Module 8 Quiz Flashcards
The applicable credit amount is the amount of transfer tax on the
A) cumulative taxable gifts.
B) gifts or inheritances going to a spouse or qualified charity.
C) applicable exclusion amount.
D) annual exclusion amount.
C) applicable exclusion amount.
The applicable credit amount is the tax on the corresponding applicable exclusion amount. The applicable exclusion amount is the amount of taxable transfers a person can make without actually having to pay gift or estate tax. No tax is actually paid on this amount because the applicable credit amount is the amount of transfer tax on the applicable exclusion amount and must be applied against any tax owed. The annual exclusion amount applies to federal gift tax. The first $17,000 (2023, indexed annually) of a present interest given to any donee in any calendar year is excluded from the donor’s total gifts as “free” from gift tax. Cumulative taxable gifts are simply the sum of the taxable gifts given. Gifts to a spouse or charity are deductions when calculating gift or estate taxes.
Harry contributed $2,000 to a Roth IRA six years ago. By this year, the investments in his account have grown to $3,785. Finding himself in a financial bind, Harry, now 34, is compelled to withdraw $2,000 from this Roth IRA. What is the tax and penalty status of this withdrawal?
A) Harry must pay both income tax and the 10% early withdrawal penalty on the $2,000.
B) Harry must pay tax on the $2,000, but there is no penalty.
C) Harry does not have to pay any tax or penalty on the $2,000 distribution, even though he is only 34.
D) Harry must pay tax a 10% early withdrawal penalty but he will not be income taxed on the $2,000.
C) Harry does not have to pay any tax or penalty on the $2,000 distribution, even though he is only 34.
All Roth IRA contributions are made with after-tax funds, and contributions are considered to be withdrawn first, tax-free, then conversions are accounted for as being withdrawn next, and finally earnings are withdrawn after the contribution and conversion amounts have been completely withdrawn. In this case Harry withdrew his $2,000 of contributions. The withdrawal of contributions is never taxed or penalized. Now his account has $1,785 of earnings remaining (at least until the next contribution or conversion).
What will be the amount and character of the capital loss carryover to the subsequent year, if any, if Sally has the following capital transactions during the current year?
Long-term capital loss on sale of ABC stock $(6,500)
Long-term capital gain on sale of DEF stock $ 2,200
Short-term capital gain on sale of XYZ stock $ 1,000
A) $1,300 long-term capital loss carryover
B) $300 short-term capital loss carryover
C) $300 long-term capital loss carryover
D)$0
C) $300 long-term capital loss carryover
Net long-term capital losses ($4,300) reduced by short-term capital gains ($1,000) result in a net long-term capital loss of $3,300. Since only $3,000 of this loss is currently allowed, the excess $300 is carried over as a long-term capital loss. The carryforward loss always retains its character as long- or short-term when moved into the next year.
Which one of the following describes the taxability of tax-exempt market discount bonds?
A) The market discount is taxed as ordinary income upon the sale or redemption of the bond.
B) They are tax-free from all state and local income tax regardless of where the taxpayer resides.
C) The market discount is subject to capital gains upon the sale or redemption of the bond.
D) They are exempt from taxation.
A) The market discount is taxed as ordinary income upon the sale or redemption of the bond.
Any market discount is taxed as ordinary income upon the sale or redemption of the bond.
Which one of the following is generally not considered a tax-deferred type of account?
A) Annuity
B) Keogh
C) Roth IRA
D) Certificate of deposit
D) Certificate of deposit
Roth IRAs, annuities, and Keoghs (qualified retirement plans) are tax-deferred investments, while a certificate of deposit is not. The annuity, Keogh, and Roth IRAs are actually tax categories (describing how the account is income taxed). Certificates of deposit (CDs) are a type of investment. You can invest in a CD inside a Roth IRA, etc. Contributions to a Roth IRA are not tax deductible, but the earnings are tax deferred while inside the account. If the earnings on a Roth IRA are withdrawn as a part of a qualified distribution, then the earnings would have grown tax deferred and then been withdrawn tax free.
Which one of the following techniques will result in tax deferral?
A) Investing in high-growth stocks
B) Reinvesting mutual fund dividends into more shares of the fund
C) Moving funds from one brokerage account into another
D)
Exchanging stocks on a regular basis by selling and reinvesting the proceeds
A) Investing in high-growth stocks
Investing in high-growth, low-dividend-paying stock is one form of deferring tax liability. The constant sale and repurchase of stocks will generate a tax liability with each sale, thus not offering any tax deferral.
Ray purchased shares in Maxgrowth Mutual Fund on July 1 of the current year. The ex-dividend date is September 15. On October 15 of the same year, Maxgrowth paid ordinary dividends of $100 and long-term capital gain distributions of $900, but Ray had the distributions reinvested in the fund. Ray sold the shares on December 23 of the current year. How will these distributions be taxable to Ray?
A) $100 qualified dividend income, subject to long-term capital gain rates and $900 long-term capital gain
B) $100 ordinary income and $900 short-term capital gain
C) $1,000 ordinary income
D) The entire transaction is tax-free.
A) $100 qualified dividend income, subject to long-term capital gain rates and $900 long-term capital gain
The treatment of the capital gain income is determined by the mutual fund, regardless of how long the investor has held those shares. The dividend income may be taxed at long-term capital gain rates, if the holding period is met. In this situation, the taxpayer held the shares for at least 61 days of the 121-day period that begins 60 days before the ex-dividend date. The $100 dividends and the $900 capital gains distributions were subject to income taxes, so they would increase Ray’s basis in the Maxgrowth fund shares. The mutual fund will document the capital gain or loss on an IRS Form 1099-B. While the capital gains distributions are accounted for from the perspective of the fund portfolio, mutual fund sales are accounted for from the investor’s perspective. In this case, Ray sold his shares a year or less after his purchase, so his December 23 sale will be short-term.
Which one of the following is the most common method for investors to use in determining the cost basis of mutual fund shares?
A) First-in, first-out
B) Last-in, first-out
C) Average cost
D) Specific identification
C) Average cost
The average cost method is the most widely used as fund companies provide this information, thus making it simple for fund shareholders. The first-in, first-out method requires the taxpayer to reconstruct his or her purchases in determining gain or loss, and results in greater gains during a rising market. Thus, it is not as widely used as the average cost method. The specific identification method results in the lowest tax liability, although it requires meticulous record keeping that most taxpayers will not adhere to. Also, the shares sold would have to be specifically identified to the mutual fund when the sale is made. This is practically impossible.
Dividend reinvestment plans are popular because
A) dividends must purchase shares in whole numbers.
B) dividends can be used for discounted stock purchases.
C) dividends are not currently taxable, thereby achieving tax deferral.
D) basis calculations are simplified.
B) dividends can be used for discounted stock purchases.
The biggest benefit of a dividend reinvestment plan is the ability to purchase additional shares of stock at a discount. Even though the dividends are reinvested, they are currently taxable. Remember that when determining basis, the taxpayer must keep meticulous records of all stock purchased and reinvested dividends. Dividend reinvestment plans usually allow purchases out to three decimal places.
Charlie contributed $2,000 to Roth IRA 1 last year, when he was age 24, and $2,000 to Roth IRA 2 this year. Two years from now, Roth IRA 1 will have a balance of $2,650, and Roth IRA 2 will have a balance of $2,590. Charlie closes Roth IRA 1 two years from now, receiving the balance of $2,650. Which one of the following statements best describes his tax and penalty status for that year?
A) He will pay neither taxes nor a penalty.
B) He cannot make any withdrawals, because the money has not been in the Roth IRA for five years or longer.
C) He must pay taxes and a penalty on the full distribution.
D) He only pays income taxes, because Roth IRA distributions are not subject to a penalty.
A) He will pay neither taxes nor a penalty.
None of the withdrawal is included in Charlie’s taxable income, because the $2,650 is less than the aggregate total of his contributions ($4,000). Remember that contributions are treated as the first dollars distributed no matter when they were actually contributed. No penalty applies since the withdrawal is not taxable. The distribution, however, is not considered a qualified distribution because Charlie’s Roth IRA has not passed the five-year holding period test. Also, the question does not address why he withdrew the Roth money. He is not dead; age 59½; buying, building, or rebuilding a first home (up to $10,000); or disabled.
Which one of the following is a requirement or rule related to the Section 121 exclusion?
A) The taxpayer must be living in the home at the time of the sale.
B) The taxpayer must have owned and lived in the home five years before the sale.
C) Capital gains on the sale may be excluded for up to $250,000 for married taxpayers who file jointly.
D) The exclusion may not be used more than once within a two-year period unless an exception applies.
D) The exclusion may not be used more than once within a two-year period unless an exception applies.
Unless the taxpayer moves because of a new job, for health reasons, or due to other unforeseen circumstances, only one exclusion is allowed within any two-year period. The taxpayer must have owned and lived in the home for at least two of the previous five years before the sale. This does not require the taxpayer to have owned the home for five years. Single taxpayers are allowed an exclusion of up to $250,000, while married taxpayers who file jointly are allowed an exclusion of up to $500,000.
Which one of the following represents the basis of stock acquired by gift, if the fair market value on the date of gift is less than the donor’s basis?
A) The mid-point between the high and the low on the date of the gift
B) The basis is not known until the stock is sold
C) Donor’s basis
D) Fair market value at the date of the gift
B) The basis is not known until the stock is sold
Normally, the basis of an asset acquired by a gift will be the donor’s adjusted basis. However, if the fair market value on the date of the gift is less than the donor’s basis, it is not possible to know the donor’s basis until the asset is sold. If the asset is sold for less than the value on the date of the gift, the loss is determined from the value on the date of the gift and the holding period is determined from the date of the gift. If the asset is sold for a value above the donor’s basis, the gain is determined from the donor’s basis and the holding period began when the donor purchased the asset. If the asset is sold for a price between the donor’s basis and the fair market value on the date of the gift, there is no taxable gain or loss, so the holding period is irrelevant.
Which one of the following is an example of a tax-deferred investment?
A) Certificate of deposit
B) Treasury bill
C) IRA
D) Mutual fund
C) IRA
An IRA is a tax-deferred investment. A traditional, deductible IRA defers income taxes on the contributions and the earnings until withdrawal. Both a Roth IRA and a traditional, nondeductible IRA defer income taxes on the earnings until withdrawal. Earnings on a Roth IRA can be withdrawn tax-free in a qualified distribution, but Roth IRA earnings are always tax-deferred until withdrawn. CDs, mutual funds, and T-bills generate currently taxable interest income. You always want to understand two aspects of any investment. First, how does this investment accrue wealth? Second, what are the tax ramifications of this investment?
Distributions from a mutual fund can be made in which of the following forms?
A) ordinary dividends
B) all of these
C) nontaxable distributions
D) capital gains distribution
B) all of these
Shareholders may receive mutual fund distributions in the form of ordinary dividends, non-taxable distributions, or capital gains distributions. The ordinary (cash) dividends may be subject to preferential long-term capital gain rates.
The cost basis of a capital asset is generally its initial cost, adjusted by
A) cost of minor repairs.
B) dividends received as a cash dividend.
C) costs incurred in buying and improving the asset.
D) maintenance costs
C) costs incurred in buying and improving the asset.
The cost basis of a capital asset includes not only its initial cost, but any related costs incurred in buying or owning the asset. Reinvested dividends increase the aggregate basis of the stock holdings, but cash dividends received but not reinvested do not impact basis. Capital improvements, such as adding a room addition, increase basis; whereas minor repairs, such as painting, do not affect basis. The same is true for regular maintenance costs.
