Investment Vehicle Taxation

Question 1

Generally, what are the tax rules on a non-MEC insurance policy?

Answer 1

Growth and interest not taxed and upon death benefit payout, the recipient is not taxed.

If distributions occur, FIFO rules apply and only proceeds above the premiums paid in, are taxed

Proceeds payable before death (surrender value) may be taxable if they exceed the amount of premiums paid in.

Question 2

Generally, how is life insurance in qualified plans taxed?

Answer 2

Premiums paid by the employer are taxable to the employee. The employee can annuitze this benefit if he doesn’t pass before retirement, but if he does, it benefits pass tax-free to the beneficiaries.

Question 3

What is section 1035?

Answer 3

IRC section that governs the exchange of one life insurance product for another. No gain or loss recognized for exchange of life insurance, LTC, annuity, or endowment.

Question 4

What is a Modified Endowment Contract?

Answer 4

An insurance product that fails the 7-pay test. If it fails, the policy is still treated the same for tax free/deferred growth, but ANY withdraws, including the contract investment, prior to 59 1/2 will utilize the LIFO rules.

Question 5

What is a material change to a policy and what impact does that have to MEC?

Answer 5

An exchange of policy or insured, increase or additional riders, increase in future benefits, increase of over $150k in death benefits.

This starts the 7 year MEC clock over.

Question 6

What are the tax rules for annuities?

Answer 6

Return of capital is non-taxable. Interest growth is taxed as ordinary income

Question 7

What is the FIXED ANNUITY exclusion ratio?

Answer 7

exclusion % = total annuity investment / total expected return

Payout x exclusion % = amount that WILL NOT be taxed. The rest is taxed as ordinary income

Question 8

What is the VARIABLE ANNUITY exclusion ratio?

Answer 8

Exclusion $ = total annuity investment / # expected payments

$ amount is excluded from taxes.

Question 9

What is a partial annuitization?

Answer 9

The ability to annuitize a portion of the contract which becomes a separate contract, leaving the rest to continue building interest.

Question 10

How are commercial annuities taxed?

Answer 10

Prior to Aug 13th, 1982, FIFO
Post Aug 14th, 1982, LIFO

Distributions prior to 59 1/2, 10% penalty on taxable portion of the distribution. Taxable income is taxed as ordinary income

Question 11

What is the rule for differenciating between short and long term capital gains?

Answer 11

It is 1 year. The day of security acquisition does not count, but the day of disposition does. For simplicity, the day after acquisition, one year later, is the requirement for long term capital gains.

Question 12

What are the rules with inherited IRAs?

Answer 12

Typically, an inherited IRA must be completely liquidated 10 years from date of death. The clock does not start for minors until they turn 18. Also, a spouse or beneficiary that is not more than 10 years younger than the deceased, can take withdraws over their lifetimes.

Question 13

What is the difference between a 1231 gain and 1250 gain?

Answer 13

1250 recaptures depreciated property when sold for a gain. The ceiling for such recapture is 25%

1231 is the long term capital gain above and beyond the recaptured gain. This uses LTCG rates.

Question 14

What is the order of capital gains that capital losses will reduce?

Answer 14

Collectible assets at 28%
1250 recaptured gains at 25%
LTGC at 20/15%

Question 15

What is a telephone transfer?

Answer 15

When a mutual fund sponsor allows an investor to switch from one type of fund to another without a fee, this is still a taxable event.

Question 16

When mutual fund earns dividends and those distributions are reinvested to purchase more shares, what is the result?

Answer 16

The numbers of shares and the aggregate basis both increase

Question 17

What are the general taxation of dividend distributions in cash?

Answer 17

Short term - ordinary income

Long term - LTCG

Question 18

What are the 3 methods for determining basis when stocks are purchased at different times and different amounts?

Answer 18

Specific ID: most preferred; matches stock sold to stock purchased
Average cost: pools all shares and divides total cost by number of shares
FIFO: least preferred. Maximizes tax liability

Question 19

How are short sales taxed?

Answer 19

Usually by STCG or losses. Short selling doesn’t typically go for over a year. In the instance it does, then LTCG/L rules apply

Question 20

According to IRC section 267, when can you NOT deduct losses during sales or exchanges?

Answer 20

Related parties such as members of your own family (blood relatives), certain business organizations, an estate to beneficiary, and certain trusts.

Question 21

If a bond is bought at discount, an original issued discount (OID), how is it taxed?

Answer 21

The phantom income generated by the difference between face value and purchase price, must be included each year as income. The tax payer should receive a Form 1099-OID that reports the annual OID amount.

Question 22

What are the tax implications for a bond bought at premium to PAR?

Answer 22

The taxpayer can take a deduction on the interest payments throughout the life of the bond

Question 23

How can a taxpayer claim a loss from an IRA?

Answer 23

Only in the year of death - the beneficiary of the IRA can claim a loss based on the amount the original owner paid into the IRA and the amount of current worth - assuming the latter is less.

This is an ordinary loss - not a capital gains loss

Question 24

What is net investment income and how is it usually taxed?

Answer 24

NII is investment interest paid or accrued on a debt that was incurred to purchase property held for investment, such as stocks, bonds, CDs, savings accounts, etc.

Similar to capital gains and losses, the taxpayer can deduct interest paid from interest gained up to the value of the interest gained. Any additional interest payments can be carried over into future years.

Question 25

What makes a dividend “qualified” for preferential tax treatment?

Answer 25

Must be paid by qualified domestic or foreign corporation

Stock must be owned more than 61 days in the 121-day period surrounding the ex-dividend date.

Dividend must generally be paid from a stock or regulated investment company

Question 26

How are dividends paid from tax-deferred vehicles taxed?

Answer 26

They do not receive preferential treatment

Question 27

How are cash and property dividends taxed?

Answer 27

To the extent that the distribution or property doesn’t exceed earning and profits (E&P), the distribution is just seen as a return of capital.

If it exceeds E&P, then the excess is treated as capital gains.

Question 28

What is the additional medicare tax?

Answer 28

0.9% tax applied once total income exceeds threshold amounts listed in the given tables. The responsibility of this tax is wholly the EE, unlike the Medicare tax which is split between EE/ER

Question 29

Is the additional medicare tax able to be deducted as an adjustment from a SE income?

Answer 29

No

Question 30

What is the calculation for determining SE tax?

Answer 30

If under wage base, = Earnings - (earnings x 7.65%) x 15.3%

If over wage base…

Medicare rate = ((Earnings - (earnings x 7.65%)) - wage base) x 2.9%
SE Tax = Medicare rate +15.3% of wage base

If over additional medicare bracket…

All the above + 0.9% x (actual earnings - medicare threshold)

Question 31

What is the difference between the additional medicare tax and the net investment income tax?

Answer 31

Additional medicare tax is imposed on wage income.

Net investment income tax is imposed on investment income

Question 32

What is the Net Investment Income Tax and how is it calculated?

Answer 32

NIIT is the investment income in excess of the deductions allowed. It is only applicable if the MAGI is over the threshold amount on the given tables.

A medicare contribution tax of 3.8% is applied to the LESSER of the net investment income or MAGI in excess of the threshold NIIT amount

Question 33

How is disability insurance payments taxed?

Answer 33

It depends on who paid the premiums. When the EE pays the premiums, the benefit is not taxed because the premiums would have been paid with after-tax dollars. When the EE/ER split the premium, the same portion of the payment is deductible to the ER and taxable to the EE. When the ER pays the premium in full, the benefit is fully taxable to the EE.

Question 34

At what threshold is the additional medicare tax applied?

Answer 34

$200k regardless of whether or not MFJ

Question 35

How are student loans taxed if cancelled?

Answer 35

The taxpayer must include the forgiven amount in their gross income the year it is cancelled unless it is due to death or permanent and total disability (after 2017).

Question 36

What is the amount that can be excluded from a taxpayers income when their employer pays tuition or loans?

Answer 36

$5,250. The business can deduct that amount as well

Question 37

How are scholarships and fellowship grants taxed?

Answer 37

The can be completely excluded from income IF they are applied toward education expenses from a eligible education institution and don’t have any strings attached

Question 38

How is student loan interest tax deductible?

Answer 38

Up to $2500 per year is allowed, but there are MAGI phase-out limits on the given tables.

Question 39

How are EE bonds taxed when used for education?

Answer 39

The interest can be tax deductible as long as the bond are either in the parents names, the purchaser is older than 24, and the bond(s) are redeemed to pay for higher education expenses.

There are phaseout limits and the taxpayer cannot deduct more interest than the amount of educational expenses.

Question 40

What is the American Opportunity Tax Credit?

Answer 40

100% of first $2000 and 25% of second $2000 for a maximum total of $2500 credit per year of the first four years of post-secondary education for qualified expenses.

Student must be half-time minimum and cannot have been convicted of felony or drug offenses.

There is a phaseout and the taxpayer can only elect this or the lifetime learning credit, but not both. They can however, still take deductions for other educational savings accounts as long as they are separate expenses. This is 40% refundable.

Question 41

What is the Lifetime Learning Credit?

Answer 41

Up to $2000 tax deduction per HOUSEHOLD on up to $10000 of qualified education expenses per year with no limits on the number of years used. This credit is far looser in that it is applied to any education and does not have the drug or felony caveats.

There are phase outs and is non-refundable.

Question 42

What are the tax rules for a Coverdell ESA?

Answer 42

Up to $2000 per year, per beneficiary total allowed. Contributions are non deductible. If a business contributed to their EE’s child, it is not a gift, but a benefit, fully taxable to the EE.

There are phaseouts and the full amount must be distributed by age 30, but it can be rolled over into another account of a family sibling.

Question 43

What are the contribution and tax rules for a 529 plan?

Answer 43

There are no IRS limits to contributions, but there may be state limits. Contributions are not deductible at the federal level, but some states allow deductions at the state level. There is no beneficiary or contributor control of the investment funds.

Contributions to a 529 are seen as gifts and subject to the gift tax rules. However, one could front-load up to five years of gifts in a single year. However, if the contributor dies before those five years are up, the funds will be subject to clawback.

Question 44

What is not included as investment income for the purpose of the additional medicare tax?

Answer 44

Muni bond interest
Qualified retirement plan distributions
Income from active trades or businesses

Question 45

If parents claim a full-time student, and that student takes on student loans as the sole borrower, who can claim the interest deduction on the student loans?

Answer 45

No one. Only the borrower can deduct the student loan interest, but in this case, the student is claimed by his parents and so he cannot claim a deduction at all

Question 46

When can a borrower deduct interest from that loan on their taxes?

Answer 46

When the loan is used to purchase taxable investments - they can deduct interest from the loan as an investment expense

Question 47

What are the tax rules when property is acquired as a gift?

Answer 47

If the FMV is lower than the donor’s basis, then the donee’s holding period begins on the date of transfer.

If the FMV is higher than the donor’s basis, then the donee’s holding period begins on the date of the donor’s purchase

Question 48

How is propter