Introduction to Taxation Flashcards
All of the following would be taxable at “earned income” rates under IRS regulations EXCEPT:
A. Social Security payments
B. Alimony payments
C. Royalty payments
D. Bonus payments
The best answer is B.
Earned income, under the tax code, has different definitions, depending on the regulation involved. The income items that are taxed at “earned income” rates (currently a maximum of 37%) includes wages, bonuses, social security payments, and royalties received (such as royalties earned for writing a book). Note that starting in 2019, alimony payments received are no longer taxable earned income, nor are they deductible to the person making the alimony payment.
Which of the following is NOT defined as “portfolio income” under IRS guidelines?
A. Dividends received from preferred stock holdings
B. Interest income received from bond holdings
C. Proceeds from the sale of securities in excess of the tax basis of those securities
D. Distributive share of income from limited partnership holdings
The best answer is D.
Income from partnership interests is defined as “passive income” under IRS rules. Passive income can only be offset by passive losses. Portfolio income consists of dividends, interest, and net capital gains on securities (except for direct participation program interests, which are considered to be passive investments). Portfolio gains can only be offset against portfolio losses.
Which of the following would be taxable to a limited partner in a Direct Participation Program?
A. Passive Income
B. Capitalized interest
C. Amortization
D. Operating expenses
The best answer is A.
Income from real estate and DPP (Direct Participation Program) investments is characterized in the tax code as “passive income.” Any expenses from these investments, such as operating expenses, are “passive losses” that only can be offset against passive income. Net passive income is taxable at the limited partner’s tax bracket. Note that this is “flow through” income – it is not taxable at the partnership level.
Capitalized interest is interest expense on a construction loan. This is not deductible. Rather, it is capitalized into the cost of the building during the construction phase. When the building is finished and a certificate of occupancy is issued, all of these costs are recovered by depreciating the building over its depreciable life.
Amortization is the principal payment portion of a mortgage payment. It is a repayment of loan and is not a deductible expense. Only the currently paid interest on a business loan is deductible.
An investor in a limited partnership generating passive losses can offset these against:
A. REIT dividends
B. income generated from direct investments in real estate
C. dividends received from blue chip corporations
D. capital gains generated from the sale of securities
The best answer is B.
Under the Tax Code, passive losses can only be offset against passive income. They cannot be offset against portfolio income (interest, dividends, capital gains) or earned income. Passive income and loss is defined as that derived from real estate investments and limited partnership interests.
Under Internal Revenue guidelines, a short term profit on securities is one which results from a
A. short sale of securities that are subsequently repurchased at a higher cost at any date in the future
B. long sale, at a price higher than the security’s cost basis, made within one year following purchase
C. sale of securities within 30 days of purchase
D. sale of securities by an insider at a profit within 6 months of purchase
The best answer is B.
Under Internal Revenue rules, a profit (or loss) is considered to be short term if a position is liquidated after being held for 1 year or less. Short term capital gains are taxed at a maximum rate of 37% (the maximum individual tax rate).
If the position is held for over 1 year (1 year and 1 day), then any gain or loss is long term. Gains on assets held over 12 months are taxed at a maximum rate of 15%. (Note that this rate is raised to 20% for taxpayers in the highest tax bracket.)
Anytime you sell short a security, and subsequently repurchase the shares at a higher cost, you have a short term loss (all gains and losses whenever you sell short are considered “short term” since there never was a holding period!).
Do not confuse the IRS definition of short term with the SEC definition for purposes of the insider trading rules. Under the Securities Exchange Act of 1934, “short swing” profits by insiders are those derived within a 6 month period and must be paid back to the issuer.
Which of the following securities transactions would result in a short term capital gain?
A. Purchase 100 shares of ABC stock at $50 on January 2, 2018; Sell 100 shares of ABC stock at $60 on July 2, 2018
B. Purchase 100 shares of ABC stock at $50 on January 2, 2018; Sell 100 shares of ABC stock at $45 on July 2, 2018
C. Purchase 100 shares of ABC stock at $50 on January 2, 2018; Sell 100 shares of ABC stock at $60 on January 3, 2019
D. Purchase 100 shares of ABC stock at $50 on January 2, 2018; Sell 100 shares of XYZ stock at $60 on January 2, 2019
The best answer is A.
Under Internal Revenue rules, a profit (or loss) is considered to be short term if a position is liquidated after being held for 1 year or less. Short term capital gains are taxed at a maximum rate of 37% (the maximum individual tax rate).
If the position is held for over 1 year (1 year and 1 day), then any gain or loss is long term. Gains on assets held over 12 months are taxed at a maximum rate of 15%. (Note that this rate is raised to 20% for taxpayers in the highest tax bracket.)
Note that to have a taxable gain or loss, the same security must have been purchased and subsequently sold (or vice versa).
Choice B is incorrect because the purchase and sale result in a loss, not a gain.
Under IRS regulations, a gain or loss upon current disposition of an asset is considered to be short term if the asset has been held for:
A. 6 months or less
B. 1 year or less
C. 2 years or less
D. 5 years or less
The best answer is B.
Under IRS rules, a security’s holding period is short term if the security has been held for up to 1 year. Short term capital gains are taxed at a maximum rate of 37% (the maximum individual tax rate).
If the position is held for over 1 year (1 year and 1 day), then any gain or loss is long term. Gains on assets held over 12 months are taxed at a maximum rate of 15%. (Note that this rate is raised to 20% for taxpayers in the highest tax bracket.)
Which of the following securities transactions would result in a long term capital gain?
A. Purchase 100 shares of ABC stock at $50 on January 2, 2018; Sell 100 shares of ABC stock at $60 on July 2, 2018
B. Purchase 100 shares of ABC stock at $50 on January 2, 2017; Sell 100 shares of XYZ stock at $40 on July 2, 2018
C. Purchase 100 shares of ABC stock at $50 on January 2, 2018; Sell 100 shares of ABC stock at $60 on January 3, 2019
D. Purchase 100 shares of ABC stock at $50 on January 2, 2018; Sell 100 shares of XYZ stock at $60 on March 7, 2019
The best answer is C.
Under Internal Revenue rules, a profit (or loss) is considered to be long term if a position is liquidated after being held for more than 1 year (1 year and 1 day or more). Short term capital gains are taxed at a maximum rate of 37% (the maximum individual tax rate). Gains on assets held over 12 months are taxed at a maximum rate of 15%. (Note that this rate is raised to 20% for taxpayers in the highest tax bracket.)
Also note that to have a taxable gain or loss, the same security must have been purchased and subsequently sold (or vice versa) making Choice D incorrect.
Choice B is incorrect because the trades result in a loss, not a gain.
An investor with a very high income is in the maximum 37% federal tax bracket. The tax rate that will be paid on long-term capital gains will be:
A. 15%
B. 20%
C. 37%
D. 50%
The best answer is B.
The maximum tax rate on short term capital gains is 37% (the same as for earned (ordinary) income).
For assets held over 12 months (a long-term capital gain), the maximum tax rate drops to 15% for the majority of investors. However, this long term rate is raised to 20% for taxpayers in the highest tax bracket.
Which statement is TRUE about capital gains taxes? A gain on a security held over:
A. 6 months is taxed at a lower rate than a gain on a security held over 3 months
B. 9 months is taxed at a lower rate than a gain on a security held over 6 months
C. 12 months is taxed at a lower rate than a gain on a security held over 9 months
D. 15 months is taxed at a lower rate than a gain on a security held over 12 months
The best answer is C.
The maximum tax rate on short term capital gains (a gain on an asset held 12 months or less) is 37% (the maximum individual tax rate).
For assets held over 12 months, the maximum tax rate drops to 15%. (Note that this rate is raised to 20% for taxpayers in the highest tax bracket.)
A customer has $3,000 of capital losses and $3,000 of capital gains in a tax year. On that year’s tax return, the investor has:
A. no taxable capital gain or loss
B. a $3,000 capital gain with no capital loss deduction
C. a $3,000 capital loss with a $3,000 capital gain carryforward
D. a $3,000 capital gain and a $3,000 capital loss carryforward
The best answer is A.
The tax law allows capital gains and losses to be netted each year. Net capital gains are fully taxable at the tax bracket. However, only $3,000 of net capital losses can be deducted in any year. Any losses above this amount can be carried forward to the next tax year. This customer has no net capital gain or loss. Here, the $3,000 loss is offset by the $3,000 capital gain, for no gain or loss.
A customer has $8,000 of capital losses and $3,000 of capital gains in a tax year. On that year’s tax return, the investor has a(n):
A. $3,000 capital loss deduction with no loss carryforward
B. $3,000 capital loss deduction and a $2,000 loss carryforward
C. $3,000 capital loss deduction and a $5,000 loss carryforward
D. $8,000 capital loss deduction
The best answer is B.
The tax law allows capital gains and losses to be netted each year. Net capital gains are fully taxable at the appropriate tax bracket. However, only $3,000 of net capital losses can be deducted in any year. Any losses above this amount can be carried forward to the next tax year. Here, the customer has a net capital loss of $5,000 of which $3,000 can be deducted this year with the unused $2,000 loss carried forward to the next tax year.
In the same year, a customer has $14,000 of long-term capital losses on stock positions and $4,000 of short-term capital gains on options positions. Which statement is TRUE?
A. The capital losses can be netted against the capital gains and a $10,000 net capital loss is reported, all of which is deductible
B. The capital losses can be netted against the capital gains and a $10,000 net capital loss is reported, $3,000 of which is deductible
C. The $14,000 of capital losses on the stock positions must be reported separately from the $4,000 of capital gains on the options positions, with all $14,000 of capital losses being deductible and all $4,000 of capital gains being taxable
D. The $14,000 of capital losses on the stock positions must be reported separately from the $4,000 of capital gains on the options positions, with only $3,000 of capital losses being deductible and all $4,000 of capital gains being taxable
The best answer is B.
Capital gains and capital losses on all assets are “netted” against each other. There is no segregation by type of asset. This customer had $14,000 of long term capital losses on stocks and $4,000 of short term capital gains on options. The customer has a net $10,000 long-term capital loss, of which only $3,000 is deductible in 1 year. The remaining $7,000 of unused net capital losses is carried forward to the next year.
A customer buys $20,000 of ABC stock in March of 20XX. On December 31, 20XX, the stock is valued at $16,000. The customer will be able to deduct how much on this year’s tax return?
A. 0
B. $1,000
C. $3,000
D. $4,000
The best answer is A.
The loss is not “recognized” for tax purposes until the securities are sold. Thus, none of the loss is deductible on this year’s tax return.
