Chapter 4

Question 1

Child Support Payments

Answer 1

Payments for support of minor children are not treated as alimony for tax purposes. It continues to be nondeductible by the payor and excludible from the income of the payee.

Question 2

The “Exclusion Ratio” for Annuitized Payments

Answer 2

The numerator of the fraction is the amount of the “investment in the contract.” The denominator of the fraction is the total “expected return” under the contract. The periodic annuity payment is multiplied by this fraction to calculate the portion of the payment that is received tax free by the annuitant as a return of the investment in the contract.

Question 3

Exclusion Ratio Example

Answer 3

Jay is 60 years old and is the owner and annuitant under a contract that begins annuitized payments this year. Jay will receive annuity payments for as long as he lives. His investment in the contract is $100,000. His life expectancy under the regulations is 24.2 years. His annuity payment will be $10,000 per year for life. The expected return under the contract is $242,000 ($10,000 × 24.2). Jay’s exclusion ratio for the annuity payments is 41.32 percent ($100,000/$242,000). Therefore, Jay may exclude from his gross income $4,132 of his $10,000 annuity payment each year. The $5,868 balance of the payment ($10,000 – $4,132) will be taxable to Jay.

Question 4

Contracts in which annuity payments begin no later than one year from the date the annuity is purchased. These contracts will be taxed using the exclusion ratio principle.

Answer 4

Immediate Annuities

Question 5

Gifting Annuity Contracts

Answer 5

Contracts that were issued after April 22, 1987. If such contracts are gifted, the owner has a taxable event at the time of the gift. The amount taxable to the donor is the cash surrender value of the contract minus the investment in the contract. In essence, the gift is treated as a complete surrender followed by a gift of cash.

contracts that were issued on or before April 22, 1987. For such contracts, the donor does not have a taxable event at the time of the gift. However,
if the donee later surrenders the contract, the donor will be taxed on an amount equal to the difference between the cash surrender value and the investment in the contract as of the time of the prior gift (not as of the time of surrender). The balance of the gain upon surrender of the contract will be taxable to the donee.

Question 6

Purchasing an annuity as a non-natural person (Trust or business entity).

Answer 6

Generally if the annuity is owned by a non-natural person the tax deferral feature of the annuity will be lost, and the income earned on the con- tract will be taxed each year to the contract owner.

Exceptions:

• The contract is owned by an estate of someone.
• An immediate annuity
• Its an IRA or qualified plan
• The owner is an agent of a person

Question 7

Premiums are generally deductible to employers. Payments by an employee are included in their taxable income.

Answer 7

True

Question 8

What is Sec. 79 IRS code

Answer 8

rules regarding qualifying as a group life contract for employees.

Question 9

Under Sec. 79 the cost of the first $50,000 of coverage is not taxed to the employee.

Answer 9

True

Question 10

A key employee of a firm is defined as any person (either active or retired) who at any time during the current plan year is any of the following:

Answer 10

• An officer of the firm who earns more than $175,000 (in 2018) in annual compensation from the firm.
• A more-than-5-percent owner of the firm
• A more-than-1-percent owner of the firm who earns over $150,000 in annual compensation from the firm

Question 11

With some exceptions, plans covering fewer than 10 employees must provide coverage for all full-time employees. For purposes of this requirement, employees who are not customarily employed for more than 20 hours in any one week or 5 months in any calendar year are considered part-time employees. It is permissible to exclude full-time employees from coverage under the following circumstances:

Answer 11

• The employee is age 65
• Employee has not satisfied the waiting period. The waiting period cannot exceed 6 months.
• The employee has elected not to participate in the plan but only if the employee would not have been required to contribute to the cost of other benefits.
• The employee has not satisfied the evidence of insurability required under the plan. However, this evidence of insurability must be determined solely on the basis of a medical questionnaire completed by the employee and not by a medical examination.

Question 12

Group term life state tax vs federal

Answer 12

There are 2 major differences.

• In most states payment of group term premiums do not result in taxable income even if insurance exceeds the $50,000 of coverage.
• For estate and inheritance tax issues generally death proceeds are partially, if not totally, exempt from taxation.

Question 13

Sec. 83

Answer 13

Inclusion of income/economic benefit theory

Question 14

A qualified employee may use the Section 83(i) election to avoid reporting gross income from a transfer of qualified stock from the employer to employee in the year in which the property vest or is transferred, as long as the election is made no later than 30 days after the earlier of the employee’s right to stock is substantially vested or is transferable.

Answer 14

True

Question 15

When restricted property becomes taxable, the employee will recognize income to the extent of the fair market value of the property reduced by the amount the employee paid for the property, if any.

Answer 15

True

Question 16

A refund feature in an annuity allows the annuitant to receive back his or her full investment in the contract before any portion of the annuity payments is taxed.

Answer 16

False
A refund feature provides that, if the annuitant dies before receiving a stated number of payments or a specified amount of payments, remaining payments will be made to a specified beneficiary.

Question 17

Until December 31, 2018 when a former husband is obligated to pay child support for a minor child, he may deduct those amounts as alimony.

Answer 17

False

Child support does not constitute alimony for tax purposes and is not deductible to the payer-spouse.

Question 18

After 2018, payments constituting alimony made by a husband to a former spouse for her support are deductible by the husband and taxable to the wife.

Answer 18

False

Question 19

The amount of each annuity payment is multiplied by the applicable exclusion ratio to determine the portion of the payment that is not taxable.

Answer 19

True

Question 20

If a qualified employee uses the Section 83(i) election, the employee entirely avoids paying income tax on the transfer of qualified stock from the employer to the employee.

Answer 20

False
If a qualified employee elects to defer income inclusion, the employee must include the income in his or her gross income for the tax year that includes the earliest of:

the first date the qualified stock becomes transferable,
the date the employee first becomes an excluded employee;
the first date on which any stock of the employer becomes readily tradable on an established securities market,
the date five years after the earlier of the first date the employee’s right to the stock is transferable or is vested, or
the date on which the employer revokes his or her inclusion deferral election.

Question 21

For a taxpayer who owns a deferred annuity, all amounts withdrawn before the starting date are received tax free.

Answer 21

False
A withdrawal of investment amounts from deferred-annuity contracts prior to the annuity starting date will generally cause immediate income taxation to the extent the cash surrender value exceeds the investment in the contract. (Different rules apply to annuities funded before August 14, 1982.) There is also a 10 percent penalty tax on any taxable amount withdrawn prior to the annuity starting date if the taxpayer has not reached age 59½, subject to certain exceptions.

Question 22

A group insurance plan that covers fewer than 10 full-time employees must provide a flat amount of coverage to each employee.

Answer 22

False

A group plan that covers fewer than 10 employees may provide either a flat amount of coverage, a uniform percentage of salary, or an amount based on certain employee classifications.

Question 23

An employee who has been given restricted stock is generally required to include the value of the stock in gross income when the restrictions are no longer in effect.

Answer 23

True

Question 24

A group life insurance plan might be found to be discriminatory in favor of key employees with regard to either eligibility or benefits.

Answer 24

True

Question 25

Restricted stock is stock that a corporation sets aside for a key employee who cannot receive it before age 65, or age 55 if he or she takes early retirement.

Answer 25

Restricted stock is stock that is given or sold at a reduced price to an employee and is subject to provisions which involve a substantial risk of forfeiture.

Question 26

The exclusion ratio for either an annuity or “partial annuity” is calculated by dividing the investment in the contract by the expected return under the contract.

Answer 26

True

Question 27

An employee who receives restricted stock may elect to have the value of the restricted property taxed immediately, even though the property is subject to a substantial risk of forfeiture.

Answer 27

True

Question 28

When group term life insurance is provided as part of an employer plan of group insurance, the cost of coverage up to $75,000 is not taxable to an insured employee.

Answer 28

False
An insured employee may exclude the value of premiums representing the first $50,000 of coverage if certain nondiscrimination rules are met.

Question 29

The actuarial value of a refund feature in a life annuity must be subtracted from the taxpayer’s investment in the contract before the exclusion ratio can be computed.

Answer 29

True

Question 30

An annuity provides for a systematic liquidation of a sum of money, including both principal and interest, over a period of time.

Answer 30

True

Question 31

Until December 31, 2018, when a former husband names his wife revocable beneficiary of a life insurance policy on his life but retains ownership of the policy and pays the premiums, the value of the premiums is tax deductible by him and includible in the wife’s income as additional alimony.

Answer 31

False
When a former husband retains a life insurance policy and merely names his wife revocable beneficiary, he has retained all economic rights and benefits of the policy. Therefore, although he pays the premiums, the premium payments are neither deductible by him nor taxable to the wife as alimony.

Question 32

Payments of alimony may be made in either property or cash.

Answer 32

False

Alimony payments must be made in cash.

Question 33

In general, an employer’s contributions for employee group term insurance coverage are not deductible by the employer.

Answer 33

False

Employer contributions for employee group term coverage are generally deductible by the employer.