stablished after EGTRRA 2001
Pension Plans - Target Benefit Pension Plans
special type of money purchase pension plan
determines the contribution based on the participant’s age
participant bears investment risk
favors older plan entrants
eligibility/coverage/vesting
requires actuary services at inception of plan
Profit Sharing Plans - Characteristics
defined contribution plans
established & maintained by an employer
provides for employee participation in profits
utilizes a definite predetermined formula for allocating the contributions to the plan
MUST be nondiscriminatory
either noncontributory or contributory
Contributory vs Noncontributory
Noncontributory = employee does NOT contribute to the plan & all contributions to the plan are from the employer
Contributory = employee contributes to the plan (deferrals/CODA)
Profit Sharing Plans - Contributions & Deductions
contributions must be made by the due date of the company’s income tax return
contributions are discretionary but MUST be “substantial & recurring”
NO requirement of company profit for contribution
limited to 25% of total employer covered compensation
limited to the LESSER of 100% of compensation or $69,000 for 2024 per employee per year
Permitted Disparity (Social Security Integration)
technique or method of allocating plan contributions to employees’ accounts so that a higher contribution will be made for those employees whose compensation is in excess of the Social Security wage base
EXAM TIP = the excess rate is generally 5.7% higher than the base rate
EXAM TIP: Base Rate + Permitted Disparity = Excess Rate, so “BP = Exxon” where Permitted Disparity equals the LESSER of the Base Rate or 5.7%
Profit Sharing Plans - Allocation of Contributions
Standard Allocation = equal percentage to all participants
Social Security Integration = provides higher allocations to employees whose earnings are greater than the Social Security Wage base; Profit sharing plans can ONLY use the excess method
Age-Based Profit Sharing Plans = use a combination of age & compensation to allocate the plan contribution
New Comparability Plan = contribution dependent upon employee classification; Owner, Officer, Rank-and-File
Profit Sharing Plans - Cash or Deferred Arrangements (CODA or 401(k))
any profit sharing can have a CODA/401(k) attached
most prevalent type of plan established today; predominantly funded by employee deferral contributions
attaches to a profit sharing plan or stock bonus plan
permits employees to defer compensation to a qualified plan; limited to $23,000 for 2024 per year or $30,500 for 2024 for those age 50 & over
employers may (but are NOT required to) match the employee’s deferral
SECURE 2.0 Sec 110 effective after 2023 allows employers to making matching contributions on behalf of employees that are making payments on outstanding student loans in lieu of retirement contributions (401(k), 403(b), 457(b) or SIMPLE IRAs)
Entities Which May Establish a 401(k) Plan (5)
Corporations
Partnerships
LLCs
Proprietorships
Tax-exempt entities
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 Eligibility & Vesting
Eligibility (2 year not available)
Vesting:
Employee deferral contributions 100% at all times
Employer matching contributions must vest as rapidly as:
- 2 to 6 year graduated (0%, 20%, 40%, 60%, 80%, & 100%), OR
- 3-year cliff
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
Failing the ADP or ACP test corrective actions (4)
Corrective Distribution = cheapest/easiest; decreases ADP of HC
Recharacterization = change from pre-tax to after tax contributions; decreases ADP of HC
Qualified Non-elective contributions (QNEC) = increases ADP of NHC, 100% vested, made to all eligible EEs
Qualified Matching Contributions (QMC) = increases ADP of NHC, 100% vested, made only to EEs who elected to defer in the current year
Profit Sharing Plans CODA - ACP Test
Actual Contribution Percentage Test (ACP Test)
Like ADP but determined utilizing EE after-tax thrift contributions & ER matching contributions
uses same scale as ADP
uses same corrective procedures as ADP
Profit Sharing Plans CODA - Safe Harbor 401(k)
NOT required to pass ADP or ACP tests
ER must provide either one of the following:
1. 3% non-elective contribution to all eligible EEs
2. Matching contribution: 100% up to 3% & 50% from 3% to 5%
ER contributions are 100% vested at all times
EXAM TIP = safe harbor ER contributions are 100% vested AT ALL TIMES!
Profit Sharing Plans - Stock Bonus Plans
defined contribution profit sharing plan
ER contribute stock to plan
contributions are discretionary but must be substantial & recurring
allocations to the plan must be nondiscriminatory
tax deduction for FMV of stock; cashless tax deduction
Stock Bonus Plans vs Profit Sharing Plans
Profit Sharing Plans Stock Bonus Plans - NUA
Net Unrealized Appreciation; lump sum
In-kind distribution of ER securities; usually from ESOP or Stock Bonus Plan
NUA = FMV at date of distribution - value of stock at date of ER contribution
In year of distribution of ER stock = ordinary income, value at date of ER contribution, 10% penalty if applicable, deferred LTCG
At date of sale of ER stock = recognize deferred LTCG regardless of holding period; any subsequent gain/loss short/long term CG based on holding period since date of distribution
ESOPs - Nonrecognition of Gain Treatment
allow owners of closely held businesses to sell all or part of their interest in the corporation & defer recognition of the capital gain
Qualification Requirements:
- the ESOP must own at least 30% of the corporation’s stock immediately after the sale
- the seller or sellers must reinvest the proceeds from the sale into qualified replacement securities w/in 12 months after the sale & hold such securities 3 years; qualified replacement securities are securities in a domestic corporation, including stocks, bonds, debentures, or warrants, which receive no more than 25% of their income from passive investments; the qualified replacement securities can be in the form of stock in an S Corporation
- the corporation that establishes the ESOP must have no class of stock outstanding that is tradeable on an established securities market
- the seller or sellers, relatives of the seller/sellers, & 25% shareholders in the corporation are precluded from receiving allocations of stock acquired by the ESOP through the rollover
- the ESOP may not sell the stock acquired through the rollover transaction for 3 years
- the stock sold to the ESOP must be common or convertible preferred stock & must have been owned by the seller for at least 3 years prior to the sale
if the seller purchases & retains qualified replacement securities, there will be no taxable event
Profit Sharing Plans Employee Stock Ownership Plans (ESOP)
defined contribution profit sharing plan; established as a trust
participant receives allocations of the employer stock from the ESOP
seller can defer gains if proceeds reinvested w/in 12 months
Advantages & Disadvantages of ESOPs
Stock Bonus Plans vs ESOPs
ESOP - Voting Rights
Publicly Traded Corporations:
- participants have voting rights as regular shareholders
- participants earn dividends
Privately Held Corporations:
- participants must be allowed to vote in major corporate decisions (mergers, acquisitions, consolidation, reclassification, liquidation, dissolution, recapitalization or a sale)
- trustee of the ESOP votes in all other matters
ESOP - Contributions
Cash:
- ESOP uses to purchase ER stock or ESOP uses to pay bank debt (Leveraged ESOP)
- interest on note deductible above 25%
Stock:
- ER has tax deduction for the value of the stock or the cash at the date of the contribution
- subject to 25% of ER covered compensation limit
- dividends paid are deductible
ESOP - Allocations
Age-based; CANNOT use Social Security integration
EXAM TIP = salary deferral plans, such as 401(k) plans 403(b) plans & SIMPLEs, are also prohibited from using Social Security integration; it should be noted that many 401(k) plans have a profit sharing component, which can be integrated w/ Social Security; however the CODA portion CANNOT
ESOP - Distributions
participant can demand distribution of ER securities; ER may limit
Substantially equal periodic payment requirement = if participant elects they may demand equal distributions from the ESOP for a period no longer than 5 years unless their account is value at more than $1,380,000 for 2024 in which case the distribution period may be extended one year for each additional $275,000 for 2024 of account value up to a total of ten years; NOT eligible for NUA
If lump sum, then NUA net unrealized appreciation
ESOP Put Outs
Put Option
EE can require ER to repurchase stock at the FMV on the distribution date - w/in 60 days after distribution OR w/in a 60 day period during the following plan year
the put option reduces the EE’s risk but increases the ER’s cash requirements
ESOP - Diversification Requirement
IMPORTANT RULE!
a Qualified Participant may force investment diversification w/in their account during the qualified election period
Qualified Participant = at least age 55, completed 10 years of participation in the plan
the qualified election period is the 6-plan year period beginning after becoming a qualified participant
may diversify 25% of their post 1986 stock balance for the first 5 years of their qualified election period & 50% of their post 1986 stock balance during their 6th & final year
the diversification calculation is a cumulative calculation meaning that the stock balance consists of the # of eligible shares that have ever been allocated to a qualified participant’s account less any shares previously distributed, transferred, or diversified
diversification can be satisfied by a distribution, a transfer to another qualified plan, or offering 3 or more investment options in the ESOP (certain requirements apply)
Note that ESOPs are not generally subject to the diversification requirements implemented under PPA 2006; exception is if the ESOP is a contributory plan or is a publicly traded business
Distributions from Pension Plans During Service w/ Employer
NO in-service withdrawals for participants under age 59.5
At Participant’s Death = distributed to beneficiary or participant’s estate; Qualified Preretirement Survivor Annuity (an annuity benefit payable to the surviving spouse of a participant if the participant dies before attaining normal retirement age)
At Participant’s Disability = distributed to participant
Distributions from Pension Plans Termination of Service before normal retirement age
lump sum distribution, rollover plan assets to IRA or other qualified plan, or leave assets in plan (value must be greater than $7,000 as per SECURE Act 2.0 effective after 12/31/23
Distributions from Pension Plans Termination of Service at Normal Retirement Age
Qualified Joint Survivor Annuity QJSA = an annuity benefit payable to the participant & spouse as long as either lives, single life annuity if QJSA is waived, signed by NON participant spouse & notarized or witnessed by plan sponsor
Lump sum distribution
rollover plan assets to IRA or other qualified plan
Profit Sharing Plans In-Service Withdrawals
may permit in-service withdrawals after 2 years of participation in the plan
at termination of service:
- lump sum distribution
- rollover plan assets to IRA or other qualified plan, or
- purchase annuity
Distributions from Qualified Plans - Taxation of Distributions
ordinary income except:
- direct rollovers of plan assets to IRAs or other qualified plans,
- adjusted basis in plan, (annuities w/ adjusted basis)
- lump sum distribution options, &
- Qualified Domestic Relations Orders (QDRO) if rolled over to IRA
Taxable distributions are subject to 20% income tax withholding
Distributions from Qualified Plans Taxation - Rollovers
Rollovers to IRAs causes a loss of:
- ERISA Protection (although will be protected under federal bankruptcy law as a result of BAPCPA 2005),
- 10-year forward averaging,
- NUA, &
- Pre-1974 Capital Gain Treatment
Qualified Plans Rollovers to IRAs - Direct Rollovers vs Indirect Rollovers
Direct Rollover = a distribution from a qualified plan trustee directly to the trustee of the recipient account, NO income tax withholding
Indirect Rollover = a distribution to the participant w/ a subsequent transfer to another account, mandatory 20% income tax withholding, must deposit all w/in 60 days to avoid income taxes
Distributions from Qualified Plans Taxation - Plan Loans
permissible by any qualified plan; usually only found w/ CODA type plans
Loan may not exceed the LESSER of $50,000 OR 1/2 of the participant’s vested account balance
reduced by the highest outstanding loan balance w/in the previous 12 month period
EXCEPTION when vested account balance is < $20,000: maximum loan limited to the LESSER of $10,000 or vested account balance
reduced by the highest outstanding loan balance w/in the previous 12 month period
SECURE Act 2.0 of 2022 Loan Provisions
permissible by any qualified individual in a qualified disaster area; plan must have loans available
loan may not exceed LESSER of $100,000 or 1/2 of the participant’s vested account balance
reduced by the highest outstanding loan balance w/in the previous 12 month period
Distributions from Qualified Plans Taxation - Plan Loan Repayment
5 years, up to 30 years if loan proceeds used to purchase principal residence
substantially level amortization of the loan is required over its term
payments must be at least quarterly
plan sponsors often apply additional rules & requirements
failure to repay the loan as prescribed will consider the value of the loan a taxable distribution, possibly subject to the 10% early distribution penalty
termination from employment generally causes entire loan to become due
however under TCJA 2017 terminated EEs will be permitted to rollover/repay loans until the due date of the tax return including extensions
10% Early Withdrawal Penalty Exceptions - Qualified Plans AND IRAs
59.5
Death, Disability
Substantially equal periodic payment SOSEPP 72(t)
Medical expenses in excess of schedule A medical AGI limit for tax year 7.5%
Federal Tax Levy
$5,000 per taxpayer for birth or legal adoption (SECURE Act)
Terminal illness
Up to an aggregate amount of $22,000 in a qualified disaster
SECURE Act 2.0 of 2022 for 2024:
- Emergency personal expense up to $1,000
- Domestic Abuse
10% Early Withdrawal Penalty Exceptions - Qualified Plans ONLY
Separation from service age 55 or after
Separation of service at age 50 or w/ 25 years of service for safety officers, firefighters & correction officers
Qualified Domestic Relations Order QDRO
10% Early Withdrawal Penalty Exceptions - IRA ONLY
Higher education costs
Health Insurance for unemployed
First time home purchase up to $10,000
Substantially Equal Periodic Payments SOSEPP Methods of Calculation (3)
- Required Minimum Distribution Method = payments calculated same as minimum distributions
- Fixed Amortization Method = payments calculated over applicable single or joint life expectancy w/ reasonable interest rate
- Fixed Annuitization Method = payments calculated using an annuity factor (w/ reasonable interest rate & mortality table)
Required Minimum Distributions
Age 72 after 12/31/2019 (SECURE Act 2019) but before 1/1/2023 (SECURE Act 2.0 of 2022)
Age 73 for those obtaining age 72 after 12/31/22; first minimum distribution must begin by April 1 of the year following the year in which the participant attains the age of 72/73 (Required Begin Date RBD)
Those that began RMDs on or before 12/31/22 will continue them
EXAM TIP = watch the year on the exam!!!
EXCEPTION = a participant who is still employed by the plan sponsor may delay the first minimum distribution until April 1 of the year after the participant terminates employment (a > 5% owner cannot use the exception)
NOTE: this exception does NOT apply to SEPs or SIMPLE IRAs
All other RMDs must occur by December 31 of each year
missed RMD penalty = 25% on amount equal to RMD less any distribution that was taken but the result cannot be less than zero
Distribution due to QDRO
QDRO = order under state law recognizing the right of a former spouse to benefits under the participant’s qualified plan
former spouse is an alternate payee
describes the spouse’s interest in the plan benefits
cannot override plan rules (e.g. if QDRO calls for lump sum distribution but plan does NOT allow lump sum distributions)
Portfolio Withdrawal Strategies (4)
- Flat amount of income = fixed dollar income throughout entire lifetime
- Inflation-adjusted income = annual income increased based on prior year inflation or a flat pre-selected inflation amount
- Performance-based income = annual income determined by performance of the investment portfolio
- Combination
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
Methods for correcting excess annual additions
allocate the excess annual additions to other plan participants
hold excess annual additions in a separate account & allocate in future years
make corrective distributions
Calculating the self-employed individual’s contribution
Self-employed contribution rate = Contribution Rate / (1 + Contribution Rate)
Self-Employment Tax = Net Self-Employment Income x 92.35% = Net Earnings Subject to Self-Employment Tax
Net Earnings Subject to Self-Employment Tax x 12.4% up to $168,600 + 2.9% on all income = Self-Employment Tax
Net Self-Employment Income - 1/2 Self-Employment Tax = Adjusted Net Self-Employment Earnings
Adjusted Net Self-Employment Earnings x Self-employed Contribution Rate = Self-Employed Individual’s Plan Contribution
Keogh Plan Contributions
EXAM TIP:
know that for the maximum Keogh Plan contribution the 25% really equals 20%!
if a self-employed individual contributes 15% to their employees, 15% is used in the contribution rate formula making the ER contribution 13%
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
Doctrine of Constructive Receipt
when income is readily available to the taxpayer, & that income is not subject to substantial limitations or restrictions, that income should be subject to tax
New Line of Business
if the new line of business is purchased & it is in a different line of business as the current trade or business operation, the costs of investigation are recouped by capitalizing the expenses & amortizing it ratably over a 60 month period
Dealing w/ an exchange - Realized & Recognized
when dealing w/ an exchange there are 2 things to note: realized & recognized
realized is a transaction happening
recognized is when a realized transaction has NOT met an exception & must have tax calculated
a like kind exchange is an exception to realized transactions to not be recognized
realized amount is the value received plus debt relief
FICA Taxes
First $168,000 (2024) taxed at partial employee FICA rate of 6.2%
all earnings will be taxed at the remaining FICA Medicare rate of 1.45%
Total is the two multiplications added together
Insurance Proceeds - Destroyed Property
insurance proceeds which exceed the current basis of destroyed property will not be taxable if the taxpayer replaces that property w/ similar property w/in a 2 year period from the end of the year in which realization resumed if a natural disaster (fire) or 3 years from the end of the year in which realization occurred in the event of a government taking (emminent domain)
Cash Basis Method of Accounting
recognizes income upon either actual OR constructive receipt
actual receipt = taxpayer has received cash directly
constructive receipt = though not having received the money in hand, the taxpayer has immediate access to the money (i.e., lock box receipt)
includes income upon receipt
Cafeteria Plans
must offer at least one taxable benefit (usually cash) & one qualified nontaxable benefit
a written plan under which the EE may choose to receive either cash or taxable benefits as compensation or qualified fringe benefits that are excludable from wages
authorized by Section 125 of the IRC
appropriate when EE benefit needs vary w/in the EE group
When is a trip outside the United States considered to be purely for business?
Less than 25% of the time spent on trip was personal
taxpayer does not have control over the timing or arrangements for the trip
the trip outside the United States lasts for less than 7 days
vacation was not a primary consideration for the trip
Earned Income vs NOT Earned Income (IRA Eligibility)
IRAs - Excess Contributions
contributions in excess of the contribution limit
subject to 6% excise tax for each year the excess contribution remains in account
avoid excise tax by withdrawing excess contribution & attributable earnings before April 15 of the following tax year plus extensions
SECURE 2.0 Act of 2022 will waive the 10% early withdrawal penalty (under age 59.5) for corrective distributions made w/in the correction window
IRAs - Contribution Due Date
contributions must be made by the due date of the individual’s income tax return (w/out extensions)
usually April 15 of the following tax year
Jan - April 15 can be current or prior year contribution
IRA Contribution Phaseout calculation formula
Deduction Reduction = contribution amount x ([AGI - lower AGI threshold] / AGI Phaseout Range)
10% Early Withdrawal Penalty Exceptions - Qualified Plans AND IRAs
age 59.5
death, disability
substantially equal periodic payment Section 72
medical expenses in excess of schedule A medical AGI limit for tax year - 7.5%
up to $5,000 for birth or legal adoption, w/in 12 months of birth or adoption
federal tax levy
terminal illness
$22,000 aggregate for federal disasters
emergency funds up to $1,000 every 3 years
domestic abuse
10% Early Withdrawal Penalty Exceptions - Qualified Plans ONLY
separation from service after age 55 (50 safety/fire/corrections)
Qualified Domestic Relations Order QDRO
10% Early Withdrawal Penalty Exceptions - IRA ONLY
health insurance for unemployed
higher education costs
first time home purchase up to $10,000
IRAs - Roth IRA Qualified Distributions
income tax-free
NOT subject to 10% early withdrawal penalty
- distribution is made after a 5 taxable year period (which begins Jan 1 of the tax year for the first contribution) AND
- the distribution is on account of the owner attaining age 59.5, the owner’s death, disability, or first-time home purchase (maximum $10,000) (trigger)
*5 years AND a trigger
IRAs - Roth IRA Nonqualified Distributions
contribtutions first then conversions then earnings finally
*think “best out 1st”
Roth 401(k) vs Roth IRA
Investments NOT Permitted for IRAs
Life Insurance
Collectibles
Other coins (Krugerrands, Maple Leaf, Pandas)
IRAs - Prohibited Transactions
if an individual or beneficiary of an IRA engages in ANY of the following transactions then the account will cease to be an IRA as of the first day of the current taxable year:
selling, exchanging, or leasing of any property to an IRA
lending money to an IRA
receiving unreasonable compensation for managing an IRA
pledging an IRA as security for a loan
borrowing money from an IRA
buying property for personal use (present or future) w/ IRA funds
if a “deemed distribution” is made d/t a prohibited transaction then the entire balance in the IRA is treated as having been distributed; taxpayer will be subject to ordinary income tax on the entire balance & will also be subject to the 10% early withdrawal penalty
Simplified Employee Pensions (SEPs) - Characteristics
small business retirement plan
tax-deferred growth of contributions
NOT a QP but has similar characteristics w/ unique rules:
- more liberal coverage requirements
- can be established as late as the extended due date of the income tax return
- unique contribution, vesting, & distribution rules
established utilizing Traditional IRA accounts
EXAM TIP: no longer the only plan eligible to be established after the calendar year has ended
SEPs - Eligibility
employers that sponsor SEPs MUST provide benefits to all employees who meet the following requirements:
1. attainment of age 21 or older, &
2. performance of services for 3 of the last 5 years, &
3. received compensation of at least $750 (2024) during the year
SECURE 2.0 Act of 2022 made SEP plans available to domestic employees (ie nannies) beginning w/ the 2023 tax year
SEPs - Establishment
employer MUST complete the following 3 steps by the extended due dates of the tax return:
1. complete a formal written agreement (form 5305-SEP)
2. give eligible employees notice
3. open a SEP-IRA account for each eligible employee
SECURE 2.0 Act of 2022: employees can direct all or a portion of employer contributions to a designated Roth account; contributions will be taxable to the employee
SEPs - Contributions
employer funded ONLY
contributions are discretionary - must be made to all employees eligible during the year even if dead or no longer employed at time of contribution
contributions limited to LESSER of:
- 25% of an employee’s covered compensation, or
- $69,000 for 2024
can utilize pro-rata, flat dollar & Social Security Integration
Self-Employed Individual - Noncontributory Contributions
self-employed individuals subjected to special contribution calculation
Self-Employed Contribution Rate = contribution rate to other participants / (1 + contribution rate to other participants)
EXAM TIP = applies to all self-employed plans
SEPs - Vesting & Distributions
employees 100% vested in their account balance at all times
withdrawals treated just as withdrawals from IRAs
- ordinary income
- 10% penalty unless excepted under IRA penalty exceptions
SIMPLEs - Characteristics
Savings Incentive Match Plans for Employees (SIMPLEs)
retirement plans for small employers
easy to establish & maintain
similar tax advantages to QPs
employee elective deferral contributions
SIMPLEs - Types
SIMPLE IRA - utilizes an IRA account as the funding vehicle
SIMPLE 401(k) - utilizes a 401(k) plan as the funding vehicle
SECURE 2.0 Act of 2022 allows for SIMPLE Roth contributions for both ER & EE contributions (in whole or part); EE is taxed on the Roth contributions
SIMPLEs - Establishment
can ONLY be established by small employers; small employer = ER w/ 100 or fewer EEs who each earned at least $5,000 of compensation in the preceding calendar year
must be a calendar year plan
to establish complete & provide participants w/ either Form 5304-SIMPLE or Form 5305-SIMPLE
provide participants w/ 60-day period to elect deferral
ER cannot maintain a QP
SIMPLEs - Eligibility & Vesting
EEs eligible if they earned at least $5,000 in any 2 preceding years from the ER & is expected to earn $5,000 in the current year
EXAM TIP = $5,000 of earnings for eligibility
participant 100% vested in all their contributions to either a SIMPLE IRA or 401(k) & ER contributions if the plan is a SIMPLE IRA
SIMPLE IRAs - Contribution Limits
Employee Elective Deferrals:
- maximum $16,000 (2024) plus $3,500 (2024) catch-up age 50 & over; contribution limit (& catch-up) increased to 110% of the regular contribution limit after 12/31/23
- Roth contributions for allowed for taxable years after 12/31/22
Employer Contributions (they choose one):
1. Employer Matching Contributions
- dollar-for-dollar match up to 3% of all compensation
- may be reduced under special circumstances
2. 2% Non-elective Employer Contributions
- 2% of covered compensation contribution to each eligible employee
SIMPLEs - Contributions
tax deductible, tax deferred growth
employer contribution must be made by the due date of the employer’s income tax return filing deadline (including extensions)
employee deferral contributions subject to payroll taxes; employee designated Roth contributions subject to payroll, federal & state taxes
additional non-elective contributions for taxable years after 12/31/23; LESSER OF:
1. up to 10% of compensation or $5,000 (indexed beginning in 2025)
2. cover comp limit for non-elective contributions
SIMPLEs - Distributions
ordinary income to recipient
may be rolled over to an IRA or other QP
may be subject to early withdrawal penalties
- 25% penalty, rather than 10%, if withdrawal completed w/in first 2 years of the EE’s participation in the plan
- subject to IRA early withdrawal penalty exceptions
SIMPLE IRA Replacements
SIMPLE IRA plan can be replaced by a SIMPLE 401(k) plan or other 401(k) plan that requires mandatory employer contributions during a plan year
- 2 year 25% penalty withdrawal rule waived
- effective for plan years beginning after 12/31/23
SIMPLEs - SIMPLE 401(k)
similar to SIMPLE IRAs
participants may take loans from SIMPLE 401(k)s
very few established
covered comp rules apply
403(b) Plans or Tax Sheltered Annuities (TSAs)
retirement plan for the following:
- public schools or educational organizations &
- tax-exempt organizations under IRC Section 501(c)(3)
403(b) Plans - ERISA
ERISA applies to:
- EE benefit pension plans of 501(c)(3) organizations; unless ER involvement is minimal; ER only provides salary reduction agreement
ERISA does NOT apply to:
- Governmental 403(b)s
- Church Related 403(b)s
WHEN ERISA APPLIES:
- plan must meet the nondiscrimination test & matching contributions must satisfy ACP test
- plan must offer preretirement Joint & survivor annuity & qualified Joint & survivor QJSA
403(b) Plans - Contributions
employee elective deferrals:
- tax deductible
- subject to payroll taxes
- limited to $23,000 per year for 2024 plus $7,500 for 2024 catch-up 50 & over (combined limit w/ other CODA plans) (401(k)s)
401(k) + 403(b)
employer may match or provide non-elective contribution
403(b) Plans - 15-Year Catch Up HER Organization
15-year catch up contributions
permits up to an additional $15,000 (maximum $3,000 additional per year) of contributions to the 403(b)
participants must have completed 15 years of service w/ the employer & have unused deferral
ONLY applies to HER organizations (Health, Education, Religious)
EXAM TIP = maximum either be $23,000, $26,000, $30,500, or $33,500!
403(b) Plans - Investment Choices
can only be invested in:
1. insurance annuity contracts
2. mutual funds
3. SECURE 2.0 Act of 2022 allows for investment in Collective investment trusts; SEC rules need to be modified to have this available
403(b) Plans - Loan Availability
only permissible from ERISA plans
subject to same rules as loans from 401(k) plans
457 Plans - Types
Nonqualified Deferred Compensation Plan
- Eligible tax-exempt entities
- Eligible governmental entities
Employee elective tax-deferred savings
Designated Roth contributions
457 Plans - Public vs Private Plans
457 Plans - Flowchart
457 Plans - Special Catch-Up
3 years prior to normal retirement age an EE may defer an additional $23,000 for 2024 to the 457(b) plan
- public & private eligible
- limited to prior unused deferral amounts
- maximum contribution equals $46,000 2024
($23,000 for 2024 deferral contribution + $23,000 for 2024 catch-up contribution prior unused contributions)
- CANNOT include 50 & over catch-up contribution when determining the 3-year catch-up or for Private 457
457(f) Plans
457 Plan Comparison Chart
457 Plan General Characteristics Chart
Deferred Comp & Nonqualified Plans - Why offer deferred compensation?
to provide benefits to a select group of EEs w/out the limitations of QPs
to discriminate the provision of benefits to key EEs
QPs CANNOT provide sufficient retirement resources for key executives who earn in excess of the covered compensation limit of $345,000 for 2024
Deferred Comp & Nonqualified Plans - Economic Benefit Doctrine
an EE will be taxed on funds or property set aside for the EE if the funds or property are unrestricted & nonforfeitable
in other words, if there is constructive receipt or no substantial risk of forfeiture the EE will currently have taxable income
Deferred Comp & Nonqualified Plans - IRC Section 83
property transferred to an EE in connection w/ the performance of services is taxable to the extent the FMV of the property is greater than the amount paid by the EE; ordinary income subject to payroll taxes
ER gives EE stock w/ FMV of $10, EE pays $3, $7 is taxable as ordinary income for the EE
Advantages of Deferred Compensation Plans to the Employer (3)
- cash outflows are often deferred until the future
- the employer will save on payroll taxes except for the 1.45% Medicare match (since EE’s income probably over Social Security wage base)
- the employer can discriminate & provide these benefits exclusively to a select group of key employees
Deferred Comp & Nonqualified Plans - Funding Arrangements
Funded - Secular Trusts, Rabbi Trusts
Arrangements - Deferred Compensation, Salary Reduction, SERP, Phantom Stock Plan, 401(k) WRAP
Deferred Comp & Nonqualified Plans - Funding Types - Secular Trusts
Irrevocable Trust
Holds set-aside funds of a NQDC Plan
- for the benefit of executive
- trust funds are not available to ER or ER’s creditors
Usually, no substantial risk of forfeiture for EE
- trust may require a vesting period
- executive would have substantial risk of forfeiture until meeting the vesting period requirements
W/out substantial risk of forfeiture, value of trust is taxable to executive at the time it is funded
Deferred Comp & Nonqualified Plans - Funding Types - Rabbi Trusts
Irrevocable Trust
Holds set-aside funds of a NQDC Plan
- for the benefit of executive
- funds are not available to ER BUT may be available to the ER’s general creditors under bankruptcy
Substantial Risk of Forfeiture exists
Assets w/in the rabbi trust are NOT currently taxable to the executive
Characteristics of Alternative Deferred Compensation Arrangements Table
Deferred Comp & Nonqualified Plans - Funding Types - Phantom Stock Plans
NQDC plan
ER gives fictional shares of stock to key executives
at a later time, stock is valued & the executive will receive the increase in value as compensation
no actual stock is issued
executive has taxable income & ER has deduction at time payment is made to the executive
Deferred Comp & Nonqualified Plans - Funding Types - Employer Stock Options
Stock Options - the right to buy stock at a specified price for a specified period of time; agreement must be in writing & holder has no obligation to exercise
Option Price = FMV at date of grant
Vesting - right to exercise options only after certain period of time, performance, or occurrence
Types:
1. Incentive Stock Options (ISOs)
2. Nonqualified Stock Options (NQSOs)
3. Stock Appreciation Rights (SARs)
Deferred Comp & Nonqualified Plans - Employer Stock Options - ISOs
Incentive Stock Options
Statutory Stock Option
ties an EE benefit to the stock price of the company & may provide special taxation
may only be granted to EEs
aggregate FMV of ISO grants must not exceed $100,000 per year per executive; excess over $100,000 treated as a NQSO
for ISO special tax treatment, individual must hold stock 2 years from date of grant, one year from date of exercise
Taxation of ISOs
Grant Date = no taxable income unless exercise price less than FMV at date of grant
Upon Exercise = no regular tax; AMT adjustment equal to appreciation over exercise price
Upon Sale of Stock = LTCG for stock appreciation over exercise price; negative AMT adjustment
ER does NOT have a tax deduction related to the ISO
Deferred Comp & Nonqualified Plans - Employer Stock Options - ISOs Disqualifying Disposition
selling stock acquired from an ISO before 2 years from grant date or 1 year from exercise date
loss of favorable tax treatment
appreciation over exercise price at exercise date = ordinary income (reported on W-2)
Appreciation after exercise date = capital gain (short/long) based on holding period beginning at exercise date
ER has tax deduction equal to the executive’s W-2 income
Deferred Comp & Nonqualified Plans - Employer Stock Options - ISOs Cashless Exercise
an executive exercises an option w/out cash; very common
3rd party lends executive cash to exercise the option
executive repays the lender almost immediately w/ the proceeds & has W-2 income for the excess value over the exercise price
a cashless exercise IS a disqualifying disposition
Deferred Comp & Nonqualified Plans - Employer Stock Options - NQSOs
NonQualified Stock Option (NQSO)
option that does not meet requirements of an ISO
ties an EE benefit to the performance of the company stock
exercise does not receive favorable tax treatment
no statutory holding period requirements; ER’s may place holding period requirements on the stock
Taxation of NQSOs
Grant Date = no taxable income unless exercise price less than FMV at date of grant
Upon Exercise = executive will have W-2 income for the appreciation over the exercise price; ER has income tax deduction for same amount
Upon Sale of Stock = executive will have capital gain/loss w/ holding period beginning at exercise date
Deferred Comp & Nonqualified Plans - Employer Stock Options - Gifting
Gifting of ISOs & NQSOs
ISOs:
- unexercised ISOs cannot be gifted
- can only be transferred after exercise date
NQSO:
- may be gifted if allowed by ER
- when donee exercises: EE W-2 income; ER tax deduction
- donee’s basis equals exercise price plus W-2 amount
ISO v NQSO Chart
Deferred Comp & Nonqualified Plans - Employer Stock Plans - SARs
Stock Appreciation Rights (SARs)
rights that grant the holder cash in an amount equal to the excess of the FMV of the stock over the exercise price
ties an EE benefit to the value of the ER’s stock
essentially a cashless exercise w/out any right to purchase the stock
NO taxation at grant; unless EE elects 83(b):
Employee = W-2 income for excess value over exercise price
Employer = tax deduction for W-2 amount
Deferred Comp & Nonqualified Plans - Employer Stock Plans - Restricted Stock
Restricted Stock Plans
plan which pays executives w/ shares of the employer stock
executive does NOT pay any amount towards the stock
stock has restrictions preventing the executive from selling or transferring; usually on a vesting schedule; creates substantial risk of forfeiture
plan increases executive retention & ties the executive’s benefit to the employer stock price
Deferred Comp & Nonqualified Plans - 83(b) Election
IRC Section 83(b)
EE election to include value of stock in taxable income at date of grant rather than at date of vesting or when restrictions are lifted
any gain in value over the grant date is capital gain rather than W-2 income
if EE does not vest, or otherwise loses rights, no tax deductible loss
EE’s holding period for stock received will be the date the amount was included in the EE’s gross income
must be filed no later than 30 days after the stock is transferred
EE must file a written statement w/ IRS
Deferred Comp & Nonqualified Plans - Employer Stock Plans - ESPP Plans
Employee Stock Purchase Plan (ESPP)
allows EEs to purchase ER securities at a discounted price & receive favorable tax treatment on the subsequent disposition of the stock (if qualifying disposition)
ties EE benefit to the price of the ER stock
no less than 85% of a date determined stock price or an average price (Example = lesser of FMV at grant date or exercise date)
statutory purchase limit of $25,000 per year; based on the FMV of the stock at the date of grant
ESPP Taxation
if held 2 years from grant & 1 year from exercise then discount taxed at Ordinary Income rates (double check in class)**
if not held for the required holding period then the discount is W-2 income (OI + payroll)
remaining gain = LT/ST capital gain w/ holding period starting at exercise
ESPP - Losses:
- short or long term capital losses
- holding period begins at exercise date
Employee Benefits: Fringe Benefits - Important Numbers 2024
Employee Benefits - VEBA
Voluntary Employees’ Beneficiary Association (VEBAs)
tax exempt trust vehicle
provides out of pocket reimbursement for healthcare costs
available to both EEs & retirees
may not provide retirement benefits or commuting benefits
Taxation:
- ER deducts contributions to a VEBA; earnings on contributions are NOT taxed to the ER or EE
- EE does NOT recognize income on contributions to VEBA
COBRA Qualifying Events
Reformation vs Rescission
Reformation = both parties agree to work together
Rescission = occurs when no agreement can be reached & is usually carried out by a court of law
Estate Planning
process of accumulation, management, conservation, & transfer of wealth considering legal, tax, & personal objectives
GOALS:
1. Effective Transfers - decedent’s assets transferred based on their wishes
2. Efficient Transfers - transfer costs including taxes are minimized; maximize net to heirs
Heirs
people who inherit under state laws
Legatees
people who inherit under the will
Abatement
reduction of bequest
Ademption
extinguishment of a right
Testator
the will maker
Basic Estate Planning Documents
Wills - avoids intestacy; age 18 & of sound mind
Durable General Power of Attorney
Durable Power of Attorney for Health Care (to keep principal alive) - in writing, survives disability but NOT death
Advance Medical Directive - power to terminate life sustaining treatment
Others:
- side letters of instruction
- powers of attorney for property
- living wills
- do-not-resuscitate orders
Wills
a legal document that provides the testator (the will maker) the opportunity to control the distribution of their property at death & thus avoid their state’s intestacy laws
testate = decedent w/ valid will
intestate = dieing w/out a valid will or die w/ a will that does NOT dispose of all property (also known as “partially intestate”)
Holographic Wills
in own hand
written in testator’s handwriting
must be signed & dated by testator
Noncupative Wills
usually only covers tangible personalty
oral
dying declarations made before sufficient witnesses
NOT valid in all states
Statutory Wills
generally drawn by an attorney
complying w/ the laws for wills of the domiciliary state
Survivorship Clause
selected will provision
requires that the beneficiary to survive the decedent for a specified period of time in order to inherit
cannot be longer than 6 months for transfer to qualify for unlimited marital deduction
Disclaimer Clause
selected will provision
reminds legatee they may disclaim & the clause may direct who inherits if they do disclaim
Disclaimer Clause - Rules to Disclaim (3)
- disclaiming party cannot have benefited
- must be made in writing w/in 9 months
- person disclaiming can’t direct disposition of property
surviving spouse may disclaim so more assets go to kids & the applicable estate tax credit is utilized
kids may disclaim so that the surviving spouse may inherit to utilize the marital deduction
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
No-Contest Clause
sometimes called an “in terrorem clause”
attempts to discourage disappointed heirs from contesting the will by substantially decreasing or eliminating a bequest to them if they file a formal, legal contest to the will
Revocation
the testator can destroy the will, either by shredding or burning
testator can also create a new will specifically revoking the previous will
in some states the testator can revoke the will by writing “cancel” across the will
Changing Wills - Codicil
supplement to a will
may be executed like a statutory will, which must be signed, properly witnessed, & notarized
used to modify, explain, or amend a will
Side Instruction Letter
details the testator’s wishes regarding the disposition of specific tangible possessions (such as household goods), as well as funeral & burial wishes
exists separately from the will
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
Powers of Attorney - Exam Info
All POAs cease at death
- exam questions may be structured to see if you know whom you work for; once the principal dies the accounts will be frozen until the estate administrator brings the letters testamentary to gain control over the accounts
Planners are NOT required to recognize the POA
- if the agent requests an action that is harmful to the principal, the planner can refuse to take action; contacting the compliance department is also a good answer choice for these types of questions
Durable Power of Attorney
agent’s power does NOT expire upon the principal’s incapacity or disability but rather expires ONLY at the principal’s death
Springing Power of Attorney
agent’s power “springs” into existence upon some defined event or determination (i.e., at the disability of the principal)
even though the principal has signed the power of attorney, the agent CANNOT exercise the powers granted to him until the specific event occurs
Durable Power of Attorney for Health Care
medical power of attorney
legal document appoints an agent (someone w/ authority to act on behalf of another) to make health care decisions in the case of a principal who is unable to make those decisions for themselves
Living Will (a.ka. Advance Medical Directive)
legal document expressing an individual’s last wishes regarding sustainment of life under specific circumstances
establishes the medical situations & circumstances in which the individual no longer desires life-sustaining treatment in the event they are no longer capable of making those decisions
Methods to Transfer Property at Death (4)
- Operation of Law
- Contract
- Trust
- Probate - Will, Intestate, Estate named as beneficiary; process of retitling assets
Does NOT Avoid Probate:
No Survivorship Feature or
No Beneficiary Listed
Examples:
- Sole Ownership Property
- Tenancy in Common Property
- Community Property
- Invalid or no named beneficiary designations
AVOIDS Probate
State Contract Law
- Life insurance
- Annuities
- IRAs, SEPs, SIMPLEs, & QPs
- Pay-on-Death (bank accounts) & Transfer-on-Death accounts (investment accounts)
State titling law- if survivorship feature
State trust law - all trusts
EXAM TIP = non-traditional (non-married) relationships should always avoid probate
Sole Ownership
one owner
no survivorship feature
100% included in probate & gross estate
qualified for marital deduction if spouse
step to FMV at death
Tenants In Common TIC
2 or more undivided interest
no survivorship feature
% owned included in probate
included in gross estate
qualified for marital deduction if spouse
partitionable involuntarily (portion can be sold w/out consent of other interest)
% step to FMV at death
Actual Contribution Rules
NO Deemed Contribution Rule
JTWROS
2 or more undivided interest w/ survivorship rights (w/ certified death certificate)
AVOIDS probate
included in gross estate
qualified for marital deduction if spouse
partitionable involuntarily
% step to FMV at death
Actual Contribution Rules EXCEPT spouse
Deemed Contribution Rule IF spouse
Tenants In Entirety TIE
married couple w/ survivorship (w/ certified death certificate)
AVOIDS probate
included in gross estate
qualified for marital deduction
NOT partitionable involuntarily
% step to FMV at death
NO Actual Contribution Rules
Deemed Contribution Rule
Community Property
married undivided interest, NO survivorship, NO gift splitting
fruits are separate or are community property
step to FMV on both halves
50% included in probate
50% included in gross estate
qualified for marital deduction if spouse
NOT partitionable involuntarily
100% step to FMV at death
NO Actual Contribution Rules
Deemed Contribution Rule
separate property includes property acquired before marriage, inherited property, gifted property, & any income related thereto if maintained separately
Probate Process
assets may transfer & be retitled through the probate process, by contract, by state titling law, or by state trust law
Personal Representative
appointed to administer the probate estate
called the executor or administrator
Duties of Court-Appointed Executor or Administrator
identify & produce a detailed list of decedent’s property/assets
safeguard, manage, & invest assets
give legal notice to creditors & heirs/legatees
pay the estate’s expenses
pay the debts & taxes of the decedent
collect revenues, interest, rents, etc during the estate
file all federal, state, & local tax returns timely
make appropriate tax filing elections
distribute assets to heirs/legatees as appropriate
close the estate w/ the court
Heir vs Legatee
Heir = person who receives property under the state intestacy laws
Legatee = person named in a will to receive property
Specific Duties of Administrator
petition court for appointment
put up security bond
court selects
court issues letter of administration
Specific Duties of Executor
locate will
submit will to court
prove will w/ witnesses/notary
receives letters of testamentary
Crummey Provision
creates a present interest in a trust which then qualifies the contribution to the trust for annual exclusion
allows the trust beneficiary to withdraw some or all of any contribution to a trust for a limited period of time to create a present interest
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
Applicable Exclusion Amount
each person also has one lifetime credit equivalency amount up to $13,610,000 (2024) of cumulative taxable transfers
equals a credit against tax of $5,389,800 for 2024; gift & estate taxes are a cumulative lifetime tax
Credit calculated as:
- first $1M = $345,800 in taxes due (estate & gift tax table not provided)
- amount over $1M taxed at 40% ($12.61m x 40% = $5.044m)
- to arrive at the credit: $5,044,000 + $345,800 = $5,389,800
Form 709 - Gift Tax Return
must be filed - April 15 of the following year
can be extended by extending income tax return
the donor is primarily liable for gift tax but the donee can become responsible if the donor does not pay
Maximum Gift/Estate Tax Rate
Memorize!
Taxable Gifts/Estates are over $1M….
Tentative Gift/Estate Tax = $345,800 + 40% of the excess of such amount over $1,000,000
Lifetime Gifting Techniques to Achieve a Lower Gross Estate at Death
EXAM TIP = know this chart!
Advantages of Lifetime Gifts vs. Bequests
Bequest = testamentary, or at death, transfers
Advantage to lifetime gifting:
- ability to use annual exclusion ($18,000 2024)
- gifting appreciating assets out of the estate
- any future income/appreciation from property gifted is taxable to donee & out of donor’s gross estate
- any gift tax paid on a taxable gift is excluded from the donor’s gross estate if the gift was made more than 3 years prior to the donor’s death
- payments of support & the expenses that would be considered qualified transfers during life are excluded from the calculation of gift tax; the estate tax calculation includes the transfers for future support & for reasons that would otherwise be a qualified transfer
Gross Estate Formula
value of a decedent’s gross estate = the FMV of all interests owned by the decedent at their time of death
The Gross Estate
includes the FMV at the date of death or alternate valuation date of the following:
property owned by the decedent
General powers of appointment
Life insurance (death benefit if policy transferred w/in 3 years before death)
Joint tenancy property - actual or deemed contribution rule applies
Retained life interests
Retained power to amend or revoke
Reversionary interest
Gift taxes paid w/in 3 years of death
IRC Section 2035 Gifts Made Within 3 Years of Death
section 2035 requires a decedent’s gross estate to include: (3)
- any gift tax paid on gifts made w/in 3 years of the decedent’s date of death
- the value of any property gifted w/in 3 years of the decedent’s date of death if the decedent retained an interest
- the death proceeds of any life insurance policy insuring the decedent’s life that was gifted w/in 3 years of the decedent’s date of death (if decedent continued to pay premiums on policy gifted w/in 3 years of death the premium payments would be a gift eligible for the annual exclusion if a present interest & any gift tax paid on the gift may be included in the decedent’s gross estate)
Transfers w/ a Retained Life Estate - Section 2036
a decedent’s gross estate includes the value of any interest in property transferred by the decedent in which he retained some interest in the property during his life
Interest Retained for a Period Only Ascertainable by Death
a decedent who retains an interest in property for any period not ascertainable w/out reference to the decedent’s death must include the FMV (determined at the decedent’s date of death) of the property in his gross estate
Retained Interest Held at Death
when a decedent transfers property & retains or reserves an interest for any period of time & that interest does not in fact end before the decedent’s death the FMV of the property at the decedent’s date of death must be included in his gross estate
inclusion also applies when the decedent retains the use, possession, right to the income, other enjoyment of the transferred property, or the right, either alone or w/ another person, to designate the person, or persons, who shall possess or enjoy the transferred property or its income
Reversionary Interest
any interest which includes a possibility that the property transferred by the decedent may return to him or his estate or the possibility that property transferred by the decedent may become subject to a power of disposition by him
the FMV of a decedent’s reversionary interest is calculated as of the moment immediately before his death, & use of the alternate valuation date does NOT apply
to determine whether or not the decedent retained a reversionary interest in transferred property of a value in excess of 5%, the FMV of the reversionary interest in the property is compared w/ the FMV of the transferred property, including interests in the property which are not dependent upon survivorship of the decedent
Revocable Transfers - Section 2038
a decedent’s gross estate includes the FMV at the decedent’s date of death of any interest in property transferred by the decedent if the enjoyment of the interest was subject, at the date of the decedent’s death, to any change through the exercise of a power by the decedent to alter, amend, revoke, or terminate, or if the decedent relinquished such a power in contemplation of death
Section 2038 does NOT apply to:
1. to the extent that the transfer was for full & adequate consideration, or
2. if the decedent’s power could be exercised only w/ the consent of all parties having an interest (vested or contingent) in the transferred property, & if the power adds nothing to the rights of the parties under local law, or
3. to a power held solely by a person other than the decedent
Gross Estate - Annuities Section 2039
Straight Single Life Annuity = decedent who owned a straight life annuity before his death will NOT include any amount related to the annuity in his gross estate since the annuitant’s interest in the contract terminated at his death
Survivorship Annuity = when the first annuitant dies the value of a comparable policy on the second annuitant is included in the first annuitant’s gross estate; if the second to die has contributed to the purchase of the policy then only the proportionate value of the annuity is included in the gross estate of the first to die; the value of the survivorship annuity included in a decedent’s gross estate is based on the ratio of the decedent’s contributions to the survivorship annuity’s total cost to the total cost of the survivorship annuity
Gross Estate Inclusion = Value of annuity at decedent’s death x (Decedent’s cost basis / Total annuity cost basis)
Powers of Appointment
power to name who will enjoy or own property
General power of appointment = causes inclusion in the holder’s gross estate
To avoid inclusion in gross estate limit to ascertainable standard (HEMS):
- Health
- Education
- Maintenance
- Support
5-and-5 Power:
- if the right to exercise is limited to the greater of $5,000 or 5% of the aggregate value of the property each year & the power lapses before the decedent’s death then the power of appointment is NOT included in the decedent’s gross estate; 5-and-5 power designed to limit the withdrawal right to a de minimis amount & penalize those withdrawals that exceed the de minimis amount
Proceeds of Life Insurance - IRC Section 2042
includes the DB proceeds of a life insurance policy on the life of the decedent in the decedent’s gross estate if at the decedent’s death, either the proceeds were receivable by the decedent’s estate or the decedent possessed any incident of ownership in the policy
generally the amount to be included is the full DB payable from the life insurance policy; if the proceeds of the policy are made payable to a beneficiary in the form of an annuity for life or for term of years, the amount to be included in the decedent’s gross estate is the value of the available lump-sum payment at the decedent’s death
if the proceeds of a life insurance policy made payable to the decedent’s estate are community property under the local community property law & as a result 1/2 of the proceeds belongs to the decedent’s spouse, then only 1/2 of the proceeds is included in the decedent’s gross estate
Valuation of Assets
FMV at date of death or alternate valuation date (6 months from death)
Valuation of Assets - Real Estate
appraisals
Valuation of Assets - Closely Held Business
Valuation Discounts:
- Minority discount
- Lack of marketability discount
- Blockage discount
- Key person discount
Valuation of Assets - Financial Securities
Average of the High & Low FMV on the trading day
Accrued Interest - included in value
Accrued Dividends - included in value
Stock that is not actively traded
Valuation included in decedent’s gross estate = [(Trading price after decedent’s DOD x # of days b/t decedent’s DOD & first preceding trade) + (Trading price before decedent’s DOD x # of days b/t decedent’s DOD & next subsequent trade)] / The sum of the days before & after the DOD*
*NOTE = weekends, holidays, or other days that the market is closed are NOT included in the calculation
Valuation of Assets - Life Insurance in Gross Estate
Policy owned on another:
- depends on pay status of premiums
- Premium Pay Status = interpolated terminal reserve + unearned premium
- Paid up status = replacement value
Policy owned on decedent:
- death benefit (face value)
Alternate Valuation Date
To Qualify:
1. the total value of the gross estate must depreciate after the DOD, &
2. the total estate tax must be less than the estate tax calculated using the date-of-death values
Valuation if properly elected:
1. all assets valued at the alternate valuation date
2. EXCEPT:
- assets distributed or sold before 6 months which are valued at the date of distribution or sale, &
- Wasting assets (annuitized annuities, patents, royalties, installment notes, lease income) must be valued at the DOD
wasting assets = assets that will decline in value for reasons other than market movement
SUMMARY:
- 6 months after DOD
- executor must make election by the filing date of the estate tax return
- election must lower the gross estate & estate tax due
- election applies to all assets in gross estate
- exceptions = wasting assets (notes, patents, annuities), & assets disposed of b/t death & alternate valuation date
Deductions from the Gross Estate (Adjusted Gross Estate)
funeral expenses
last medical expenses 1040 / 706
administration expenses 1041 / 706
debts
casualty losses during administration 1041 / 706
Estate Formula
Adjusted Gross Estate
LESS unlimited:
- Charitable deduction
- Marital deductions
EQUALS Taxable Estate
PLUS sum of all Post ‘76 gifts (keeps taxation cumulative)
EQUALS Tentative Tax Base
Qualification for the Marital Deduction
Inclusion in the decedent’s gross estate
- must actually be included in the gross estate
Property transferred to a surviving spouse
- must go to the spouse… not just in trust for someone else
The Terminable Interest Rule
- must later be included in the surviving spouse’s GE
- surviving spouse’s interest cannot terminate at a future date
The Terminable Interest Rule Exceptions (4)
- 6 month survival contingency
- terminable interest where spouse has general power of appointment
- QTIP trust
- CRT where spouse is the only noncharitable beneficiary
Planning for the Non-Citizen Spouse
unlimited marital deduction NOT available for non-U.S. citizen spouse
Remedy = non-U.S. citizen spouse becomes a U.S. citizen before the due date of the return & maintains residency following the death of the spouse
of utilize a Qualified Domestic Trust (QDOT):
- at least 1 U.S. trustee
- must prohibit distribution unless U.S. trustee has right to withhold taxes
- trustee must keep sufficient assets to pay taxes
- executor must elect marital deduction (election made post-mortem)
Estate Credits
Applicable estate tax credit:
- $5,389,800 for 2024 ($13,610,000 exemption)
Prior transfer credit:
- credit for estate taxes paid w/in the last 10 years
Foreign death taxes credit:
- tax paid on property outside the U.S.
Paying & Reporting Estate Taxes
Estate Tax Return:
- Form 706 due 9 months after death
- Extension to file (but not to pay) can be granted for an additional 6 months
Penalties:
- Failure to File = 5% per month up to 25%
- Failure to Pay = 0.5% per month up to 25%
- Failure to File is REDUCED by Failure to Pay
if penalties are concurrent, the reduction of failure to file does NOT elevate the failure to pay penalty
Estate Tax Portability Issues
you have to actually file a timely 706 to make the portability election
Remarriage Issues - the election is based on the last deceased spouse
- a remarriage in & of itself would NOT impact the last deceased spouse
- if multiple spouses are deceased, then the calculation can be complicated
Income in Respect of a Decedent IRD
income a decedent was entitled to be paid but did NOT receive before his or her death
the asset is included in the gross estate of the decedent BUT there is NO step-up in basis
income tax must be paid by the recipient
IRD Assets
All IRAs & qualified retirement accounts (excluding Roth IRAs, Roth 401(k)s, Roth 403(b)s & Roth 457s)
Dividends declared but not received
Commissions earned but not paid
Rents & royalties owed but not yet paid
Partnership income of a deceased partner
S corporation income of a deceased shareholder
Continuing payments from an annuity (period-certain annuity)
Unpaid debt on an installment note
Capital Needs Analysis Approach - Life Insurance
the amount of capital needed under the capital needs analysis approach can be determined using the following formula:
Capital needed = Annual Income / Interest Rate
Interest Rate = real rate (1 + ROR) / (1 + inflation)
Investor’s At-Risk Amount - At-Risk Rules
the amount invested plus the investor’s share of recourse debt
Intra-Family Transfers
transfers not subject to gift tax
gifts outright & in trust
partial sales/gifts
full consideration transfers/sales (SCIN vs private annuity)
Family limited partnerships FLP
Trusts
Transfers NOT Subject to Gift Tax
NOT considered a gift, does NOT utilize annual exclusion
Legal Support
Qualified Transfers - direct payment to medical/educational institution
Below-Market Rate Loans - deminimis
Transfers to U.S. citizen spouses will generally result in no tax d/t unlimited marital deduction
Arm’s-Length Transactions
transfer b/t unrelated parties in the form of a sale, an installment sale, or an exchange
Gifts Outright & in Trust
can be used to:
- Utilize annual exclusion - requires a present interest
- Remove future appreciation
- Reduce gross estate
Partial Sale-Gift Transactions
sell an asset for less than the FMV
gift for difference b//t the FMV & the sale price will be a gift
Full Consideration Transfers/Sales - Private Annuities
transaction b/t 2 private (but usually related) parties
unsecured promise from the buyer to make payments to the annuitant for the remainder of the annuitant’s life
effective when the actual life expectancy is less than the IRS life expectancy table
used when the seller is in poor health
can’t be terminally ill… but if seller lives > 18 months then it is presumed that the annuitant was NOT terminally ill
risk that the seller/annuitant will live longer
from annuitant’s perspective, each private annuity payment is split into 3 components:
1. interest - at the section 7520 interest rate in effect at the date of the sale
2. capital gain
3. income-tax-free return of capital (adjusted basis)
capital gain portion = (current FMV - adjusted basis) / number of expected payments (yearly capital gain portion)
interest portion = subtract both the return of adjusted basis & the capital gain from the yearly annuity payment
Full Consideration Transfers/Sales - SCIN
Self-Canceling Installment Notes
installment sale w/ payments of interest & principal over term
SCIN premium paid to cancel note at seller’s death
no gift if the PV of the note is = to the value of the underlying property & the SCIN premium is appropriate
interest can be deductible
used when seller is in poor health
SCIN vs Private Annuity
Family Limited Partnerships (FLP)
partnership created to transfer assets to the younger generation
1% general partner - parent
99% limited partner - gift these to the child (make use of annual exclusion)
take advantage of minority shares & marketability discounts
use when transferor is intent on gifting asset while maintaining control
Legal Title
held by the trustee
trustee is a fiduciary (acts in the best interest of the beneficiaries)
Taxation of Trusts
Revocable - NOT a completed gift
Irrevocable - generally completed (unless retained interests)
Income tax:
- Grantor trust = income taxed to grantor
- Non-grantor trust = hybrid entity
Distributed = taxed to beneficiaries
Accumulated = taxed at trust rates - Simple trust = mandates distribution of income
- Complex trust = permits accumulation of income
Revocable Trusts vs Irrevocable Trusts Chart
Classification of Trust Arrangements
- Revocable Trusts - grantor can revoke the trust
- Irrevocable Trusts - grantor CAN’T revoke the trust
- Inter Vivos Trust - created during life
- Testamentary Trusts - created at death
- Standby Trust - unfunded or minimally funded; waiting for trigger event (usually incapacity)
- Pourover Trust - receives assets from another source
- Grantor Trust - inter vivos trust for the grantor; grantor pays ALL income tax
- Funded or Unfunded (available to receive $ or property in the future)
Inter Vivos Revocable Trusts
avoids probate
provides for management of the grantor’s assets if grantor is incapacitated
important in states w/ high probate costs
privacy is maintained - no notice requirements, terms confidential
will contests are discouraged - state law controls but generally more difficult
NOT effective for reducing estate taxes
Inter Vivos Irrevocable Trusts
used to achieve estate & gift objectives
completed gift
use annual exclusion - remember need present interest!
- distributions of income are considered a present interest
- Crummey (do NOT forget “5-and-5” power)
Crummey Power
makes it possible to transfer an irrevocable trust for the gift tax annual exclusion; allows beneficiaries of trust to withdraw any contribution made to the trust w/in a certain period of time (typically 30 days)
REMEMBER: whenever a trust that gives the beneficiaries the right to demand distribution of the grantor’s contribution to the trust is created, the “5-and-5” power must be considered
hanging power = to the extent that a demand beneficiary has a right to withdraw that does not lapse (the portion over the “5-and-5” amount), the nonlapsing portion will hang over to a subsequent year, when it can lapse under the “5-and-5” standard
“5-and-5 Power” allows beneficiary the right to appoint the GREATER of $5,000 or 5% of trust assets; power is made noncumulative (when it is not exercise for a give year it lapses) thus failure to exercise this power in any year will NOT result in gift tax consequences
- IF the power has NOT been exercised in the year of death, the beneficiary’s gross estate will only include the GREATER of $5,000 or 5% of the property & NOT all the trust assets
Grantor Retained Annuity Trust (GRAT)
pays fixed annuity to grantor for defined term
remainder to noncharitable beneficiary at the end of term
Gift = PV of remainder interest
if grantor dies during term = value of trust IS included in gross estate; no tax saved
use property that is expected to appreciate at a rate greater than the 7520 rate
RISK = grantor dies too EARLY
Grantor Retained Unitrust (GRUT)
similar to GRAT EXCEPT pays fixed percentage of assets each year that are revalued on an annual basis
NOT suitable for hard to value assets
used very infrequently
Qualified Personal Residence Trust (QPRT)
form of GRAT for personal residence
grantor receives use of the house transferred
ideal if house is appreciating faster than the 7520 & family plans to keep home
Gift = PV of remainder interest
if grantor dies during term = INCLUDED in Grantor’s Gross Estate
Irrevocable Life Insurance Trust (ILIT)
trust holds life insurance policy
utilizing the annual exclusion; Crummey provision
avoid requiring the trust to pay proceeds to estate for taxes or administration expenses because it causes inclusion in the gross estate
in order to provide liquidity:
- allow trust to purchase assets of the estate
- allow trust to loan money to the estate
not included in the gross estate of the insured if there is no incidence of ownership
Trusts for Minors - Section 2503(b) & Section 2503(c)
minors are not generally permitted to own property
2503(b):
- may hold assets for beneficiary’s lifetime but must distribute income annually
- annual exclusion available for the PV of the income interest
2503(c):
- allows income to be accumulated but assets must be available to child when they turn 21
- annual exclusion available for the contribution
ABC Trust Arrangement - A Trust
power of appointment trust
gives surviving spouse general power of appointment over trust’s assets; avoids terminable interest rule
value of property qualifies for marital deduction
ABC Trust Arrangement - B Trust (Credit Shelter or Bypass Trust)
taxable beneficiaries to ensure use of applicable credit amount
spouse can still get the income, HEMS, “5-and-5”
ABC Trust Arrangement - C Trust (Qualified Terminable Interest Property QTIP)
allows decedent to qualify a transfer for the marital deduction at his death yet still control the ultimate disposition
taxed in the estate of the second spouse to die
property must qualify for marital deduction
spouse entitled to trust income for life & the income must be paid annually
spouse must be able to compel the trustee to sell non-income-producing assets
during the spouse’s lifetime no one can appoint property to anyone other than the spouse
must file an election on the 706
QTIP is election
executor has 15 months to determine the applicability of the QTIP election; 9 months plus extension
QDOT
allows a noncitizen spouse to qualify for the martial deduction
requires a domestic trustee
When is a gift tax return required on charitable contributions?
if there is a split gift b/t charity & non charitable beneficiary
Charitable Gifts of a Split Interest - Pooled Income Funds PIF
contributions are pooled in a trust maintained by the charity
income for life to donor
remainder to charity
good for SMALL gifts
Charitable Gifts of a Split Interest - Charitable Remainder Annuity Trust CRAT
less flexible
fixed annuity greater than or equal to 5% initial FMV
annuity must be paid at least annually to donor
life or term (term cannot be more than 20 years)
donor can change charitable beneficiary
no contributions after inception
Remainder Interest greater than or equal to 10% of initial FMV
Charitable Gifts of a Split Interest - Charitable Remainder Unitrust CRUT
more flexible
fixed percentage of at least 5% of the annual FMV
annual valuation
donor can contribute after inception
catch up provisions allowed if only distribute income if less than stated %
Remainder Interest greater than or equal to 10% of initial value
Charitable Gifts of a Split Interest - Calculation of the gift & remainder interest
CRAT:
- multiply annuity by IRS table to get income interest
- deduct income interest from FMV to get remainder
CRUT:
- complex calculation
Non-Trust Split Interest Charitable Gifts
donate the property but retain the right to use it
similar to a QPRT
personal residence or farm
Charitable Remainder Trusts - Summary Characteristic Table
Charitable Gifts of a Split Interest - Charitable Lead Trusts CLT
charity receives income, remainder to noncharitable beneficiary
used by high net worth individuals who do NOT need current income
use appreciating assets!
must be grantor trust to receive charitable income tax deduction
Testamentary Giving to Charities
no deduction for income tax purposes
for estate deduction (if applicable):
- must be mandatory
- amount must be certain & included in the gross estate
some items are more beneficial at death - papers of political figures:
- During life = income tax deduction limited to AB which is 0
- At Death = no income tax deduction, but no estate tax either
- Potentially Better = get adjustment to basis, give to an heir & let heir donate & get higher income tax deduction
Transfer-for-Value Rule Exceptions
transfer-for-value rule will not apply when there is a transfer of a life insurance policy to any of the following individuals:
the insured
a partner of the insured
a partnership in which the insured is a partner
a corporation in which the insured is a shareholder or officer
a transferee who takes the transferor’s basis in the contract
Installment Payments of Estate Tax - Section 6166 & Section 6161
closely held business
extend the payment of estate taxes over a 14 year period
first 4 years of payments are interest-only, followed by 10 payments that amortize the estate tax liability over the payment period
the value of the business interest must be at least 35% of the value of decedent’s Adjusted Gross Estate
the business interest MUST be a closely held business:
- a sole proprietorship;
- a partnership if at least 20% of the capital interest is included in the decedent’s gross estate or if the partnership has fewer than 45 partners; or
- a corporation if at least 20% of the voting stock is included in the decedent’s gross estate or if the corporation has 45 or fewer shareholders
Corporate Stock Redemption - Section 303
stock may be redeemed from an estate up to the total amount of:
- estate & inheritance taxes, estate administration costs, & funeral expenses w/out being treated as a dividend
business must be a corporation & the value of said corporation must be more than 35% of the decedent’s adjusted gross estate
EXAM TIP = question is likely to ask about the percent of the estate that the corporate makes up; also it is ONLY applicable to corporations
Generation Skipping Transfer Tax
3 Tax Systems = Estate, Gift, & GSTT
GSTT = an excise tax imposed on the transfer of property to a donee who is 2 or more generations younger than the donor
GSTT rate = the maximum estate tax rate in effect at the time the generation-skipping transfer (GST) occurs times the “inclusion ratio” (2024 = 40%; flat)
Non-Skip Person
any natural person or trust that is not a skip person
Skip Person
Lineal Descendants = 2 or more generations younger than the transferor
Unrelated = transferees that are 37.5 years younger than the transferor
Trust may be skip person if:
- all interests in the trust are held by skip persons, or
- if distributions can only be made to skip persons
charitable organizations are considered to be in the same generation as the transferor
Predeceased Ancestor Rule = if a child of the transferor is deceased at the time of the transfer, then the deceased child’s descendents are moved up one generation
Lineal Descendants
Unrelated Parties
Types of Taxable Transfers - Direct Skip
outright gift to a skip person
direct skips are taxed only once regardless of how many generations are skipped
GSTT on a direct skip is imposed only on the amount received by the transferee
any GSTT associated w/ a direct skip that is paid by the transferor is treated as a taxable gift by the transferor
the transferor is generally liable for the GSTT on a direct skip
if a direct skip is made from a trust, the trustee is liable
Types of Taxable Transfers - Taxable Termination
any termination of a trust interest unless at the termination of the trust:
- the trust property transferred is subject to federal or gift tax,
- a non-skip person receives an interest in the property transferred out of the trust, or
- the distribution from the trust will never be made to a skip person
the taxable amount = the value of the trust property transferred less any expenses, indebtedness, & taxes attributed to the termination
the trustee is liable for the GSTT on a taxable termination
Types of Taxable Transfers - Taxable Distribution
any distribution from a trust to a skip person that is not a taxable termination or a direct skip
taxable about = amount received by the recipient, reduced by any expenses incurred by the recipient in connection w/ the determination, collection or refund of the GSTT imposed on such distribution
transferee is liable for the GSTT on a taxable distribution
GST - Exclusions
Qualified Transfers
Annual Exclusions $18,000 (& split gifts)
Lifetime Exemption $13,610,000 2024
GST - Exemption
the transferor may elect out
automatically allocated at death to the extent not actually allocated on or before the due date for the transferor’s estate tax return
- first allocated pro rata to direct skips
- remaining GST exemption allocated pro rata to trusts
GST - Applicable Fraction
= GST Exemption Allocated / (Value of property transferred - Death taxes - Charitable deductions - Nontaxable gift portion)
GST - Inclusion Ratio
= 1 - Applicable Fraction
GST - Applicable Rate
= Inclusion Ratio x Maximum Transfer Tax Rate (40% for 2024)
GSTT Summary - EXAM TIP = KNOW THIS INFORMATION
KEY POINTS:
- designed to tax large transfers b/t skipped generations (i.e., grandparent to grandchild)
- it is separate from, & additional to, the gift & estate tax systems
TRANSFERS SUBJECT TO GSTT:
- Direct skips
- Taxable termination
- Taxable distribution
GSTT RATE:
- the GSTT rate is the highest marginal rate for the unified gift & estate tax rates (40% for 2024)
- any GSTT paid will be added to the FMV of the gift to determine total taxable gifts for the federal gift tax
EXCEPTIONS TO GSTT:
- GSTT annual exclusion is $18,000 per donee per donor, gift splitting is available if both spouses elect
- Indexed but $18,000 for 2024
- The predeceased-parent rule applies for direct skips to lineal descendants & collateral heirs if the decedent does not have any direct lineal descendants (children, grandchildren)
- Lifetime exemption available during life or at death equal to the applicable estate tax exemption of $13,610,000 for 2024
- Qualified transfers are excluded
Punitive Damages
punitive damages = included in income
only compensatory damages for bodily injury are excludable from gross income
compensatory damages w/out bodily injury are includable as are punitive damages
Fed Funds Rate
rate at which member banks borrow from each other
TIP = follow supply & demand for banks looking for loans and banks w/ loans to give
fed has no direct control but DOES have influence
