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.
William Sanders, age 38, earns $250,000 a year and wants to establish a profit-sharing plan for his business. He has 3 employees, who each earn a salary of $20,000, are between ages 22 and 26, and have been employed with the company for approximately 4 years. Which of the following vesting schedules would be the best choice for the company?
A) 3-year cliff.
B) 2-to-6-year graded vesting.
C) Immediate vesting.
D) 5-year cliff.
B) 2-to-6-year graded vesting.
The plan is a defined contribution plan and must use one of the 2 accelerated vesting schedules: 3-year cliff or 2-to-6 year graded. The 2-to-6-year graded would be better from the employer’s perspective because of the possibility of termination of some employees and reallocated forfeitures.
All of the following statements regarding whole life insurance are correct EXCEPT
A) Whole life policies issued on a participating basis may return part of the premium in the form of policyowner dividends.
B) Ordinary life insurance is a type of whole life insurance for which premiums are based on the assumption that they will be paid for life (or up to age 120 if still the insured is still living).
C) The nonparticipating version of whole life insurance pays a set policyowner dividend – the insurance company retains the remaining gains from favorable experience.
D) The premiums for an ordinary life contract remain level throughout the premium-paying period.
C) The nonparticipating version of whole life insurance pays a set policyowner dividend – the insurance company retains the remaining gains from favorable experience.
The nonparticipating version of whole life insurance does not pay any policyowner dividends – the insurance company retains all gains from favorable experience.
Doug has a personal automobile policy (PAP) covering his automobile. His Part A policy limits are 200/300/50 and his Part B coverage is $10,000 per person. He does not have Part D coverage. One winter night, Doug and his wife are driving home from dinner when Doug takes his eyes off the road and drives into an unoccupied parked car. The other car sustains $20,000 in damages as a result of the collision. Doug and his wife both suffer bodily injuries and incur medical bills of $15,000 each. Doug’s car suffers $10,000 in property damage. Which of the following statements regarding Doug’s coverage under his PAP for this accident is(are) CORRECT?
1) Doug’s PAP covers all of the $30,000 in medical bills.
2) Doug’s PAP covers the $20,000 in damages to the other car.
3) Doug’s PAP covers the $10,000 in property damage to his car.
2 only
Statement 2 is correct because the $20,000 in property damage to the other car falls within Doug’s $50,000 policy limit for property damage under Part A - Liability Coverage. Statement 1 is incorrect because the coverage for the $30,000 is medical bills for Doug and his wife is limited to $10,000 per person under Part B - Medical Payments Coverage. Statement 3 is also incorrect; the damage to Doug’s car is not covered because he does not have coverage under Part D - Damage to Your Auto Coverage
Personal Auto Poliy Parts: A B C D E F
The PAP consists of six parts Part A—Liability coverage Part B—Medical payments Part C—Uninsured motorists Part D—Damage to your auto Part E—Duties after an accident or loss Part F—General provisions
Liability coverage may be written on a split-limit basis, such as 100/300/50. A coverage limit of 100/300/50 means
there is coverage up to $100,000 for bodily injury to one person, coverage up to $300,000 total for all persons injured in a single accident, and coverage up to $50,000 for property damage, all based on a single accident
Mrs. Chips taught elementary school for 30 years for a public school district that opted out of Social Security. Her monthly benefit from the State Teacher Retirement System is $2,400. Her husband was hired by the federal government in 1986. Both spouses have reached their full retirement age and are ready to start their Social Security benefits. Mr. Chips’ Social Security retirement benefit is $2,000/month. Mrs. Chips has 23 Social Security credits. What will her Social Security retirement benefit be while Mr. Chips is living?
A) $1,500/month. Social Security spousal retirement benefits are 75% of the worker’s PIA.
B) $0/month even though a spouse does not have to be fully insured to receive spousal retirement benefits.
C) $1,000/month. Social Security spousal retirement benefits are 50% of the worker’s PIA.
D) $0/month because she is not fully insured.
B) $0/month even though a spouse does not have to be fully insured to receive spousal retirement benefits.
Mrs. Chips is subject to the Government Pension Offset. Since she receives a retirement from an employer at which she was not FICA taxed on the income, her spousal Social Security benefits are reduced by 2/3rds of her state and local government pension amount. In this case, she is receiving $2,400/month. $2,400 x .6667 = $1,600/month. So, Mrs. Chips loses $1,600 of spousal Social Security per month. Since her spousal Social Security retirement benefits are 50% of her husband’s PIA of $2,000, she is initially entitled to $1,000/month. The $1,000 is reduced by the $1,600 Government Pension Offset and she will get nothing currently. Most teachers find this most unsatisfactory. Financial planners who do not warn them about this would also be found most unsatisfactory.
Which of the following could be classified as a highly compensated employee for 2020? Assume no special elections were made by the different employer sponsors for each of their their retirement plans.
1) John, a 1% owner, who earned $150,000 in the previous year.
2) Bill, a 6% owner, who earned $28,000 in the previous year.
3) Mary, an officer who earned $135,000 in the previous year, and who is the 25th highest paid employee of 100 employees.
4) Maria, who earned $70,000 in the previous year, and is in the top 20% of paid employees.
5) Anna, who earned $84,000 in the previous year, and is in the top 20% of paid employees.
1,2,3
Employees 1, 2, and 3 are highly compensated. For 2020, an HCE is anyone who is a greater than 5% owner or anyone who received in excess of $130,000 in compensation during the previous year (2019). Because the law includes a look-back provision, employees who earned more than $130,000 in 2019 are generally considered HCEs for 2020 plan year testing.
Aimee is the vice president and major shareholder of Peak, Inc. She owns a life insurance policy with a face amount of $1 million on her own life. Peak, Inc. adopts an entity purchase (stock redemption) buy-sell agreement and, as part of the agreement, the corporation buys Aimee’s life insurance policy for $200,000 and names itself as beneficiary. The corporation pays $100,000 in premiums on the policy before Aimee dies. When Aimee dies, what amount of the $1 million death benefit is subject to income tax?
$0
Peak’s purchase of the policy from Aimee is not subject to the transfer-for-value rule because the transferee (Peak) is a corporation in which the insured is an officer or shareholder. Therefore, the entire death benefit remains tax-free.
Yvonne is a full-time accountant for the DEF Company. DEF has 25 full-time employees and provides a group health plan for its full-time employees. Yvonne and her two children, ages 6 and 9, are covered by the plan. This year, DEF terminates Yvonne’s employment after discovering she has been embezzling company funds. Which of the following statements regarding Yvonne’s eligibility for COBRA continuation coverage is CORRECT?
A) Yvonne and her children are eligible for continuation coverage for up to 18 months.
B) Neither Yvonne nor her children are eligible for continuation coverage because Yvonne’s employment was terminated for gross misconduct.
C) Yvonne is not eligible for continuation coverage because her employment was terminated for gross misconduct, but her children are eligible for continuation coverage for up to 29 months.
D) Yvonne is not eligible for continuation coverage because her employment was terminated for gross misconduct, but her children are eligible for coverage until they reach age 19.
B) Neither Yvonne nor her children are eligible for continuation coverage because Yvonne’s employment was terminated for gross misconduct.
Termination of employment for gross misconduct is not a qualifying event for purposes of COBRA, so neither Yvonne nor her children are eligible for continuation coverage.
Cobra allows extended coverages to business with how many employees?
Employers who have a group health plan and 20 or more employees on more than 50% of its typical working days in the previous calendar year; a part-time employee counts as half an employee for purposes of the 20-employee rul
Terms of cobra coverage? in months:
Reduction in hours -
Normal Termination -
Meets social Security Definition of disability -
Divorce -
Spouses and Dependents of a covered person who’s eligible for medicare -
Death -
- ) 18 months for employees and dependents for reduction in hours
- ) 18 months for employees and dependents for normal termination (except death)
- ) Up to 29 months if employee (or qualified beneficiary) meets Social Security definition of being disabled
- ) 36 months for divorce
- ) 36 months for spouses and dependent children of a covered employee becoming eligible for Medicare
- ) 36 months for death
H0-2
HO-2—broad form, homeowner. This named perils form insures the dwelling, other structures, and personal property for specifically named perils (18)
H0-3
HO-3—special form, homeowner. This special form insures the dwelling and other property against losses on an open perils basis 1.) Personal property is subject to the same named perils coverage as HO-2 (unless an HO-15 endorsement is added that provides coverage for personal property on an open perils basis) 2.) Personal property is also subject to ACV loss settlement (unless an endorse-ment is added to provide loss settlement on a replacement-cost basis)
H0-4
HO-4—contents broad form, tenant. HO-4 provides protection from named perils (same as HO-2) for a tenant’s personal propert
H0-5
HO-5—comprehensive form, homeowner. Same as HO-3 coverage except it provides open perils coverage for personal propert
H0-6
HO-6—unit-owners form, condominium owner. HO-6 insures the personal property of the insured (condominium owner) for named perils (same perils as HO-2)
H0-8
HO-8—modified coverage form, homeowner. HO-8 provides protection for dwellings with a fair market value (FMV) that is less than their replacement value (e.g., a home, ACV of $150,000 with a replacement value of $400,000)
Home owners section coverage: A B C D Additional Coverage
A: Dwelling B: Other structures C: Personal property D: Loss of use Additional: Debris removal, damage to trees, and credit card los
Jane is an agent for the ABC Life Insurance Company. Her agency agreement authorizes her to solicit insurance applications, collect initial premium payments, and issue conditional receipts. When Jane issues a conditional receipt, she is exercising what type of authority?
A) Apparent authority
B) Vicarious authority
C) Express authority
D) Implied authority
C) Express authority
Jane exercises express authority when she issues a conditional receipt because the authority to issue conditional receipts is expressly stated in her agency agreement.
Express authority—the actual authority that an insurance company gives representatives (agents)
Implied authority—the authority that the agent is not expressly given by the principal but that an agent in similar circumstances normally possesses
Apparent authority—when the insured is led to believe the agent has authority, either express or implied, where no such authority actually exists
All of the following statements regarding the need for disability insurance are correct EXCEPT
A) If a disability arises from a work-related accident or illness, benefits to the injured employees are generally paid by workers’ compensation.
B) The probability of becoming disabled is less than the probability of premature death.
C) Disability insurance replaces lost income when a person becomes disabled.
D) A disability may be more of a financial hardship than premature death because increased expenses often accompany the loss of income.
B) The probability of becoming disabled is less than the probability of premature death.
The probability of becoming disabled is greater than the probability of premature death.
AMT Adjustment for ISO trades?
When is a positive AMT and a negative AMT calculated?
There is a positive AMT adjustment equal to the bargain element whenever an ISO is exercised. That same amount is subtracted in the form of a negative AMT adjustment whenever the stock is sold.
Trish, age 57, owns a modified endowment contract (MEC). Her investment in the contract equals $35,000 and the policy has a cash surrender value of $50,000. This year, she takes a policy loan of $25,000 from the policy. Assuming Trish’s marginal income tax rate is 24%, what are the income tax consequences of this loan?
A) Trish will owe income tax of $7,000 but no penalty.
B)Trish will owe no income tax and no penalty.
C) Trish will owe income tax of $3,600 plus a penalty of $1,500.
D) Trish will owe income tax of $7,000 plus a penalty of $700.
C) Trish will owe income tax of $3,600 plus a penalty of $1,500.
Loans from MECs are taxed on a last in, first out (LIFO) basis. Trish will owe income tax of $3,600 ($15,000 × 24%) on the gain ($50,000 cash surrender value − $35,000 investment in the contract = $15,000 taxable gain). She will also owe a 10% penalty on the $15,000 taxable gain because the policy is a MEC and she is younger than 59½ years old.
Nelson is the beneficiary of a trust established last year (2019) by his Uncle Walter. The trust allows Nelson to withdraw 9% of the trust principal each year. Nelson made no withdrawals from the trust in 2019. Nelson died in 2020 before his right to withdraw for that year had lapsed. The balance of the trust in both years was $1 million. What amount must be included in Nelson’s gross estate?
A) $90,000
B) $0
C) $1 million
D) $130,000
D) $130,000
$130,000 must be included in Nelson’s gross estate. This includes 9% ($90,000) of the trust principal because of the unexercised withdrawal right at Nelson’s death in 2020, plus 4% ($40,000) for 2019 because the 9% withdrawal right exceeded the 5-and-5 power by 4%. Lapses of general powers of appointment above the 5-and-5 power in the three years prior to the holder’s death are included in the holder’s gross estate (in addition to the full amount of any unused general power of appointment for the year of death).
Earl drafts a will leaving his entire estate to a charitable remainder annuity trust (CRAT). The CRAT provides that Earl’s surviving spouse, Helen, will receive an annuity from the trust for life and that when Helen dies, the remaining trust assets will pass to a local chapter of a national charity. Earl dies this year, and assets with a total fair market value of $10 million pass to the CRAT. Which the following statements regarding the CRAT is(are) CORRECT?
I - The annuity passing to Helen is a terminable interest that does not qualify for the estate tax marital deduction.
II - The present value of the remainder interest passing to the charity must be at least $1 million.
II ONLY
Statement I is incorrect because the marital deduction is allowed when a surviving spouse receives a bequest of an income interest from a CRAT or CRUT if the surviving spouse is the only income beneficiary. Statement II is correct because in a CRAT, the present value of the remainder interest passing to the charity must be at least 10% of the initial fair market value of the property transferred to the trust.
IRA assets are or 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.
You have determined with Bob and Jill that their current resources will result in a retirement income deficit of $37,000 for their first year in retirement. This deficit will increase with inflation each year. They expect to earn an average annual 6% investment return. They assume inflation will average 4%. Using a 27-year retirement period, what is the lump sum retirement fund required?
A) $788,482
B) $482,788
C) $877,482
D) $773,605
A) $788,482
Calculator input (with calculator set for beginning-of-period payments): 37,000 PMT, 27 N, 1.9231 I/YR; solve for PV.
inflation adjusted return = return divided by inflation minus one x 100.
1.06 / 1.04 -1 x 100 = 1.9231
Financial risk is associated with
A) the nature of the business enterprise.
B) the proportion of debt used to fund a firm.
C) changes in the prices in a specific securities market.
D) fluctuations in the general level of interest rates.
B) the proportion of debt used to fund a firm.
Which of the following are included among the tools available to the Federal Reserve (the Fed) to accomplish its responsibilities?
- Open market operations
- Taxation
- Discount rate
- Reserve requirement
1,3,4
Johanna, an attorney, is considering revoking the existing S corp status of her practice. She is in the 37% bracket. She will be the sole owner and employee of the corporation. Which one the following statements accurately describes the income tax consequences of the proposed arrangement?
A) The corporation would be subject to a flat rate of 21%.
B) The corporation would be considered a personal holding company.
C) The corporation would be considered a personal service corporation, subject to graduated tax rates.
D) The corporation would be subject to Johanna’s personal rate of 37% tax because it is a closely held C corp.
A) The corporation would be subject to a flat rate of 21%.
C corporations are subject to a flat rate of 21%. The personal service corporation classification for a C corporation was effectively repealed with TCJA. C corps are not flow-through entities subject to personal income tax rates. None of the income is from passive sources. Therefore, it would not be subject to PHC rules.
2020 Traditional IRA phase outs:
1) Single filer
2) Married filing jointly
3) Married filing separate
4) married filing jointly with a spouse who is covered by a plan at work
1) $65k - $75k
2) $104k - $124k
3) $0k - $10k
4) $196k - $206K
Which of the following are CORRECT regarding eligible individual account plans?
1) They are permitted to invest plan assets in qualifying employer securities.
2) They are subject to ERISA’s diversification requirements for investments made in qualifying employer securities.
3) They include all defined benefit pension plans.
4) They are subject to Pension Benefit Guaranty Corporation (PBGC) coverage.
1 & 2
Eligible individual account plans (i.e., defined contribution plans such as profit sharing plans, stock bonus plans, and money purchase pension plans) are permitted to invest in qualifying employer securities and are subject to ERISA’s diversification requirements. Note: Defined contribution plans are not subject to PBGC coverage.
Personal Services Corporation
A personal service corporation is a taxing entity set up under IRS regulations. The services provided by a personal service corporation may include any activity performed in the following fields: accounting, engineering, architecture, consulting, actuarial science, law, performing arts and health, including veterinary services. Financial services activities are not considered qualified services.
C corps, taxed at 21%,
An Eligible Individual Account Plan (EIAP)
An Eligible Individual Account Plan (EIAP) is a good alternative for a C corporation that wants to share stock with its employees but does not want to have the plan borrow money to buy the stock. It’s actually a custom-designed profit sharing plan statutorily permitted to invest up to 100% of assets in company stock.
The term “eligible individual account plan” means an individual account plan which is (i) a profit-sharing, stock bonus, thrift, or savings plan
Which of the following are functions of the dealer, known as a specialist?
1) Facilitate the transfer of securities in the over-the-counter market
2) Buy securities at the posted bid price and sell at the posted ask price
3) Help stabilize the market prices of the stocks in which the dealer specializes
4) Ensure that the supply of securities exceeds the demand
2 & 3
A specialist is a dealer whose function is to stabilize the prices of securities by balancing supply and demand on a listed exchange, such as the NYSE. To perform this function, the dealer must buy at the bid price when no other buyers are available and he must sell at the ask price when no other sellers are available.
Over-the-counter or off-exchange trading is done directly between two parties, without the supervision of an exchange.
What is over-the-counter trading
Over-the-counter or off-exchange trading is done directly between two parties, without the supervision of an exchange.
Harlan is a sales manager with a comfortable income and his own home. He lives in a state where the minimum auto liability coverage is 25/50/15. Harlan has purchased a policy with levels of coverage at 50/100/30.
What recommendation would you make in this situation?
A) At a minimum, increase the policy’s liability coverage to $200,000 or $300,000.
B) Leave the coverage as is, but purchase an umbrella liability policy.
C) Do nothing, coverage of at least double the required amount is more than adequate.
D) Reduce the coverage to save premium costs because there is no reason to have more than the minimum required by the state.
A) At a minimum, increase the policy’s liability coverage to $200,000 or $300,000.
In an accident, an injured party could suffer economic damages well in excess of $50,000. In addition, with the cost of today’s vehicles, a limit of $30,000 for property damage is likely to be too low. Umbrella liability coverage may be a good idea, but basic policy coverage normally must be increased prior to purchasing an umbrella policy.
Liability coverage may be written on a split-limit basis, such as 100/300/50. A coverage limit of 100/300/50 means there is coverage up to $100,000 for bodily injury to one person, coverage up to $300,000 total for all persons injured in a single accident, and coverage up to $50,000 for property damage, all based on a single accident.
A coverage limit of 100/300/50 means
Liability coverage may be written on a split-limit basis, such as 100/300/50. A coverage limit of 100/300/50 means there is coverage up to $100,000 for bodily injury to one person, coverage up to $300,000 total for all persons injured in a single accident, and coverage up to $50,000 for property damage, all based on a single accident.
Seven years ago, Karen purchased U.S. EE savings bonds for $5,000. During the current year, at 27 years old, she redeemed the bonds to help pay for her graduate school tuition. The accrued value at the time of redemption was $7,000.
Assume Karen incurs $11,000 of tuition expenses in the year. What are the tax consequences upon the redemption of the bonds?
All the accrued interest is taxable in the current year
The exclusion for EE bond interest redeemed to pay for qualifying higher education expenses applies only to bonds purchased by an individual age 24 or older, and held in that person’s name, or jointly with a spouse. Karen is 27 years old; the bonds were purchased seven years ago, when Karen was approximately 20. Because Karen does not qualify for the exclusion of the interest income, all of the interest is taxable in the year the bonds are redeemed. Remember that the interest of EE bonds is deferred until maturity, unless an election has been made to have the interest taxed each year as it accrues. Also, the interest income from EE bonds (and other federal government obligations) is generally not subject to state income tax.
The capital market line (CML) & security market line (SML)
The capital market line (CML) represents portfolios that optimally combine risk and return.The CML, like Markowitz’s efficient frontier, uses standard deviation as a risk measure.
The SML depicts the risk-return relationship for efficient portfolios of securities. The SML uses beta (βi) as a risk measure, whereas the CML uses standard deviation (σ).
The SML, like the CML, may be used to compare actual results to expected results on a risk-adjusted basis
The security market line (SML) is a line drawn on a chart that serves as a graphical representation of the capital asset pricing model (CAPM).
The SML can help to determine whether an investment product would offer a favorable expected return compared to its level of risk.
Which of the following statements does NOT describe a function of the security market line?
A) Indicates the relationship between risk and return
B) Uses standard deviation to measure risk
C) Relates interest rates and beta to a stock’s return
D) Uses beta coefficients as a measure of risk
Standard deviation is used in the capital market line to measure risk, not at the individual security level. The securities market line uses beta to measure risk.
What is the beta coefficient?
The Beta coefficient is a measure of sensitivity or correlation of a security or an investment portfolio to movements in the overall market. We can derive a statistical measure of risk by comparing the returns of an individual security/portfolio to the returns of the overall market and identify the proportion of risk that can be attributed to the market.
Josefina, owner of Western Printers Inc. is considering installing a retirement plan for her employees. Josefina is 37 and her salary is $107,000. Josefina’s accountant recommends a 401(k) plan because it is more flexible and allows employee pretax contributions. Which of the following legal requirements apply to a profit sharing 401(k) plan?
1) Nonelective employer contributions must be made out of profits.
2) In-service withdrawals must satisfy the hardship restrictions.
3) Salary reduction elections must be made before compensation is earned.
4) Special safe harbor provisions can be used to comply with the ADP tests.
2,3,4
Statements II, III, and IV correctly describe the restrictions on hardship withdrawals, the timing of salary reduction elections so as to avoid constructive receipt, and the availability of special provisions (safe harbors) to enable a 401(k) plan to comply with the ADP tests. I is incorrect because contributions can be made to a profit sharing plan, even if the employer does not have current or accumulated profits.
Ernie gave a gift of $100,000 to his new spouse, who is 40 years younger than Ernie. Is this gift a GSTT?
A gratuitous transfer to a person’s spouse or former spouse is not a generation-skipping transfer regardless of the ages of the donor and donee.
GSTT, who is considered a skip person?
An individual is considered a skip person if one of the following is true:
The individual is a direct lineal descendent of the donor and is 2 or more generations younger than the donor (i.e., a grandchild or great grandchild).
The individual is not a direct lineal descendent of the donor, but is more than 37.5 years younger than the donor.
George and Chelsea want to make sure they will have enough funds available, at the beginning of the period, to send their son Oliver to college. Oliver is eight years old and will begin a four-year college program at age 20 (after working full-time for two years following high school graduation). The annual tuition today is $10,000, and it is expected to increase annually by 5%. George and Chelsea estimate that they can get a 7% after-tax return on their investments.
If George or Chelsea were to die, using a present value of an annuity due (PVAD) serial payment calculation, what would be the amount of insurance needed today to provide for Oliver’s education?
C) $31,012
TVM = $10,000 x 12 yrs @ 5% inflation Payment 1 = $17,958 Payment 2 = $18,856 Payment 3 = $19,799 Payment 4 = $20,789
CFJ 0-11 = 0 payments
CFJ 12 - 15 use the above payments
include a 7% return and calculate for NPV
Jane owns a printing business. She wants to trade her old copiers for new fax machines. In the contemplated exchange, Jane will pay $750 in cash. Use the following information to answer the question.
The copiers have an adjusted basis of $1,500.
The copiers have a fair market value of $1,000.
The fax machines have a fair market value of $1,750.
What is Jane’s recognized gain or loss in this exchange?
($500) loss
Jane is paying $750 plus the adjusted basis of $1,500, compared to the fair market value of the property received of $1,750, yields a $500 loss. There is no loss recognized in a like-kind exchange. This exchange is simply treated as a sale of the asset. A loss on a Section 1231 asset may be recognized in the year of the loss. TCJA restricted the like-kind exchange rules to real estate only. Personality no longer qualifies for like-kind exchange treatment.
Consumer debt ratio should be based on gross or net income and not exceed what percentage of that income?
Based on net income and should not exceed 20% of net income.
Non-housing monthly debt payments / monthly net income
Housing cost ratio is based on gross or net income and should not exceed what %?
Housing cost ratio is based on gross income and should not exceed 28%.
All monthly non-discretionary housing costs / monthly gross income = housing costs ratio.
Debt to income ratio is based on gross or net income and should not exceed what %?
Debt to income is based on gross income and should not exceed 36% of gross income.
All monthly debt payments and housing costs / gross income = debt to income
Emergency fund is calculated by adding which expenses and how many months is appropriate?
Adding all non discretionary cash flow items: Expenses that remain after a job loss Mortgage Car loan Credit card loans Taxes
3 months for two working spouses
6 months for one income family
Snowball vs avalanche method of debt payment
Snowball = prioritizing smaller balances first
Avalanche = prioritizing high interest rate debt first
What is the calculation for American Opportunity Tax Credit vs lifetime learning credit?
What are the phase outs?
How many years can they be used?
Are they refundable?
American opportunity tax credit =
100% of first $2,000 of expenses and 25% of the next $2,000. Max credit is $2,500 must spend $4,000 to realize Max credit.
Used in the first four years of post secondary education.
Married phaseout of $160k-$180k for married filers, $80k-$90k everyone else.
40% refundable
Lifetime learning credit =
$2,000/year credit max. Based on a 20% calculation. Must have $10,000 of expenses to claim max credit.
Unlimited use year wise
Phaseout for married filers of $118k-$138k, $59k-$69k for everyone else.
Not refundable
Phaseout for Coverdell accounts?
Max contribution?
Single: $95k-$110k
Married: $190k-$220k
$2k max contribution per year per child
Qualifying for the series EE bind exclusion?
Bonus: does the EE bind have a phase out for exclusion.
Must be purchased after 1989
Must be purchased by someone age 24 years old
Must redeem the bond in the year of the expense
Phaseout:
$123,550-$153,550 for married returns
$82,350-$97,350 for single filers
Which of the following legal requirements apply to defined benefit pension plans?
1) A separate funding standard account must be maintained for each plan participant.
2) The maximum benefit permitted by law is reduced proportionately for each year of participation less than 10.
3) The services of an actuary are needed to demonstrate that the minimum funding standards are satisfied.
4) A definitely determinable retirement benefit must be provided, regardless of employer profits.
Statements II, III, and IV correctly state the rules concerning the 10-year participation requirement for the maximum benefit, the need for an actuary to demonstrate adequate funding, and the requirement that the plan’s benefit be definite. A pension plan’s benefit cannot be conditional upon the employer earning profits.
The funding standard account is maintained for the plan, not for each participant.
Roberta is a private investor who researches individual stock purchases thoroughly. She uses charts and historical price movement to determine entry and exit points for her stock trades. Roberta
A) believes in the semi-strong form of the efficient market hypothesis (EMH).
B) does not believe in the efficient market hypothesis (EMH) in any form.
C) believes in the weak form of the efficient market hypothesis (EMH).
D) believes in the strong form of the efficient market hypothesis (EMH).
B) does not believe in the efficient market hypothesis (EMH) in any form.
A person who believes that fundamental analysis can result in superior performance believes in the weak form of the EMH. The weak form states that all historical price information is fully reflected in the stock price, therefore technical analysis will not produce superior results. The semi-strong hypothesis states that neither fundamental nor technical analyses deliver superior performance. The strong form states that all information, including insider knowledge, is already reflected in the stock price.
Which of the following are items of tax preference for the individual alternative minimum tax (AMT)?
1) Medical expenses in excess of 7.5% of adjusted gross income
2) Percentage depletion deduction in excess of adjusted basis
3) The deduction for gambling losses to the extent of gambling income
4) Tax-exempt interest on qualified private-activity bonds issued in 2011
2,4
By definition, the percentage depletion in excess of adjusted basis and the tax-exempt interest on qualified private-activity bonds are preference items or adjustments for purposes of the AMT. Remember that interest on private-activity municipal bonds issued in 2009 and 2010 is not a preference item for the AMT. The medical expenses in excess of 7.5% of adjusted gross income (for 2020) and the gambling losses to the extent of gambling income are both allowable itemized deductions for AMT purposes.
AMT Tax Preference Items
- Deductions for accelerated depreciation/depletion
- Net income from oil and gas properties
- Excess intangible drilling costs
- Interest on special private activity bonds reduced by any deduction (not allowable in computing the regular tax) which would have been allowable if such interest were included in gross income
- Qualifying exclusion for small business stock
- Capital gains from exercise of stock options
- Investment tax credits
Recently, Bruce, a CFP® certificant, was convicted of illegal possession of narcotics. What is Bruce required to do?
A) Do nothing, as nothing is required by the Code of Ethics
B) Report the conviction to the CFP Board, as required by the Code of Ethics and Standards of Conduct
C) Terminate his professional client-planner relationships
D) Contact his clients and confess the conviction
B) Report the conviction to the CFP Board, as required by the Code of Ethics and Standards of Conduct
Your client has decided to establish an irrevocable life insurance trust (ILIT) to own life insurance policies on her life. She is now trying to decide whether the ILIT should be funded or unfunded. Which of the following statements regarding these two types of ILIT are correct?
1) A funded ILIT will require the grantor to gift more property in the year of creation.
2) An unfunded ILIT is revocable until it is funded.
3) The beneficiaries of a funded ILIT should each be given a Crummey power.
4) Some of the income of a funded ILIT would be taxed to your client.
1 & 4
A funded ILIT has assets other than a life insurance policy or policies. Therefore, the grantor would have to gift more property in the year of creation. The income of a funded ILIT that is or may be used to pay life insurance premiums on the life of the grantor or the grantor’s spouse is taxable income to the grantor. There is no need to give the beneficiaries of a funded ILIT a Crummey power, as such a trust is not dependent on future contributions to make the premium payments on the policy or policies.
Funded vs unfunded ILIT
A funded trust contains assets other than life insurance policies. The assets are often investment accounts held to produce sufficient income to pay the insurance premiums. Funding the trust has the additional benefit of allowing future appreciation of the assets to be sheltered from estate taxation.
An unfunded trust contains only life insurance policies. The trustee of an unfunded ILIT is dependent on cash gifts from the grantor to pay the premium payments that become due. The cash contributions are often made annually, and are sheltered (or partially sheltered) from gift taxation by giving trust beneficiaries a power to withdraw contributions made to the ILIT.
A spendthrift trust or provision does what?
A spendthrift trust is a trust that is created for the benefit of a person that gives an independent trustee full authority to make decisions as to how the trust funds may be spent for the benefit of the beneficiary. Creditors of the beneficiary generally cannot reach the funds in the trust, and the funds are not actually under the control of the beneficiary.
How is a funded and unfunded ILIT income taxed?
A typical ILIT is unfunded and produces no income. Accordingly, there is no need to determine how the trust will be treated for income tax purposes.
Megan wants to receive payments of $5,000 at the beginning of each month during her retirement. Megan estimates she will need to receive this monthly payment for 30 years. If a 6.0% annual return is earned on investments, compounded monthly, what amount does Megan need to have at the time of her retirement to fund her needs? She estimates inflation during retirement to be 3% annually.
$838,128
With calculator in the BEG mode and set for 12 payments/year, $5,000 = PMT, 6% = I/YR, and 30 = N. Calculate the present value (BEG mode 360 N; 6, I/YR; 5,000, PMT and solve for PV).
Jerry, age 48, works for Parts Unlimited Inc. and earns $350,000 per year. The company provides a nonelective contribution under a SIMPLE IRA plan. What would be the maximum amount that Jerry could contribute to the account for 2020 (total of employer and employee contribution)?
$19,200
Under a SIMPLE IRA plan, the employee could defer up to $13,500 this year (2020). The employer’s 2% nonelective contribution was limited by the Section 401(a)(17) annual limit on includible compensation, which is $285,000 in 2020. With the nonelective contribution, the maximum the employer would contribute for one employee would be $5,700 ($285,000 × 2%). If the employer were to make a 3% matching contribution, the 401(a)(17) limit would not apply and the entire salary of $350,000 would be included.
Your client has determined that she needs to do something before she dies to ensure that her estate will have sufficient liquidity at her death. Which of the following actions, if taken by your client, could potentially give her estate increased liquidity?
1) Elect the alternate valuation date
2) Establish and fund an irrevocable life insurance trust (ILIT) with all life insurance policies in which she has any incidents of ownership
3) Purchase another life insurance policy on her own life naming her estate as beneficiary
4) Enter into a cross-purchase buy-sell agreement with her business partners
2,3,4
Establishment of an ILIT will increase liquidity by removing the death benefit from the gross estate if your client lives at least three years after the transfer. Even if she does not live for three years, if the trust is properly drawn, the trustee will be able to make loans to her estate and/or purchase illiquid assets from the estate. The outright purchase of a new life insurance policy, while not the best alternative, will increase liquidity even though it would be included in her gross estate because the top estate tax rate is less than 100%. The buy-sell agreement would provide liquidity by ensuring that her estate would have the ability to turn her closely held business interest into cash. Election of the alternate valuation date will help estate liquidity, but it can only be done after death by the personal representative of the estate.
Louise is 43 years old and a teacher in the Ferndale County school system. She has taught in the Ferndale County schools for 15 years and will earn $52,000 this year. She has contributed a total of $56,000 to the school’s tax-sheltered annuity (TSA) over the years. What is the maximum amount she can contribute to the plan as a salary deferral in 2020?
A) $15,000
B) $19,500
C) $22,500
D) $12,500
C) $22,500
Employees with fifteen or more years of service with the school district may be eligible for a special higher annual limit of $22,500 for 2021 ($3,000 additional per year). To qualify, a participant’s prior average annual contributions must not exceed $5,000 per year. This extra annual amount of $3,000 per year is capped at a cumulative limit of $15,000. The participant’s age is not a factor for determining eligibility for this higher limit. Employees who qualify for this catch-up must take this amount prior to taking advantage of the Age-Based Catch-up. The special Catch-Up provision is calculated and used prior to using the Age-Based additional amount.
What is the normal shape of a yield curve?
What does a normal yield curve represent economically and what does a downward sloping yield curve mean?
Upward sloping (also known as normal yield curves) is where longer-term bonds have higher yields than short-term ones. While normal curves point to economic expansion, downward sloping (inverted) curves point to economic recession. Yield curve rates are published on the Treasury’s website each trading day.
Increasing money market yields and increasing Treasury bond yields would characterize a tight or loose policy by the Federal Reserve (the Fed)?
When the Fed increases the discount rate or the federal funds rate, it is using a tight monetary policy. This causes both short- and long-term yields to increase. If inflation is especially strong, the Fed may increase short-term rates so sharply that the yield curve becomes negatively sloped, downward from left to right.
Bill’s 2019 income tax return, which was for a full year, showed an AGI of $140,000 and an income tax liability of $32,100. He estimates his 2020 income tax to be $38,000 and his total wage withholding to be $5,000.
What minimum amount of estimated tax payments must Bill pay (in equal quarterly installments) for 2020?
$27,100
The safe harbor for avoiding the underpayment penalty is the lesser of 90% of the current year tax liability or 100% of the prior year tax liability (110% if the prior year’s AGI was over $150,000). One hundred percent of the prior year tax liability is $32,100. Ninety percent of the current year tax liability of $38,000 is $34,200. The smaller of these numbers, reduced by the $5,000 withholding, equals $27,100.
Which of the following are fundamental characteristics of insurance?
1) Probability (possibility and predictability of a loss)
2) Law of large numbers
3) Transfer of risk from individual to group
4) Insurance is a form of speculation
1,2,3
A great many protections have been put into place to keep insurance from being used in a speculative manner. Indemnity and insurable interest are among the concepts developed to ensure that insurance does not equal gambling.
Which one of the following requirements is a possible disadvantage of a simplified employee pension (SEP) for an employer?
A) The SEP’s trustee is subject to ERISA’s prohibited transaction excise tax penalties.
B) The vesting requirements for a SEP prohibit forfeitures.
C) Employer contributions to a SEP are subject to payroll taxes.
D) A SEP must have a fixed contribution formula that is nondiscriminatory.
B) The vesting requirements for a SEP prohibit forfeitures.
SEP contributions must be 100% vested (i.e., nonforfeitable at all times). Prohibited transaction excise tax penalties do not apply to SEPs. The contribution formula of a SEP is not required to be fixed. Employer contributions to a SEP are not subject to payroll taxes.
In January 2018, Thomas received 10,000 ISOs to purchase Wine Tasting, Inc., stock at $5 per share. In February 2019, he exercised the options when the market price of the stock was $15 per share. In March 2020, Thomas sells the 10,000 shares of the stock for $50 per share. How will Thomas’s sale in 2020 be treated for federal income tax purposes?
A) Long-term capital gain of $450,000 and a negative $100,000 AMT adjustment
B) W-2 income of $450,000
C) W-2 income of $100,000 and capital gain of $350,000
D) Long-term capital gain of $350,000
A) Long-term capital gain of $450,000 and a negative $100,000 AMT adjustment
There are no regular tax implications associated with exercising ISO shares. The only tax consequence from the exercise is a positive AMT adjustment of $100,000 on the bargain element ($15 – $5 = $10, $10 × 10,000 = $100,000). In 2020, Thomas’s sale would be categorized as a qualifying disposition because the sale occurred over two years from the grant and over one year from the exercise date. As a result of meeting the holding period requirements, Thomas will have a long-term capital gain of $450,000 [($50 − $5) × 10,000] and a negative AMT adjustment of $100,000.
What is a pooled income fund? (PIF)
PIF—This is an irrevocable transfer of assets to a charity for an income stream from the charity’s commingled asset management.
A charitable deduction is available.
Created and maintained by the charity
Donor transfers property, including irrevocable remainder interest, to charity (must be a public charity and managed by the charitable remainder man)
Property commingled with property of other donors
Grantor retains income interest for one or more beneficiaries for life (no term trusts)
Investments cannot include tax-free municipal bonds
Payment to donor is determined by earnings of trust annually
UNI-TRUST vs ANNUITY TRUST
LEAD vs REMAINDER TRUST
The UT in the acronyms stands for “UniTrust.” The AT stands for “Annuity Trust.” With a Unitrust, the income payments vary with how well the investments in the trust are doing. If the investments are doing well, the payments are high and vice versa.
With an Annuity Trust, the payments are fixed, no matter how the investments are doing.
The C in all these acronyms stands for charitable. The L stands for “Lead” and the R stands for “Remainder.” This refers to what the charity gets. If the charity gets the income, it’s a lead. If the charity gets the principal, it’s a remainder.
Your client wants to make a charitable gift that will accomplish all of the following objectives:
Allow her to take a current income tax deduction
Pay her an income that can keep up with inflation
Allow her to make additional donations to the same charity in the future that will accomplish the previous two objectives without establishing a new trust
Which of the following inter vivos charitable trusts would accomplish all of these objectives?
1) A charitable lead unitrust (CLUT)
2) A charitable remainder annuity trust (CRAT)
3) A charitable remainder unitrust (CRUT)
4) A pooled income fund (PIF)
3 & 4
a CLUT stands for charitable lead uni-trust - lead means the charity gets the income.
CRAT stands for charitable remainder annuity trust - the annuity part stands for fixed income payments meaning it will not keep up with inflation.
Matthew, age 47, purchased a deferred annuity in January 1982 for $50,000. In the current year, when the surrender value was $125,000, Matthew took a nonperiodic distribution of $75,000. Which of the following statements is CORRECT regarding the income tax consequences of the distribution?
A) $50,000 is tax free, $25,000 is taxable.
B) $75,000 is tax free.
C) $75,000 is taxable income.
D) $50,000 is taxable, $25,000 is tax free.
A) $50,000 is tax free, $25,000 is taxable.
The pre-August 14, 1982, annuity retains first in, first out (FIFO) treatment. Thus, the basis of $50,000 is treated as being withdrawn first, and is tax free. The remaining $25,000 is taxable. If this were a post-August 13, 1982 contract, it would be treated on a last in, first out (LIFO) basis.
What is malpractice insurance and who typically needs it?
Malpractice insurance is a type of professional liability insurance purchased by healthcare professionals. This insurance coverage protects healthcare providers against patients who file suits against them under the complaint that they were harmed by the professional’s negligence or intentionally harmful treatment decisions. Malpractice insurance also covers the death of a patient.
