Questions Flashcards
In order to give the stock price a boost a corporate officer posts favorable, yet slightly inaccurate information, about his company's earnings in an internet chat room. After a few days of posting and blogging, the stock starts to rise a couple of points and the officer decides to exercise a number of stock options in order to make a sizable profit. Which of the following acts did this officer violate by his actions? A) Securities Act of 1933 B) The Investment Company Act of 1940 C) The Investment Advisers Act of 1940 D) Securities Exchange Act of 1934
D)
Securities Exchange Act of 1934
Which of the following statements regarding bonds is(are) CORRECT?
1) Lower coupon bonds are more volatile than higher coupon bonds as interest rates change.
2) Bond prices and changes in interest rates have an inverse relationship.
3) A direct relationship exists between a bond’s coupon rate and duration.
1 & 2
Lower coupon bonds are more volatile than higher coupon bonds as interest rates change. When interest rates fall, bond prices increase and vice versa. Bond prices and the direction of market interest rates have an inverse relationship. The greater the bond’s duration, the greater the price volatility of the bond. The coupon rate and duration of a bond have an inverse relationship.
Rob built a house several years ago in New Orleans. The replacement value has increased to $200,000. Rob originally purchased insurance on the house under a homeowners broad form HO-2 policy in the amount of $150,000. The policy contains an 80% coinsurance clause. The roof of the house has been damaged by fire. Since the home was built, the roof had depreciated by 25%. The cost to replace the roof will be $20,000. How much will Rob collect from his insurance policy? A) $20,000 less the deductible B) $18,750 less the deductible C) $0 D) $15,000 less the deductible
B) $18,750 less the deductible
Jeff and Kay, ages 67 and 65, respectively, filed a joint income tax return for the current year. They provided all of the support for their 18-year-old son, who had $2,200 of gross income. Their 23-year-old daughter was a full-time student until her graduation on June 25 of the current year. Before her graduation, she earned $4,450, which was 40% of her total support for the current year. Her parents provided the balance of her support. Jeff and Kay also provided 100% of the support for Kay's father, who is a lifelong resident and citizen of Colombia. How many dependents may Jeff and Kay list on their income tax return for the current year? A) 2. B) 5. C) 3. D) 4.
A) 2
Which of the following statements regarding employee elective deferrals under a Section 401(k) plan is(are) CORRECT?
A) These contributions are subject to FICA and FUTA but not to federal income tax at the time of contribution to the plan.
B) These contributions are not subject to federal income tax, FICA, or FUTA.
C) The actual deferral percentage (ADP) for highly compensated employees in a Section 401(k) plan cannot be more than the ADP of the nonhighly compensated employees multiplied by 1.50.
D) These contributions are not subject to payroll taxes but are subject to federal income tax.
A)
These contributions are subject to FICA and FUTA but not to federal income tax at the time of contribution to the plan.
Joan gives her son property with an adjusted tax basis of $35,000 and a fair market value of $30,000. No gift tax is paid. Joan's son subsequently sells the property for $33,000. What is his recognized gain (or loss)? A) $2,000 loss. B) $3,000 gain. C) $33,000 gain. D) No gain or loss.
D) No gain or loss.
Because the fair market value (FMV) on the date of the gift was less than the donor’s (Joan’s) adjusted tax basis, the double basis rule applies. Under the double basis rule, no gain or loss is recognized if the donee sells the property at a price that is between the donor’s adjusted basis and the FMV on the date of the gift.
Janice, age 50, wants an investment that will offer her the opportunity for long-term growth with moderate risk. She wants a customized portfolio based on an asset-based fee structure. Which of the following would be the best choice for Janice?
A) Large-cap growth separately managed account.
B) S&P 500 Index exchange-traded fund.
C) Growth and income mutual fund.
D) Balanced mutual fund.
A) Large-cap growth separately managed account.
The best choice for Janice is the large-cap growth separately managed account. This type of investment account offers a customized portfolio approach and an asset-based fee structure for portfolio management services.
Vicki, age 62, has a net worth of $540,000. Her home has a fair market value of $250,000. She recently had a stroke and is paralyzed. Vicki has 2 children and 6 grandchildren. As her financial planner, which of the following would you recommend?
1) Transfer the house to an irrevocable trust in an effort to qualify for Medicaid immediately.
2) Transfer both the house and contents to a revocable living trust to avoid probate.
3) Give 1 of the adult children a durable power of attorney for health care.
4) Gift $15,000 to every child and grandchild each year.
2 & 3
Transferring both the house and contents to a revocable living trust to avoid probate and giving 1 of the adult children a durable power of attorney for health care are good recommendations. Because of the look-back period, transferring the house to an irrevocable trust in an effort to qualify for Medicaid may result in Vickie being subject to a delay before qualifying for Medicaid. Gifting $15,000 to every child and grandchild each year would divert resources needed for Vickie’s care. With her poor health and low level of assets, it is not advisable for Vickie to reduce her available resources.
Sally purchased a single premium deferred annuity (SPD in 1990 at a cost of $42,000. Her lifetime annuity distributions of $833.33 per month will begin on September 1st of the current year, at which time her life expectancy will be 21 years. How much must Sally include in her gross income from this SPDA in the current year? (Round to the nearest dollar)
A) $2,667
B) $8,000
C) $667
D) $2,000
$2,667
Sally must include $2,667 in her gross income in the current year. Before the annuitant reaches the age of projected life expectancy, each payment from a fixed annuity is considered partially a return of basis and partially as taxable income as determined by an exclusion ratio. Therefore, $42,000 (cost basis) divided by $210,000 (total expected benefits over 21 years) equals 20% exclusion ratio. This means 20% of the payments in the current year ($3,333 × 20%), or $667, is excluded from gross income. The remaining 80%, or $2,667, must be included in gross income.
Based on Markowitz’s theory, which of the following portfolios do NOT belong on the efficient frontier?
Portfolio Expected Return Standard Deviation
1 10% 12%
2 11% 13%
3 14% 12%
4 17% 17%
5 19% 17%
1, 2 & 4
The efficient frontier consists of portfolios with the highest expected return for a given level of risk. Portfolio 3 has a higher expected return and a standard deviation less than or equal to portfolios 1 and 2. Therefore, portfolios 1 and 2 are not on the efficient frontier. Portfolio 5 has a higher expected return and a standard deviation equal to portfolio 4. Therefore, portfolio 4 is not on the efficient frontier.
On January 10 of the current year, Mark sold stock with an adjusted tax basis of $6,000 to his son Les for $4,000 (fair market value). On July 31 of the next year, Les sold the same stock for $5,000 in a bona fide arms-length transaction to Sara, who is unrelated to Les or Mark. What is the proper tax treatment for these transactions?
A) Les has a recognized gain of $1,000 in the next year.
B) Neither Mark nor Les has a recognized gain or loss in either year.
C) Mark has a recognized loss of $2,000 in the current year.
D) Les has a recognized gain of $2,000 in the current year.
B) Neither Mark nor Les has a recognized gain or loss in either year.
This is an application of the related party rules. Neither Mark nor Les has a recognized gain or loss in either year. Mark has a $2,000 realized loss in the first year, but cannot recognize it because of the related party rule. Mark forever loses the ability to take a deduction for the loss because it is the result of a related party transaction. Les has a realized gain of $1,000 in the second year. He can reduce his gain by Mark’s loss (up to the amount of gain). Les has no gain or loss in the second year. The remaining $1,000 loss is no longer available to either of them.
All of the following are reasons an employer might favor a nonqualified deferred compensation plan over a qualified retirement plan EXCEPT
A) nonqualified plans do not have to comply with the nondiscrimination rules that apply to qualified plans.
B) nonqualified deferred compensation plans are not subject to all the reporting and disclosure requirements that pertain to qualified retirement plans.
C) a nonqualified plan typically has lower administrative costs.
D) nonqualified plans provide the employer with an immediate income tax deduction.
D) nonqualified plans provide the employer with an immediate income tax deduction.
Nonqualified deferred compensation plans provide deferred employer deductions and do not allow an income tax deduction until the employee recognizes the income on his tax return.
Which of the following statements regarding the income tax treatment of involuntary conversion of real property is(are) CORRECT?
1) Gain may be deferred if the taxpayer reinvests the amount realized from the converted property in another property.
2) The period for reinvestment is 2 years from the end of the year in which the realization took place for conversion events caused by nature (e.g., fire, earthquake).
3) The reinvestment period for conversion acts caused by government (eminent domain) is 3 years from the end of the year in which realization of the conversion took place.
4) If the conversion was into cash, the nonrecognition treatment is mandatory, not elective.
1, 2, & 3
Gain may be deferred if the taxpayer reinvests the amount realized from the converted property in another property. The period for reinvestment is 2 years from the end of the year in which the realization took place for conversion events caused by nature. The reinvestment period for conversion acts caused by government/eminent domain is 3 years from the end of the year in which realization of the conversion took place. If the conversion is into cash, nonrecognition is elective.
Which of the following statements regarding nonqualified stock options (NQSOs) and incentive stock options (ISOs) is(are) CORRECT?
1) NQSOs will not create an AMT adjustment upon exercise, but ISOs will.
2) Gain may be included in W-2 wages upon exercise for NQSOs but not ISOs.
3) Once vested, both NQSOs and ISOs can be exercised and the stock can be sold immediately.
4) Typically, on the date of the option grant, W-2 compensation income, which is a type of ordinary income, is created for an NQSO but not for an ISO.
B)
1, 2, and 3.
Statement 4 is incorrect. The grant date of the option is not typically a taxable event for either an NQSO or an ISO.
John, age 55, is divorced and retired. He has the following liquid assets on deposit at Allworld Bank, an FDIC-insured financial institution:
Account Ownership Balance
Certificate of deposit John $225,000
Savings account Joint with son $70,000
Rollover traditional IRA John $150,000
Checking account John $80,000
What amount is insured by the FDIC?
$470,000
The FDIC insures separate legal categories of accounts. As a result, the IRA will be insured for $150,000, but can be insured up to $250,000 as the balance increases. The individual accounts (checking and CD owned by John are aggregated and are insured up to $250,000 in total. The joint account is insured for $70,000.
Portfolio A has a standard deviation of 12%, and the market has a standard deviation of 16%. The correlation between Portfolio A and the market is 0.5. What percentage of the total risk is unsystematic risk?
A) 25%
B) 0%
C) 75%
D) 50%
C) 75%
The coefficient of determination (R-squared) of Portfolio A is 25% (0.25). This is calculated by squaring the correlation coefficient (R) of 0.50 (0.50 × 0.50 = 0.25). Therefore, 25% is the percentage of Portfolio A returns that may be explained by the market (or systematic risk). The remainder of the percentage of returns (movement) of Portfolio A is explained by factors independent of the market (or unsystematic risk). To determine this, subtract the systematic risk from 1.0 (1.0 − 0.25 = 0.75).
Which of the following pension plans must be covered by Pension Benefit Guarantee Corporation (PBG) insurance?
1) Cash balance pension plan.
2) Money purchase pension plan.
3) Target benefit pension plan.
4) Traditional defined benefit pension plan.
1 & 4
Only defined benefit pension plans (including cash balance pension plans) are covered by the PBGC.
Janice has owned her own company for 25 years. She is now 54 and wishes to retire at 64. She currently employs 5 people, all between the ages of 24 and 33. If Janice wanted to establish a retirement plan with the highest benefit for her, assuming the company has adequate cash flow, what is the most appropriate plan?
A) Age-based profit-sharing plan.
B) Money purchase pension plan.
C) Cash balance pension plan.
D) Traditional defined benefit pension plan.
D) Traditional defined benefit pension plan.
A defined benefit pension plan is the best choice because a traditional defined benefit pension plan favors older participants and would allow the maximum contribution for Janice. This plan is especially appropriate because the company has adequate cash flow.
The other plans are incorrect because:
A cash balance pension plan does not favor older participants. Janice is age 54 and wants to retire in 10 years. Money purchase pension plans do not favor older participants with larger annual contributions than a similarly compensated younger participant.
Although an age-based profit-sharing plan will favor older participants, it is still a defined contribution plan and would be subject to annual additions limits. A traditional defined benefit pension plan will allow for a larger contribution for Janice. An age-based profit-sharing plan would only be appropriate if the company had unstable cash flows.
Ray is 72 years old and must take a required minimum distribution from his IRA. The calculation will be based on an account balance of $200,000. His 53-year-old wife, Susie, is his beneficiary. The Table III life expectancy factor for someone 72 is 26.5 The Table II life expectancy for a 72- and 53-year-old married couple is 32.4. What is the lowest amount Ray can receive from his IRA without incurring a penalty (round to the nearest dollar).
$6,173
Based on the required minimum distribution rules, the lowest amount Ray can withdraw without incurring a penalty is $6,173. The minimum distribution rules automatically factor in a 10-year age difference for the single life expectancy table; however, when the beneficiary is a spouse who is more than 10 years younger, the joint life expectancy factor from Table II may be used. Therefore, Ray can use the 32.4 factor ($200,000 divided by 32.4 equals $6,173).
Which of the following individuals are highly compensated employees for qualified plan purposes for 2020? Assume the company made no relevant elections regarding the top 20% of employees.
1) Steve, a 6% owner of an incorporated law firm.
2) Mike whose salary was $180,000 last year and who was the company’s top-paid employee.
3) James, whose salary was the 10th highest of 40 people, and who earned $135,000 last year.
4) Donna, the corporate vice president of marketing, and an officer, whose salary last year was $85,000.
1, 2 & 3
Your client has received a large financial windfall. She is concerned her family will be tempted to spend it unwisely, so she would like as much as possible designated for retirement over the years. Rank the following retirement funding approaches from largest to smallest according to the size of the annual saving amount needed to fund the goal.
1) Capital Preservation Approach
2) Capital Utilization Approach
3) Wealth Preservation Approach
4) Never retiring
3, 1, 2, 4
The wealth preservation approach retains the purchasing power of the money in the fund at the assumed retirement date. The capital preservation approach only retains the amount of dollars in the retirement account at the assumed retirement date. If the retirement is planned for about 25 years and inflation averages around 3%, the purchasing value of the capital will be cut in half. The wealth preservation approach addresses this issue. The capital utilization approach consumes the principal at retirement over time. Since never retiring is the obvious choice for the lowest amount, only two answers were viable candidates.
Bonnie, age 45, has a Roth IRA she established at age 35 and a qualified tuition plan (QTP) under Section 529. She has previously contributed $8,000 to the Roth IRA. Three years ago, she converted $20,000 from a traditional IRA to a Roth IRA. Her Roth IRAs have a combined balance of $35,000. There is another $35,000 in the QTP. If the entire $70,000 were distributed today to pay for her son’s college tuition, which of the following is CORRECT?
A) The QTP distribution is taxable, but no penalty is applied.
B) A portion of the Roth distribution is subject to regular income tax but the QTP distribution is tax free.
C) The entire distribution of $70,000 will be tax free.
D) A portion of the Roth distribution will incur a 10% early withdrawal penalty.
B) A portion of the Roth distribution is subject to regular income tax but the QTP distribution is tax free.
While Bonnie has satisfied the 5-year holding period requirement, the distribution is nonqualified because the distribution is not attributed to attainment of age 59½, death, disability, or first time home purchase. The portion of the distribution attributable to earnings is subject to regular income tax. None of the Roth distribution will incur a 10% penalty because the funds are being used to pay for higher education for her son. The QTP distribution is tax and penalty free.
Mary is 32 years-old. She worked in high school resulting in her earning two credits. She didn’t work while in college or graduate school. She was employed at a non-profit for three years after graduating. After two years of employment, she married Juan. A year later, she had a child and was a homemaker for the next five years. She reentered the workforce one year ago following a divorce. Which of the following are true concerning the Social Security program?
1) She is fully insured.
2) She is currently insured.
3) Mary would receive Social Security disability benefits if she experienced a qualifying disabling event this year.
4) Upon her death, her child would receive survivor benefits.
1 & 4
The best way to process a scenario is working backwards in time. If the question says someone worked “a year” or “for 6 years,” etc., assume they get four credits per year. She has 4 of the last 4 credits. Then she has none of the previous 20 credits. She has 12 of the next 12 credits and she has 2 of all previous credits. Thus, she has 18 total credits. She is fully insured. She needs 10 credits (32 – 22) and she has 18. She is not currently insured because she only has 4 of the most recent 13 credits, not 6 of the last 13. Mary is not currently eligible for disability benefits. Even though she is fully insured, she is age 31 and over with less than 20 of the most recent 40 credits. She has 16 of the 40 most recent credits. Her child would receive survivor benefits because she is fully insured.
Which of the following individuals are highly compensated employee(s) of XYZ Corporation for qualified plan purposes this year? Assume the highly compensated election was made by the corporation.
1) Bill, who owns 10% of XYZ and is an employee, but he does not rank in the top 20% based on compensation.
2) Mary, the president, whose compensation was $140,000 last year and who was in the top 20% of paid employees.
3) Ralph, an employee salesman, who earned $145,000 last year and was the top-paid employee in XYZ this year.
4) Joe, who earned $132,000 last year as the XYZ Corporation legal counsel (not in the top 20%).
1, 2 & 3
Joe is not considered an HCE if the company makes the top 20% election. Notice that he does not own more than 5% of the company and his salary is not in the top 20%. Mary and Ralph are considered HCEs because they each have compensation in excess of $130,000 (2020) and rank in the top 20%. Bill is an HCE because he is a greater-than-5% owner, even though his compensation does not rank in the top 20%. A greater-than-5% owner is always considered HCE, regardless of compensation.
Which of the following statements describes a disadvantage of a target benefit pension plan, compared with a traditional defined benefit pension plan?
A target benefit pension plan must cover all eligible employees, whereas a traditional defined benefit pension plan can exclude certain nonhighly compensated employees.
B) Contributions to a target benefit pension plan are subject to the annual additions limit of the Internal Revenue Code.
C) For a given compensation level, a target benefit pension plan requires the same contribution for all employees regardless of age.
D) A target benefit pension plan will always have less stringent vesting requirements than does a traditional defined benefit pension plan.
B) Contributions to a target benefit pension plan are subject to the annual additions limit of the Internal Revenue Code.
Michael, age 56 and the owner of Davis Engineering, would like you to recommend a qualified retirement plan for his company that might allow him to maximize retirement benefits for himself. He has owned the firm for 12 years and has a current salary of $140,000. The other employees are between the ages of 25 and 40 with salaries ranging from $40,000 to $65,000. Michael feels that the company can spend approximately $350,000 on retirement benefits this year and in the future. Based on this information, which of the following plans would you recommend?
A) Employee stock ownership plan (ESOP).
B) Traditional defined benefit pension plan.
C) Defined benefit cash balance pension plan.
D) Target benefit pension plan.
B) Traditional defined benefit pension plan.
A traditional defined benefit pension plan would maximize retirement benefits for Michael because he is older than the other employees and has a considerably higher salary. Due to these factors, the major portion of the corporate contribution would go toward funding Michael’s benefits. The company has the financial stability to maintain this degree of funding over the next nine years to Michael’s age 65.
Joe, age 52, has opened a consulting company. He currently employs 6 people who range in age from 22 to 31 years. Joe estimates that the average employment period for his employees will only be approximately 3 years. He would like to start a retirement plan that will favor older participants and include an appropriate vesting schedule. In addition, he would like the employees to bear the risk of investment performance within the plan. Which of the following plans is the most appropriate for Joe’s consulting company?
A) Target benefit pension plan.
B) SIMPLE IRA.
C) Cash balance pension plan.
D) Traditional defined benefit pension plan.
A) Target benefit pension plan.
A target benefit pension plan is the best choice because it favors older participants. Also, because a target benefit pension plan is a qualified plan, Joe could incorporate a vesting schedule to accrue benefits (probably 2-to-6-year graduated vesting).
The others are incorrect choices because:
A SIMPLE does not favor older participants. In addition, SIMPLEs provide for 100% immediate vesting of employer contributions.
Although a traditional defined benefit pension plan favors older participants and allows vesting schedules, it is not appropriate in this situation because the company would bear the investment risk.
A cash balance pension plan does not typically favor older participants and does not require the employees to bear the investment risk.
George, age 48, an employee of RST Company, is participating in RST’s money purchase pension plan. His spouse, Betty, age 45, has an IRA currently valued at $12,000. She opened her IRA several years ago with a nondeductible contribution of $2,000, which represents the only contribution she made to her IRA. All of the following statements regarding distributions from these plans are correct EXCEPT:
A) Any distribution Betty would receive from George’s pension plan under a QDRO would not be subject to a 10% early withdrawal penalty.
B) The RST plan must meet ERISA’s preretirement and joint and survivor annuity rules.
C) Betty’s IRA assets are not protected from creditors if she files bankruptcy.
D) If Betty withdraws the entire balance from her IRA, she would have to pay an early distribution penalty of $1,000.
C) Betty’s IRA assets are not protected from creditors if she files bankruptcy.
IRA assets are afforded protection from creditors (up to $1,362,800 (4/1/2019 - 4/1/2022) inflation-indexed) in case of bankruptcy. Betty must pay a 10% early withdrawal penalty on the amount withdrawn in excess of her basis in the IRA ($12,000 − $2,000). All qualified pension plans must provide a participant’s spouse with a preretirement survivor annuity and a joint and survivor annuity at retirement. Distributions made to an alternate payee pursuant to a QDRO are not subject to the 10% early withdrawal penalty.
Jonathan, now age 42, established a Roth IRA in October 2013 with an initial $2,000 contribution. He also contributed $2,000 in May 2014. His account balance is currently $6,000. If he makes a withdrawal of $5,000 from the Roth IRA, how will the distribution be taxed?
$1,000 as ordinary income
ABC Corporation is trying to set up a qualified retirement plan and has established the following criteria: simplicity, must be able to be integrated with Social Security, funding flexibility, ability to invest in company stock is unrestricted, employees can make in-service withdrawals, and distribution of benefits can be in the form of cash (ABC can deduct value of any stock contributed to plan.) Which of the following types of qualified plans would meet ABC’s criteria?
1) ESOP.
2) Stock bonus plan.
3) Cash balance pension plan.
4) Money purchase pension plan.
2 only
Stock bonus plan is correct. An ESOP cannot be integrated with Social Security. Money purchase and cash balance pension plans cannot invest an unrestricted amount in company stock and do not have funding flexibility.
Tom, age 30, earns $300,000 annually as an employee for Waste Distributors. His employer sponsors a SIMPLE IRA, and provides nonelective contributions to the plan. Tom has participated in the SIMPLE for 2 years. What is the maximum contribution (employer and employee) that can be made to Tom’s SIMPLE IRA in 2020?
$19,200
The maximum total contribution is $19,200 ($13,500 employee + $5,700 employer). The maximum employee contribution for 2020 is $13,500. Tom’s employer has chosen to make a nonelective contribution. If his employer chooses a nonelective contribution to the SIMPLE, its required contribution is 2% of annual compensation up to a compensation cap of $285,000 (2020). Therefore, the employer must make a contribution of $5,700 ($285,000 compensation × 2%). The compensation limit that applies to SEP plans and qualified plans also applies to SIMPLE nonelective contributions. However, this compensation limit does not apply to SIMPLE IRA matching contributions. However, the limit does apply to SIMPLE 401(k) matching contributions.
Which of the following statements is correct regarding a target benefit pension plan?
1) The participant does not know ahead of time exactly the retirement benefit he will receive.
2) The employer bears the investment risk.
3) Forfeitures reallocated by the employer to participants are not considered in applying the annual additions limit.
4) Contributions to the plan are flexible.
1 only
A participant in a target benefit plan will not know the amount of retirement benefit she will receive because benefits depend on the plan’s investment returns. A target benefit pension plan is a defined contribution with individual participant accounts. Therefore the investment risk is borne by the participant and the account balance determines the final benefit. Pension plans require mandatory annual funding. Forfeitures reallocated to participants are included in the application of the annual additions limit.
Sabrio Financial Group sponsors a Section 401(k) plan in which the nonhighly compensated employee group defers an average of 5% of compensation. If Jay, age 48, is the only highly compensated employee and he earns $118,000, what is his maximum allowable elective deferral contribution in 2020 to this Section 401(k) plan assuming Jay’s contribution is equal to the maximum ADP allowable for the HCE group?
$8,260
Because the ADP for the nonhighly compensated employee group equals 5%, the maximum ADP for the highly compensated group cannot be more than 7% (5% + 2%). Therefore, Jay’s maximum elective deferral contribution is $8,260 ($118,000 × 7%) for 2020. Employees who have attained age 50 by the close of the tax year are eligible to make an additional elective deferral catch-up contribution. This catch-up contribution is not subject to the ADP test or annual additions limit.
Marilyn and Larry have a working interest in an oil property in which they have personal liability. They lost $15,000 this tax year from the venture. Their earned income for this year was $165,400, itemized deductions were $20,000, and unearned income was $25,000. What is their taxable income for this year?
$150,600
Losses from oil and gas working interests for which the taxpayer is personally liable are deductible against active or portfolio losses without limit and without respect to the taxpayer’s AGI. [$165,400 − $24,800(MFJ 2020) + $25,000 − $15,000 = 150,600]. Because itemized deduction were less than the standard deduction for a married couple, the couple will use the standard deduction.
Jenny incurred investment interest expense of $10,000 this year. The investment income she received, as a result, was $40,000, of which $5,000 was tax-free interest income on bonds. How much of her investment expenses will be deductible for this year?
$8,750
Interest expense generated by a source that creates tax-exempt income are not deductible. Because 12.5% ($5,000 ÷ $40,000) of her income was tax-exempt, the same proportion of her interest expense is not tax deductible. In other words, because 87.5% of her income was taxable, 87.5% of her interest expenses were tax deductible ($8,750).
Joel, a self-employed individual, has the following items related to his tax return in 2020:
Gross receipts from his business $50,000
Operating expenses for business $30,000
Self-employment tax paid $2,826
Medical insurance premiums $1,200
Mortgage interest $5,000
What is Joel’s adjusted gross income (AGI)?
$17,387
AGI is calculated by taking the net profit from the business of $20,000 ($50,000 − $30,000) less deductions for AGI of the deductible portion (employer share) of self-employment tax paid ($20,000 × 0.9235 × 0.0765 = $1,412.95) and 100% of the medical insurance premiums.
Mortgage interest is an itemized deduction.
The rule excluding employer-paid health insurance premiums from employee income is applicable to coverage on:
1) The employee, if currently employed.
2) The employee’s spouse.
3) The employee’s dependents other than a spouse.
4) The employee, if retired.
1,2,3,4
All these premiums are excludable from employee income.
Brandi is facing a risk which has the potential for a high severity of loss but has a low probability of occurring in the future. Which risk management technique would be appropriate for Brandi to manage this risk?
Risk Transfer
Brandi should transfer this risk to an insurance company. Insurance is designed to manage risks which have a potentially high severity of loss and low probability of occurring in the future.
Raul is a 50-year-old businessowner with one employee, who earns $18,000 per year. Raul earns $170,000 per year and is establishing a profit-sharing plan that uses an age-weighted feature. The age-weighting formula allocates $27,850 to Raul and $350 to the employee. Which of the following statements is CORRECT?’
A) The contribution that must be made to the employee’s account is $540.
B) The plan cannot allow the employee to direct the investment of his share of the plan’s assets.
C) A 3 to 7-year graded vesting schedule would be appropriate for this plan.
D) Raul can make a deductible contribution of up to $4,500 for his employee.
E) The contribution for worker is $350 and it will be deductible.
A) The contribution that must be made to the employee’s account is $540.
The plan is top heavy, resulting in a minimum contribution to all nonkey employees of 3%. Therefore, the contribution that must be made to the employee’s account is $540 (3% of $18,000). Top-heavy plans must use either a 3-year cliff or a 2- to 6-year vesting schedule. An employer can actually contribute more than $4,500 for employees as long as total contributions for all employees do not exceed 25% of aggregate covered compensation and the contributions do not violate the nondiscrimination rules. Either the employer (or plan trustee) can invest the plan’s assets or employees can be allowed to choose from among several different investment options in which to invest their own account balance.
Which of the following are examples of risk management techniques?
1) Avoiding a particular risk by refusing to participate in the activity.
2) Transferring a risk to the insurance company through an insurance contract.
3) Exercising risk retention by installing a smoke alarm.
4) Utilizing the risk reduction technique by increasing a deductible on an automobile insurance policy.
1,2
Statements 3 and 4 are incorrect. Statement 3 is an example of risk reduction and statement 4 is an example of risk retention.
Ted is seriously ill, and a doctor has certified that he is expected to die within 24 months. He owns a whole life insurance policy with a face amount of $500,000 and a cash surrender value of $150,000. Ted’s investment in the policy is $120,000. He sells the insurance policy to a qualified viatical agreement company for $200,000. Ted dies 17 months later. The viatical agreement company paid premiums of $10,000 on the policy before Ted died. Which of the following statements regarding the income tax consequences of this transaction is(are) CORRECT?
1) Ted receives the $200,000 payment from the viatical agreement company income tax-free.
2) Ted must pay income tax on $80,000 of the $200,000 payment received from the viatical agreement company.
3) The viatical agreement company must include $290,000 of the $500,000 death benefit in gross income.
1,3
Statement 1 is correct. Ted receives the payment from the viatical agreement company free of income tax because a doctor certified that he was expected to die within 24 months. Statement 3 is correct. The viatical agreement company’s basis in the policy was $210,000 ($200,000 purchase price + $10,000 paid in premiums). The remaining $290,000 of the $500,000 death benefit is taxable income to the corporation.
Harvey is a one-third partner in the HARVMAN partnership. Harvey’s adjusted basis in the partnership is $10,000. Harvey decides to sell his partnership interest for $40,000. Assuming the partnership has no unrealized receivables and no substantially appreciated inventory, how will the sale of the partnership be treated on Harvey’s personal income tax return in the year he makes the sale?
A) He must recognize a net capital gain of $40,000.
B) He must recognize a net capital gain of $30,000.
C) He must recognize ordinary income of $30,000.
D) He must recognize ordinary income of $40,000.
B) He must recognize a net capital gain of $30,000.
When a partner sells his interest in a partnership, the gain is treated as a capital gain, unless the partnership has substantially appreciated inventory or unrealized receivables. The net capital gain equals the sale price less the partner’s basis, which in this case is $40,000 less $10,000, or $30,000.
Delores wants to create a trust for the benefit of her niece, Annie, who is 14 years old. After consulting with a CFP® professional, she decides to create a Section 2503(b) trust for Annie’s benefit and fund it with annual trust contributions of $15,000 in cash. Which of the following statements regarding this trust is(are) CORRECT?
1) Delores’s annual contributions to the trust do not qualify for the gift tax annual exclusion.
2) The trust principal must be distributed to Annie when she turns 21.
3) All income from the trust must be distributed annually.
4) The trust is a complex trust.
5) The trust income may be subject to the kiddie tax.
3,5
Statement 1 is incorrect; Annie’s right to the income from the trust is a present interest, so the portions of Delores’s contributions that are attributed to Annie’s right to income are eligible for the annual exclusion. Statement 2 is incorrect; a Section 2503(b) trust (unlike a Section 2503(c) trust) is not required to end when the minor turns 21. Statement 3 is correct. Statement 4 is incorrect; a Section 2503(b) trust is a simple trust because all income must be distributed annually. Statement 5 is correct.
On January 10 of last year (Year 1), Todd sold stock with a cost of $6,000 to his son, Trey, for $4,000 (its fair market value). On July 31 of the current year (Year 2), Trey sold the same stock for $5,000 in a bona fide arms-length transaction to Mary, who is unrelated to Trey or Todd. What is the proper tax treatment of these transactions?
A) Todd has a recognized loss of $2,000 in Year 1, and Trey has a recognized gain of $1,000 Year 2.
B) Trey has a recognized gain of $2,000 in Year 2.
C) Neither Todd nor Trey has a recognized gain or loss in either Year 1 or Year 2.
D) Trey has a recognized gain of $1,000 in Year 2.
C) Neither Todd nor Trey has a recognized gain or loss in either Year 1 or Year 2.
Todd’s sale to Trey, his son, is a related-party transaction, and therefore, Todd cannot recognize a loss ($4,000 − $6,000). Trey’s basis in the stock is $4,000. When he sells it for $5,000, he has a realized gain of $1,000. However, Trey will not recognize this gain because he can utilize $1,000 of his father’s unrecognized loss. The remaining $1,000 of Todd’s loss is gone forever.
Mr. and Mrs. Concepcion have an HO-6 homeowners policy covering their condo. Their coverage under Coverage C is $100,000. One day while they are at work, their plumbing freezes and their unit is uninhabitable due to water damage. They are forced to move into an apartment for 6 weeks while their unit is repaired. Which of the following statements regarding the Concepcions’ coverage under their HO-6 policy is(are) CORRECT?
1) The water damage is not covered under the Concepcions’ HO-6 policy.
2) The HO-6 policy provides the Concepcions with loss of use coverage of up to $40,000.
2 only
Statement I is incorrect; frozen plumbing is a covered peril under an HO-6 policy. Statement II is correct; an HO-6 policy provides for loss of use coverage equal to 40% of the amount of Coverage C coverage.
You have a 35-year-old client with an extremely conservative risk tolerance. He is an attorney specializing in entertainment law and his income for the next ten years will probably be the highest of his career. He wants a life insurance policy that has stability and is guaranteed to be in force until age 95. He is also concerned about the possibility of negligence liability in his business practice. Based on your client’s profile and insurance needs, which of the following statements are CORRECT?
1) A whole life insurance policy may be appropriate for this client.
2) This client may be a good candidate for malpractice insurance.
3) Modified premium whole life insurance may be appropriate for this client.
4) Errors and omissions insurance may be appropriate for this client.
1,4
Whole life insurance is the most appropriate type of coverage for this client. Current cost is not an issue and, in the long run, he will end up paying less for the coverage over his life expectancy. In addition, whole life insurance fits his low risk tolerance. This type of policy has guaranteed costs, a guaranteed death benefit, and guaranteed cash values. Modified premium whole life insurance is used for individuals who have a long-term insurance need, but cannot initially afford the higher initial cost of traditional whole life. Errors and omissions insurance covers professionals whose negligence primarily causes financial harm, such as accountants, lawyers, and financial planners. Malpractice insurance covers professionals whose negligence primarily causes physical harm, such as physicians, dentists, and physical therapists.
Sherri received enough incentive stock options (ISOs) to purchase 10,000 shares of Dupre Co. stock at $10 per share. One year later, Sherri exercised all of the options when the market price of the stock was $25 per share. Sherri sold the 10,000 shares of Dupre Co. stock for $100 per share 2 years after exercise. Which of the following statements about these transactions is(are) CORRECT?
1) The grant of options is not a taxable event.
2) Sherri will pay income tax on a gain of $15 per share at exercise.
3) Sherri will have a positive AMT adjustment of $150,000 upon exercise.
4) At sale, Sherri’s adjusted taxable basis equals $10 per share.
1,3,4
Statement 2 is incorrect. The exercise of ISOs does not incur any regular income tax liability. Statement 3 is correct. Sherri has a positive AMT adjustment of $150,000 [($25 − 10) × 10,000] upon exercise of the ISOs. Statement 4 is correct. Sherri’s adjusted tax basis is equal to the grant price, or $10 per share.
Dennis participates in a qualified retirement plan maintained by his employer. The retirement plan includes a life insurance policy with a $100,000 death benefit payable to Dennis’s son, Bob. The cash value of the policy is $60,000. During his participation in the plan, Dennis included $25,000 in his gross income, representing the cost of insurance. If Dennis dies today and the $100,000 death benefit is paid to Bob, what amount must Bob include in his gross income?
$35,000
When a beneficiary receives the death benefit from a life insurance policy funded within a qualified plan, the taxable portion equals the cash surrender value ($60,000) minus any costs included in the participant’s income during the participant’s life ($25,000).
Sheldon owns a life insurance policy. His investment in the contract is $50,000 and the cash surrender value is $75,000. This year, he surrendered the policy in exchange for a lump-sum cash payment of $75,000 and later used the funds to purchase a portfolio of mutual funds. Which of the following statements is(are) CORRECT?
1) Sheldon will have to report $25,000 as ordinary income.
2) Sheldon could have transacted a Section 1035 exchange into a variable annuity and continued the tax deferred growth on his funds.
3) Sheldon has to report a long-term capital gain of $25,000.
1,2
The cash surrender value minus the investment in the contract equals the gain at surrender ($75,000 - $50,000 = $25,000 gain taxed as ordinary income).
Steve purchased a house for $750,000. The house has a replacement cost of $1 million with an 80% coinsurance provision and a $2,000 deductible. What is the minimum amount of coverage Steve should have on the house in order to be fully covered for a partial loss up to the policy limit?
$1,000,000
Under the coinsurance provision, the amount of coverage required to fully cover a partial loss up to the policy limit would be $800,000, or 80% of $1 million. Financial planners should always recommend that homes be insured for 100% of replacement cost in order to protect against a total loss. Homeowners insurance policies only cover damages up to the policy limit.
Julian is a partner in the XYZ Partnership. He owns a life insurance policy with a face amount of $300,000 on his own life. The XYZ partners adopt a cross-purchase buy-sell agreement, and as part of that agreement William, another partner, buys Julian’s life insurance policy for $50,000 and names himself as beneficiary. William pays $10,000 in premiums on the policy before Julian dies. Upon Julian’s death, what amount of the $300,000 death benefit must William include in his gross income?
William’s purchase of the policy from Julian is not subject to the transfer-for-value rule because the transferee (William) is a partner of the insured. Therefore, the entire death benefit is excluded from William’s gross income.
Exceptions:
1) Policy transfers to the insured on the policy
2) Policy transfers to a partner of the insured on the policy
3) Policy transfers to a partnership in which the insured on the policy is a partner
4) Policy transfers to a corporation in which the insured on the policy is an officer or shareholder
5) Policy transfers in which the recipient’s cost basis in the policy being transferred is calculated in reference to the cost basis of the transferor.
Josephine, age 56, is a surgeon at the local hospital with an annual salary of $300,000. Which of the following disability policies would be appropriate for Josephine?
A) Short-term, own occupation
B) Long-term, any occupation
C) Long-term, own occupation
D) Short-term, any occupation
C) Long-term, own occupation
Josephine needs a long-term, own occupation (own occ) disability insurance policy. As a surgeon, her income is $300,000 and she is unlikely to earn this salary in another occupation.
