Domain IV - Specialty Client Services Flashcards
1
Q
Incentive Stock Options (ISOs)
- More rules and restrictions than NSOs
- Can only be given to _____
- No ordinary income tax at exercise
- Spread between FMV and exercise price is AMT preference item
- Not transferable except in event of death
- Annual $_____ limit
- Long-term capital gains treatment
If sold more than ______ year after exercise
And
if sold more than _____ years after grant
A
- employees
- $100,000
- 1 yr.
- 2 yrs.
2
Q
This results when one does not adhere to the “2 year from grant”
and “1 year from exercise” holding requirements.
A
Disqualifying Disposition
3
Q
Non-qualified Stock Options (NSOs)
- Few rules and regulations apply
- Do not qualify for income tax deferral on exercise
- _____ tax due on spread between exercise price and FMV
- Can be granted to _____ or _____.
- Holding period requirement for stock?
- Can be transferred
A
- Income
- employees / non-employees
- none
4
Q
ISOs
- triggering event?
- taxable income?
- AMT impact?
NSOs
- triggering event?
- taxable imcome?
- AMT impact?
A
ISOs
- sale of stock
-LTCG potential
- preference item at exercise
NSOs
- Exercise
- ordinary
- none
5
Q
Stock Option Strategies:
- Diversification (1)?
A
Exercise and Sell
6
Q
Stock Option Strategies:
- Tax minimization (4)?
A
AMT planning
Tandem exercise
Option gifting
Grantor CLT
7
Q
Stock Option Strategies:
- Wealth Accumulation (3)?
A
Stock swap
Early exercise
Exercise early / exercise late
8
Q
Five applicable situations for Exercise and Hold?
A
– Prior to expiration
– To capture dividends
– Recognize income in a specific year
– To produce LTCG on future appreciation
– To meet company requirements
9
Q
Stock Swap - Pyramiding
- Plan specific provision must specifically allow
- Available for ___ and _____.
- Client pays exercise cost with _____.
- Bargain element on options taxable at exercise (same as with cash exercise)
- Avoids capital gain and AGI lift from sale of stock
- “Reload” feature replaces stock used to exercise options, offers future appreciation opportunity
- Works best if client intends to _____
A
- NSOs and ISOs
- existing shares
- exercise and hold
10
Q
Option gifting only applies to NSOs or ISOs?
A
NSOs
11
Q
For option holders with NSOs and ISOs
Goal: AMT tax minimization on ISO exercise and hold
Raise ordinary income to level greater than potential AMT with combination ISO/NSO exercise
Potential downside -pay income tax now on NSOs
A
Tandem Exercise
12
Q
ISO Tax Ramifications
Grant - ?
Exercise - ?
Sell - ?
A
Grant - none
Exercise - AMT preference item on difference between exercise price and FMV
Sell -ordinary income or capital gains
13
Q
NSO Tax Ramifications
Grant - ?
Exercise - ?
Sell - ?
A
FMVGrant - none
Exercise - ordinary income on diff. between exercise price and FMV(bargain element)
Sell - Capital gain on diff. between FMV at exercise and sale price
14
Q
- Plan specific provision
- Exercise stock options prior to vesting
- Must be elected within 30 days of grant
- Stock subject to control and resale restrictions until vesting
- Opportunity to reduce taxes on bargain element with this election
– NSOs: tax on bargain element
– ISOs: AMT liability - Big risk if stock declines in value
A
Section 83(b) Election
15
Q
Section 83(b) Election - True or False
Without Election
- Ordinary income tax paid on exercise price
- Capital gains paid on diff. between exercise price and sale price
With 83(b) Election
- Ordinary income tax paid on grant price
- Capital gains paid on diff. between grant price and sale price
A
True
16
Q
- A strategy for retirement asset distribution under Internal Revenue Code 402(e)4.
- Applies to employer securities held in a qualified retirement plan (ESOP, pension, 401K, etc.).
- Means to trade ordinary income taxation on retirement assets for long-term capital gains treatment.
A
NUA (Net Unrealized Appreciation)
17
Q
NUA:
Must elect lump-sum, in-kind distribution from plan (_____% of all assets in single calendar year).
Original basis immediately taxable as _____.
Remaining value (NUA) tax at _____rates.
Subject to premature distribution penaly rules for qualified plans (applies only to _____).
No step-up of basis on which portion?
A
- 100%
- ordinary income
- long-term capital gain rates
- original basis
- NUA portion
18
Q
Restriced Stock Sale:
Advantages (3)?
A
- Increased liquidity
- Improved diversification
- Reduced price exposure
19
Q
Restricted Stock Sale:
Disadvantages (4)?
A
- Capital gains taxes
- Immediate transaction costs
- No upside price participation
- Public disclosure
20
Q
Rule 144:
Holding period: _____ if non-reporting company, _____ if reporting company.
A
1 yr. / 6 mths.
21
Q
Rule 144:
Trading Volume: Number of shares sold during a _____ mth. period can’t exceed:
- The greater of _____% of outstanding shares of same class being sold or if class is listed on stock exchange or quoted on NASDAQ.
- The greater of _____% or the average reported weekly trading volume during the ____ preceding the filing a noticce of the sale on Form 144.
A
- 3 mth
- 1%
- 1%
- 4 wks.
22
Q
Rule 144:
Filing Notice with SEC: Must file notice with SEC on Form 144 if sales involve more than _____ shares or the aggregate dollar amount is greater than $_____ in any ___ mth. period.
A
- 5,000 sh.
- $50,000
- 3 mth.
23
Q
Exec. Compensation - Restricted Stock:
Voting rights?
Triggering event?
Dividends?
Tax treatment?
A
- Yes
- Vesting
- Yes, when paid to shareholders
- Ordinary income
24
Q
Exec. Compensation - ESOs:
Voting rights?
Triggering event?
Dividends?
Tax treatment?
A
- No
- Exercise / Sale of Stock
- No
- NSO: ordinary income / ISO: LTCG potential
25
Exec. Compensation:
Issuer expense at which point:
Restricted stock - ?
ESOs - ?
- At vesting
- At exercise
26
Matching Solutions to Needs:
Liquidity (4)?
Restricted Stock Sale
Writing OTC Covered Call
Variable Prepaid Forward
Loan
27
Matching Solutions to Needs:
Hedging (3) - ?
Purchase OTC Put Option
Zero Premium Collar
Participating Collar
28
Matching Solutions to Needs:
Diversification (5) - ?
Variable Prepaid Forward
Exchange Fund
Purpose Loan
Collar with Purpose Loan
Custom Diversification Collar
29
Matching Solutions to Needs:
Wealth Transfer (3) - ?
Charitable Remainder Trust
Charitable Lead Trust
Family Foundation
30
Objective/Strategy:
- Investor wants to continue to own underlying equity but hedge price risk.
- Purchases put option and sells call option against holdings for net zero premium.
- Specifies option maturities and degree of downside protection and upside appreciation.
Zero Premium Collar
31
Defined: Occurs when an investor borrows shares of stock and sells them short, while at the same time owning shares in the same stock.
Short Against the Box
32
Objective/Strategy:
- Monetizes concentrated position without selling the shares upfront.
- Diversifies a large, appreciated equity position while deferring taxation.
- Variable contract to sell a specific value of a security in the future (i.e., the number of shares to be delivered will depend on the stock’s value at the time of delivery).
- Retains appreciation up to an upper limit (cap) as defined by client.
- Protects against depreciation in stock below a lower limit (floor price).
Prepaid Variable Forward
33
Prepaid Variable Forward:
Advantages (4) - ?
- Substantial liquidity generated upfront
- No tax event until maturity
- Provides floor for stock price
- Investor retains ownership, dividends and voting rights until maturity date
34
Prepaid Variable Forward:
Disadvantages (2) - ?
- Ceiling on upside exposure; Investor does not participate in any appreciation of the stock above the cap
- Self-financing; No separate loan vehicle required
35
Exchange Fund:
- Private placement, registration is required or exempt?
- Avoids publicity since contribution is not public sale and does / does not require Rule 144 filing?
- Diversifies a large, appreciated equity position while deferring taxation.
- Diversification may, however, _____?
- Exempt
- Does not
- not be optimal
36
Diversification: Exchange Fund
Advantages - true or false?
- May offer attractive diversification benefits
Disadvantages - true or false?
- May not offer desired diversification benefits
- True
- True
37
Wealth Transfer: Charitable Remainder Trust
- When does the investor receive an income tax deduction for charitable gift?
- year gift is made
38
Wealth Transfer: Charitable Remainder Trust
Disadvantages (3) - ?
* Irrevocable trust
* Principal passes to charity not heirs
* Minimal tax deduction reduces benefits for younger investors
39
Wealth Transfer: Charitable Remainder Trust
Advantages (5) - ?
* Beneficial capital gains treatment
* Increase after-tax, net spendable income
* Reduction of grantor’s taxable estate
* Diversifies investment portfolio
* Potential income tax deduction
40
- Pre-arranged trading plans for insiders and affiliates
- Specifies amount, price and date at which securities should be traded
- Allows trading during “blackout periods”
- May provide public with greater disclosure
10b5-1 Plans
41
This type typically forms groups to provide equity financing to start up companies. They should be considered if the new business owner(s) cannot qualify for adequate bank financing, but still require outside financing. Because this group can set their own terms, care should be taken when negotiating this financing.
Angel Investors
42
True/False:
Angels tend to invest locally and look for opportunities that may be beneficial to their community. Most angels will want to assist with advising the business; however, they do not seek control. They may also set certain contingent guidelines and goals for the business.
True
43
Venture capital firms (VCs) provide financing for high growth companies in exchange for significant equity. VCs are generally funded by risk tolerant private investors who seek high returns within a short period of time. VCs typically strive for annual returns of at least _____% to _____% with investment periods ranging from _____ to _____ years.
- 20 - 40%
- 3 -7 yrs.
44
This may be characterized by a hybrid type of security, junior to venture capital and senior debt, often requires little to no collateral, equity conversion feature in case of default.
Mezzanine Financing
45
At its most basic level, this is a method of acquiring a company with money that is nearly all borrowed. This allows investors to make a large acquisition without committing a lot of capital. The acquirers of the target company often attempt to sell or take the target company public after five or ten years in the hopes of making sizable profits.
Doing this can be expensive and complex, but if successful can provide considerable returns.
Leveraged Buyouts (LBO)
46
Succession and Exit Strategies (6)?
Private and public sales
Recapitalization
Employee stock ownership (ESOP)
Self-cancelling installment notes (SCIN)
Seller financing
Private annuities
47
Business Entities:
How are the following taxed?
C-corporations - ?
S-corporations - ?
Limited liability companies (LLC) - ?
Partnerships - ?
Family holding company - ?
- Separate taxpaying entity
- Flow-through entity
- Treated as a partnership unless elected to be taxed as a corporation
- Unless the partnership is an LLC, LLP, or limited partnership, partners are “jointly and severally” liable for partnership debts.
The assets and income stream of the partnership are jointly owned by the partners and are allocated according to agreement. It should be noted that the existence of a tax partnership may not be determinative of the existence of a legal partnership and vice versa.
- Typically, the FHC is operated as an LLC or LP.
48
This structure may be appropriate for businesses with the following characteristics;
Multiple owners
Multiple types of owners
Need for limited liability
Need for continuing life
Future intentions to go public
Future intentions to acquire other companies by merger
Exit strategy involving tax-free reorganization
Desire to retain taxation at the entity level
C-Corporation
49
This is often an ideal structure for the closely held business because it provides the legal protection of a corporation with a single level tax structure similar to a partnership. This can actually be more advantageous than a partnership because dividend distributions are not subject to self-employment tax.
S-Corporation
50
S-Corporations
In order to qualify for the election to be taxed as an S corporation, there must be ___ or fewer shareholders and all shareholders must generally be either individuals who are U.S. citizens or residents, a decedent's estate, certain types of trusts, or certain exempt organizations. Thus, if even one shareholder is a nonresident alien, a partnership, a corporation, or an ineligible trust, the company cannot be an S corporation.
100
51
This structure would be appropriate for a sole proprietor seeking liability protection without the creation of a corporate tax entity. This would also be appropriate for a partnership seeking liability protection without the constraints and paperwork requirements of the corporate structure. This entity also offers the advantageous combination of flexibility and liability protection.
Limited Liability Company (LLC)
52
A _____ is also sometimes called an asset holding company and is a method of recapitalization.
Family holding company (FHC)
53
Section 1202 Stock
IRC 1202 allows individuals to exclude _____% to _____% of the
gain realized from the sale of qualified small business stock
held for more than _____ years. Exclusion is limited to the greater of $______ or ten times basis. Taxable amount taxed at a maximum 28% rate.
50-100%
5 yrs.
$10 million
54
An agreement between the owners of a business, or among the owners of the business and the entity, to purchase and sell interests of the business at a price set under the agreement upon the occurrence of certain future events.
Buy-Sell Agreement
55
Typical issues covered by Buy-Sell Agreements (6)?
- Control of ownership
- Provide liquidity for ownership interests upon the occurrence of certain "triggering events"
- Avoid "deadlock" among owners
- Protect the business from competition from former owners
- Establish value for estate tax purposes
- Does not typically provide a mechanism for establishing or determining the best price
56
Triggering events for a Buy-Sell Agreement (5)?
- Death
- Retirement or disability of an owner
- Attempted sale to a third party
- Termination of employment of an owner for reasons other than death, retirement, or disability.
- Divorce, bankruptcy, or insolvency of an owner may also trigger an option or obligation to purchase.
57
Explain Cross-Purchase Buy-Sell
All business principals agree to buy out other partner's ownership shares upon their demise.
- Each surviving principal's % of ownership adjusted for increase in ownership share.
58
The _____ is typically a significant component of a business’s value
and is often estimated by capitalizing a future period’s expected cash flow, earnings or EBITDA (or some other similar financial metric).
Terminal Value
59
Structures & Strategies:
Tools for Business Transfer - To Family (3)?
* Installment Sales, Private Annuities and SCINs
* Trusts
* FLP/LLC
60
Structures & Strategies:
Tools for Business Transfer - To Co-Owners (3)?
* Buy-Sell Agreements
* Right of First Refusal
* Dutch Auction
61
Structures & Strategies:
Tools for Business Transfer - To Employees (3)?
* Employee Stock Option Plan (ESOP)
* Management Buyouts
* Stock Appreciation Rights
62
Structures & Strategies:
Tools for Business Transfer - To Outsiders (3)?
* Recapitalization
* Private Auctions
* Public Offerings
63
ESOP may be an effective way to (4)?
* Obtain tax benefits;
* Create a leveraging opportunity;
* Provide a tax-advantaged means of compensating employees; and
* Motivate employees.
64
Code Section 1042 provides that taxable gain will not be recognized by a shareholder's sale of stock to an ESOP if
- The shares are _____
- Immediately after the sale, the ESOP owns at least ____% of the total value of all outstanding stock (other than certain nonvoting, nonconvertible preferred stock) or each class of outstanding employer stock (other than certain nonvoting, nonconvertible preferred stock); and
- Qualified replacement securities are purchased by the seller within a _____ period beginning three months before the sale date.
- qualified securities
- 30%
- 15 mth.
65
This involves the sale of property in exchange for an installment note calling for a specified number of fixed payments at a specified interest rate over a set period of time, but also provides that the note payments terminate upon the death of the seller.
– Since death terminates the seller’s right to receive payments, there is nothing of value to include in the seller decedent’s estate.
Self-Canceling Installment Note
66
When does a SCIN work best?
If the seller does not survive the term of the note.
67
The business owner (transferor) transfers ownership of the business to the family member (transferee) in exchange for the transferee’s promise (which must be unsecured) to make payments to the transferor for life.
Private Annuity
68
Who prefers asset sales? Stock sales?
Generally speaking (for tax purposes)...
Buyers prefer to buy assets.
Sellers prefer to sell stock.
69
Allows acquiring corporation to buy stock of the target company for “legal purposes” BUT allows this purchase to be considered a purchase of assets for “tax purposes”.
IRS Section 338 Election
* Only allowed by corporations (C-Corps and S-Corps)
70
A relief provision to permit the deferral of estate tax payments. Available only if the decedent was a U.S. citizen or resident at the time of death and the value of the decedent’s interest in a closely held business exceeds 35% of the value of the decedent’s adjusted gross estate.
Elect to defer completely for five years payment of the portion of the estate taxes attributable to the closely held business interest and thereafter pay the deferred portion of the estate taxes in up to 10 annual installments
Code Section 6166
71
Sources of Liquidity: Code Section 6166
Elect to defer completely for _____, payment of the portion of the estate taxes attributable to the closely held business interest and thereafter pay the deferred portion of the estate taxes in up to _____ annual installments
5 yrs.
10 annual installments
72
For qualified transactions, distributions in redemption of a deceased shareholder’s stock may be treated as a capital gain and not as dividends taxable at ordinary income tax rates.
Helpful for liquidity at death (to pay taxes).
- Value of stock must >35% of the adjusted gross estate.
- Estate is generally liable for taxes and expenses.
- Redemption must be made no later than 3 years and 90 days from due date of IRS Form 706, or 60 days after court decision if contested, or no later than allowed installment payments of estate tax due.
IRS Section 303
73
Some leading inicators for this plan would include:
* When the employer is interested in supplementing an existing defined benefit or other qualified retirement plan to provide an additional employee savings vehicle.
* When the employer is interested in providing a qualified retirement plan for employees but cannot afford a significant investment beyond plan installation and administration costs. While employers may make contributions to a this plan, the plan may be funded almost entirely from employee salary deferrals. In this way, employees can take matters into their own hands and save for retirement despite the inability or unwillingness of the employer to make plan contributions for the benefit of the employee.
* When the employee group is relatively young, has the ability to accumulate several years of contributions, and is willing to accept a certain degree of investment risk on their accounts.
* When the employee group is interested in a certain degree of choice in the amounts that they wish to tax defer for retirement savings.
* When the organization is private taxpayer or is tax exempt. Government employers are not eligible for this plan. However, certain tax exempt organizations such as a not for profit hospital are eligible to offer this plan to their employees as a substitute for 403(b) files.
401(k) plan
74
True or False: A business may contribute to a profit-sharing plan even during periods in which the business experiences a loss for tax purposes.
True
75
The following are leading indicators for implementing a ____ include:
* When company profits tend to vary widely from year to year (e.g., in a cyclical business).
* When the employer would like to supplement an existing defined benefit plan to provide a more balanced employee retirement plan.
* When the employer wants to implement a qualified plan that includes an employee incentive to participate in the increase in company profits.
* When the employee group is relatively young, with the ability to accumulate several years of contributions, and is willing to accept a certain degree of investment risk on their individual accounts.
Profit Sharing Plan
76
True or False: Profit-sharing plans are not subject to ERISA.
False
77
This plan is a qualified plan that specifies the amount of benefit promised to the employee at retirement. As with any other plan of this type, the employer assumes the risk of providing the anticipated benefit amount to the employee at retirement.
Defined Benefit Pension Plan
78
Defined Benefit Plan limits:
An employee retiring at age 65 would be entitled to receive an annual benefit of no more than _____ (2023)?
$265,000
79
Some of the leading indicators for implementing this type of plan include:
* When the employer is interested in, and capable of, guaranteeing a specific benefit amount to employees at retirement.
* When the business owner is an older participant who needs to defer a large amount of taxable income. This plan provides the maximum tax shelter potential available under any qualified plan.
* When the employer is interested in providing an attractive retirement benefit for highly compensated or older participants, regardless of length of service.
Defined Benefit Plan
80
What is a Cash Balance Pension Plan?
A qualified pension plan in the defined benefit category that provides a specified employee benefit, which is funded by annual employer contributions to hypothetical individual employee accounts. The accounts themselves are fictitious. The actual employer contributions are commingled in a large trust account with money allocated at a specified rate to individual employee accounts.
81
Some of the leading indicators for implementing a this type of plan include:
* When the employer is a mid-size or larger corporation who is interested in a less costly alternative to a traditional defined benefit plan.
* When the employer is interested in providing a defined benefit plan that is simpler to explain to its employees. In this plan, employees receive an annual statement showing their allocated account balance.
* When the employee group is relatively young, with the ability to accumulate several years of contributions and prefer a guaranteed rate of return on their accounts.
Cash Balance Pension Plan
82
True or False: For purposes of the dollar limitations, a Hybrid Plan is treated as a defined contribution plan to the extent that benefits are based on the separate account of a participant, and as a defined benefit plan with respect to the remaining portion of the plan's benefits. Each of these portions is subject to the applicable limitation.
True
83
This trust is a type of funded trust where specific funds are set aside for the employee. These funds are insulated from the claims of the employer's general creditors. However, all assets placed in the trust are taxable to the employee.
Secular trust
84
This is a type of unfunded nonqualified plan that is subject to the claims of the employer's general creditors. However, in this type of trust, unlike a traditional unfunded plan, the employer is barred from accessing participant funds. In this way, the participant in this trust receives more protection from the potentially unscrupulous actions of an employer. The employer likewise is not tempted by the easy access and availability of employee retirement plan funds.
Rabbi Trust
85
Capital Needs Analysis determinants (4):
STSR
- Savings (contributions)
- Time
- Spending
- Rate of return (and inflation)
86
Return Sequencing:
Disparities in the early years have a ______ effect over time.
Magnified
87
Order of Returns
* In situations where an individual is making contributions to his/her account, it would be preferable to experience market losses _____ in the period (as opposed to later) so that the individual could purchase more shares at lower prices.
* In situations where an individual is withdrawing from his/her account, it is generally less harmful to experience heavy market declines in the_____ years of withdrawals as there is less value to
be negatively impacted.
* If there are no cash in flows or out flows, the order of returns _____
- Early
- Later
- does not typically matter
88
This will not give an exact value of a portfolio at any specific time, but it will indicate the possible range of these values and the probability of that range.
Monte Carlo Simulation
89
Two assumptions made on Monte Carlo simulations?
- expected return of the portfolio and standard deviation of the portfolio.
90
IRS Code Section 72(t)?
* Provide access to qualified accounts prior to age 59 1/2
– IRAs
– Qualified plans (if allowed)
* Distribution must be taken for the longer of 5 years or until
age 59 ½
* 3 methods to calculate payments
– Annuitization
– Amortization
– Life expectancy
91
Per Secure Act 2.0 (2023) the penalty for not taking RMD has been reduced to _____% of required amount not taken plus applicable taxes. The penalty can be reduced to _____% if corrected in a timely manner.
- 25%
- 10%
92
When must RMD be taken (per Secure Act 2.0, beg. 2023)?
- Must be taken by April 1st of the year following the year in which owner/participant turns 73.
93
Asset Location:
Taxable accounts (5)?
– Index and other passive funds
– Growth funds with low turnover
–Tax-managed funds
– REITs (could be better for either type of account)
– Municipal bonds
94
Asset Location:
Tax-deferred accounts (4)?
– Dividend stocks
– Most taxable bonds
– Actively management, high turnover funds
– Partnerships “IF” they avoid UBTI
95
Trusts as Beneficiaries
Five rules if beneficiaries of a trust are to be considered designated beneficiaries of an IRA for stretch purposes:
1. Trust must be valid under state law
2. Beneficiaries must be identifiable from the trust instrument
3. Trust must be irrevocable or become irrevocable upon the death of the participant
4. Required documentation must be provided to the plan administrator by Oct. 31st of the year following the calendar year the participant died.
5. All beneficiaries of the trust must be individuals
96
Reasons for using trusts (5)?
* Conservation of Property
* Protection of Assets
* Squabbling Beneficiaries
* Inflexible Prototypes
* Minor Beneficiaries
97
Complications of trusts (3)?
* Determination of taxable income
* Administrative issues
* More complex drafting requirements
98
Social Security Benefits Revie: True or False
A spouse may apply to receive benefits (up to 50% of the other spouse’s benefit) based on the other spouse’s earnings if that amount is greater than their own benefit.
When one spouse dies while both are receiving benefits, the survivor only gets to keep the higher of the two benefit amounts.
Divorced ex-spouses may apply for benefits based on their ex-spouse’s earnings record if the marriage lasted at least 10 years.
- True
- True
- True
