EXAM TIPS Flashcards
Remember that the ‘U’ in GRUT stands for ‘Up and down.’ The trust assets are valued annually, and the resulting amount determines the income stream in a given year. This trust is especially useful as an inflation hedge (keep an eye out for this phrase!).
As long as 90% of their income is distributed to shareholders, that income is free from taxation for the REIT. At least 75% of a REIT’s assets and income must be derived from real estate equity or mortgages.
The grantor retained unitrust (GRUT) is the most appropriate option when there is inflation. Investors generally sell off utility stocks and invest in higher-yielding bonds when inflationary pressures set in. Additionally, factory capacity utilization above 84% and price increases in commodities, specifically, copper & lumber (used in new construction) indicate increasing inflation. Therefore, the GRUT is the only viable solution since trust assets are revalued annually, and the income stream may serve as an ‘inflation hedge’ as a result.
For stock (equity funds), the following ratios are used to evaluate:
Price/Earnings Ratio
Price/Book Ratio
Four Year Earnings Growth Percentage
Price/Cash Flow
Debt as Percentage Total Capitalization
Medium Market Capitalization in $mil
Foreign Percentage
A CLAT is the best Charitable Lead Trust (CLT) choice when interest rates are lower, since smaller annuity payments to a charity result in a greater value of the trust corpus for the remaindermen.
The market prices of the shares of closed-end funds are published daily in the financial media, provided that the funds are listed on an exchange or traded actively in the over-the-counter market. Unlike the market price, a fund’s net asset values are published weekly and are based on the closing market price for the previous Friday.
Charitable Lead Trusts are considered ‘non-tax-exempt entities.’ Income earned by the trusts is taxed to the grantor.
Typically, Class B shares of a fund are shares with CDSC charge plus a 12b-1 fee. After the CDSC’s term is up, the Class B share may convert to Class A shares.
When the Generation-Skipping Transfer (GST) tax is a concern, CLUTs are a better alternative. This is due to the fact that the unlimited charitable deduction is available for the full value of the interest going to the qualified charity.
A contingent deferred sales charge (CDSC) may be assessed to an investor that sells the fund prior to an agreed-upon holding period.
Remember! A marital deduction is not available for Terminable Interest Property (TIP) unless there is an exception:
General Power of Appointment, or
Qualifying the Terminable Interest Property (Q-TIP election).
Credit risk is firm-specific and can be diversified away.
Financial risks are specific to the company and therefore are unsystematic (diversifiable).
Remember 2503(b) trusts ‘bring beneficiaries bucks’ while 2503(c) trusts accumulate & can ‘cease current cash.’
Assets that have a correlation coefficient of 1.0 will be perfectly positively correlated and will move in the exact same direction at the exact same time.
The child’s taxable income = [Gross income – standard deduction (greater of $1,150 or amount of earned income + $350)]
Investments with Beta values that are less than 1 are considered to be defensive
.5 means the stoke is half as volatile as the S&P eg. if S&P rises or falls 10% stock with beta of 2 will move 20% and beta of .5 will move 5% if S&P moves 10%
Funded ILIT. Within this type of ILIT, trust income will pay for the policy premiums, and the grantor is taxed on trust income due to grantor trust rules. it doesn’t matter if the income is used to pay insurance premiums. The income is still taxed.
Inflation-Adjusted RRR = (1 + RRR) / (1 + Inflation Rate) – 1
inflation adjusted Return = (1 + Return) / (1 + Inflation Rate) – 1
Kiddie tax: under age 18 and has received unearned income from the FLP exceeding the $2,300 threshold, the ‘Kiddie Tax’ rules will apply to the $16,000 distribution.
The taxes are calculated as follows: eg. $16k distribution
- First $1,150: $0 tax due (child’s standard deduction)
- Next $1,150: $1,150 x 0.10 (child’s tax rate) = $115
- Remaining $13,700: $13,700 x 0.35 (parents’ highest marginal rate) = $4,795
- add both $115 + $4,795 = $4,910
buying a machine to produce baseballs costs $10,000. Alta expects to produce and sell 1,000 baseballs per year for $3 per baseball, net of all costs. The machine’s life is five years, with no salvage value. On the basis of these assumptions and an 8% discount rate, what is the net present value of Alta’s investment?
The first step is to establish a cash flow line: Time / Cash Flows 0 / (10,000) 1 / 3,000 2 / 3,000 3 / 3,000 4 / 3,000 5 / 3,000 Keystrokes: 10000 CHS g CFo 3000 g CFj 5 g Nj 8 i f NPV The Calculator Returns: 1,978.13 The Project should be accepted since the NPV is positive.
In disability policies
The principal sum benefit pays a lump-sum benefit of 12 times the monthly benefit if death is due to injury.
if k* (internal rate of return) is less than k (market capitalization rate) , or the IRR is less than the appropriate discount rate, the stock is an unfavorable investment.
Market capitalization rate:
Expected return on a security. The market-consensus estimate of the appropriate discount rate for a firm’s cash flow.
Use the exclusion ratio to determine the portion of each annuity payment that represents a return of basis (tax-free amount).
Exclusion Ratio:
(Basis in Contract ÷ Expected Total Payments) x Annuity Payment Amount = Return of Basis.
Dt = (Pt)(Et); dividends are replaced by the payout ratio multiplied by expected earnings. When solving for the normal price/earnings ratio, the expected earnings is divided into the intrinsic value.
Most term insurance policies include a convertible feature. This feature permits the policy owner to exchange the term policy for a cash-value insurance contract, without evidence of insurability.
When the cost of an investment is deducted from its present value (PV) of the future inflows, net present value (NPV) is obtained. NPV = PV of Future Cash Flows – Purchase Price.
A life insurance policy that is sold or exchanged for valuable consideration may cause the death benefit to be taxed in certain situations. This is known as a transfer-for-value.
There are exceptions to the transfer for value rule which will not cause the death benefit to be subject to income taxes at the insured’s death. This occurs when the insurance policy is transferred to the following individuals or entities.
The insured.
The insured’s partner.
The transferor’s spouse incident to a divorce.
A new owner who takes the transferor’s basis in the contract.
To a partnership in which the insured is a partner.
To a corporation in which the insured is a shareholder or officer.
net present value of the bond, or the difference between the value of the bond and the purchase price. (NPV = V-P)
Under Section 1035(a), no gain or loss shall be recognized on the exchange of the following insurance policies:
A contract of life insurance for another contract of life insurance or for an endowment or annuity contract; or
A contract of endowment insurance (A) for another contract of endowment insurance which provides for regular payments beginning at a date not later than the date payments would have begun under the contract exchanged, or (B) for an annuity; or
An annuity contract for an annuity contract.
The present value of expected dividends can be calculated for a given required rate of return. However, many investment firms use a computerized trial and error procedure to determine the discount rate that equates the present value of the stock’s expected dividends with its current price. Sometimes this long-run internal rate of return is referred to as the security’s implied return.
If the insured withdraws the savings value of the insurance and if this value exceeds the insured’s adjusted basis, the excess is subject to federal income tax in the year of the withdrawal.
Adjusted basis = Premiums paid – Dividends received
Open rating allows an insurer to use whatever rate it chooses after filing the rate and the supporting statistics with the regulator. Open rating, the more popular scheme, allows the regulator to disapprove any rates being used.
taxable estate is worth over $12.06 anything over that is taxed 40%
Estate tax formula
Gross state
minus: expenses, debts,
taxes & losses
Adjusted Gross Estate
minus: marital ded
minus: charitable
deduction
Taxable Estate
The taxable equivalent yield for the municipal bond is
TEY =r:(1 − t)
unlimited marital deduction is not available
when we’re dealing with terminable interest property.
Annual Coupon Payment = Par x Coupon = $1,000 x 0.07 = $70
Current Yield = Annual Coupon Payment ÷ Market Price
spousal gift during lifetime to non citizen spouse is limited to $164, 000 in 2022
If Sri’s T-Bill were sold today, he would receive $990.83, calculated as follows:
Face Value × [1 - ((Days to Maturity ÷ 360) X Yield)] = Current Price
$1,000 × [1 – ((120 ÷ 360) × 0.0275)] = $990.83
706- 6 feet under- estate tax return due 9 months after death
Asset allocation funds attempt to time the market but in doing so, focus on total return instead of current income. The most significant type of an asset allocation funds are target funds. These funds are targeted to a specific time horizon (e.g., PQR Mutual Fund 2025). Target funds are of particular interest for retirement and college funding goals.
Marital Deduction:
An unlimited marital deduction is available for most gifts made to a donee spouse.
An unlimited marital deduction can NOT be used for gifts made to a non-citizen spouse.
The annual exclusion for a gift to a non-citizen spouse is $164,000 in 2022.
Not available for Terminable Interest Property (TIP).
A decedent may receive a charitable estate tax deduction for property passing to a qualified charity. Calculated on Form 706: Estate Tax Return.
Charitable Lead Trusts: Grantor receives a charitable income tax deduction for the PV of the charity’s income interest.
Charitable Remainder Trusts: The grantor receives a charitable income tax deduction for the PV of the charity’s remainder interest.
Charitable Gift Annuities: A donor transfers cash or property to a charity and the charity pays the donor or other donees an annuity payment each year for life.
Gift tax charitable deduction is the PV of the charity’s remainder interest.
Gift annuity payments to a spouse: a marital deduction is available if the spouse receives all annuity payments and has general POA over payments after the donor’s death.
Gift annuity payments to others: gift tax is the PV of the annuity payments.
Pooled Income Funds: A donor gifts property to a charity and receives an annual pro-rata share of income from the charity’s commingled funds, for life.
Additional gifts can be made to the fund to increase the donor’s income stream.
The charity manages the fund which cannot invest in tax-exempt securities and receives the remainder when the donor’s income interest ends.
Donor takes an income tax deduction for the PV of the charity’s remainder interest.
The donor pays income taxes on the income received from the fund.
Private Foundation: A separate legal entity, either a not-for-profit corporation or a tax-exempt trust.
Most are funded and controlled by family members. High set-up and maintenance fees.
Family members who make gifts to the foundation may take an income tax deduction limited to 30% for cash and to 20% for LTCG property.
The foundation must distribute a minimum of 5% of the assets to public charities every year.
