FC CH 3 Flashcards
What is the tax consequence if a municipal Original Issue Discount (OID) bond is sold prior to maturity?
A capital gain or loss determined by the difference between the adjusted basis and the proceeds on the sale
What types of municipal bonds are most likely subject to the Alternative Minimum Tax?
Private Activity bonds
Grandparents contributing to a grandchild’s 529 plan may give how much money and still avoid gift tax consequences?
Front-loading five years of contributions is allowed; therefore, each could contribute $75,000 for a total of $150,000.
An OID is sold prior to maturity. Is the capital gain (or loss) based on the original cost basis or accreted value?
The accreted value of the bond.
The process of adjusting the basis of a premium bond down to par over its life is called _______________.
The process of adjusting the basis of a premium bond down to par over its life is called amortization.
Is there an income threshold for 529 College Savings Plan contributors?
No. There are no income limits imposed for these plans.
Municipal bond interest is exempt from __________ tax.
Municipal bond interest is exempt from federal tax.
A father establishes a 529 plan for his son. Who is the owner of the account?
The father is the owner, while the son is the beneficiary.
True or False: An OID that is greater than the de minimis exemption must be accreted.
True
Prices on long-term debt are ____ sensitive to changes in interest rates than short-term debt.
Prices on long-term debt are more sensitive to changes in interest rates than short-term debt.
Who receives the benefit from a 529 plan?
The beneficiary
True or False: The accretion of the cost basis on a municipal original issue discount is tax-free.
True
Bonds subject to the AMT will trade with a _________ yield.
Bonds subject to the AMT will trade with a higher yield.
Mack, in the 35% tax bracket, is earning 5.4% on a tax-free municipal bond. What is his taxable equivalent yield?
The formula is: Tax-Free Yield ÷ (100% - Tax Bracket %). 5.4% ÷ 65% = 8.3%
True or False: 529 plans allow for a five-year front-end contribution of $75,000, which avoids gift tax.
True ($15,000 x 5 years)
When using the constant yield method for accretion, what is added to a bond’s cost basis to determine the adjusted cost
The bond’s compound accreted value
The formula for taxable equivalent yield is: __________ ÷ (________ - ________)
The formula for taxable equivalent yield is: Tax-Free Yield ÷ (100% - Tax Bracket %)
True or False: For a person saving for future college expenses, 529 plans allow for the highest annual contributions.
True. Although other plans exist, 529 plans allow for the highest contributions.
Describe the tax treatment of contributions made to a 529 Plan.
They are after-tax contributions that may possibly grow tax-free.
True or False: Interest rate risk is greater on short-term debt than on long-term debt.
False
May an aunt set up a 529 plan for her niece?
Yes. The donor is not required to be a parent.
A muni. bond is bought at a secondary market discount and sold for a gain before maturity. What is the tax consequence?
The gain is taxable as ordinary income up to the accreted value, and a capital gain for any amount above that.
A private activity bond is also referred to as a(n) _______________________ bond.
A private activity bond is also referred to as an alternative minimum tax (AMT) bond.
What may be the result of purchasing municipal bonds at a price other than par?
Investors may be subject to unique tax implications which may result in an adjusted basis
Is a broker-dealer involved in the distribution of a 529 plan required to provide an official statement to its customers?
Yes, an official statement or other form of disclosure document must be provided.
Who funds a 529 plan?
The donor
True or False: When a 529 plan is funded, an irrevocable gift is made.
False. The contributor (account owner) may revoke the gift.
During periods of rising interest rates, an investor should purchase bonds with _____ maturities.
During periods of rising interest rates, an investor should purchase bonds with short maturities.
Interest paid on bonds issued by U.S. territories or possessions is ___________________.
Interest paid on bonds issued by U.S. territories or possessions is triple-tax-exempt.
To determine whether a wash sale violation has occurred, what is the total time period used?
61 days; which includes the trade date and 30 days both before and after the trade date.
When is the OID on a municipal bond required to be accreted?
When the OID is more than .25% of the principal multiplied by the number of years to maturity
How is the phantom interest on an OID treated for tax purposes?
It is considered interest income on a municipal bond, and therefore, tax exempt.
Banks receive a special deduction when they invest in ______________ issues.
Banks receive a special deduction when they invest in bank qualified issues.
Name the two types of 529 plans.
Pre-paid college tuition plans and college savings plans
May clients invest in an out-of-state 529 plan?
Yes. Clients may choose to invest either in-state or out-of-state.
For wash sale purposes, what would cause the loss on the sale of a municipal bond to be disallowed by the IRS?
Purchasing a substantially identical bond at any point within the wash sale period
What is the tax consequence if a municipal Original Issue Discount (OID) bond is held to maturity?
Since the basis must be accreted up to par, there is no capital gain or loss when an OID is held to maturity.
True or False: Funds invested in a college savings plan may be used in any state.
True
What is the tax consequence if a municipal bond is purchased at a secondary market discount and held to maturity?
The gain is taxed as ordinary income.
In a 529 plan, if the funds are not used by the beneficiary, to whom may the funds be transferred?
Other family members
What is the maximum annual contribution to a 529 plan?
For exam purposes, the federal gift tax exclusion (currently $15,000) should be used as the maximum contribution.
How often may a 529 plan be rolled over?
Once per year
True or False: The same state tax benefits are provided when investing in out-of-state 529 plans.
False. State tax benefits may be lost or reduced when investing in out-of-state 529 plans.
What is the IRS method for accreting the basis of a bond?
Constant yield or constant interest method
How is the discount on a municipal secondary market discount bond treated for tax purposes?
As ordinary income
The formula for net (after-tax) yield is: __________ x (________- ________)
The formula for net (after-tax) yield is: Taxable Yield x (100% - Tax Bracket %)
_____ Plans are college savings plans with high contribution limits set by the state sponsor.
529 Plans are college savings plans with high contribution limits set by the state sponsor.
What is the tax consequence if a municipal bond is purchased at a premium and sold prior to maturity?
A capital gain or loss determined by the difference between the adjusted basis and the proceeds of the sale
If a gift to a 529 plan is made from joint property, what is the maximum amount that may be spread over a 5-year period?
$150,000 ($75,000 times 2)
Who may issue bonds that offer interest that is triple tax-exempt?
Commonwealths, territories, and possessions (e.g., Puerto Rico)
If not needed for a child’s education, may the funds in a 529 Plan be transferred to a relative’s 529 Plan?
Yes
What is a municipal OID?
An Original Issue Discount (OID) bond.
What bond factors should be altered to avoid triggering a wash sale violation?
The bond’s issuer, coupon rate, or maturity date
Bonds with ______ maturities should be purchased when interest rates are falling.
Bonds with longer maturities should be purchased when interest rates are falling.
What condition must exist for a municipal bond’s interest to be exempt at the state and local level?
Investors must buy the bond from the state in which they reside.
The process of adjusting the basis of an Original Issue Discount bond up to par over its life is called ____________.
The process of adjusting the basis of an Original Issue Discount bond up to par over its life is called accretion.
What are the other names for the official statement of a 529 plan?
The plan disclosure document, program description, or disclosure statement
How is interest on municipal bonds treated for tax purposes?
Federally tax-exempt, but may be subject to state and local tax
May a person contribute to her own 529 plan?
Yes
What is the tax consequence if a municipal bond is purchased at a premium and held to maturity?
Since the basis must be amortized down to par, there is no capital gain or loss when a premium bond is held to maturity.
True or False: Bonds with longer maturities are generally more liquid than those with shorter maturities.
False
In a 529 Plan, what happens if the funds are withdrawn, but not used for qualified education expenses?
The earnings would be subject to ordinary income tax plus a 10% penalty.
What is the net yield for an investor in the 28% tax bracket who owns an 8.5% corporate bond?
The formula is: Taxable Yield x (100% - Tax Bracket %). 8.5 x 72% = 6.12%.
What is the concern of an investor who purchases an out-of-state municipal bond?
His state potentially taxing the interest of the out-of-state bond
A tax swap is generally done to realize a ____________.
A tax swap is generally done to realize a capital loss.
