Questions from Mock Exams Flashcards
CONCEPT: Standard Deviation
Your client, Alice, owns the following four different diversified mutual funds:
Growth fund - $45,000
Emerging market fund - $14,000
Government bond fund - $50,000
Corporate bond fund - $35,000
Alice is concerned about overall portfolio risk. She is concerned about standard deviation and other factors. Due to a recent inheritance, she has additional money to invest. To which among her currently held mutual funds do you suggest she add money?
The emerging market fund currently represents is the smallest percentage of the portfolio allocation and likely has the lowest correlation coefficient relative to the other funds. Reducing correlation coefficient would reduce the portfolio’s overall risk. The correlation coefficient to be highly important for the exam. (Somewhat subjective.)
QUESTION: When, if ever, can a corporation that issues qualified stock options (ISOs) receive a tax deduction for the ISOs?
A. Never
B. Always
C. Yes, if the ISO is disqualified
D. Yes, if the ISO is qualified
E. Yes, if no more than $100,000 worth of ISO stock is granted that vests in a specific year
ANSWER: C. If the stock that was acquired under the option (right to buy) is sold before the two year /one year holding period, the excess of the fair market value of the shares at the time of exercise over the exercise price is treated as compensation to the option holder. That creates a corresponding deduction for the issuing corporation.
QUESTION: Todd wants to defer the distributions from the money purchase plan in which he participates for as long as possible. He works for RJ, Inc. RJ wants him to continue working for it beyond the plan’s stated retirement age 65. If he continues to work beyond 72 and contribute to the plan, what is the latest time when he can take his first distribution and not be penalized?
A. When he attains age 72
B. By April 1st of the year after he turns 72
C. When he retires from his job with RJ, Inc.
D. By April 1st of the year following the year when he retires from his job with RJ, Inc.
ANSWER: D. Todd is a rank-and file-participant in the money purchase plan and clearly not a 5% owner. Thus, he may delay his required beginning date (RBD) from the plan until April 1 of the year following the year when he retires from service with this employer.
QUESTION: When you met with John and Jodi Adams for your regular monitoring meeting, they provided you with information about new developments in their lives. After you congratulate them they ask you to help them prioritize the reasons for making changes to the original financial plan that you wrote for them. How would you rank the changes listed below in order of importance from highest to lowest?
I. They inherited money from Jody’s mother
II. Jody is expecting a second child in 2 months
III. John just received new job promotion which entails a move to an adjacent state (50 miles away).
IV. The adjacent state has a high state income tax
A. I, II, III, IV
B. II, III, IV, I
C. III, I, IV, II
D. IV, II, I, III
ANSWER: A. Identify the most important and the least important reasons to modify the original plan. The Adams’s will need a plan for the inherited money. The state level income tax differential is likely to be small. If the Adams’s itemize, it may produce an itemized deduction. Because the new baby is a second child, they have already considered the financial planning that accompanies parenting. (In ranking questions, identifying the “most” and “least” generally leads you to the answer: The middle choices are often too similar to differentiate.
QUESTION: You are a CFP® certificant and Todd and Belinda Harding are your new clients. During the initial interview Todd excuses himself for a restroom break. Belinda whispers to you that Todd is a compulsive gambler. She confides in you that she has managed to squirrel away a significant amount of cash that at the moment is in a money market account. Belinda asks you not to tell Todd about the account and says that she wants to call you the following morning to discuss allocation options for the money. How should you best handle this awkward situation?
A. When Todd returns to the room and as you begin to gather data step, act as if you have no awareness of the account that Belinda mentioned.
B. Speak with Belinda the following morning to discuss asset allocation choices.
C. Terminate the relationship before you proceed to the data gathering step in the financial planning process.
D. When Todd returns from the bathroom tell him about the account.
ANSWER: The correct answer is C. Who is the client? The presumption was that both Todd and Belinda would become your clients (not just Belinda). This is the initial interview (going to be clients). Regarding Answer D Belinda makes clear that she does not want her compulsive gambler husband to know about the account. Further, without the disclosure of the value of assets –including the money market account, the data is too vague for meaningful financial planning.
QUESTION: Your client, Dennis Hart explains to you that he wants a reasonable level of income but also some long-term growth. If you believe that he can address both of his investment objectives, which of the following securities would you suggest to Dennis?
A. Convertible bonds
B. Preferred stocks
C. Blue chip stocks
D. Corporate commercial paper
ANSWER: The best answer is A. Most logical investors will accept a lower interest rate in exchange for the potential price appreciation from converting the bond if the prices of the issuers’ stocks rise above the bond’s conversion price. Preferred stock is regarded as a fixed income investment with little growth potential. Many blue-chip stocks distribute small dividends and they can be skipped in a profit-less year.
QUESTION: Smokestack Inc. voluntarily terminated its defined benefit plan. Your client, Homer Connors, age 61, has been a long-time employee of Smokestack, Inc. and a participant in this pension. The “termination” has made Homer quite anxious. What might you tell Homer that may make him feel less anxious?
A. The 10% penalty (59½ year rule) will not apply to distributions.
B. The account balance must be rolled over into an IRA account.
C. Homer is 100% vested.
D. The plan is fully funded. There is no need to worry.
ANSWER: C. The 10% penalty will not be imposed on Homer because he is over age 59½ and is a possible answer. The plan is fully funded at normal retirement age, not necessarily at a premature termination. Homer would get the account balance that is attributable to him and be fully vested.
QUESTION: Mrs. Smith, age 80, is comparing different investment portfolios. The thought of losing principal makes her very uncomfortable. While she would appreciate some income from her investments, that is a secondary concern. After listening to her carefully, which of the following portfolios would you suggest?
A. 10% money market mutual funds, 10% blue chip common stocks, 80% long-term bonds
B. 50% bank issued CDs, 50% long-term investment grade corporate bonds
C. 10% money market mutual funds, 10% blue chip common stocks, 80% investment grade short-term bonds
D. 10% money market mutual funds, 40% bank issued CDs, 50% investment grade long-term bonds
ANSWER: The best answer is C. Due to their high durations, the long-term bonds carry significant principal risk if interest rates rise. The short-term bonds (80%) along with only 10% in quality common stock seems reasonable given her fear of principal loss and desire for income.
QUESTION: Your client, Jane Thompson is divorced. Her ex-husband Alex Thompson is now remarried to Lola, age 25. Lola is an exotic dancer. Since he married Lola, Alex has been a bit tardy on making alimony payments. Jane wants you, her financial planner, to meet with Alex. Jane is willing to pay for your services and Alex is willing to meet with you. What should you do?
A. Tell Jane that you cannot meet with Alex because there is a conflict of interest.
B. If you do see Alex, do not discuss Jane’s financial affairs with him.
C. Tell Jane that Lola needs to be included in the conversation.
D. Tell Jane that the best solution is to refer Alex to another financial planner.
ANSWER: The best answer is D. Jane and Alex want help but you don’t want to be in an awkward situation. Answer D does provide help regarding the situation. Lola is not a party to the alimony agreement between Jane and Alex.
QUESTION: You, a CFP certificant, are having a first meeting with Will, an energetic, young client. He is 28 and a promising entrepreneur. He says, “I do not want a whole song and dance, I just want to invest some money. Can you help me with that?” What should you do next?
A. Create an asset allocation model for Will.
B. Because he has a business, recommend that he open an IRA.
C. Check that his insurance coverages are adequate.
D. Calculate and analyze his cash flow.
ANSWER: D. While Answer C may be arguable, D is a better choice. If Will turns out to have negative cash flow, he should be addressing that before he invests. Answer A depends on Answer D. The insurance answer is too vague, especially without knowing more about Will’s family situation.
QUESTION: Sally donates several bags of old clothes to the Salvation Army. Which statement below best reflects the documentation that Sally would need in order to claim a charitable income tax deduction?
A. Deduction of up to $250 does not require a receipt.
B. Deduction of $250 but less than $1,000 must be documented.
C. The deduction is the lesser of fair market value or the donor’s basis (substantiated).
D. The deduction is limited to basis (unsubstantiated).
ANSWER: The best answer is C. For charitable gifts of less than $250, a dated receipt is proof for purposes of an income tax deduction. The receipt should c include a description of the property. A written receipt would list the items donated with a corresponding value. Sally should keep records showing the fair market value and her cost basis. For charitable gifts exceeding $250 Sally must substantiate the deduction by written acknowledgement from the charity. Cash donations up to $300 single/$600 joint do not have to be documented for 2021 if you take the standard deduction.
A CFP® professional meets a prospective client who is prepared to discuss his retirement accounts that were provided through a former employer. The client is concerned that the investments in those accounts are too aggressive. He states that he and his wife would like to retire when they are 65 and that they have recently been writing many checks from their account to support their adult son who can’t seem to find a job. After further analysis, the CFP® professional determines that the client does not have enough cash flow to retire when they turn 65 while continuing to support their son. How should the CFP® professional proceed?
A. Communicate to the clients that their retirement goals are unrealistic: that they should plan to work until age 70, and that they should stop giving money to their son.
B. Help the clients to review and prioritize goals.
C. Review the client’s current and potential income streams to identify ways to solve the immediate cash flow shortfall.
D. Recommend a conservative asset allocation model to reduce the risk in his retirement accounts and suggest that they stop giving money to their son.
ANSWER: B. The CFP Board would feel that it is important to encourage the client to reassess priorities before making specific recommendations. Answer C is wrong because it assumes the client has established new goals. Answers A and D are arguable.
Your married clients, Adam and Jane Smith, have provided you with the following tax information for the current year.
Adam’s salary (net of his 401(k) deferral) - $135,000
Jane’s income (from babysitting) - 1,000
Real estate income (active participation) - 5,000
Dividends - 1,000
Adam’s IRA contribution - 6,000
Jane’s IRA contribution - 6,000
What is the amount of their current year AGI?
A. $124,000
B. $130,000
C. $136,000
D. $142,000
ANSWER: C.
Adam $135,000
Jane 1,000
Real estate 5,000
(income) Dividend income 1,000
IRA - 6,000
AGI - $136,000
Adam has a 401(k) and is above phase out ($109K - $129K) for IRA deductibility. However, Jane can contribute and deduct the $6,000. The spousal IRA phase out is at $204,000.
QUESTION: Mrs. Spellman has come to you for advice. Her current net worth is about $450,000. She says she could use “more spending money.” Which of the following techniques would increase Mrs. Spellman’s cash flow?
A. Take an equity loan against her home ($150,000 FMV with a basis of $30,000)
B. Sell her vacation home and invest the net proceeds in municipal bonds
C. Sell investment property that is producing minimum net income ($8,000/yr.). ($200,000 FMV, original cost $100,000 but fully depreciated)
D. Sell non-income producing land ($100,000 FMV, basis $150,000)
ANSWER: B. In Answer A, the loans produce negative cash flow because they carry interest. The sales of the home and the investment property do not increase cash flow. We do not know how the money will be invested. The question focuses on increasing cash flow.
If a taxpayer is subject to AMT, which of the following could reduce the AMT payable?
I. Exercise nonqualified stock options
II. Take short-term capital gains
III. Delay until next year the payment of a property tax bill
IV. Exercise and sell an ISO in the year of exercise
Answers:
A. I, II, III, IV
B. II, III, IV
C. III, IV
D. II and III
E. I and IV
ANSWER: Increasing taxable income (Answers I and II) for regular tax purposes until it reduces or eliminates AMT exposure. Delaying certain itemized deductions such as medical expenses, charitable gifts and local property tax creates more regular income. An ISO exercise adds to AMT income, but that addition is nullified by a disqualifying disposition such as a sale in the year of exercise).
QUESTION: Sidney is very displeased with a particular CFP® practitioner’s recommendations. He strongly believes that they were unsuitable and resulted in unnecessary losses. Further, Sidney later learned that the planner did not provide him with adequate disclosure of conflicts of interest and other matters. To which the following parties should Sidney send his letter of complaint?
Answers:
A. The CFP® Board
B. The planner’s supervisor
C. FINRA
D. The SEC
ANSWER: A. We know that the planner is a CFP®. Nothing in the question indicates FINRA registration. Nor does the question indicate that the planner is a federal covered advisor regulated by the SEC. The planner may or may not have a direct supervisor. The culture of the exam is that CFP Board wants to know of the complaints, then they can investigate them.
QUESTION: An employer can self-fund certain benefits under a 501(c)(9) voluntary employees’ beneficiary association (VEBA). Which of the following may be funded?
I. Death benefits
II. Medical benefits
III. Unemployment benefits
IV. Retirement benefits
V. Deferred compensation benefits
A. I, II, III, IV
B. I, II, III
C. I, II
D. IV, V
E. All of the above
ANSWER: B. Retirement and deferred compensation benefits may not be funded through a VEBA.
QUESTION: George Hallas owns 80% and his daughter, Georgina 20% of Hallas, Inc. (a corporation). Hallas, Inc. grosses approximately $20 million in a typical year. George and his daughter also own a general partnership worth $5 million. George owns a $3 million life insurance policy outright under which he is the named insured. He wants to remove the life insurance policy from his estate. What do you recommend?
A. Sell the policy to the corporation for buy-sell purposes.
B. Sell the policy to the partnership for buy-sell purposes.
C. Transfer the policy to the partnership for buy-sell purposes.
D. Gift the policy to his daughter.
ANSWER: D. If the corporation owns the policy, the proceeds may be considered in valuing the decedent’s interest for federal estate tax purposes unless there is valid agreement fixing the price that would reflect an arms-length sale to an unrelated party (questionable because the buyer and seller are daughter and father, respectively. Answers B and C create a similar problem. When George dies the partnership dissolves. The ownership of the policy after that point would be uncertain and possibly flow through to George’s estate.
QUESTION: Joe Jones works for “Take-A-Boat” boat rentals. The company has a SIMPLE plan in which Joe participates. As he approaches 72, plans on working fewer hours. He would still like to participate in the SIMPLE plan. Which of the following can you accurately tell Joe?
A. You cannot contribute to a SIMPLE IRA after age72; but you can contribute to a non-deductible IRA
B. You can continue to contribute to a SIMPLE.
C. Since you are a more than 5% owner you must start to take distributions from the SIMPLE when you reach 72 and then stop contributing.
D. You can contribute to a Roth IRA.
ANSWER: B. We do not know Joe’s AGI. AGI affects Answer D. If Joe’s AGI is over the threshold, he may not contribute to a Roth. As an employee, Joe must take distributions from the SIMPLE when he reaches 72, however, he can still contribute. (Yes, money is flowing out and into Joe’s account in the same year(s).
QUESTION: Baker, Inc. provides a qualified retirement plan (employer funded). The plan falls under numerous ERISA rules. The plan lost 50% due to poor investment decisions in the previous year. What recourse can the employees take?
A. Sue the plan officials for 100% of the investment losses.
B. Sue the plan officials for 50% of the 50% loss.
C. Do nothing: qualified plan investment managers are not required to make profits.
D. Sue the plan officials for 100% of the losses plus punitive damages
E. Sue the plan officials for losses to the plan
ANSWER: E. Errant plan officials can be held personally liable for losses to the plan as well as other factors. ERISA prohibits monetary punitive damages for claims.
QUESTION: Pension contributions are based on compensation. Which of the following is generally considered to be compensation to an employee?
I. Salary
II. Bonus
III. Business expense reimbursement
IV. Incentive stock options
V. Contributions to a deferred compensation plan
A. All of the above
B. I, II, IV
C. I, II, III
D. I, II
E. I, IV
ANSWER: D. Salaries and bonuses are clearly compensation. A reimbursement pays the employee back for business expenses incurred but is not compensation. An ISO is a right to buy the employer’s stock and is not compensation. However, if the ISO becomes disqualified because the stock is exercised and sold in the same calendar year, the employee may be required to recognize any profits as compensation. Deferred compensation is not treated as compensation until it is constructively received. For tax purposes, compensation is considered current when it is paid no later than 2½ months after the year in which it is earned. For a more-than-50% owner, the compensation must be paid by year end. Deferred compensation is not compensation for tax purposes until it is constructively received.
QUESTION: Duggan is a 70-year-old man about to retire. If he annuitizes the current account balance from the retirement plan in which he has participated throughout his long career, which of the following annuity options will provide Pat with the highest payment in his first year of retirement?
A. Life income with a 5-year period certain
B. A life annuity
C. Joint lifetime income with his son (age 49)
D. Joint life income with his wife (age 71)
ANSWER: B. The life annuity always produces the highest payout. A life annuity may also be called as a pure life annuity or a straight life annuity.
QUESTION: Which of the following statements is true a regarding a QPRT if the grantor dies during the retained-interest term?
A. The value of the remaining term will return to the grantor’s gross estate.
B. It leaves the grantor’s estate with no greater tax liability than had the QPRT had not been established.
C. The applicable credit amount plus any gift tax actually paid on the original transfer are lost.
D. The present value of the retained income interest is brought back into the gross estate.
ANSWER: B. The full value of the home generally reflecting date of death FMV is brought back into the gross estate. Let’s say you transferred a home worth $1 million under a 10-year QPRT. Had the QPRT never been established the estate would have the same tax exposure because the property would appear in the gross estate at FMV.
QUESTION: A premature distribution penalty tax applies to which one of the following IRA distributions?
A. A distribution made to the owner ($10,000 lifetime limit) for the primary residence
B. A distribution made to the owner for qualified higher education expenses furnished to the owner personally
C. A distribution made to a 50-year-old beneficiary after the death of the owner
D. A distribution attributable to the owner’s disability
ANSWER: A. Don’t get tricked! The distribution must be for the purchase of a first home, not necessarily a primary residence.
QUESTION: Arthur, age 63 regrets retiring early. He’s single and bored. Arthur found a job at Walmart as a greeter. The job will pay $15,000 per year. Arthur doesn’t need the money because he is currently receiving $6,000 per month from his former employer’s money purchase pension plan plus early Social Security retirement benefits of $1,000 per month. Arthur lives in a comfortable apartment, has full medical coverage and makes no charitable contributions. He normally claims the standard deduction. Which of the following is true if he takes the job with Walmart?
A. He will remain in a 22-24% income tax bracket.
B. He should find a job that pays him more than the minimum wage ($15.00/hour).
C. The impact of the earned income will be a very marginal increase in income tax.
D. His Social Security Retirement benefits could be reduced because of his earned income.
ANSWER: A, Arthur will be in the 22-24% bracket. If he works the same hours for better pay, Arthur will exceed the 1-2 rule ($19,560) which would reduce his current Social Security retirement benefits. For now, Arthur remains with Walmart.
QUESTION: Plant Parenthood is a landscaping company, it has 18 full-time employees participating in is group health plan, and 4 full-time employees who are not participating in the plan. Joe, a participating employee with family medical coverage under Plant Parenthood’s group health insurance plan, just divorced Sara. How long will COBRA cover Sara and Debbie (Joe’s 12-year-old daughter)?
I. Sara is entitled to 18 months of continuation in the group plan.
II. Sara is entitled to 36 months of continuation in the group plan.
III. Debbie is entitled to 18 months of continuation in the group plan.
IV. Debbie is entitled to 36 months of continuation in the group plan.
V. Debbie is still covered under the plan group medical insurance plan.
A. I, III
B. II, IV
C. II, III
D. I, V
E. II, V
ANSWER: E. Under COBRA rules, Sara will get 36 months of continuation coverage in the group medical insurance plan (due to divorce). Debbie is still Joe’s daughter and will continue to be covered by his group health plan (family plan). The plan is subject to COBRA requirements because Plant Parenthood has 22 full-time employees
QUESTION: Terrie Cross and Brenda Davis have decided to close their business. They had entered into a cross-purchase buy sell agreement funded with life insurance policies. Both Terrie and Brenda are married. How should they handle the ownership of their policies at this point?
A. Each should purchase her own policy from the other owner.
B. They should maintain the current ownership arrangements of the insurance policies.
C. Terrie should sell Brenda’s policy to Brenda’s husband, and Brenda should sell Terrie’s policy to Terrie’s husband.
D. They should change to an entity buy sell agreement.
ANSWER: A. After the business closes, it is reasonable that each owner then owns the policy on her own life. Because the business is closed, there is no reason to maintain the current arrangement of ownership of the policies. Answers C and D trigger “transfer for value”.
QUESTION: Mr. Smith is subject to the AMT. Which of the following can reduce his AMT payable?
A. Exercising more nonqualified stock options
B. Assuming a larger mortgage
C. Purchasing more municipal bonds (private activity)
D. Buying an oil and gas partnership
E. Purchasing more public purpose bonds
ANSWER: A. Exercising nonqualified stock options will increase his regular income which thus reduces his AMT payable. The mortgage interest deduction associated with a larger mortgage will decrease his taxable income. Purchasing public purpose bonds will have no effect.
QUESTION: Toby Smith, age 61, gifts $1 million to an irrevocable trust that provides income only to his troublesome son, Bugsy, age 37. Bugsy can’t keep a job and is always asking his father and others. The trust income is distributed quarterly. Toby’s investment advisor handles the $1 million trust portfolio. The payout is approximately 3% or $30,000. Toby is married with three other children. The other children are upset because no trust arrangement established for them. Which of the following statements accurately reflects Toby’s situation?
A. Toby has made a taxable gift of $1 million.
B. Toby and his wife have made taxable gifts of $484,000 (split-gift less $16,000)
C. The $30,000 is taxable income to Toby.
D. Toby should have established a 2503(c) trust.
ANSWER: A. Gifts in trust are future interest gifts. No Crummey powers are included. The income is taxable to Bugsy. This is a 2503(b) trust. The trust is not tainted; nothing indicates that Toby is the trustee. Toby transferred the money into the trust. Nothing indicates a split gift. There is no Crummey provision.
QUESTION: Which of the following types of qualified retirement plans can be integrated with Social Security?
I. A 401(k) plan (no match or company contribution)
II. A money-purchase plan
III. An ESOP
IV. A stock bonus plan
V. A defined benefit plan
A. I, II, III, IV
B. II, IV, V
C. III, V
D. II, V
E. All of the above
ANSWER: B. ESOPs and 401(k) plans with no employer matching contributions cannot be integrated with Social Security. Item I does indicate a pure 401(k) with no match or profit sharing contribution plan. Defined benefit and money purchase pension plans can be integrated. Stock bonus plans can be integrated.
QUESTION: Bill Williams, CFP®, wrote a plan for his client, Sally Linton, age 58. Sally indicated she would work for 9 more years until her FRA (full retirement age) to qualify for full Social Security and maximum qualified plan benefits. One month later Sally unexpectedly quit her job. The facts are, however, that the company she worked for was sold to a competitor and her position was eliminated. The new company offered her an unacceptable position. Now Sally realizes, at 58, with outdated skills, retirement is her only option. Sally indicates to Bill she is willing to sell her second home at the beach. How should Bill proceed?
A. Make no recommendations until Sally sells the second home.
B. Advise Sally to go back to her employer and take the position.
C. Review Sally’s current lifestyle and expenses and establish a budget until the second home sells.
D. Advise Sally to apply for unemployment benefits.
E. Ask Sally to come back in a few days. The planning needs to be reevaluated.
ANSWER: C. Bill has all of Sally’s data. He just completed a plan. Sally is upset, she needs advice now. Making her wait might make her more upset. In creating the plan, Bill did assess Sally’s current lifestyle and expenses. Sally can’t file for unemployment insurance benefits because she terminated voluntarily. Sally clearly does not want to take the newly offered position.
QUESTION: Your client, Mrs. Cates, died 6 months ago. Her family inherited almost $5 million without shrinkage from federal estate tax. Mrs. Cates property generally received a step-up in basis. Her son, Caleb, received $2 million from his mother’s estate. Caleb deposited the money into a joint account that he and his wife have maintained for years. Caleb and his wife, Cindy, had been your clients before Mrs. Cates died. The account, which holds other assets in addition to the inheritance has a current FMV of $3.5 million. This morning Caleb called to request $100,000 in cash, (not a check) from the account. This is a very unusual request, so you ask Caleb the reason for the withdrawal. He says he needs it to pay his mistress in exchange for her agreeing not to tell Cindy about the affair. What should you do?
A. Call Cindy for authorization to make the distribution (joint account)
B. Tell Caleb that you will ignore federal money laundering rules, and hide the distribution from your compliance officer.
C. Tell Caleb that this situation creates a conflict of interest for you and that and cannot proceed with the withdrawal without Cindy’s consent
D. Terminate the relationship. Make arrangements to pay him $100,000 in the form of a joint check
C. This situation creates a serious conflict of interest for you because you were hired by both Caleb and Cindy. The account is joint property Due to federal money laundering rules, brokerage firms generally will not facilitate substantial distributions in cash. Obviously, Caleb does not want Cindy to learn about his request for the money.
Which of the following risks is not present in an investment in zero coupon bonds?
A. Interest rate risk
B. Market risk
C. Reinvestment rate risk
D. Purchasing power/inflation risk
E. Default risk
ANSWER: C. One advantage of a zero-coupon is the elimination of reinvestment rate risk because there is no coupon to be reinvested. The zero-coupon bond is generally subject to market risk, interest rate risk, and, if the zero is not a Treasury security,
Mrs. Kalish, age 82, gifted the following assets over the past three years. Three years ago, she gifted a stock portfolio with a basis of $1million and a FMV of $1.5 million currently worth $2 million. Two years ago, she placed $2 million in a 5 year GRAT with a gift tax value of $1.25 million, currently worth $2.4 million. One year ago, she gifted a whole life insurance policy with a face value of $1 million and an interpolated terminal reserve plus unearned premium of $100,000. This year, because she is sad over the passing of her pet cat, Melina, she gave $100,000 to the Society for the Prevention of Cruelty to Animals. Mrs. Kalish passed away today. Which of the following is true?
A. All the assets shown above will be included in Mrs. Kalish’s gross estate at FMV (throwback rule).
B. If her daughter sells the stock, she will have to pay tax on $500,000 at LTCG rates.
C. $3.4 million of the assets will be included in Mrs. Kalish’s gross estate.
D. The stock is not included in her gross estate because she lived 3 years following the transfer.
ANSWER: C. No 3-year throwback rule applies to stock. Because it was a taxable gift it will be added to the taxable estate rather than be included in the gross estate. The stock was gifted to the daughter. Thus, the daughter’s carryover basis is $1 million, which, given the $2 million in sales proceeds produces a capital gain of $1 million. The GRAT (5 year) and the life insurance (3-year rule) are included in the gross estate. The GRAT assets would be included in Mrs. Kalish’s gross estate likely at date of death FMV because she died before the end of the term of the trust. The life insurance policy would be included in her gross estate at face value because Mrs. Kalish had held incidents of ownership in the three-year period prior to her death.
Robert Zimmerman owns Smokey Bacon, Inc. Smokey Bacon provides a profit sharing 401(k). Robert makes the maximum elective deferral, and with the company match and typical forfeitures, annual additions have ranged between $20,000 - $25,000. He has started another company, Eggcellent Eggs, Inc. with some good friends, and they are considering a profit sharing 401(k) plan for Eggcellent Eggs. Robert will be a controlling shareholder in Eggcellent Eggs. Given Robert’s positions, which of the following statements is true?
A. Robert cannot be a participant in the Egcellent Egg’s profit sharing 401(k) plan.
B. Since Robert is fully participating in the Smokey Bacon profit sharing plan, he cannot participate in Eggcellent Eggs profit sharing plan (related employers).
C. Robert is limited to the littlest of 25% of covered compensation or $61,000 (2022) for annual additions provided by both Bacon and Eggs.
D. He cannot defer any compensation into Eggcellent Egg’s 401(k) plan.
ANSWER: D. He can be a participant in Eggcellent Egg’s plan for profit sharing contributions but not elect any more deferrals. Answer C is incorrect because his annual additions limit (for both plans combined) is the lesser of 100% of compensation or $61,000 in 2022 (Bacon and Eggs are related employers).
Your client, Byron Sheridan, died recently at the age of 83. He is married to Virginia, age 83. Byron enjoyed managing his investments and diversified his invested assets among several asset classes. When Byron died, he held the asset listed below. Which of them would be eligible for a step up in basis?
A. A $100,000 CD now worth $105,000 (acquired 5 years ago).
B. A municipal bond purchased at a discount ($95,000) two years ago now having a date of death FMV of $100,000
C. Stock purchased 6 months ago for $50,000 that created a $10,000 STCL.
D. An annuity purchased 10 years ago for $100,000 having a date of death FMV of $115,000.
ANSWER: B. The municipal bond was held for the long- term and is eligible for stepped up basis upon Byron’s death. The tax deferred accounts such as an annuity (and retirement accounts, generally do not step up in basis.) The CD is cash. There is no stepped up basis; a dollar is a dollar.
QUESTION: PDQ common stock has experienced the following returns over the past 4 years.
Year 1: -20%
Year 2: +10%
Year 3: +10%
Year 4: -40%
Which of the following is true about the standard deviation for PDQ?
A. The standard deviation is negative.
B. The information provided is insufficient to calculate standard deviation.
C. Only three years of returns can be used to determine standard deviation accurately.
D. The standard deviation of PDQ is 24.5%.
ANSWER: D. Calculating was not needed to answer this question. There is no limit as to the number of years of return outcomes used to determine the standard deviation of a stock. The information necessary to calculate the standard deviation for PDQ, namely return outcomes, is shown in the question data. Answer A is incorrect because standard deviation cannot be negative.
CONCEPT: Retirement Plan Rules
QUESTION: Brad participates in his employer’s SIMPLE plan. He is not an owner of the company. He plans to continue working indefinitely and continue making contributions to the SIMPLE. His birthday is February 16. What is his latest permissible required beginning date for distributions?
A. August 16 of the year in which he turns 72
B. April 1st of the year following year in which he turns age 72
C. April 1st of the year following year when he turns age 72 or actually retires
ANSWER: B. As in other IRA-type arrangements, for SIMPLE plans, the RBD is always the April 1st of the year following the calendar year in which the covered participant attains age 72. Although he continues to work for the employer providing the SIMPLE plan, Brad may not delay his first distributions beyond that date.
CONCEPT: MECs
QUESTION: Joan purchased a single premium whole life insurance policy in 2005. She paid one $30,000 premium for the coverage. The policy’s death benefit is $100,000. Today, the contract is worth $50,000 represented by $40,000 guaranteed cash value and $10,000 of dividend cash value. If Joan takes a policy loan of $30,000, which of the following is true?
A. She can receive the $10,000 of dividends tax-free, and $20,000 will be subject to ordinary income tax plus a 10% penalty.
B. She can borrow $20,000 tax-free, but $10,000 will be subject to ordinary income taxes plus a 10% penalty.
C. $20,000 will be subject to ordinary income tax plus a 10% penalty, and $10,000 will be a tax-free return of basis.
D. The entire $30,000 will be subject to ordinary income tax plus a 10% penalty.
ANSWER: C. A single premium policy purchased after 1988 is a MEC. Current CV $50,000 - basis $30,000 = $20,000 gain. Dividends in a MEC become taxable when borrowed or withdrawn. Joan’s gain is $20,000; $10,000 is her true basis in the policy. Dividends under a MEC are generally taxed. Only the gain is subject to the 10% penalty in addition to tax at ordinary rates.
Due to impressive growth rates in recent years, T Max, Inc. is concerned about its exposure to the corporate AMT. The company owns four substantial life insurance policies which fund a stock redemption buy-sell agreement. The officer owners have decided to switch to a cross purchase buy-sell agreement. What can or should be done with the life insurance policies that are now owned by T Max, Inc.?
Answers:
A. Use the existing life insurance policies to fund the cross-purchase buy-sell agreement(s).
B. Retain the policies for key-person coverage.
C. Sell the policies to the insureds, if they are interested, or surrender the policies.
D. Do not worry about it since the new tax law eliminated the corporate AMT.
ANSWER: D. If the owners who had been covered under the corporation’s stock redemption (entity) buy –sell agreement wish, they may buy the policies on their own lives that were acquired to fund that arrangement. Since the sales of the policies will be to the insureds, there is no exposure to transfer-for-value income taxation of the death proceeds. Answer A will trigger transfer-for-value problems. In answer C, surrendering the policies is not an option as they still need the buy/sell policies. Answer D is true, the new tax law eliminated the corporate AMT.
CONCEPT: American Opportunity Credit and Lifetime Learning Credit.
QUESTION: Lamar and Abby Sanford, who have three teenage and pre-teen children, are confused about the differences between the American Opportunity Credit (AOC) and the Lifetime Learning Credit). How would you answer the Sanfords?
A. If you elect a full Lifetime Learning Credit you cannot claim an AOC for the same expense in the same year.
B. The maximum amount of the AOC is $2,000 plus 25% of the next $2,000 for a total of $2,500 per tax year. The maximum amount of the Lifetime learning credit is $2,000 per year.
C. The Lifetime Learning Credit is no longer available after the student turns age 30.
D. The AOC is available for both undergraduate and graduate post-secondary education.
ANSWER: A. Answer B is incorrect. The AOC is per eligible student, per year. If a family has three children in college in the same year, each is eligible for the full AOC. Lifetime is maximum per year. The AOC is available only for the first four years of post-secondary education. No age limit applies to the Lifetime Learning Credit.
CONCEPT: NPV
QUESTION: Your client Bob made an investment in a commercial property. Given the risk this investment carries, he had a required rate of return of 10%. He recently sold the property and has asked you whether the investment was profitable. Was it?
A. Yes, the investment was profitable, but only if the NPV of its cash flows was positive
B. Yes, the investment would meet Bob’s required rate of return if the NPV was zero.
C. No, the investment would not be profitable if its NPV was negative
D. Yes, the investment was profitable presuming that its NPV was greater than Bob’s 10% required rate of return.
ANSWER: B. When, given the cash flows of an investment its NPV is zero, the investment met the buyer’s required rate of return. An investment can be profitable even its NPV is negative. A positive or a negative NPV tells whether the client achieved his required rate of return, but not the amount of the profit.
CONCEPT: Gross Estate
QUESTION: Your client Bob Brubaker died three months ago. Which of the following items must be included in his gross estate for federal estate tax purposes?
A. A life insurance policy owned by Bob’s daughter, Roberta. She is the beneficiary of the policy which has a death benefit of $10 million
B. $6 million of taxable gifts that Bob made to others during his lifetime
C. A general power of appointment Bob had on his deceased mother’s trust
D. Stocks and bonds gifted to his ex-wife who is a resident alien
ANSWER: C. Property subject to general powers of appointment is included in the gross estate of the holder of that power. The life insurance policy is owned by Roberta. The taxable gifts are added to the taxable estate. Transfers to Bob’s ex –wife may or may not be taxable gifts however, they are added to the taxable estate rather than included in the gross estate.
CONCEPT: MEC
QUESTION: Which of the following are amounts received by the owner of a life insurance policy would be treated as income-first distributions under a MEC contract?
I. Cash dividends
II. Interest accrued on a policy loan (added to the loan balance)
III. Dividends retained by the insurer to purchase “paid-up” additions
IV. Dividends retained by the insurer as principal or interest to pay off a policy loan
A. All of the above
B. I, II, IV
C. II, III
D. III, IV
ANSWER: B. When policy dividends from modified endowment contracts (MECs) are used like cash, they are distributed under FIFO rules such as those applicable to annuity distributions. Cash distributions, and dividends used to pay off policy loans are considered to be income first distributions. The interest accruing on a policy loan from a MEC is treated the same way for federal tax purposes. Dividends used to buy paid up (permanent) additions are not treated as income-first distributions. The loan interest was not distributed: It was added to the outstanding loan balance.
CONCEPT: Trust Types
QUESTION: Both of Rusty Whitman’s parents recently died in an auto accident. Rusty is 12 years old. Before their death, the Whitman’s had established various trusts including revocable living trusts (each parent), an irrevocable life insurance trust, and a 2503(c) minor’s trust. While Rusty is younger than age 21, the trust earnings will support his living needs. Into which of the following trusts will Rusty’s parents’ assets ultimately pass?
A. A revocable living trust
B. A 2503(c) trust
C. A Crummey trust
D. A Standby trust
E. A Family trust
ANSWER: E. The revocable trust will become irrevocable and will operate as a family trust for Rusty’s benefit thereafter. It is rare that a revocable trust would name its beneficiary as a 2503(c) children’s trust. 2503(c) trusts generally terminate when the minor beneficiary turns age 21.
CONCEPT: ADV
QUESTION: SEC registered advisers with AUM at least $100 million – are required to file annual updates to their ADV within _____ days of the end of their fiscal year.
A. 30
B. 60
C. 90
D. The number of days following the end of the adviser’s fiscal year depends on the state in which the firm maintains its office.
ANSWER: C. Federal covered advisers must update their ADV forms no later than 90 days following the close of their fiscal year. Smaller advisers that have registered with states securities regulators will comply with state specific deadlines for annual updates to their ADVs or equivalents.
CONCEPT: Gross Estate
QUESTION: George and Linda gifted $106,000 to an irrevocable living trust that includes Crummey provisions. The trust has named their two twin nephews, Larry and Barry as its beneficiaries. George and Linda consent to gift splitting. When George or Linda dies, how much, if any, of the gift will be brought back into their gross estate(s)?
A. -0-
B. $23,000
C. $46,000
D. $106,000
ANSWER: A. A gift of cash to an irrevocable living trust is irrevocable and removed from their gross estates for federal estate tax purposes. While both George and Linda will have made taxable gifts of $21,000, that is not reflected in their gross estate (s). Rather, it is added to their taxable estate(s) to arrive at the tax base. ($106,000 - [$64,000 ($16,000 x 4)] = $42,000. 42,000 / 2 = $21,000 each.
CONCEPT: Section 121 Exchange
QUESTION: Mr. and Mrs. Iverson, who file their federal income taxes jointly, sold their home for a $400,000 gain. Under Section 121, they were eligible to exclude the entire gain from their gross income. They used the proceeds of the (first) home sale to purchase another home. Now, a year and a half later, they sold the second home for a $50,000 gain. How much of the gain must they report for federal income tax purposes?
A. -0-
B. $12,500
C. $37,500
D. $50,000
E. $450,000
ANSWER: D. The Section 121 exclusion may be elected every two years. The Iversons only owned their second home for a year and a half. Since the question did not indicate that the Iversons sold their second home because of a job change, divorce, or unforeseen circumstance, they could not prorate the exclusion amount.
CONCEPT: Time-Weighted vs Dollar-Weighed Return
QUESTION: Which of the following statements is true regarding differences between time-weighted return and dollar-weighted return?
A. The time-weighted return and the dollar-weighted return are essentially different words that express the same calculation: They are Interchangeable.
B. The reason to calculate the time-weighted return rather than the dollar-weighted return is to evaluate the performance of the portfolio manager.
C. The reason to calculate the dollar-weighted return rather than the time-weighted return is to evaluate the performance of the portfolio manager.
D. The reason for calculating the time-weighted return rather than the dollar-weighted return is to identify the strategy that would eliminate reinvestment rate risk in the portfolio.
ANSWER: B. The time-weighted return is the geometric mean calculation. The dollar-weighted return is the IRR.
CONCEPT: Disability Insurance
QUESTION: Your client, Tom Adkins is concerned about his disability income insurance policy. When he bought the policy, the agent told him the company would not change the premium at any time. What should he look for in the policy provision?
A. Loss of income benefit determination
B. Guaranteed renewability
C. Own occupation definition of total disability
D. Non-cancelable continuation
E. Unilateral contract application
ANSWER: D. Non-cancellable policies provide premium rates that are guaranteed not to increase in the future. Insurance is a unilateral contract, which means that the insured pays the premium to the insurance company to cover the perils, but that does not answer this question.
CONCEPT: Profit-sharing plans
QUESTION: Which of the following statements is (are) true about profit-sharing plans?
I. They may be integrated with Social Security.
II. They may receive contributions for individual employees in excess of 25% of that participant’s eligible compensation.
III. They generally permit the employer to make flexible contributions.
IV. They may be age weighted.
A. I, II, III, IV
B. I, II, III
C. I, III
D. I, IV
E. III and IV
ANSWER: A. Qualified profit-sharing plans feature flexible employer contributions. They may be age weighted and integrated with Social Security. While the employer may contribute and deduct up to 25% of its overall payroll, the contribution for an individual participant may exceed that percentage.
CONCEPT: Insurance
QUESTION: Mrs. Roberts, age 60, is about to purchase a life insurance policy for estate planning purposes. She wants you to help her determine which policy she should buy. Various life insurance agents have proposed that she acquire one of the following policies:
* A whole life policy with Insurance Company A. The illustration shows premiums are paid in full with dividends in 10 years. (They vanish.)
* Universal life policy with Insurance Company B. The illustration shows the death benefit will be zero at age 95 based on current interest assumptions
* Whole life policy with Insurance Company C. The illustration shows premiums are paid in full with dividends in 15 years. (They vanish.)
On what criteria would you base your advice to Mrs. Roberts?
I. Review the insurance company’s ratings (A. M. Best etc.)
II. Review the size of the insurance company.
III. Review the insurance company’s past history of paying claims and its future ability to pay.
IV. Review the insurance agents’ competence, knowledge, and reliability.
V. Review whether the whole life insurance premiums will vanish and whether the universal life policy will pay the death benefit to the insured’s age 95
A. All of the above
B. I, III, IV, V
C. I, III, IV
D. III, IV, V
E. II, V
ANSWER: B. High ratings from two or three rating agencies should indicate that the insurance company is well able to pay its claims. The size of an insurance company is not necessarily an indicator of its financial strength. The experience and reliability of the insurance agent matters. The NAIC prohibits language indicating that the whole life premiums will vanish or the UL will last to age 95. In fact, the NAIC prohibits such language.
CONCEPT: Deductions to determine AGI
QUESTION: Chris Towns is the self-employed owner of the Chris Craft Stores. He reports profits or losses from his business on Schedule C. Chris Craft Stores has 10 employees. The business is very successful. As a result, the business is able to fund various employee benefits for Chris and his employees. Which of the following current benefits are either added to the front of Chris’s 1040 as part of gross income or are shown as deductions on the front of the 1040 to determine AGI?
I. Group life insurance having a death benefit of $200,000 under which Chris is the named insured
II. A SEP contribution for Chris
III. Net profit from Chris Craft Stores of $350,000
IV. A spousal IRA contribution by Chris to his wife’s account
V. Group health insurance premiums himself and his wife
A. All of the above.
B. I, II, III, V
C. I, II, III
D. II, V
E. III and IV
ANSWER: B. Because the face value of the group life insurance exceeds $50,000, the premium on the face value exceeding that amount is treated as compensation and becomes part of Chris’s gross income. The SEP contribution and the health insurance premiums for Chris and his wife are deductions for AGI (above the line deductions). The net profit from this unincorporated business represents income to Chris: It is part of his gross income. Chris’s income, which clearly exceeds phaseout limits, makes his wife ineligible for the spousal IRA deduction.
CONCEPT: ESOP Taxation
QUESTION: Bill has retired. His company provided an ESOP. Stock with a basis of $50,000 was contributed to Bob’s ESOP account. At Bill’s retirement stock having a market value of $125,000 was distributed to him. Six months after retirement, Bill sold all the shares for $150,000. Which statement below best Bill’s tax situation?
A. $50,000 was taxed as ordinary income when Bill retired; $75,000 will be taxed at LTCG rates at the time of sale, and $25,000 will be taxed at STCG rates when Bill sells the stock.
B. $150,000 will be taxed at LTCG rates when Bill sells the stock.
C. $100,000 will be taxed at LTCG rates when Bill sells the stock.
D. $50,000 was taxed as ordinary income when Bill retired; $100,000 will be taxed at LTCG rates when Bill sells the stock.
ANSWER: A. The unrealized appreciation is taxable as long-term capital gain to Bill when the ESOP shares are sold, even if they sold immediately. If Bill holds the shares for a period of time after distribution, any additional gain (above the net unrealized appreciation) is taxed as long or short-term capital gain, depending on the holding period. The $25,000 gain above the distribution price of $125,000) and the sale price of $150,000 is STCG because Bill held the shares for only 6 months after they were distributed to him.
CONCEPT: Retirement Plan Types
QUESTION: An employee contribution to which of the following plans is not subject to FICA and FUTA taxes?
A. Profit sharing 401(k)
B. SIMPLE IRA
C. SARSEP
D. 403(b)
E. Section 125 plan
ANSWER: E. A 125 is a flexible spending account (FSA) into which contributions are elected before the employee compensation is actually earned. All the other plans shown require FICA and FUTA tax on employee deferrals.
CONCEPT: Basis on inherited stock
QUESTION: Several years ago, Mrs. Pike purchased XYZ stock for $100,000. The stock was such a good investment that she bought additional shares from year to year. The additional purchases were for $10,000, $25,000, $35,000, and $20,000, respectively. On the day when Mrs. Pike died, the stock had an FMV of $500,000. Mrs. Pike’s grandson, Paul inherited the stock. He then invested his entire yearly performance bonus of $15,000 in the same stock. Six months later, he has decided to sell all the stock. What will be the taxable event if the stock Mrs. Pike bequeathed to Paul has an FMV of $600,000 and the stock that he purchased has a FMV of $25,000?
A. $110,000 of long-term capital gains
B. $410,000 of long-term capital gains and $10,000 of short-term capital gains
C. $110,000 of short-term capital gains
D. $100,000 of long-term capital gains and $10,000 of short-term capital gains
ANSWER: D. Paul’s gain from the sale of the stock bought with his performance bonus produces a short-term capital gain of $10,000. The gain on the amount of the stock that Paul inherited is LTCG.
CONCEPT: Transfer for value, gross estate
Former college roommates Barbara and Kathy are 50/50 owners of BK, Inc. When they started BK, the corporation acquired two $1,000,000 face value key-person term life insurance policies. Barbara is the named insured in one policy and Kathy in the other. Over the years, the company has paid $5,000 in premiums on Barbara’s policy and $4,000 in premium on Kathy’s policy. Barbara and Kathy have decided to use the policies to back a new cross purchase buy-sell agreement. If Barbara buys the policy in which Kathy is the named insured paid by BK, what will be the tax outcome if Kathy dies within one year following Barbara’s acquisition of the policy?
A. Barbara will receive $1,000,000 income tax-free (term insurance exclusion).
B. The policy will be subject to the transfer for value rule making the death benefit net of basis subject to federal income tax.
C. The policy will be included in Kathy’s gross estate for federal estate tax purposes (3-year rule).
D. The policy’s death proceeds will increase the fair market value of BK, Inc. by $1,000,000.
ANSWER: B. The policy was sold to someone other than the insured or to a business in which the buyer is an owner or partner. Whether the policy is term or permanent insurance is immaterial to the rule. Transfer for value rules makes the policy’s death benefits income taxable to the beneficiary to the extent that it exceeds basis. The 3-year rule doesn’t apply when a sale (transfer for value occurs).
CONCEPT: Earned Income Sources
QUESTION: Millie Tilley has the following income. How much of it would be treated as earned income for federal income tax purposes?
I. $50,000 in wages from Plant Parenthood, an S corporation Milllie works for Plant Parenthood as a landscaper.
II. $5,000 in dividends from stock held in Millie’s investment account (non-qualified)
III. K-1 income of $10,000 from an S corporation in which Millie owns 20% of the equity and is and an active participant in the business
IV. Proceeds from the sale of an oil painting inherited from her great aunt that generated a $5,000 long-term capital gain
A. $70,000
B. $65,000
C. $60,000
D. $55,000
E. $50,000
ANSWER: E. Only Millie’s salary would be classified as earned income. The other answers indicate investment income which is, by nature unearned. K-1 from an S corporation represents a distribution of profits and thus, is treated as investment income. Although Millie is an active participant in the S corporation’s activity, this is true.
CONCEPT: Sale for value
QUESTION: Joan Thomas sells her term life insurance which has a face value of $200,000 policy to Linda Bell for $1,000. Joan dies five years later. Linda, who immediately named herself as beneficiary of the policy, paid $4,000 in premiums over the past five years. To what extent, if any, will the insurance policy proceeds be subject to federal income tax?
A. None of the death proceeds will be subject to federal income tax because term life insurance policy does not trigger transfer for value rules.
B. $199,000 will be taxable to Linda for federal income tax purposes.
C. $195,000 will be taxable to Linda for federal income tax purposes.
D. The $200,000 face value of the policy will be included in Joan’s gross estate for federal estate tax purposes.
ANSWER: C. Her payments increase her basis. When Joan sold the life insurance policy to Linda, that sale triggered transfer for value rules making the death proceeds in excess of basis taxable to the beneficiary who is now Linda. Linda will receive the death proceeds subject to federal income tax. When Joan dies, nothing attributable to the life insurance policy will be included in her gross estate. The 3-year throwback rule does not apply when a life insurance policy is sold.
CONCEPT: UTMA
QUESTION: This year, Joe Jackson started a 529 college savings plan for his sister’s son, Jimmy. He gifted $75,000 ($15,000 for five years) to a 529 plan that is operated by the state in which both he and Jimmy reside. However, Joe does not feel that the ending balance in the 529 account will be enough to pay for his nephew’s total college costs. Joe has observed that his sister and brother-in-law seem to live well beyond their means. His brother-in-law is an executive earning $500,000 per year. His sister and her husband travel extensively to compete in winter sports. They have not earmarked any money for their son’s education. Joe’s financial advisor said he could fund an UTMA with $50,000 and invest it in AA rated nationally diversified municipal bonds that would generate around $1,000 in annual income. The UTMA would increase by the interest on a tax-free basis and all the funds can be distributed Jimmy’s for college expenses. Joe could name himself as the custodian. How would you, a CFP ® practitioner respond if Joe asked you whether or not this advice is sound?
A. Advice should be implemented
B. The gift to the custodial account seems reasonable, but it would be treated as a taxable gift for federal gift tax purposes
C. He has already used up all of his annual exclusions for the next five years
D. The gift would have to be made first to his brother-in-law who would then in turn contributed to Jimmy’s UTMA.
ANSWER: A. Both B and C are true statements, but answer A is the best planning. The UTMA invested in municipal securities appears to be sensible while the transfer of the $50,000 to Jimmy’s custodial account is a taxable gift, Uncle Joe can use his gift tax property exemption of $12,060,000 to avoid current gift tax. Under kiddie tax rules, earnings generated by the UTMA may be taxed at 37% plus the 3.8% Medicare investments tax. In that light tax-free interest from municipal bonds make sense. The tax-free income should enable the account to have a FMV of $65,000 in 10 years.
CONCEPT: Income Tax Rules
QUESTION: Mrs. Tilden, a widow, has gifted extensively to her daughter, Sally. She used her entire gift property exemption amount and actually paid federal gift tax on her most recent gifts. Mrs. Tilden recently married Bill Widner. She is considering gifting him $1,000,000 with the written understanding that he will then gift the $1,000,000 to Sally. How would you respond after she explains her strategy?
A. This is an effective way to accomplish effective gift tax planning
B. The transfer of $1,000,000, reduced by one annual gift tax exclusion from Mrs. Tilden to Bill Widner will be a taxable gift.
C. Mrs. Tilden and Bill Widner need to be married for one year for this technique to work.
D. The transfer of $1,000,000 reduced by one annual gift tax exclusion from Mrs. Tilden to Bill Widner will be a non-taxable gift.
ANSWER: B. It appears that the gift will not qualify for the marital deduction. To qualify for the deduction, the donee spouse must be given the property outright or must have at least a right to the income from the property and a general power of appointment over the principal. The IRS would consider this to be a step transaction and thus a fraudulent transfer.
CONCEPT: Retirement Plan Type
QUESTION: Law school classmates, Mr. Ball and Mr. Desmond are both attorneys. At this time, their law practice which specializes in personal injury law, BaDe, PC (Professional corporation) does not provide any retirement plan. The two Counselors want to establish a qualified plan. They want a plan that requires no employee contributions nor mandatory annual employer contributions. BaDe currently has only two other employees who are part-time paralegals. The practice plans to hire another attorney. Which of the following plans would you recommend for BaDe, Attorneys at Law?
A. Given the current cash flow of BaDe and the objectives of its owners, no plan is recommended at this time.
B. A SEP
C. A Profit-sharing plan
D. A Profit-sharing 401(k) plan
E. A Defined-benefit plan
ANSWER: The profit-sharing plan best fits the objectives and preferences of Esquires Ball and Desmond. They do not want a plan that requires mandatory annual funding. The defined-benefit plan would not fit their model. The attorneys do not want to defer personal income. This eliminates the 401(k). The SEP is not a qualified plan. The SEP would probably have to cover part-time employees. Relative to the profit-sharing arrangement, the ERISA 1,000-hour rule would exclude the part-time employees from participating.
CONCEPT: Wash Sale Rule
QUESTION: Your client, Mr. Smith purchased and sold the following stocks during a two-year period. Which situation or situations below created a “wash” sale?
NOTE: All transactions are 100 share round lots.
I. March 1st purchased ABC @ $15; December 1st purchased ABC @ $10; December 31st sold ABC @ $10
II. November 30th purchased LMN @ $50; December 15th purchased LMN @ $52; December 29th sold LMN @ $54
III. January 1st purchased XYZ @ $60; February 15th sold XYZ @ $50; March 16th purchased XYZ at $52
A. I, II, III
B. I, III
C. I and II
D. II
E. III
ANSWER: C. The ABC and the XYZ transactions violate the wash sale rules
–ABC’s basis is $10 cost plus $5 recognized loss. (December 1st and December 31st)
–XYZ’s basis is $52 cost plus $10 recognized loss. (February 15 and March 16) There are only 28/29 days in February.
-LMN was sold for a gain.
The deduction is disallowed for any loss from any sale or other disposition of stock within a period beginning 30 days before and ending within 30 days after the date of the sale or disposition. A gain cannot create a wash sale.
CONCEPT: Social Security
QUESTION: Hal, age 63, is trying to decide whether he should begin taking Social Security benefit 36 months before his FRA. He is a fully insured worker. Regarding Hal’s situation, which of the following statements is correct?
I. Once Hal begins taking Social Security Retirement benefits, he will be eligible for Medicare.
II. Hal will receive 80% of his PIA that would apply at his FRA
III. If Hal works part-time, his benefits will be reduced by 20%.
IV. If Hal works part-time, his benefits will be reduced $1 for every $3 he earns above a specific earnings threshold.
V. If Hal does not work, his benefits may or may not be subject to federal income taxation.
A. I, II, III, IV
B. II, IV, V
C. III, IV
D. II, V
E. IV, and V
ANSWER: D. Hal will not be eligible for Medicare until age 65 (Answer I). Claiming benefits 36 months early would result in a 20% permanent reduction in Hal’s benefits (36/180). If Hal works part-time, before the year in which he reaches his full retirement age (FRA) his benefits will be reduced $1 for every $2 he earns above a specific threshold. During his FRA year only he will lose $1 in benefits for every $3 by which his earned income exceeds that threshold. Hal’s Social Security retirement benefits will be subject to federal income tax if his AGI plus ½ of his benefits (provisional income) exceed $25,000+. Given that we do not know Hal’s provisional income indeed his Social Security benefits may (or may not) be subject to federal income tax.
CONCEPT: Corporate Annual Reports
QUESTION: Corporate annual reports would generally not include which of the following?
A. Depreciation methods
B. Stock options
C. Profitability projections
D. Inventory methods
E. Outlook for the firm’s products in various industries in which it operates
ANSWER: C. Profitability projections should not be included in corporate annual reports. The SEC believes that such projections could mislead shareholders and others.
CONCEPT: Prepaid tuition plans
QUESTION: Mr. and Mrs. Grandparent have paid $50,000 into their granddaughter’s “prepaid tuition program.” The arrangement qualifies as a Section 529 program. Which of the following is true?
A. Prepaid tuition plans may only pay for tuition and mandatory fees.
B. Prepaid tuition plans do not affect the expected family contribution for determining available financial aid.
C. Prepaid tuition plans do not allow the beneficiary to attend a private or out-of-state college.
D. Prepaid tuition plans provide a rate of return that is linked directly to the return on the securities in which the prepaid tuition plan invests.
E. If the qualified higher education expenses (QHEE) are less than the total distributions, the distributions from the prepaid plan are then treated as taxable income.
ANSWER: A. If the beneficiary of a prepaid tuition (529) plan attends a private or out-of-state college, the program will determine the value of the contract. If the QHEEs are equal to, or greater than, the total distribution, they are tax-free. Prepaid tuition plans pay for tuition and mandatory fees. They do not cover room and board. Prepaid tuition plans do affect the expected family contributions.
CONCEPT: ERISA
QUESTION: Toby, age 72, has been taking distributions from his qualified plan. Now, to his dismay, he has been sued and lost in court. His only real asset is the qualified plan distributions. Can the plaintiff collect against his qualified plan distributions?
A. No, ERISA forbids “alienation of plan benefits.”
B. No, Toby can file for Chapter 7 bankruptcy and keep his plan benefits.
C. Yes, but only for a portion of the distributions
D. Yes, because that is his only asset
ANSWER: C. The anti-alienation provision only applies during the accumulation period, not after the account goes into pay status. Once the distributions are paid out, they become an asset of the participant, subject to any creditor’s claims that may be pending when the benefits are received.
CONCEPT: Trust Taxation
QUESTION: Mark Spout created an irrevocable trust for the benefit of his dependent children. Mark named the local bank as trustee of the trust and authorized it to invest in stocks, bonds, and negotiable certificates of deposit. Included in the investment authority is the right to use trust income to purchase insurance on Mark’s life. All funds are currently invested in high-yielding bonds paying 7% semiannual interest on a par value of $100,000. Twenty-five percent of the bond investment income is being used to pay the premium on a policy on Mark’s life. Which taxpayer must pay tax on the income of the trust and why?
A. The bank because of its broad authority as trustee
B. The children because the income is paid by them
C. The trust because it is irrevocable with no benefits to grantor
D. Mark because of the grantor trust rules
ANSWER: D. If any portion of the trust income is, or may be, used to purchase insurance on the life of the grantor or grantor’s spouse, then the trust is a grantor trust. The trust is/was also used to benefit his dependent children (support). 25% is to purchase insurance and the remainder is used for support.
