Module 8

Question 1

Mutual Fund Long-Term Capital Gains

Answer 1

Net gains from the sale of shares held by the fund for more than one year

Question 2

Mutual Fund Short-Term Capital Gains

Answer 2

Net gains from the sale of shares held by the fund for one year or less

Question 3

Mutual Fund Qualified Dividends

Answer 3

Dividends from common stock of domestic corporations and qualifying foreign corporations

Question 4

Stock Cash Dividends

Answer 4

Cash dividends are commonly referred to as “ordinary dividends.”
Normally taxed at the long-term capital gains rate

Question 5

Stock Dividends

Answer 5

Such a distribution is not a taxable event but is one that affects the investor’s cost basis

Question 6

Taxable Bonds

Answer 6

At the election of the taxpayer, the premium may be amortized on a constant yield basis and taken as an annual, tax-deductible adjustment to the cost basis of the bond, in this case it would be $10 per year. The deduction is claimed in the form of an offset to the interest income received. Alternatively, if this election is not made, the premium paid becomes part of the cost basis used in calculating capital gain or loss in the event of a sale or redemption.

Question 7

Tax-Exempt Bonds

Answer 7

In contrast with the tax treatment for taxable bonds, the premium paid for tax-exempt bonds must be amortized on a straight-line basis as an adjustment to the bond’s cost basis and cannot be used to reduce income each year.

Question 8

Zero Coupon Bonds

Answer 8

Although there is no interest cash flow to tax, the tax code nevertheless requires the annual increase in value of zero-coupon bonds to be taxable as interest. In other words, zero-coupon bonds generate tax obligations without generating the cash to pay them.

Question 9

Deductible IRAs

Answer 9

Deductible IRAs have a cost basis of $0 because:
1.) Contributions were deductible, they were made with pretax money
2.) Investment earnings have been tax-deferred
Therefore, any funds withdrawn are fully taxable as ordinary income—i.e., there is no preferential treatment with respect to capital gains.

Question 10

Non-Deductible IRAs

Answer 10

Contributions to a nondeductible IRA, as the name implies, cannot be deducted from taxable income. But when the account owner begins taking distributions, taxes are owed only on the earnings of the account. Because the amount contributed represents after-tax dollars, it is not subject to taxation (neither income nor the 10% early withdrawal penalty) upon distribution.

Question 11

Substantially Equal Periodic Payments (Section 72(t))

Answer 11

For substantially equal periodic payments to be exempt from the 10% penalty, these payments:
1.) Must continue for at least five years or
2.) Until the participant reaches age 59½, whichever is later and
3.) The distribution amount may not be altered during this period
This means that individuals beginning distributions at age 40 must continue them until at least age 59½, since this is the later of the two choices. Someone who begins distributions at age 58 must continue distributions until at least age 63, the later of the two choices.

Question 12

Rule 72(t) Calculation - Method 1: RMD Method

Answer 12

Using Method 1, the annual payment is determined by dividing the account balance for the year by the applicable life expectancy obtained from the chosen life expectancy table. The participant or IRA owner must select the table from among the three alternatives: the RMD Single Life Table, the RMD Joint and Last Survivor Table, and the Uniform Table. Each year’s result is based upon the life expectancy factor for that year and the account balance for that year. The payments are recalculated each year. When using this method, there is not a deemed modification of the series of substantially equal payments if the amount of the payment changes, as long as the method remains unchanged.

Question 13

Rule 72(t) Calculation - Method 2: The Fixed Amortization

Answer 13

Under Method 2, the annual payment is determined by amortizing in level payments the account balance over a specified number of years (determined from the selected table) and the elected interest rate. The interest rate must be less than or equal to 120% of the federal mid-term rate (the “IRS Section 7520” rate—4.6% for January 2023) for either of the two months prior to the month the distribution begins. Once the initial distribution amount is determined it cannot be changed; the payment is the same in all subsequent years.

Question 14

Rule 72(t) Calculation - Method 3: The Fixed Annuitization

Answer 14

This method determines the payment by dividing the account balance by an annuity factor that is the present value of an annuity of $1 per year, beginning on the participant’s or owner’s age in the first distribution year. The annuity factor is derived by using the mortality table in Appendix B of Revenue Ruling 2002 and selecting the interest rate. Once the first payment is determined, it remains unchanged in the subsequent years.

Question 15

RMD Beginning Date for Qualified Plans

Answer 15

The required beginning date for qualified plans, 403(b) plans, and 457 plans is April 1 of the calendar year following the later of the calendar year in which the employee (1) attains age 73, or (2) retires, so distributions may be delayed until retirement.

Question 16

Qualified Roth IRA Distribution

Answer 16

1.) The distribution is made after the attainment of age 59½, death, or disability, or if it is made to a first-time homebuyer for the purchase of a home (limited to a maximum distribution of $10,000), and
2.) A five-year holding period has been met
No income tax or 10% penalty

Question 17

Roth IRA 5-Year Rule

Answer 17

This five-year holding period starts on January 1 of the year when the first contribution is made, and it applies even if the individual establishes multiple contributory Roth IRAs. In other words, the five-year holding period begins in the year of the first Roth IRA contribution regardless of whether future contributions are made to the same or different Roth account.

Question 18

Three Categories of Roth IRA Distributions

Answer 18

1.) Return of contributions. Principal is returned first, and there is no income tax or 10% penalty assessed on this portion (regardless of age).
2.) Return of conversion amount. This will not be subject to income tax, since it was taxed when converted; however, if the individual is under age 59½ it will be subject to the 10% early withdrawal penalty tax if the converted funds have not been in the Roth IRA for at least five years from the date of conversion (unless an exception to the early withdrawal penalty is met).
3.) Return of earnings. Earnings come out last and will not be taxed if it is a qualified distribution. If it is not a qualified distribution, then the earnings will be subject to income tax and the 10% early withdrawal penalty (unless an exception to the 10% early withdrawal penalty is met).

Question 19

Annuity Withdrawals - Non-Periodic Distributions

Answer 19

Distributions are fully taxable as ordinary income until all of the gains have been withdrawn. The principal amount—the original contribution(s)—is then withdrawn and is not subject to tax as it is attributable to after-tax money - LIFO

Question 20

Annuitized Distributions

Answer 20

If monthly payments are being made from a nonqualified annuity as a result of annuitization, the tax treatment is different from withdrawals because the principal has been exchanged for a stream of income and the contract owner no longer has access to the principal. Each monthly payment is considered partially a return of principal and partially a receipt of gain, so each payment is taxable to some extent. The amount of each payment that is subject to tax is proportional to the extent it represents gain versus a return of principal.

Question 21

Common Goals and Objectives of Estate Planning

Answer 21

1.) Fulfilling the client’s property transfer wishes
2.) Minimizing transfer taxes
3.) Minimizing transfer costs
4.) Maximizing net assets to heirs
5.) Providing needed liquidity at death
6.) Fulfilling the client’s health care decisions

Question 22

Parts of an Estate

Answer 22

An estate is all the rights, titles, or interests that a person (living or deceased) has in any property. The various classifications of property that generally are used in estate planning are:
1.) Real property—meaning land and its permanent improvements (such as a residence)
2.) Tangible personal property—meaning any property other than real property that has value because of its physical existence (such as an automobile)
3.) Intangible personal property—meaning any property other than real property that has value because of the legal rights that it confers (such as a stock certificate)

Question 23

Probate Estate

Answer 23

Involves all property interests that do not automatically transfer to beneficiaries under applicable state law and that, therefore, are subject to the state-prescribed transfer process known as probate.

Question 24

Gross Estate

Answer 24

Includes all property that is subject to the federal estate tax.

Question 25

Federal Estate Tax

Answer 25

Calculation of the estate tax begins by aggregating the fair market value of all property subject to federal estate tax. This amount is known as the gross estate. The gross estate includes all real and personal property: house, automobiles, jewelry, furniture, securities, checking accounts, collectibles, etc. The estate also includes life insurance that is payable to the decedent’s estate, as well as policies to which the decedent retained “incidents of ownership” until their death, such as the right to change beneficiaries or to borrow against the cash surrender value of the policy.
A decedent’s estate is also required to include any gift tax paid on gifts made within three years of the decedent’s date of death and the value of any property gifted within three years of death if the property would have otherwise been included in the decedent’s gross estate. Finally, the estate must also include the death proceeds of any life insurance policy insuring the decedent’s life that was gifted within three years of their death.

Question 26

Estate Transfer

Answer 26

The act of conveying title to property interests from one person to another. Selecting proper estate transfer alternatives is the key to efficient and effective estate planning.

Question 27

Will

Answer 27

A will is a legally enforceable declaration of how an individual’s probate property is to be distributed at death.

Question 28

Probate

Answer 28

The court-supervised process for administering a decedent’s probate estate. Probate is used to determine that a person has died, has or has not left a valid will, has certain heirs, has certain property not disposed of by other testamentary arrangements, and has or does not have certain debts and taxes that require payment.

Question 29

Purposes of Probate

Answer 29

1.) Validated a will
2.) Appointment of someone to administer the decedent’s probate estate
3.) Allows valid creditors of the decedent to be paid

Question 30

Disadvantages of Probate

Answer 30

1.) Everything is public: The decedent’s financial affairs will not be private since their property interests, creditors and debts, and the persons who will receive the property are made part of the public record.
2.) Delay in transfer: Distributions are delayed because paperwork and steps in the process require time for completion. This can be a big problem for family members who need the money to pay bills and funeral expenses.
3.) Legal and administrative costs: Probating the will may be costly for the estate because of the hours needed by the personal representative and attorneys to complete the paperwork and steps in the process. As we will soon see, good estate planning minimizes the costs associated with probate by reducing the property transferred by will. With fewer things passed by the will, legal and administrative costs are generally lower.

Question 31

Substitutes to a Will

Answer 31

1.) Some forms of jointly held property
2.) Insurance proceeds paid to named beneficiaries
3.) The naming of beneficiaries for the proceeds of IRAs, Keoghs, and other individual and qualified retirement plans
4.) Trusts funded during the owner’s lifetime (known as inter vivos or living trusts)
5.) Payable on death (P.O.D.) accounts
6.) Transfer on death (T.O.D.) securities accounts

Question 32

Tenancy in Common

Answer 32

A person owns property with one or more other persons. Each person holds a distinct title to an undivided interest in the property that may be equal or unequal. (An “undivided interest” means that the person owns a percentage interest in every part of the property, as opposed to only a specific portion of it.)
Each has the right to sell their interest without the other’s consent. If either tenant dies, the decedent’s share of ownership goes to the deceased’s estate. Thus, tenancy in common is not a will substitute.

Question 33

Community Property

Answer 33

Community property is a form of property ownership available only to a legally married couple. Under this concept, with a few exceptions, property acquired during marriage belongs one-half to each spouse, no matter whose name is on the title and no matter who actually put up the money to purchase the property. (The primary exceptions to this concept are properties acquired with separate funds, and separate property given to or inherited by one spouse during the marriage.) Each spouse has an equal right to use, enjoy, sell, borrow against, or give away their portion of the property during their lifetime.
Traditional community property is not a will substitute. When one spouse dies, their half of the community property does not automatically go to the surviving spouse. Instead, it is distributed through the probate process to the person or persons designated in the deceased spouse’s will.

Question 34

Joint Tenancy

Answer 34

In joint tenancy ownership, a person owns an undivided equal interest in the property (unless expressly stated otherwise and allowed by state law) with one or more other persons. The unique feature of joint tenancy is survivorship. A joint tenant does not have the right to direct who will receive their interest at death; therefore, a will provision concerning the property will have no effect on who will receive the property. Instead, the deceased joint tenant’s name drops off the ownership chart and the surviving joint tenants then own equal interests (see caveat above) in 100% of the property. Thus, joint tenancy is a will substitute.

Question 35

Tenancy by the Entirety

Answer 35

This is a special type of joint tenancy that exists only between spouses and only in certain states. Some states that recognize this type of ownership also allow registered domestic partners to own property in this manner. Like joint tenancy, the tenants have a right of survivorship. However, unlike joint tenancy, tenancy by the entirety does not allow either tenant to sell or gift their interest without the consent of the other tenant. This form of ownership acts as a will substitute because of the survivorship feature.

Question 36

Insurance

Answer 36

Insurance proceeds are transferred by contract to a named beneficiary. This feature of insurance makes it an important estate planning tool and a will substitute.

Question 37

Trusts

Answer 37

A trust is a legal relationship in which one party, the trustee, manages property for the benefit of another party, the beneficiary. The beneficiary may be the person creating the trust (the grantor), or some other party, such as the spouse or children of the person creating the trust. Whichever the case, once property is transferred to the trust, the trust has legal title to the property. If this is an inter vivos trust—i.e., one that the donor establishes and funds during their lifetime—it constitutes a will substitute. When the person who transferred the property dies, the property in the trust is not part of the deceased’s probate estate for purposes of distribution (it has already been distributed).

Question 38

Dying Intestate

Answer 38

Total intestacy results from the decedent dying with a probate estate and no will. Partial intestacy results from a decedent dying with a will that does not dispose of all of the decedent’s probate property.

Question 39

Top Gift and Estate Tax

Answer 39

40%

Question 40

Federal Estate Tax Definition

Answer 40

The federal estate tax is a tax levied on the transfer of property at death. The tax is based on the size of the decedent’s estate. The taxable estate is determined by reducing the gross estate by allowable deductions. Then, all lifetime taxable gifts made by the decedent are added to arrive at the amount upon which tax rates are applied. After subtracting allowable credits, the final tax owed by the estate is determined.

Question 41

Federal Gift Tax

Answer 41

The federal gift tax is imposed on all gratuitous transfers of property made during life. The tax is meant to account for property transfers that would otherwise reduce the estate, and thus the estate tax liability at death. The donor’s tax on the gift is based on the gross value of the gift less any available deductions and exclusions: the taxable gift.

Question 42

Generation-Skipping Transfer Tax (GSTT)

Answer 42

If family wealth was subjected to federal estate tax at the death of every other generation instead of every generation, much tax liability over a period of time could be avoided. The means to accomplish this was a trust that gave the generation immediately below the decedent’s generation (second generation) only an income interest in the family wealth, with the principal going to the third generation at the death(s) of the second generation. Because the second generation had only an income interest that ceased with death, there was no remaining interest in the trust to tax at the death of the second generation, and only at the death(s) of the third generation was the federal estate tax again imposed.
40% tax rate.

Question 43

Federal Unified Transfer Tax System

Answer 43

Gifts from prior years and estate are combined to determine tax rate

Question 44

Fair Market Value at the Time of Transfer

Answer 44

For federal transfer taxes, the value used to calculate taxes is the fair market value at the time of the transfer.
“the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell, and both having reasonable knowledge of relevant facts.”
In other words, fair market value is regarded as the price agreed upon by a willing seller and a willing buyer.

Question 45

Date of Valuation

Answer 45

If we must determine the value of something, then the date on which that value is determined matters, since value can change. The rules for the date of valuation are as follows:
1.) Gifts: The valuation date for gifts is the date on which the transfer is considered to be completed.
2.) Estates: Date of death

Question 46

Federal Gift Tax

Answer 46

The federal gift tax applies to transfers of wealth by a person while they are still alive. These transfers are called inter vivos (during life) gifts. An inter vivos gift typically occurs when two things happen:
1.) The giver (or donor) receives less than the full value of the property in return for property transferred
2.) The donor gives up control over the property.

Question 47

Federal Gift Tax Annual Exclusion

Answer 47

Under current tax law, an individual can give up to a certain amount per year to as many individuals—even nonrelatives—as they wish without incurring a gift tax. This value is known as the annual exclusion and is subject to indexing.

Question 48

Gifts of a Present Interest

Answer 48

Only gifts of a present interest are eligible for the annual exclusion. To be a gift of a present interest, the recipient must be able to immediately use or enjoy the gift. With an outright gift, this is not a problem. However, with a gift in trust, it is more difficult to qualify, and special planning is required.

Question 49

Gift Splitting

Answer 49

Married persons may double the tax-free gift to a particular recipient by both spouses consenting to gift splitting. With gift splitting, an election is made by the spouses to treat a gift made by one spouse as made one-half by each. However, all gifts in that year made by both spouses to third parties must be treated as split gifts.

Question 50

Calculating the Gift Tax

Answer 50

In a situation where taxable gifts have been made in prior years, the gift tax calculation for the current year is affected in two ways:
1.) First, the taxable gifts of prior years are added to the taxable gifts of the current year to create a tax base, or total taxable gifts. Total taxable gifts is the amount on which a tax is calculated. From this calculated tax, another tax calculated on all prior taxable gifts (using the current year rate chart) is subtracted; the result is a current year tax figured at the highest marginal tax rate applicable.
2.) The amount of the applicable credit available for the current year is whatever amount remains after subtracting the applicable credit amount used in prior years from the maximum applicable credit amount available in the current year.

Question 51

Estate Tax Deductions

Answer 51

After the value of the gross estate is determined, the taxable estate is then determined by deducting certain expenses, including funeral and estate administrative expenses, death taxes paid to a state, uninsured casualty and theft losses involving gross estate assets, any claims against the estate, and debts of the decedent. The two gift tax deductions discussed earlier—the charitable deduction and the marital deduction—apply to the estate tax as well.

Question 52

Taxable Estate

Answer 52

The gross estate reduced by all applicable deductions

Question 53

Calculating the Federal Estate Tax

Answer 53

Similar to the gift tax calculation, the next step involves adding to the taxable estate all taxable lifetime transfers since 1976. This step is required because the estate tax, like the gift tax, is cumulative. The value of any taxable gifts made by the decedent since 1976 (adjusted taxable gifts) must be added to the taxable estate to establish the amount against which the tax rate will be applied. This sum is known as the estate tax base.

Question 54

Trusts’ Role in Estate Planning

Answer 54

1.) They can provide management of property for the grantor’s convenience, or for legally, mentally, or financially incapacitated beneficiaries.
2.) They can prevent creditors of both the grantor and beneficiaries from having access to the trust assets (asset protection).
3.) They can accumulate income for later distribution to a beneficiary.
4.) They can enable the grantor to provide one person (such as a surviving spouse) with lifetime benefits, while ensuring that the remainder will go to another person (such as a child from a prior marriage) at the life beneficiary’s death.
5.) They can provide income, gift, and estate tax savings.
6.) They can provide management of assets located in several different states.
7.) Since trusts are independent and separate legal entities, they can eliminate the need to have property pass through probate at the death of the grantor if they are established and funded while the grantor is alive.
8.) Trusts can provide privacy. Except in the case of so-called pourover trusts, whose assets come (in part) from a publicly disclosed will, the trust, its property, and the beneficiaries are not a matter of public record.

Question 55

What is a Trust?

Answer 55

A trust is a legal relationship in which one party (the trustee) manages property for the benefit of another party (the beneficiary). The beneficiary may be the person creating the trust (the grantor) or some other party, such as the spouse or children of the person creating the trust.
Once property is transferred to the trust, the trustee has legal title to the property. They are not, however, the owner of the property in any traditional sense. The beneficiaries who have an equitable or beneficial title are the real owners.

Question 56

Types of Trust Beneficiaries

Answer 56

1.) Income beneficiaries: These are the people who will benefit from the trust during the existence of the trust.
2.) Remainder beneficiaries: These persons take title to the trust assets when the trust ends.
A fiduciary relationship exists between the trustee and these beneficiaries in which the trustee (as a fiduciary) has the highest duty known in the law, created by their undertaking to act in good faith for the benefit of the beneficiaries.

Question 57

Types of Trusts

Answer 57

1.) Living (inter vivos) trusts are established and funded in the grantor’s life. They can be either revocable or irrevocable.
2.) Testamentary trusts are created in the grantor’s will or living revocable trust and are funded only after the grantor’s death.

Question 58

Unlimited Marital Deduction

Answer 58

In order for property to qualify for the unlimited marital deduction it must meet three requirements:
1.) It must be included in the decedent’s gross estate.
2.) It must be transferred to the surviving spouse.
3.) The interest in the property must not be terminable (unless it meets an exception). In other words, the surviving spouse’s interest in the property cannot be subject to termination at some point in the future based on the passage of time or the occurrence or non-occurrence of some contingency.

Question 59

Federal Estate Tax Exclusion Portability

Answer 59

Any unused portion of the estate tax applicable exclusion amount of the first spouse to die (called the “deceased spousal unused exclusion” or “DSUE” amount) is portable to a surviving spouse, if any. The DSUE amount available to the surviving spouse is the lesser of the deceased’s spouse’s applicable exclusion amount or the deceased spouse’s exclusion amount less the deceased spouse’s tax base.