CFP - Missed Questions Flashcards
Ted pays alimony from a 2018 divorce to his ex-wife, Cruella, in the following amounts. Has Ted made an “excess alimony payment”?
Year 1 $10,000
Year 2 $30,000
Year 3 $10,000
Year 4 $10,000
B. Yes, in the second post-separation year
To determine excess alimony, note the difference in the payment between years 2 and 3. Under the Internal Revenue Code, the excess alimony payment for the second year is the amount that exceeds the payment in the third year by more than $15,000. The excess is $5,000; [$30,000 - $10,000 + 15,000)]. Doubtful this will be tested.
Patrick Parker died at age 44 with most of his property in joint tenancy (JTWROS) or with a beneficiary designation. If Mrs. Parker (who is wealthy) does not want to receive all of the joint tenancy property, what amount of property do you recommend that she disclaim?
C. Up to any amount with which she feels comfortable
Mrs. Parker does not need Patrick’s assets. The portability will only allow $13,610,000 to pass tax-free from Patrick’s estate.
Your client, Roger, is looking for an investment that will accomplish his objective of income tax deferral. Which of the investment vehicles shown below would defer income taxes?
A. A rental apartment building
Investing in the rental apartment building enables depreciation deduction to offset rental income on an asset that can appreciate in value over time. The single premium annuity shown does not indicate if it is immediate or deferred. Municipal bond interest is tax exempt rather than tax deferred. Interest on Certificates of Deposit is currently taxable.
For purposes of calculating the AMT, which of the following is/are add-back items?
I. Private-activity municipal bond interest
II. The bargain element on exercised incentive stock options
III. Financial adviser fees
IV. NY City income tax
V. Percentage depletion from oil and gas drilling program
D. II, IV
The bargain element of exercised ISOs, local and state income tax, are “add-back” items. Financial advisor fees are no longer deductible so therefore they are not “add-back” items. Answers I and V indicate preference items.
- Kevin, a wealthy retired individual is interested in establishing a gifting program for his 3 children and 8 grandchildren. Another financial planner is suggesting a plan that would create limited tax consequences to the donee plus provide the donee with potential future growth. Currently, Kevin owns the following assets and is considering whether to gift them.
$1,000,000 high-yield corporate bonds
$1,000,000 corporate zero coupon bonds
$1,000,000 T-bills that mature in 90 days
$1,000,000 ABC, Inc. stock with a basis of $400,000 paying $20,000 of dividends annually
A. Wait until the T-bills mature, and then give each donee $18,000 with instructions to buy a security that is similar to ABC, Inc. stock.
The strategy to gift cash then have the donees acquire common stock means that the donee’s basis will be the purchase price ($15,000) whereas under Answer D, the donee’s basis is the donor’s (carry-over) basis ($6,000). Answers B and C have no growth capacity and could trigger kiddie tax relative to the grandchildren.
- Mrs. Tillman, age 58, has an assortment of health problems such as chronic back pain, obesity, high blood pressure, etc. Mr. Tillman, age 65, is retired after working for one employer for 40+ years, but he is in good health. The Tillmans own about $1.6 million in assets. Their cash flow meets their expenses sometimes with a little to spare. If Mr. Tillman would consider only one of the types of insurance contracts shown below, which would be your strongest recommendation?
A. Long-term care insurance/Life Insurance with LTC rider
If Mrs. Tillman needs long-term care, Mr. Tillman may have to use their assets for the expenses relating to her care. He needs to protect their assets in case he needs long-term care. The question asks about insurance for Mr. Tillman rather than for Mrs. Tillman. He is 65, and after working for 40+ years should qualify for Medicare.
- At the local library, Todd attended a program called “You and Your 1040.” Now, Todd thinks he understands how federal income tax works. He is 55, married, and earns about $150,000. Todd’s three children have all graduated from college. At work, he makes the maximum 401(k) elective deferral. He also invests in stocks that pay qualified dividends that, given his tax bracket, are taxed at a 15% rate. Todd has been trading stocks actively this year. Todd thought he figured his tax liability accurately, but his CPA said he needed to pay $10,000 more because of recent tax law changes and may get hit with a late payment penalty. You are Todd’s investment advisor and he called you for advice. How would you respond to Todd’s concern about taxes?
B. Todd, you need to change your investment timing and allocations to avoid extra short-term gains.
Reallocating to growth stocks and reducing short-term trading should lower Todd’s federal income tax liability. Gains produced from short-term trading are subject to ordinary income tax and often, the AMT. While Answer D is reasonable, it appears that Todd prefers the equity market.
- Pauline Hirsch, age 75, tells you that, through personal oversight, required minimum distributions were not taken from her IRA beginning at age 73. You are aware that the penalty for failing to take required minimum distributions is substantial. How should you tell Pauline to proceed?
C. File an amended return (1040X) and ask for the excise tax be waived, but pay the tax now. The IRS may waive the excise tax if the taxpayer demonstrates: (1) the missed distribution was due to reasonable error and (2) appropriate steps are being taken to remedy the situation. An amended return is the 1040X. Making up missed distributions (Answer D) does not per se motivate the IRS to grant a waiver of excise tax if it later discovers the under-distribution. While, given that this is the second year of missed RMDs, his/her CPA should have better advised Pauline. While you can share your concern with Pauline, it is not appropriate that you independently confront the CPA.
- Mac Blair decided to make a gift of Blair, Inc. common stock to his son Blake. Mac seeks that any future appreciation of the stock not be included in his estate for federal estate tax purposes. He is going to retire soon and will need income during his post-retirement years. Mac has converted the majority of his common stock to preferred stock and gifted the remaining common stock to his son. What is the result?
A. The value of the common stock for gift tax purposes will be based on dividends paid on the preferred stock.
The preferred share value will be determined based on the stated dividends. The common stock value would then be the difference between the FMV of the corporation and the aggregate value of the preferred shares.
- Mr. Boyd has been your client for many years. Mr. Boyd’s portfolio has weathered ups and down cycles in the economy. His average return over time is approximately 11 percent. Now Mr. Boyd wants to buy a $35,000 car. His old car has very limited trade in value. He asked you whether he should buy the car for cash, which he has available, or lease the car under a 3-year lease agreement. How would you best respond?
B. “Mr. Boyd, you should consider the opportunity cost of investing the money and lease the car.”
The decision as to whether it is best to buy versus lease a car is often based on opportunity cost. First, determine the break even return on the investment. If investing can outperform the breakeven return, it makes sense to the car.
- John, age 69, and Mary, age 69, (married) both worked until this year. Throughout the last 35 years, both had high paying jobs that consistently exceeded the maximum Social Security taxable wage base. As a result, both his and her benefits will be in the same amount when they claim them at age 70. They will each receive over $3,000 per month. If John predeceases Mary, what will happen to Mary’s benefits?
A. The amount will not change. Mary will still receive her benefits After John’s death, Mary will be entitled to the greater of her benefits or 100% of John’s benefits. John and Mary had matching amounts at or over $3,000 per month. That amount will continue.
- Harry Porter started working immediately after he graduated from college. He earned an engineering degree specializing in computer software. At his first job, he immediately started making $39,000 annually. Since then, every year he has been making 401(k) maximum deferrals plus maximum Roth IRA contributions. This year he contributed $6,000. His total contributions to date are $42,500 and his Roth IRA has a balance of $62,500. Now Harry has an opportunity to buy his first house that is a few minutes away from his job. He needs $52,500 as a down payment to get a very attractive mortgage rate. If he withdraws $52,500 what will be his tax situation?
A. The $52,500 will be income tax free and no 10% early withdrawal penalty would apply. Harry’s regular Roth IRA contributions are distributed first and are tax-free. Additionally, he qualified under the five-year holding period to withdraw $10,000 for a first home purchase. The $10,000 is tax-free and no penalty applies.
- Mrs. Pratt who has always been a conservative investor, expects interest rates to decline. She wants to purchase some high yield debt to take advantage of current interest rates. Which of the following bond features would best help Mrs. Pratt relax about potential interest rate changes going forward?
B. Call protection for 10 years
Ten years of call protection enables Mrs. Pratt to enjoy the relatively high rates for at least ten years. Bond premiums and discounts are not features. Given current “high rates”, Mrs. Pratt would not be anxious about rates rising soon. A put feature would matter if she feels interest rates will rise. Further, both the put feature and conversion feature would reduce yields.
- Mr. Pike, a sole proprietor, has a gross income of $40,000 from his landscaping business. He also has $1,000 of tax-free municipal bond interest and $1,000 from qualified dividends. Mr. Pike incurred a $500 IRA contribution, $500 of meals expenses and $500 of business expenses for advertising and supplies. What is Mr. Pike’s AGI?
C. $36,977 +/- $1
Gross income
$40,000
less 50% of meals
- 250*
less business expenses
- 500
Net income
$39,250
plus dividends
+ 1,000
less the self-employment tax
- 2,773
($39,250* x .07065)
or 1/2 of .1413
less IRA deduction
- 500
$36,977
The calculation starts with gross income. Mr. Pike is filing on a Schedule C. His proprietorship can deduct 50% of its meals.
- Mrs. Smythe, a widow, just discovered that 85% of her Social Security retirement benefits were taxable last year. What could have caused her benefits to be taxable?
B. She redeemed a large quantity of 30-year-old EE bonds.
Answer A would make only 50% of Mrs. Smythe’s benefits taxable. For a single taxpayer, the 85% is triggered when the provisional income exceeds $34,000 in any given year. The EE bonds produce taxable income when she redeemed them. When HH bonds were issued, EE bonds could be exchanged at maturity for HH bonds. HH bonds are no longer issued.
- Puffy Sleeves, Inc. an over-the-counter stock is currently selling for $28.50. Its estimated future earnings are $3 per share. If Puffy’s P/E ratio is 11 using the P/E valuation model, is the stock underpriced or overpriced?
B. Puffy Sleeves, Inc. stock is underpriced.
The stock is underpriced ($3 x $11 = $33) using the P/E formula.
- Mrs. Fenner rents out a room in her house to Stanley Warner who is a graduate student at the local university. Stanley needs additional storage space. Mrs. Fenner allows Stanley to store his off season clothes (value $1,000) in her garage. If the garage burns down including Stanley’s clothes, how would Mrs. Fenner’s property insurance company most likely handle the claim?
A. The claim would be denied
All homeowner’s insurance forms specifically exclude coverage for property of roomers or boarders regardless of where it is on the premises. It doesn’t matter if the property is kept in her garage or the boarder’s room.
- Sam believes he was cheated on an investment transaction with a broker/dealer with which you are not affiliated. As a financial planner, if Sam is seeking recourse, how would you recommend that he proceed first?
E. Write to the compliance officer (registered principal) of the broker/dealer that handled the transaction and ask for his money back
A disgruntled client of a broker/dealer should generally begin the complaint process through that broker/dealer’s compliance function. If the firm is unresponsive or disagrees with the customer’s claim, arbitration should be pursued through FINRA. Mediation may also be available. the broker/dealer community is governed by FINRA directly under the supervision of the SEC. The CFP Board is not the regulator for broker/dealers.
- An individual holding a FINRA Series 6 license can receive commissions relative to the sales of which of the following investments?
I. Mutual funds
II. Variable life insurance
III. Variable annuities
IV. ETFs
E. I only
A Series 6 limited securities representative licensed individual can sell mutual funds only. To sell variable products, the individual must also hold a state-issued insurance producer’s license. The question does not indicate any insurance license. ETFs are Exchange traded funds. They are normally traded on a national exchange without a prospectus. To earn commission for sales of products not accompanied by a prospectus, one must hold the FINRA Series 7 general securities representative’s license.
E. I only
A Series 6 limited securities representative licensed individual can sell mutual funds only. To sell variable products, the individual must also hold a state-issued insurance producer’s license. The question does not indicate any insurance license. ETFs are Exchange traded funds. They are normally traded on a national exchange without a prospectus. To earn commission for sales of products not accompanied by a prospectus, one must hold the FINRA Series 7 general securities representative’s license.
B. I, III
Under ERISA rules, a profit sharing plan may exclude from participation employees working fewer than 1,000 hours per year. Eligibility to participate in an employer-provided group health insurance plan normally requires 32 hours per week. SEP eligibility falls under the 3-year rule which could force Sonia to cover certain returning part-time workers. The SIMPLE (401k) implies employee deferrals. At this point it is not clear as to whether the employees would want to make elective deferrals. Her own maximum contribution would be lower than that under the profit-sharing plan.
- Andrew Albertson has been your client for many years. He is a 69-year-old widower. He has three grown children and his eldest daughter, Andrea, lives in the same town. When you gather data from your client, you learned the names and contact information for his tax and legal advisors. Because he chose to delay claiming his Social Security retirement benefits until he attained age 70, Andrew was paying the monthly premium for his Medicare Part B coverage by personal check. He showed you several late premium notices from the Social Security Administration. However, he can’t recall whether or not he actually paid the premium. His coverage could be canceled. In the past year or so, Andrew has been unable to recall many of his activities. You are a CFP ® certificant. Given Andrew’s situation, what would be your best response?
C. Under the Duty of Integrity, discuss your concerns with Andrew’s personal physician. At times the CFP® practitioner must weigh the Duty of Integrity against the Duty of Confidentiality. Integrity requires putting the client’s interest first and it is important that Andrew not lose his Medicare Part B Coverage. Discussing Andrew’s late premium payment with his daughter would blatantly violate the Duty of Confidentiality. However, discussing your concerns with Andrew’s doctor is a reasonable choice because the doctor is required to maintain confidentiality under HIPAA and to serve the interest of patients under the Hippocratic Oath.
- In 2016, Sidney and Ruth Silverman borrowed $100,000 from a bank pledging their home as collateral. At the time of the loan, the Silverman’s equity in their home was $125,000. The proceeds from the loan were used to start their new delicatessen business, Crosby, Stills, and Nosh. They also used other funds to fully equip the business. Which statement below best describes the tax result of this home equity loan in tax year 2024?
D. The interest on the home equity loan is not deductible because interest on home equity loans is generally nondeductible in tax year 2024. Interest on home equity loans is generally nondeductible unless utilized for home improvement. While interest on a home equity loan was an itemized deduction, it was not classified as a “miscellaneous itemized deduction.” However, interest on home mortgages up to $1M are grandfathered if taken out prior to December 15, 2017.
- Sheldon Shrink, MD is a practicing psychiatrist. He operates his sole practice as an LLC. After covering expenses such as office space and malpractice insurance, Dr. Shrink’s practice has net revenue of $700,000. Sheldon is married to Shirley Shrink, who is an architect working for a major urban design firm. Her annual salary is $200,000. The Shrinks file their taxes jointly reporting AGI of $900,000 and taxable income of $827,000. To what amount, if any, of qualified business income (QBI) are the Shrinks entitled on their 2024 form 1040?
A. $0 The psychiatric practice is a “service related” business. The owner of a service business is ineligible to claim a deduction for qualified business income if that taxpayer’s taxable income is over the eligible thresholds. At joint taxable income of $827,000, the Shrinks have exceeded the threshold QBI.
- At only thirteen years old, Melissa Moore is a promising figure skater with dreams of Olympic competition. When she was born, her parents established a (section 2503-(c)) minors trust on her behalf. Melissa’s parents are in the 37% marginal federal income tax bracket. The trust assets, which are now substantial, are invested conservatively in bonds and bank-issued certificates of deposit. In the 2024 tax year, $15,000 of income from the trust is distributed to cover private figure skating coaching sessions for Melissa. Assume that Melissa has no other sources of income. How will this distribution of trust income be taxed?
D. This distribution of unearned income from a trust for a minor’s enjoyment will be taxed under “kiddie tax” rules. The amount of tax that applies to the distribution is $4,718.
Income distributed from a (Section 2503-(c)) minor’s trust is taxed under “kiddie tax rules” as follows:
-$1,300 (child’s standard deduction)
$1,300 (child’s bracket $130.00
$12,400 x 37% $4,588.00
$4,718.00
- Which exchange of property as shown below is most likely to generate the deferral of capital gains tax?
B. The exchange of a hotel for a shopping center. The shopping center exceeds the value of the hotel by $1 million. Exchanges of domestic real estate for other domestic real estate qualifies for like-kind exchange tax treatment providing deferral of capital gain. Equipment is no longer eligible for like-kind exchange treatment. Intangibles such as copyrights and mineral rights never were eligible for like-kind exchange treatment
- Dasch Hund, a married taxpayer, owns and operates Spaniel Spas, an exclusive dog grooming spa. Spaniel Spas operates as an S corporation. Spaniel Spas has one full time employee, Clem Clipper, who will earn a current year salary of $60,000. Spaniel Spas will generate $350,000 in qualified income this year. Dasch’s wife, Fifi, is a novelist. In the current year, she received substantial royalties from sales of Fifty Shades of Financial Planning. The Hund’s current year taxable income is $775,000. Their AGI is $800,000. Regarding this situation, which statement below is correct?
A. Dasch can claim a QBI deduction of $30,000. Because the Hund’s taxable income exceeds the phaseout threshold of $483,900, their deduction is now limited to the lesser of 20 percent of business income or 50 percent of W-2 wages. Thus, the QBI deduction is only $30,000.
- Olivia and John Walton have eight children. Their 2024 AGI will be $300,000. If six of their children are under age 16, what amount of Child Tax Credit may they claim?
C. $12,000 A credit of $2,000 per child under age 17 is available. The credit does not phase out until joint adjusted incomes exceed $400,000.
- Cleopatra Client believes that her financial planner and neighbor, Sheldon Selfish appropriated some of her money. Cleopatra had given Sheldon a limited power of attorney to trade her securities account. Lately, she noticed several unauthorized distributions of money from the account and has yet to receive the checks. Sheldon holds the CFP® designation but is not an associate of any securities firm. To which party listed below should Cleopatra initiate her claim against Sheldon.
C. CFP® Board Nothing in the question indicates that Sheldon is affiliated with a FINRA firm or has registered as an investment advisor with the SEC. However, he does hold the CFP® designation. Cleopatra should file her complaint initially against Sheldon with the CFP® Board and also with FINRA/SEC depending on how/if the person is licensed. In fact, she may do so through the CFP® Board’s online portal
- Which of the following taxpayers would be eligible for the Retirement Savings Contributions credit (Saver’s credit)?
D. Married couple (AGI 63,000) deferring $7,000 into a 401K plan to get the employer match The Retirement Savings Contributions credit is designed for low to moderate income taxpayers and matches a percentage (based on AGI) of the taxpayers IRA, retirement plan or ABLE account contributions but not 529s. The maximum credit is $2,000 (single) and $4,000 (MFJ) and no credit is available for taxpayers over $38,250 (single) and $76,500 (MFJ) AGI.
- A CFP® professional is discussing an adjustable mortgage with a client. What rate is used most often as the base rate for resetting the mortgage rate?
B. SOFR The Secured Overnight Financing Rate (SOFR) is the base rate used for many loans and financial derivatives (LIBOR was used in the past). One possible example could be a mortgage readjusting using the SOFR on a specific date plus 300 basis points.
QUIZ TWO START:
2. George Hallas owns 80% and his daughter, Georgina, 20% of Hallas, Inc. (a corporation). Hallas, Inc. grosses approximately $20 million in a typical year. George and his daughter also own a general partnership worth $5 million. George owns a $3 million life insurance policy outright under which he is the named insured. He wants to remove the life insurance policy from his estate. What do you recommend?
D. Gift the policy to his daughter
If the corporation owns the policy, the proceeds may be considered in valuing the decedent’s interest for federal estate tax purposes unless there is valid agreement fixing the price that would reflect an arms-length sale to an unrelated party. This would be questionable because the buyer and seller are daughter and father, respectively. Answers B and C create a similar problem. When George dies, the partnership dissolves. The ownership of the policy after that point would be uncertain and possibly flow through to George’s estate.
- Baker, Inc. provides a qualified retirement plan (employer funded). The plan falls under numerous ERISA rules. The plan lost 50% due to poor investment decisions in the previous year. What recourse can the employees take?
E. Sue the plan officials for losses to the plan
Errant plan officials can be held personally liable for losses to the plan as well as other factors. ERISA prohibits monetary punitive damages for claims.
- Childhood pals Stu and Lou had always wanted to spend time together, so shortly after graduating high school, they opened a hamburger joint called Good Guys Burgers. The business has been quite successful over the past forty some years and has grown into a chain of 33 stores. Stu and Lou estimate that the business is worth $9 million and plan to engage a business valuation specialist to peg an accurate fair market value for the business. Stu and Lou, now in their early sixties, recently had their first discussion about business succession planning. Although Stu has a son, Mark, in his late twenties, Mark tours with a rock band and has no interest in stepping into his father’s shoes. Lou has no children, and his wife has serious health problems so she could not assume his business responsibilities if Lou dies. On the advice from their insurance agent, Lou and Stu decide to enter into an insurance-funded cross purchase death buy/ sell agreement. Each owner acquires life insurance on the other. If this agreement is executed and funded and Lou dies, who, if anyone, would experience a stepped-up basis relative to the buy/sell transaction?
C. Both Lou’s Estate and Stu
Both Lou’s estate and surviving owner Stu both experience basis step up. Lou’s estate gets an increase in basis to date-of-death fair market value (unless the AVD was selected which is not indicated in the data) due to the post mortem sale. Stu receives basis step up due to contributing additional capital (the life insurance death benefit) to the business (Good Guys Burgers) to buy out Lou’s equity in the business.
- Pension contributions are based on compensation. Which of the following is generally considered to be compensation to an employee?
I. Salary
II. Bonus
III. Business expense reimbursement
IV. Incentive stock options
V. Contributions to a deferred compensation plan
D. I, II
Salaries and bonuses are clearly compensation. A reimbursement pays the employee back for business expenses incurred but is not compensation. An ISO is a right to buy the employer’s stock and is not compensation. However, if the ISO becomes disqualified because the stock is exercised and sold in the same calendar year, the employee may be required to recognize any profits as compensation. Deferred compensation is not treated as compensation until it is constructively received. For tax purposes, compensation is considered current when it is paid no later than 2-1/2 months after the year in which it is earned. For a more-than-50% owner, the compensation must be paid by year end. Deferred compensation is not compensation for tax purposes until it is constructively received.
- Holly, the daughter of Mr. and Mrs. Golightly, is going to college. She plans to get her Masters at a state university. Unfortunately, due to economic conditions, her parents never set up a 529 plan or other education related arrangements. Holly may qualify for some state merit scholarships. Her parents, both professionals, earn well over $80,000 each, but spend most of what they make. Which of the following college tax and funding strategies may generate federal income tax credits for undergraduate as well as graduate education?
E. None of the above
The American Opportunity Credit may be available for the undergraduate years, but not for the graduate years. The Lifetime Learning Credit is subject to an AGI phaseout. The Coverdell ESA and PLUS loans do not generate federal income tax credits.
- Sadly, doctors have diagnosed your client, Sam, as being terminally ill with heart disease. He sold his $250,000 face value life insurance policy to a qualified viatical settlement company for $175,000 a year ago. In the past few weeks, Sam was invited to participate in a clinical trial of a new medicine that will prolong his life for 5-10 years. The medicine appears to be working effectively for Sam. How is the $175,000 that Sam received on the viatical sale affected?
C. The viatical settlement company will regret this particular transaction.
The viatical company’s return will suffer if Sam lives too long. Sam is not affected.
- Mr. Sims purchased a $500,000 life policy in 1987 paying a single premium of $50,000. The contract cash value has grown to $110,000. He has decided to surrender the contract this year. Which of the following is true?
A. $50,000 of the $110,000 will be income tax free; the remaining $60,000 will be subject to tax at ordinary income tax rates.
The policy is not a MEC; therefore, the cash value in excess of basis ($50,000) will be subject to tax at ordinary income tax rates, but not the 10% penalty. 2023-36 years in 1987. The policy was acquired before MEC rules took effect in 1988.
- Arthur, age 63 regrets retiring early. He’s single and bored. Arthur found a job at Walmart as a greeter. The job will pay $15,000 per year. Arthur doesn’t need the money because he is currently receiving $6,000 per month from his former employer’s money purchase pension plan plus early Social Security retirement benefits of $1,000 per month. Arthur lives in a comfortable apartment, has full medical coverage and makes no charitable contributions. He normally claims the standard deduction. Which of the following is true if he takes the job with Walmart?
A. He will remain in a 22-24% income tax bracket. Arthur will be in the 22-24% bracket. If he works the same hours for better pay, Arthur will exceed the 1-2 rule ($22,320) which would reduce his current Social Security retirement benefits. For now, Arthur remains with Walmart.
- Charlie was granted an incentive stock option (ISO) four years ago when the FMV and option price was $20 per share. Charlie exercised the option two years ago when the stock was trading at $30 per share. If he sold the stock today for $35 per share, which statement(s) is/are true?
I. Charlie was taxed on the $10 per share gain at capital gains rates when he exercised the option (no substantial risk of forfeiture).
II. There are no regular income tax consequences when the ISO is granted or exercised; Charlie will pay capital gains presuming the stock is sold at a gain.
III. If Charlie sells the stock for $35 per share, he will be taxed at capital gains rates on the $15 gain per share.
IV. At the time of exercise, $10 per share may have been an add-back item for AMT purposes.
B. II, III, IV
Because the stock was held for the two-year/one-year holding periods, it retains ISO status and thus qualifies for LTCG. The bargain element of $10 per share may hvae an AMT add-back. However, the question does not indicate any AMT was paid, therefore the basis is the cost of the shares.
- Mr. Smith is subject to the AMT. Which of the following can reduce his AMT payable?
A. Exercising more nonqualified stock options.
Exercising nonqualified stock options will increase his regular income which thus reduces his AMT payable. The mortgage interest deduction associated with a larger mortgage will decrease his taxable income. Purchasing public purpose bonds will have no effect.
- Mr. and Mrs. Bell are divorced. Under the divorce decree, Mr. Bell is required to pay alimony for 10 years. After two years, Mr. Bell dies. What happens to the alimony payments?
B. Alimony payments cease.
The ex-spouse generally has no rights to the decedent’s estate. Often the divorce decree mandates that the alimony payor acquire life insurance on his/her own life. This insures that the ex-spouse will receive alimony as decreed.
- A few years ago, John and Jim started a business J&J, Inc. as an S corp. In spite of a sluggish economy, the company has grown at a rapid rate. J&J has focused on selling shoes to men with small feet. At the time the business formalized they entered into an entity buy sell agreement funded with life insurance policies on each owner. However, John produces more of the income than does his partner Jim. This reflects Jim’s personality; he is uncomfortable around most people. Therefore, Jim handles the administration of the business. John now believes that he can outsource the administrative work and decrease the overall expense of the business. Because of this John wants to sever ties with J&J and start his own company with lower overhead and thus substantially higher revenues. He believes he can do this by selling all sizes of shoes rather than shoes only to men with small feet. His research shows that this will greatly increase the size of his market. Upon learning of John’s plans, Jim went into business with a new co-owner, Scott. They too will form an S corporation, J&S Inc. This time Scott and Jim will implement a cross purchase buy sell agreement. Jim does not want to manufacture shoes of all sizes due to the inherent cost of production. Which of the following statements is/are correct regarding the situation if Jim is looking to use his current life insurance policy owned by J&J, Inc to fund the new Cross Purchase Buy Sell with Scott.
I. Jim’s Policy Owned by J&J can be acquired by Scott to fund the Cross Purchase Agreement for J&S, Inc.
II. If Scott and Jim enter into an Entity purchase buy sell agreement J&S Inc could buy Jim’s policy from J&J Inc and there would not be a transfer for value exposure.
III. If J&S was established as a C corporation and the policy was transferred to Scott the death benefits would avoid federal income taxation if Jim lived for at least 3 years.
IV. Because the policy has only been in force for 2 years, Jim would have to wait 1 more year. Before he could remove the policy from J&J Inc to avoid inclusion in his gross estate.
V. John could buy his policy from J&J Inc and this would not trigger transfer for value rules.
B. I, II, V
Statement I is correct. It is permissible although it would create a transfer for value issue. Statement II is correct because a corporation in which the insured is a shareholder can purchase the policy without triggering transfer for value rules. Statement III is not correct. There will still be tax due to transfer for value regardless of how much longer Jim lives. Statement IV confuses 2 different rules. Statement V is correct because John can buy his own policy.
- Bill Williams, CFP®, wrote a plan for his client, Sally Linton, age 58. Sally indicated she would work for 9 more until her FRA (full retirement age) to qualify for full Social Security and maximum qualified plan benefits. One month later Sally unexpectedly quit her job. The facts are, however, the company she worked for was sold to a competitor and her position was eliminated. The new company offered her an unacceptable position. Now Sally realizes, at 58, with outdated skills, retirement is her only option. Sally indicates to Bill she is willing to sell her second home at the beach. How should Bill proceed?
C. Review Sally’s current lifestyle and expenses and establish a budget until the second home sells. Bill has all of Sally’s data. He just completed a plan. Sally is upset. She needs advice now. Making her wait might make her more upset. In creating the plan, Bill did assess Sally’s current lifestyle and expenses. Sally can’t file for unemployment insurance benefits because she terminated voluntarily. Sally clearly does not want to take the newly offered position.
- Sam Waters, age 63, has decided to retire. The company he has worked for maintains an endorsement type split dollar life insurance arrangement on his life. Sam has no other life insurance and has been told that due to several health problems if he applied for life insurance he would be rated (increased premium) or declined coverage altogether. His employer has informed him that he can purchase the policy that is currently held under the split dollar agreement. Presuming that Sam does buy the policy from his employer, what amount would he have to pay for it?
Universal Life Current death benefit $1,000,000
Cash Value $120,000
Premiums paid $100,000
C. $120,000
Under this endorsement method split dollar life insurance arrangement, if Sam wants to buy the policy under which he is the named insured, he will have to pay the higher of the cash value or premiums paid. The company will realize a gain representing the excess of the cash value over the premiums paid. The endorsement split dollar agreement typically precludes the employer charging interest to the insured employee.
- Your married client, Mr. Hart, has a son, Robert. Robert is about to enroll in college to study pharmacology. Mr. and Mrs. Hart are delighted that Robert has turned his life around. Only two years ago, Robert was convicted of a felony for distributing a controlled substance. Which among the following education financing strategies is available to the Harts if their AGI is around $100,000?
C. Claim the Lifetime Learning Credit
Both the American Opportunity credit and Lifetime Credit programs specify certain exclusions. For the American Opportunity Credit only, an otherwise eligible student can be excluded if convicted of a felony (in this case distributing a controlled substance). This restriction does not apply to the Lifetime Learning Credit. The Hart’s relatively low joint AGI qualifies them for a Lifetime Learning Credit. Answer D is unclear because it does not indicate whether the tuition is to be paid directly to the education provider. If it is paid to Robert, all or part of the gift may be exposed to federal gift tax. Regarding Answer D. No charitable gift deduction is available for tuition payments to a school.
- Which of the following risks is not presented in an investment in zero-coupon bonds ?
C. Reinvestment rate risk.
One advantage of a zero-coupon is the elimination of reinvestment rate risk because there is no coupon to be reinvested. The zero coupon bond is genrally subject to market risk, interest rate risk, and, if the zero is not a Treasury security, defafult risk.
- Your client, Tom, purchased a bond for $950 with a coupon rate of 6%. The bond matures in 17 years and is callable in 5 years at $1,110. What is the YTC for Tom’s bond?
C. 9.05%
10BII
12C
BA II Plus
Set for 2 P/YR
Set for 2 P/YR
5, gold, x P/YR
10,n
5, 2nd, xp/yr, N
$950, +, PV
$950, CHS, PV
$950, +, PV
$1,110, FV
$1,110, FV
$1,110, FV
$30, PMT
$30, PMT
$30, PMT
I/YR
i, 2, x
CPT, I/YR
Solution: 9.05% (end mode/semiannual)
- Robert Zimmerman owns Smokey Bacon, Inc. Smokey Bacon provides a profit sharing 401(k). Robert makes the maximum elective deferral and with the company match and typical forfeitures, annual additions have ranged between $20,000 - $25,000. He has started another company, Eggcellent Eggs, Inc. with some good friends, and they are considering a profit sharing 401(k) plan for Eggcellent Eggs. Robert will be a controlling shareholder in Eggcellent Eggs. Given Robert’s positions, which of the following statements is true?
D. He cannot defer any compensation into Eggcellent Eggs 401(k) plan.
Robert can be a participant in Eggcellent Eggs plan for profit sharing contributions but not elect any more deferrals. Answer C is incorrect because his annual additions limit (for both plans combined) is the lesser of 100% of compensation or $69,000 in 2024 (Bacon and Eggs are related employers).
- Your client, Byron Sheridan, died recently at age 83. He was married to Virginia, age 83. Byron enjoyed managing his investments and diversified his invested assets among several asset classes. When Byron died, he held the assets listed below. Which of them would be eligible for a step up in basis?
B. A municipal bond purchased at a discount ($95,000) two years ago now having a date of death FMV of $100,000
The municipal bond was held for the long-term and is eligible for stepped up basis upon Byron’s death. The tax deferred accounts such as an annuity (and retirement accounts generally do not step up in basis). The CD is cash. There is no stepped up basis; a dollar is a dollar.
- What is the least important obligation when you, a CFP® practitioner, are about to begin the first step in the financial planning process?
C. Disclosing the exact amount of conpensation that you will receive for performing the planning services. Disclosure of planner compensation should occur be in the first step that establishes a mutually agreeable relationship between the planner and the client(s). However, the exact amount of planner compensationis unknown in the earlier steps of the financial planning process. Thus, disclosing the exact amount of planner compensation is not required.
- George Able, age 60, enjoys working and has no wish to retire. He is researching businesses he could buy. Given that entrepreneuring is risky, George’s required rate of return is 7% to 8%. If a business earned an annual net profit of $100,000, what should George pay for the business?
B. $1,250,000 Using the higher rate 8% produces a lower number ($1,250,000). George would prefer to pay less to acquire the risky business. Using the 7% produces a maximum number. ($1,428,571) $100,000 = $1,250,000 .08
- Corporation X, Corporation Y and Corporation Z are all members of the same controlled group. X and Y jointly sponsor a profit-sharing plan covering their eligible employees. Corporation Z does not participate in the profit-sharing plan nor does it have a plan of its own. Chris works for all three of the corporations and receives $40,000 in compensation from each (total $120,000). How much may be contributed for Chris in the current year?
B. $20,000 The Section 404(a) limit on deductible contributions relative to Chris would be $20,000 ($80,000 x 25%). The $80,000 represents $40,000 in compensation from Corporation X and $40,000 from Corporation Y. You cannot consider the salary from Corporation Z because it does not provide a plan.
- Joan Lundy and Judy Baker own a successful business together. They want to create a buy-sell arrangement funded by life insurance. They are both in their early fifties and in good health. They want the arrangement to cover death, retirement, or one of them leaving the business. Which of the arrangements and policies make the most sense?
C. A cross-purchase buy-sell agreement funded with whole life insurance policies The only way the surviving owner will receive a step-up in basis is to implement the cross-purchase buy-sell arrangement. Whole life insurance has a level premium which will build the cash value for one owner to buy the stock of the (other) retiring or departing owner. Joan and Judy are both in good health. They indicate no immediate plans to retire or leave the business, so the policy may have to last until they reach age 80 or 90.
- John has invested $110,000 in a single bond debenture. The yield to maturity on the bond is 5.5%. The bond has a duration of 15.7. What can John expect to happen to the value of his bond portfolio if (market) interest rates decrease by 1%?
A. The value of the bond will increase by $16,370 +/- 1
The change in bond price is -15.7 x ( -.01 ) = 14.88%
1+.055
14.88 % of $110,000 is $16,370
- It is unusual that referred clients are not cooperative, but Tess is quite difficult. She glares after every recommendation you make. She makes comments like, “You’re just trying to make money off me, because I am a woman”. You are very uncomfortable. What should you do?
C. You should terminate the relationship in a polite manner. Nothing in the CFP® Code of Ethics requires you to continue serving a client who is impossible to please or who is rude.
- To generate extra cash for daily needs Ken’s mother should sell some of her stock. Ken’s mother bought the stock years ago for $25,000. It is now worth $50,000. If Ken buys the stock from his mother for $50,000 and sells it three months later for $62,000, what amount of gain, if any, does he have to report?
B. $12,000 STCG Ken purchased the stock. He owned it for 3 months. His gain is $12,000 STCG. This is a sale rather than a gift.
- With the uncertainty of investments, which of the following married couples would you recommend purchase LTC insurance?
B. Mr. and Mrs. Banker, ages 65 and 60, respectively have a combined net worth of $1,000,000. The Bankers need to acquire the insurance while they are insurable. The Ables appear not to be insurable. The Carefrees can probably self-insure. At this point the Doubtfuls are too young to buy long-term care insurance.
- Your Uncle Jim, a cash-method taxpayer, died and left you a $1,000 series EE bond. He bought the bond for $500 and had not chosen to report the increase in value each year. As of the date of Uncle Jim’s death, interest of $94 had accrued on the bond and the value of $594 had been included in your uncle’s estate. Uncle Jim’s personal representative chose to include the interest earned on the bond in your uncle’s final income tax return. If you cash in the bond at maturity, how much income will you have to report on your own income tax return?
C. $406 You would report the difference ($1,000 - $594) at the maturity of the EE bond.
QUIZ THREE START:
5. Your client, Frank, age 44, believes that the business cycle is about to turn sharply and that an 8% inflation rate is a necessary assumption in the construction of his retirement plan. You, a CFP® certificant, strongly believe that inflation will continue to be substantially lower averaging between 3 and 4 percent in the long run. Which inflation rate from the choices below would you reject first?
A. Current year’s inflation rate
A one-year inflation rate does not constitute an inflation rate for a long-term goal achievement. Remember that client and planner must mutually agree on plan assumptions. While the client’s 8% assumption may not end up as the one used in the plan, it should be considered. It might make sense for the planner to run the numbers using both his personal inflation assumption and run them again using the client’s so the client can see that his assumption would probably be less workable
- Due to impressive growth rates in recent years, T Max, Inc. is concerned about its exposure to the corporate AMT. The company owns four substantial life insurance policies which fund a stock redemption buy-sell agreement. The officer owners have decided to switch to a cross purchase buy-sell agreement. What can or should be done with the life insurance policies that are now owned by T Max, Inc.?
D. Do not worry about it since the new tax law eliminated the corporate AMT If the owners who had been covered under the corporation’s stock redemption (entity) buy-sell agreement wish, they may buy the policies on their own lives that were acquired to fund that arrangement. Since the sales of the policies will be to the insureds, there is no exposure to transfer-for-value income taxation of the death proceeds. Answer A will trigger transfer-for-value problems. In Answer C, surrendering the policies is not an option as they still need the buy/sell policies. Answer D is true, the new tax law eliminated the corporate AMT.
- Lamar and Abby Sanford, who have three teenage and pre-teen children, are confused about the difference between the American Opportunity Credit (AOC) and the Lifetime Learning Credit. How would you answer the Sanfords?
A. If you elect a full Lifetime Learning Credit, you cannot claim an AOC for the same expense in the same year. Answer B is incorrect. The AOC is per eligible student per year. If a family has three children in college in the same year, each is eligible for the full AOC. Lifetime is maximum per year. The AOC is available only for the first four years of post-secondary education. No age limitation applies to the Lifetime Learning Credit.
- Which of the following are amounts received by the owner of a life insurance policy that would be treated as income-first distributions under a MEC contract?
I. Cash dividends
II. Interest accrued on a policy loan (added to the loan balance)
III. Dividends retained by the insurer to purchase “paid-up” additions
IV. Dividends retained by the insurer as principal or interest to pay off a policy loan
B. I, II, IV
When policy dividends from modified endowment contracts (MECs) are used like cash, they are distributed under FIFO rules such as those applicable to annuity distributions. Cash distributions and dividends used to pay off policy loans are considered to be income first distributions. The interest accruing from a policy loan on a MEC is treated the same way for federal tax purposes. Dividends used to buy paid up (permanent) additions are not treated as income-first distributions. The loan interest was not distributed. It was added to the outstandting loan balance
- Both of Rusty Whitman’s parents recently died in an auto accident. Rusty is 12 years old. Before their death, the Whitmans had established various trusts including revocable living trusts (each parent), an irrevocable life insurance trust, and a 2503(c) minor’s trust. While Rusty is younger than age 21, the trust earnings will support his normal living needs. Into which of the following trusts will Rusty’s parents’ assets ultimately pass?
E. A family trust
The revocable trust will become irrevocable and will turn operate as a family trust for Rusty’s benefit thereafter. It is rare that a revocable trust would name its beneficary as a 2503(c) children’s trust. 2503(c) trusts generally terminate when the minor beneficiary turns age 21.
- Monetary policy refers to activities in which the Federal Reserve engages to influence the amount of ______________ and _____________ in the U.S. economy.
C. Money and credit Activities of the Federal Reserve Board (FRB) seek to influence the domestic supply of money which, in turn, affects interest rates. Money is like any commodity: shrink the supply and the cost, in this case interest, rises.
- SEC registered advisers with AUM at least $100 million – are required to file annual updates to their ADV within _____ days of the end of their fiscal year.
C. 90 Federal covered advisers must update their ADV forms no later than 90 days following the close of their fiscal year. Smaller advisers that have registered with states securities regulators will comply with state specific deadlines for annual updates to their ADVs or equivalents.
- Which of the following statements is (are) true about profit-sharing plans?
I. They may be integrated with Social Security.
II. They may receive contributions for individual employees in excess of 25% of that participant’s eligible compensation.
III. They generally permit the employer to make flexible contributions.
IV. They may be age weighted.
A. I, II, III, IV
Qualified profit sharing plans feature flexible employer contributions. They may be age weighted and integrated with Social Security. While the employer may contribute and deduct up to 25% of its overall payroll, the contribution for an individual participant may exceed that percentage.
- Mrs. Roberts, age 60, is about to purchase a life insurance policy for estate planning purposes. She wants you to help her determine which policy she should buy. Various life insurance agents have proposed that she acquire one of the following policies:
A whole life insurance policy with Company A. The illustration shows premiums are paid in full with dividends in 10 years. (They vanish.)
Universal life insurance policy with Company B. The illustration shows the death benefit will be zero at age 95 based on current interest assumptions
Whole life insurance policy with Company C. The illustration shows premiums are paid in full with dividends in 15 years. (They vanish.)
On what criteria would you base your advice to Mrs. Roberts?
I. Review the insurance company’s ratings (A. M. Best etc.)
II. Review the size of the insurance company
III. Review the insurance company’s past history of paying claims and its future ability to pay
IV. Review the insurance agents’ competence, knowledge, and reliability
V. Review whether the whole life insurance premiums will vanish and whether the universal life policy will pay the death benefit to the insured’s age 95
B. I, III, IV, V
High ratings from two or three rating agencies should indicate that the insurance company is well able to pay its claims. The size of an insurance company is not necessarily an indicator of its financial strength. The experience and reliability of the insurance agent matters. The NAIC prohibits language indicating that the whole life premiums will vanish or the UL will last to age 95. In fact, the NAIC prohibits such language.
- You are an insurance agent and a CFP® practitioner. A client is referred to you. The client started a fire that ultimately spread to his neighbor’s house. The police are investigating the fire. The client wants to disclose all the facts to you to get insight on how his and his neighbor’s property insurers are likely to react when the truth comes out. How should you respond to this situation?
B. Tell the client you do not have advisor-client privilege and terminate the relationship immediately
A CFP® certificant shall treat information as confidential except as required in response to proper legal process. Although you are also an insurance agent, you should respond as a CFP® practitioner
- Chris Towns is the self-employed owner of Chris Craft Stores. He reports profits or losses from his business on Schedule C. Chris Craft Stores has 10 employees. The business is very successful - enough to fund various employee benefits for Chris and his employees. Which of the following current benefits are either added to the front of Chris’s 1040 as part of gross income or are shown as deductions on the front of the 1040 to determine AGI?
I. Group life insurance having a death benefit of $200,000 under which Chris is the named insured
II. A SEP contribution for Chris
III. Net profit from Chris Craft Stores of $350,000
IV. A spousal IRA contribution by Chris to his wife’s account
V. Group health insurance premiums for himself and his wife
B. I, II, III, V Because the face value of the group life is in exceeds $50,000 the premium on the face value exceeding that amount is treated as compensation and becomes part of Chris’s gross income. The SEP contribution and the health insurance premiums for Chris and his wife are deductions for AGI (above the line deductions). The net profit from this unincorporated business represents income to Chris: It is part of his gross income. Chris’s income, which clearly exceeds phaseout limits, makes his wife ineligible for the spousal IRA deduction
- Your client, Jeremy owns the following investments:
A 2% interest in a non-publicly traded partnership. His initial investment was $100,000. The partnership sent him a K-1 showing a $10,000 loss.
A 30% active interest in a limited liability company. His basis is $100,000. The LLC sent him a K-1 showing a $30,000 loss.
What amount of the losses can Jeremy claim for the current tax year?
C. $30,000
A loss from a non-publicly traded partnership is a passive loss. The loss is not deductible until the limited partner sells the interest or dies. A loss from an LLC in which the investor is an active participant is deductible up to basis.
- Former college roommates, Barbara and Kathy, are 50/50 owners of BK, Inc. When they started BK, the corporation acquired two $1,000,000 face value key-person term life insurance policies. Barbara is the named insured in one policy and Kathy in the other. Over the years, the company has paid $5,000 in premium on Barbara’s policy and $4,000 in premium on Kathy’s policy. Barbara and Kathy have decided to use the policies to back a new cross purchase buy-sell agreement. If Barbara buys the policy in which Kathy is the named insured paid by BK, what will be the tax outcome if Kathy dies within one year following Barbara’s acquisition of the policy?
B. The policy will be subject to the transfer for value rules making the death benefit net of basis subject to federal income tax.
The policy was sold to someone other than the insured or to a business in which the buyer is an owner or partner. Whether the policy is term or permanent insurance is immaterial to the rule. Transfer for value rules makes the policy’s death benefits income taxable to the beneficiary to the extent that it exceeds basis. The 3-year rule doesn’t apply when a sale (transfer for value) occurs.
- Dr. Perkins is a wealthy neurosurgeon who works for the Brain Trust Practice Group. He is the named insured on the following life insurance policies.
- $200,000 Whole Life
$ 25,000 current cash value
Dividends pay premium due.
Mr. Perkins is the owner. Mrs. Perkins is the primary beneficiary; their two daughters are the contingent beneficiaries.
- $500,000 Universal Life
$ 50,000 current cash value
As a key person policy, the premium is paid by the Brain Trust Practice Group (employer). The Brain Trust Practice Group is both owner and beneficiary of the key person policy.
Dr. Perkins is about to retire. The Brain Trust Practice Group is willing to transfer the key person policy to him for its current fair market value. Dr. Perkins has concerns about the gift income and estate tax ramifications relative to these life insurance policies under which he is now insured. Which of the following strategies is (are) the best option(s) for Dr. Perkins if he lives for at least three more years?
I. Establish an irrevocable life insurance trust to purchase the employer-paid policy.
II. Have his wife purchase the employer-paid policy.
III. Gift the personally owned life insurance policy to his wife
IV. Gift the personally owned policy to his life insurance trust (His wife and two daughters its beneficiaries.)
V. Buy the employer-paid key person life insurance policy and then gift the policy to his life insurance trust
E. IV, V
Answers I and II will trigger “transfer for value” rules and make the policy’s death benefit subject to income tax. If Dr. Perkins gifts the policy to his wife, it will be includible it in her gross estate for federal estate tax purposes thus increasing potential estate tax at the second death. Answer E is the best answer to get the policies out of his wife’s estate. The exact amount of taxable gift less exclusion is not part of the answer. Since his wife is a beneficiary, it is unlikely that gift splitting is permissible. But, his estate tax applicable amount remains available.
- Charter, Inc. is owned 50% by John Tillman and 50% by his brother-in-law, Brad Porter. Currently, the company maintains a stock redemption buy sell arrangement funded with insurance. Now that John and Brad better understand step up in basis rules, they would like to change to do a cross-purchase buy-sell plan funded with insurance. In light of their situation, which of the following statements is true?
I. Charter, Inc. owns and is the beneficiary of the stock redemption plan insurance policies.
II. John owns and is the beneficiary of the life insurance policy on Brad’s life that funds the stock redemption buy sell agreement.
III. Brad will own and name himself as the beneficiary of John’s insurance policy that will fund the cross-purchase buy-sell arrangement.
IV. Charter, Inc. will own and be the beneficiary of the insurance policy on Brad’s life that will fund the cross-purchase buy-sell plan.
V. To fund the new cross purchase arrangement, the current stock redemption policies on John and Brad should be sold to Brad and John respectively. John would the policy under which Brad is the insured and Brad would buy the policy under which Joh is the insured.
E. I, III
Under an insurance funded cross-purchase buy sell agreement, each owner buys a policy on the other owner(s). Under the current corporate (Charter, Inc.) stock redemption buy sell agreement, the company owns the policies (Answer I). (Answer III) If one owner buys a policy on the other (from Charter, Inc. the transfer for value rules would cause the death proceeds of those policies to be subject to federal income tax.
- Millie Tilley has the following income. How much of it would be treated as earned income for federal income tax purposes?
I. $50,000 in wages from Plant Parenthood, an S corporation. Millie works for Plant Parenthood as a landscaper.
II. $5,000 in dividends from stock held in Millie’s investment account (non-qualified)
III. K-1 income of $10,000 from an S corporation in which Millie owns 20% of the equity and is an active participant in the business
IV. Proceeds from the sale of an oil painting inherited from her great aunt that generated a $5,000 long-term capital gain
E. $50,000
Only Millie’s salary would be classified as earned income. The other answers indicate investment income which is, by nature, unearned.
Note: K-1 from an S corporation represents a distribution of profits and thus, is treated as investment income. Although Millie is an active participant in the S Corporation’s activity, this is true.
- This year, Joe Jackson started a 529 college savings plan for his sister’s son, Jimmy. He gifted $90,000 ($18,000 for five years) to a 529 plan that is operated by the state in which both he and Jimmy reside. However, Joe does not feel that the ending balance in the 529 account will be enough to pay for his nephew’s total college costs. Joe has observed that his sister and brother-in-law seem to live well beyond their means. His brother-in-law is an executive earning $750,000 per year. His sister and her husband travel extensively to complete in winter sports. They have not earmarked any money for their son’s education. Joe’s financial advisor said he could fund a UTMA with $50,000 and invest it in AA rated nationally diversified municipal bonds that would generate $1,000 in annual income. The UTMA would increase by the interest on a tax-free basis and all the funds can be distributed for Jimmy’s college expenses. Joe could name himself the custodian. How would you, a CFP® practitioner, respond if Joe asked you whether or not this advice is sound?
A. Advice should be implemented
Both B and C are true statements, but Answer A is the best planning. The UTMA invested in municipal securities appears to be sensible. While the transfer of the $50,000 to Jimmy’s custodial account is a taxable gift, Uncle Joe can use his gift tax property exemption of $13,610,000 to avoid the current gift tax. Under kiddie tax rules, earnings generated by the UTMA may be taxed at 37% plus the 3.8% Medicare investments tax. In that light, tax free interest from municipal bonds make sense. The tax-free income should enable the account to have a FMV of $65,000+ in 10 years.
- Mrs. Tilden, a widow, has gifted extensively to her daughter, Sally. She used her entire gift property exemption amount and actually paid federal gift tax on her most recent gifts. Mrs. Tilden recently married Bill Widner. She is considering gifting him $1,000,000 with the written understanding that he will then gift the $1,000,000 to Sally. How would you respond after she explains her strategy?
B. The transfer of $1,000,000 reduced by one annual gift tax exclusion from Mrs. Tilden to Bill Widner will be a taxable gift.
It appears that the gift will not qualify for the marital deduction. To qualify for the deduction, the donee spouse must be given the property outright or must have at least a right to the income from the property and a general power of appointment over the principal. The IRS would consider this to be a step transaction and thus a fraudulent transfer.
- Your client, Mr. Smith, purchased and sold the following stocks during a two-year period. Which situation or situations below created a “wash” sale?
NOTE: All transactions are 100 share round lots.
I. March 1st purchased ABC @ $15; December 1st purchased ABC @ $10; December 31st sold ABC @ $10
II. November 30th purchased LMN @ $50; December 15th purchased LMN @ $52; December 29th sold LMN @ $54
III. January 1st purchased XYZ @ $60; February 15th sold XYZ @ $50; March 16th purchased XYZ at $52
B. I, III
The ABC and the XYZ transactions violate the wash sale rules.
–ABC’s basis is $10 cost plus $5 recognized loss. (December 1st and December 31st)
–XYZ’s basis is $52 cost plus $10 recognized loss. (February 15 and March 16). There are only 28/29 days in Feburary
– LMN was sold for a gain.
- Tom, age 51, works for a not-for-profit organization. He contributes $23,000 annually to a 403(b) provided by his employer. Tom’s wife, Melinda (age 48), works for another not-for-profit organization. She contributes $5,000 annually to her employers 457 plan. If he earns $120,000 and Melinda earns $50,000 in the current year, how much can they contribute to a traditional IRA that would be deductible on their 2024 tax return?
B. $7,000
The 403(b) retirement plan makes Tom an active participant for the purposes of deducting an IRA contribution. Given that Tom is an active participant and the amount of Tom and Melinda’s AGI, Tom’s IRA contribution is not deductible. Contributing to the nongovernmental 457 does not classify Melinda as an active participant for purposes of deducting her IRA contribution. Their combined AGI is $170,000. Under the “tainted spouse rules,” Melinda can make a deductible IRA contribution because the joint AGI is less than $230,000.
- Your client, William Smith, age 35, is divorced with no children. He has just won a local $5 million LOTTO. The LOTTO administrators have given William 4 choices as to how to receive his winnings. Considering investment opportunities that might be available to William, which distribution would you recommend to William?
B. $250,000 in annual payments made at the beginning of the year for the next 20 years (subject to tax) Very difficult to compare the options. Answer B using 5% return produces a PV of $3,271,330 Answer C using 5% return produces a PV of $3,243,128 Answer D produces a return of only 3.63% Now consider taxes. The tax on $3,500,000 is approximately $1,350,000 netting $2,150,000 The tax on $250,000 is approximately $66,000 producing net income of $184,000 To get $184,000 from $2,150,000 over 20 years, the investment would have to earn about 6.2%. This is an “opportunity cost” question.
- Corporate annual reports would generally not include which of the following?
C. Profitability projections
Profitability projections should not be included in corporate annual reports. The SEC believes that such projections could mislead shareholders and others.
- Mr. and Mrs. Grandparent have paid $50,000 into their granddaughter’s “prepaid tuition program.” The arrangement qualifies as a Section 529 program. Which of the following is true?
A. Prepaid tuition plans may only pay for tuition and mandatory fees.
If the beneficiary of a prepaid tuition (529) plan attends a private or out-of-state college, the program will determine the value of the contract. If the QHEEs are equal to, or greater than, the total distribution, they are tax-free. Prepaid tuition plans pay for tuition and mandatory fees. They do not cover room and board. Prepaid tuition plans do affect the expected family contributions
- Edward, who is married and age 50, has the following financial resources:
- $500,000 of diversified mutual funds
- A defined benefit pension plan guaranteeing him 50% of his current $120,000 salary. The company is behind on funding the plan.
- A non-qualified unfunded deferred compensation plan. It is informally funded using annuity contracts. Given his situation, what type of risk affects Edward the most?
E. Business risk If the company that employs Edward fails, the deferred compensation plan is subject to the company’s creditors. The DB plan would be insured by the PBGC, but Edwin will only be covered for the money that is now in the plan. That the company is behind on its pension funding indicates a shaky future. His mutual funds are diversified.
- Mrs. Adams, widow, has a HO-3 policy with a HO-15 endorsement. She owns the following property:
- Her wedding ring recently appraised for $2,000
- Her late husband’s gold coins currently valued at $2,000
- Her fur coat valued at $3,000
For which of the above properties, if any, should Mrs. Adams add an endorsement to her properties and for what amount?
I. The ring for $2,000
II. The gold coins for $2,000
III. The fur coat for $3,000
IV. The HO-15 rider will likely cover the property because it has more generous personal property limits than policies without this endorsement.
D. IV Because a HO-15 endorsement provides increased limits on property and higher sublimits on jewelry and furs, the items shown would be covered without additional endorsement. For example, under a HO 15 endorsement coverage for collectible coins carries a $5,000 limit.
- Helen is age 57. Over the years she has fulfilled her own 40-credit/quarter requirements to achieve fully insured status for Social Security benefits. Her husband, Sam, age 59, has also achieved fully insured status. He is currently collecting Social Security disability benefits. Helen had to retire. Her son is unable to work due to physical problems. He is deemed disabled by Social Security since childhood. Which of the following is true?
C. Helen is eligible to receive Social Security benefits because her son is disabled. Helen has a child “in care”. “In care” means that the mother performs personal services for child under age 16 or a disabled child. She is also the spouse of a disabled uninsured worker. Helen and her son are entitled to benefits. The information presented does not indicate whether her benefits will be tax-free or subject to federal income tax.
- Tilly recently inherited a significant amount of personal property from her mother. She is concerned about her property insurance coverage. Which item(s) do you suggest that she talk with her insurance agent about full protection?
I. Gold coins
II. Old furniture and workable TVs that are used in what the family calls “The Shack” that is 500 feet away from the main house
III. Silver—flatware service for twelve
IV. Paintings bought on Amazon.com
B. I, III Under the HO forms, coins are covered for no more than $200. While the question does not indicate the coins are collectible, given that they are gold the $200 limit applies. Silver has an internal (sub) limit of $2,500 in coverage for theft only. The personal property in a separate structure (“The Shack”) is covered. Artwork bought on the internet would be covered as normal personal property rather than collectibles.
- Mrs. Andrews is referred to you by a current client who happens to be her employer. The referring client is a physician and Mrs. Andrews works as the Medicare billing administrator in his office. She is divorced, and her income barely covers her living expenses. She wants to talk with you about her daughter. She asked you to meet with her daughter and son-in-law. You agree. Her daughter, Leslie, and her husband Tommy meet with you. Both are employed in hourly wage jobs and have no savings. Fortunately, their employers provide them with group health insurance. Leslie is pregnant and the expected due date is 2 months away. That is all the financial information they can provide. What you recommend that Leslie and Tommy do?
B. Buy term life insurance on Tommy’s life with a death benefit of at least $500,000. This growing family will need life insurance. This is especially true because Leslie and Tommy can’t rely on Mrs. Andrews for financial help. With term coverage they should be able to obtain a reasonably high death benefit. With two months before the baby comes and limited wages a six-month emergency fund does not seem reasonable. Further, they will have extra cash needs for baby-related expenses. Answer C is incorrect because Mrs. Andrews is not the client for whom the recommendation in the question is to be made.
- Which of the following bonds is not subject to default risk?
B. STRIPs STRIPs are issued directly by the US Treasury and thus cannot default because the Treasury prints money. CATs and TIGRs are not government issued bonds and can be subject to default risk. (While the CATs and TIGRs are backed by Treasury securities, they are created by brokerage firms that could fail). The zero-coupon bond does not specify that it is a Treasury security, so default risk is present
- Which of the following assets are liquid?
D. A 1-year CD In the absence of early withdrawal, the CD would not be expected to lose principal. The S&P ETF and CMO are marketable but there could be a substantial change in price. The GIC isn’t liquid.
- The Federal Reserve Board (FRB) has the means to affect the supply of money in the US economy. If the federal government wanted to increase the money supply, what would it most likely do?
B. Reduce federal income taxes The question asks what the federal government would do and not the activities of the FRB. This represents fiscal, rather than monetary policy. The other answers which are incorrect represent monetary policy.
- Arthur is looking to buy RST common stock for $100. The current dividend is $2. The stock is expected to grow its dividend by 6% for three years, and then by 8% thereafter. Arthur’s required rate of return on this stock is 10%. Should he buy the stock? V = D1 r-g
B. Yes, based on the DDM, the stock appears to be undervalued.
By factoring the DDM, we know that the current market price of $100 is less than $108.00. V = $2 (1 + .08) = $2.16 = $108.00
.10 - .08 .02
In the formula above, the 2nd growth rate is used to calculate the intrinsic value with an adjustment upward or downward relative to whether the early years’ dividend is lower or higher than the later years’ dividend
