Practice Quiz 11

Question 1

Richard, age 68, makes a cash gift of $50,000 to his best friend’s son, Corey. Corey is 28 years old. Which of the following statements regarding this transfer is(are) CORRECT?

1. The transfer is subject to gift tax.
2. The transfer is subject to the generation-skipping transfer tax (GSTT).
3. Richard is responsible for paying any generation-skipping transfer tax (GSTT) due on the transfer.
4. Any generation-skipping transfer tax (GSTT) paid on the transfer will be added to the value of the gift in determining the amount of gift tax due.

Answer 1

all statements are correct

Question 2

Which of the following statements concerning financial markets is (are) CORRECT?

1. In a firm commitment underwriting agreement, the investment bank is paid a flat fee to sell the new issues and the corporation receives all the benefit from a high market price.
2. In the underwriting process, the investment bank determines the appropriate sales price of the security based on the company’s historical earnings, its future prospects and the value of similar businesses.

Answer 2

2 only

Question 3

Limited-pay whole life insurance policies:

1. Require the owner to pay premiums for a shorter period than traditional whole life insurance policies.
2. Provide lifetime coverage.
3. Have cash value accumulation.
4. Require premiums to be paid for the entire life of the insured.

Answer 3

1, 2, and 3

Question 4

All of the following statements concerning the mechanics of futures trading are correct EXCEPT:
A)
An open interest indicates futures contracts that are not offset by opposite transactions or delivery, and measures the number of unliquidated contracts at any point in time, on a cumulative basis.
B)
The open interest increases when an investor goes long a contract and is reduced when the contract is liquidated.
C)
A long hedge is a transaction involving the sale of futures (a short position) while holding the asset (a long position); whereas, a short hedge is a transaction where the asset is currently not held but futures are purchased to lock in current prices.
D)
All futures contracts are marked to market daily; that is, all profits and losses are credited and debited daily to each investor’s account.

Answer 4

C

A short hedge is a transaction involving the sale of futures (a short position) while holding the asset (a long position); whereas, a long hedge is a transaction where the asset is not currently held but futures are purchased to lock in current prices.

Question 5

Mary gave a general power of appointment to her husband, Don, in her will. Mary died 10 years ago and Don died last year. Before his death, Don exercised the power in favor of his only child, Christine. The value of the property subject to the power was $500,000 at the time of Don's death and $450,000 when the power was exercised. What amount will be included in Don's gross estate?
A)
$450,000.
 B)
$0.
 C)
$500,000.
 D)
It cannot be determined from the information given.

Answer 5

B

Nothing is included in Don’s gross estate because Don exercised the power before he died and did not possess a general power of appointment at his death.

Question 6

Which of the following items is(are) NOT characteristics of a SIMPLE IRA?

1. A SIMPLE IRA is not subject to top-heavy rules.
2. Must match 3% of employee deferrals each year.
3. Allows 5-year cliff vesting of matching contributions.
4. Allows employee deferrals up to $18,000 (2017).

Answer 6

2, 3, and 4

Only statement 1 is a characteristic of a SIMPLE IRA. Under a SIMPLE IRA, an employer is generally required to match the employee’s elective deferral contributions up to a limit of 3 percent of the employee’s compensation for the entire calendar year. However, the 3-percent limit on matching contributions may be reduced for a calendar year at the election of the employer, but only if: (1) the limit is not reduced below 1 percent; (2) the limit is not reduced for more than 2 years out of the 5-year period that ends with (and includes) the year for which the election is effective; and (3) employees are notified of the reduced limit within a reasonable period of time before the 60-day election period during which employees can enter into elective deferral agreements. Alternatively, the employer may choose to make a 2% of compensation nonelective contribution for each eligible employee. SIMPLE IRA employer contributions vest immediately. These plans also allow employee deferrals of up to $12,500 in 2017 (with an additional $3,000 catch-up contribution if over age 50).

Question 7

According to ‘The Principle of Competence’ in the CFP Code of Ethics and Professional Responsibility, a CFP® certificant must:

1. Provide advice only in one’s area(s) of competence or expertise.
2. Stay abreast of developments in all financial planning areas.
3. Maintain minimum CE requirements established by 4. CFP Board as often as the certificant is able.
   Continue to improve professional competence.

Answer 7

1, 2, and 4

Question 8

Several years ago, Stan purchased a $400,000 whole life insurance policy on his life. He has paid cumulative premiums over the years of $20,000, and has accumulated a cash value of $25,000. This year, he was diagnosed with a rare liver disease, and as a result his life expectancy is only 6 months. Because of his large medical costs, he is considering selling his policy to a viatical settlement company. They have offered him $250,000 for the policy. He would also like to explore other ways to generate cash from the policy. Which of the following statements regarding Stan’s situation are CORRECT?

1. If Stan sells his policy to the viatical settlement company, he will be taxed on any gain from the sale if he dies more than 2 years later.
2. If the viatical company collects the death benefit as a result of Stan’s death, the proceeds will be tax free to the company.
3. If Stan sold the policy to his cousin for $250,000, his cousin would be subject to ordinary income tax on a portion of the life insurance benefit when Stan dies.
4. If Stan takes a loan from the policy, some or all of the loan will be subject to ordinary income tax if the policy is classified as a modified endowment contract.

Answer 8

3 and 4

Because Stan is terminally ill (i.e., expected to die within 2 years), he will not be taxed on the proceeds received from the viatical company even if he lives longer than 2 years. When the viatical company receives the death benefit, part of the death benefit will be taxed at ordinary income tax rates to the viatical company. The sale of the policy to Stan’s cousin would be considered a transfer for value. His cousin would be taxed on the death benefit (less amounts paid) because the transfer for value rules cause the death benefit to become taxable. With a MEC, loans or distributions from the policy are taxed on a LIFO basis, meaning that any earnings in the policy are taxed first.

Question 9

Which of the following statements regarding rabbi trusts is (are) CORRECT?

1. Participants have security against an employer’s unwillingness to pay.
2. Participants have security against possible employer bankruptcy.
3. Rabbi trusts provide tax deferral for employees.
4. Rabbi trusts provide employers with an immediate tax deduction for contributions.

Answer 9

1 and 3

Rabbi trusts neither provide security against employer bankruptcy nor is the employer permitted an immediate tax deduction for contributions.

Question 10

Which of the following is(are) potentially adverse consequences of spouses owning most or all of their property as joint tenants with rights of survivorship or as tenants by the entirety?

1. The surviving spouse may inherit too much of the property relative to the children.
2. There may be an unnecessary estate tax liability at the second death.
3. The children may inherit a smaller estate when the second spouse dies.

Answer 10

1, 2, and 3

Question 11

Which of the following statements regarding property interests is(are) CORRECT?

1. Property ownership interests can be characterized as either present interests or future interests.
2. Remainders and reversions are examples of present interests.

Answer 11

1 only

Remainders and reversions are examples of future interests.

Question 12

Under which of the following life insurance settlement options are installments paid while the beneficiary is alive and cease upon the beneficiary's death?
A)
Life annuity with period certain.
 B)
Life annuity with cash refund.
 C)
Single life annuity.
 D)
Joint and survivor annuity.

Answer 12

C

Question 13

Barry is the sole shareholder of Zippy Internet Services, a C corporation that employs 10 people. The company has been in business for 4 years and has had fluctuating cash flows throughout that time. Barry would like to install a qualified plan in which he can contribute 8% of compensation to each eligible employee’s account. He would also like the plan to accomplish the following objectives:
Reward, motivate, and retain employees.
Reduce corporate income taxes.
Provide for his own retirement.
What would be the most appropriate plan for Barry to establish?
A)
Establish a profit-sharing plan.
B)
Establish a money purchase pension plan combined with a profit-sharing plan.
C)
Establish a simplified employee pension (SEP) plan.
D)
Establish a money purchase pension plan.

Answer 13

A

A profit-sharing plan would accomplish all of his objectives and is appropriate for a business with unstable cash flow.

The other choices would not be appropriate:
A SEP plan is not a qualified plan. In addition, a SEP plan requires 100% immediate vesting for all employer contributions. Because Barry would like to retain employees, a 3-year cliff or 2-to-6-year graduated vesting schedule (which is available in a profit-sharing plan) would be more appropriate.
A money purchase pension plan would require an annual funding commitment from Barry. This is inappropriate for a business with unstable cash flows.

Question 14

Which of the following statements concerning the term ‘insured’ under the uninsured motorist coverage of the personal auto policy (PAP) is (are) CORRECT?

1. The term insured includes the named insured.
2. The term insured includes any family members of the named insured.
3. The term insured includes any other person occupying the insured’s covered auto.

Answer 14

all are correct

Question 15

Michael was divorced after 12 years of marriage. He had 2 dependent children, ages 4 and 6, who are cared for by their mother. He was currently, but not fully, insured under Social Security at the time of his death. The benefits that his survivors are entitled to include:

1. A lump sum death benefit of $255.
2. A children’s benefit.
3. A divorced spouse’s benefit.
4. A parent’s benefit for deceased workers’ parents who are over the age of 62.

Answer 15

1 and 2

A lump sum death benefit of $255 is payable to the surviving spouse or children of the deceased worker if he was fully or currently insured. The children’s benefit is payable because Michael was either currently or fully insured. The mother of the children would be entitled to a benefit because she is caring for Michael’s children who are under the age of 16. However, that is not called the “divorced spouse benefit.” It is the “surviving spouse caring for a dependent child” benefit. The parents are not entitled because Michael was not fully insured. Statements 3 and 4 are benefits only available under fully insured status.

Question 16

Which of the following forms insures the dwelling and other structures on an open-perils basis?
A)
HO-2.
 B)
HO-4.
 C)
HO-3.
 D)
HO-1.

Answer 16

C

Question 17

A local businessperson approaches a CFP practitioner for assistance with an investment-related tax problem. The client’s previous tax preparer had suggested the purchase of a variety of tax-advantaged investments to reduce the client’s current and future tax burden. Time passed, the client’s income dropped, and the tax laws changed. The client does not feel the tax preparer misrepresented the situation on the initial sale, but would still like to know what recourse is available with respect to the tax preparer. The CFP licensee should:

1. Explain to the client that this issue is beyond the scope of the CFP® practitioner’s professional expertise.
2. Advise the client that no recourse is available.
3. Advise the client to contact an attorney.
4. Contact the tax preparer.

Answer 17

1 and 3

Question 18

William's investment portfolio earned 10% last year, 15% two years ago, and 5% three years ago. If future returns are similar to historical returns, what is the likelihood that William's portfolio will have a return that exceeds 5%?
A)
50%
 B)
95%.
 C)
68%
 D)
84%.

Answer 18

D

The average, or mean, return for William’s portfolio is 10% and the standard deviation is 5%. Assuming a normal distribution of returns, 50% of the returns are likely to fall above the mean. Additionally, 68% of the returns will fall within one standard deviation of the mean half of which will fall below the mean or 34%. Therefore, the likelihood that William’s portfolio will have a return that exceeds 5% is 84% (50% + 34%).

Question 19

An investor selects an appropriate portfolio by choosing the portfolio:
A)
with the highest return.
 B)
that lies below the efficient frontier.
 C)
at the point of tangency between the indifference curve and the efficient frontier.
 D)
with the lowest risk.

Answer 19

C

Question 20

Retirement plan participants who wish to take advantage of the plan’s loan provision must agree to which of the following restrictions on the amount of the loan and how it is repaid:

1. Generally, a participant may borrow no more than $50,000 or one-half of the vested account balance, whichever is less.
2. A participant’s loan must be repayable by its terms within 5 years, except if the loan is used to acquire a participant’s principal residence.
3. A participant is allowed to repay a loan on the last possible date and take out the maximum loan amount again immediately after repayment.

Answer 20

1 and 2

Question 21

Karl loaned Jason $5,000 that was to be repaid, with interest, by monthly payments over 3 years. The interest was the Federal rate plus 1% at the time of the loan. Jason made payments for 10 months and then stopped due to catastrophic medical bills. Three months later, Jason filed for bankruptcy and the debt was discharged by the bankruptcy court at the end of this year. Karl has asked you, his planner, how he can treat this bad debt for tax purposes. Which of the following statements regarding the deductibility of non-business bad debts by an individual taxpayer is CORRECT?

A)
Karl’s non-business bad debt will be treated as a long-term capital loss.
B)
Karl may take a partial deduction in the year incurred if he or she realizes that some portion of the debt will not be repaid.
C)
Such a loss is a short-term capital loss and the deduction must be taken in the year the debt becomes worthless.
D)
Karl has an ordinary, not a capital, loss.

Answer 21

C

Non-business bad debts are deductible only as short-term capital losses; they cannot result from the taxpayer’s trade or business. The deduction must be taken in the year the debt becomes completely worthless. No partial deductions are allowed. These types of deductions may result from personal loans made by the taxpayer that are not repaid by the debtor.

Question 22

Which of the following statements regarding private activity bonds is CORRECT?
A)
They are issued by municipalities to provide local industries with the necessary funds to purchase plants and equipment.
B)
Private activity bonds are issued by corporations to finance administrative projects.
C)
Less than 5% of the proceeds of the issue are used for private business use.
D)
Interest is paid by the revenues received on the public project being financed by the bonds.

Answer 22

A

Private activity bonds derive their debt service only from their revenues and do not depend upon the issuing municipality. More than 10% of the proceeds are used for private business use. They are issued by municipalities to provide local industries with funds.

Question 23

Which of the following statements correctly describes overqualification of an estate?

1. Overqualification occurs when there is an underutilization of the decedent’s applicable credit amount.
2. Overqualification means that less property qualifies for the marital deduction than should have.

Answer 23

1 only

Statement II is incorrect because it describes underqualification of an estate.

Question 24

means that less property qualifies for the marital deduction than should have

Answer 24

underqualification of an estate

Question 25

occurs when there is an underutilization of the decedent’s applicable credit

Answer 25

overqualification of an estate

Question 26

Matt gives Jim securities in the current year. Matt’s adjusted basis for the securities is $48,000, and the fair market value is $40,000. Matt pays gift tax of $2,000. What is Jim’s basis in the stock for gain and for loss?

A)
$0 for gain and $0 for loss.
 B)
$50,000 for gain and $42,000 for loss.
 C)
$40,000 for gain and $40,000 for loss.
 D)
$48,000 for gain and $40,000 for loss.

Answer 26

D

On the date of the gift, the fair market value of the property was less than the donor’s basis. Therefore, the double basis rule applies. The donee’s gain basis for the property received is the same as the donor’s basis. The donee’s loss basis is the lesser of the donor’s adjusted basis or the fair market value on the date of the gift. If the FMV of the property is less than the adjusted basis at date of gift, no basis adjustment is made for gift tax paid.

Question 27

Sylvia purchased several assets for her small business in the first quarter of the year. Which of the listed assets are considered capital expenditures?

1. A commercial sewing machine that will have to be replaced in 9 months.
2. Enough inventory (fabrics and thread) to cover 3 years of manufacturing her product.
3. A lot in the suburbs on which she will build a new warehouse.
4. Other machinery that has a useful life of at least 10 years.

Answer 27

3 and 4

Capital expenditures pertain to the acquisition of assets that will last for more than 1 year. Capital expenditures are not currently deductible and must be capitalized over the useful life of the asset. Assets, such as land, that do not have a useful life cannot be deducted until they are sold or exchanged, but are capital expenditures. Inventory is also not a capital expenditure, but an asset for the production of income.