Retirement Planning Flashcards
Mary Anne has AGI of $1,000,000 (which is all comprised of earned income). She is single and age 55. She is not an active participant in her employer’s qualified plan. Which of the following statements best describes her options?
A.She can contribute to a Traditional IRA and deduct her contribution.
B.She can contribute to a Traditional IRA but not deduct her contribution.
C.She can contribute to a Roth IRA.
D.She cannot contribute to a Traditional IRA or Roth IRA.
Solution: The correct answer is A.
She can contribute and deduct her contribution to a Traditional IRA since she is not an active participant and therefore not subject to an AGI limitation. She is unable to contribute to a Roth IRA because she is clearly above the AGI limitation for the current year and filing status. Roth IRA contributions are based soley on AGI and not on participation in an employer’s plan.
The maximum contribution limits and AGI phase-outs are subject to annual increases. Familiarize yourself with the current year IRA limitations and phaseout ranges in the CFP Board Tax Tables Resource, Retirement Plan Limits & Phase-outs table. Note the deductibility with Traditional IRA contributions based on participation in employer qualified plan, filing status, and AGI limits. Roth IRA limitations are only based on filing status and AGI limits.
You have been hired to analyze the retirement prospects of Tom and Jerri Ruhn. It has been determined they need a retirement capital account of $2,750,000 at retirement which will occur in 30 years. They expect to live in retirement for 35 years. They are anxious to start a savings program to meet this goal. They anticipate an average after-tax rate of return equal to 7%. They are planning on 5% annual inflation. What level of savings put away at the end of each year will provide the Ruhn family with their desired retirement fund?
A.$27,208
B.$29,113
C.$67,787
D.$68,884
Solution: The correct answer is B.
The client has given us the capital account they want at retirement in 30 years. If it said in today’s dollars or the equivalent, then you would account for inflation. That information was a distractor in this question.
N = 30
I = 7
PV = 0
FV = 2,750,000
Solve for PMT=29,113
Match the following statement with the type of retirement plan which it most completely describes: “A qualified plan which allows employee elective deferrals of 100% of includible salary and has a mandatory employer match” is…
A.A Profit sharing plan.
B.A Money purchase plan.
C.A SIMPLE 401(k).
D.A Defined benefit plan.
Solution: The correct answer is C.
Profit sharing plans “A” are not contributory. Answers “B” and “D” do not permit employee elective deferrals.
Which of the following statements accurately reflect the characteristics of a Section 457 plan?
- Benefits taken as periodic payments are treated as ordinary income for taxation.
- Lump-sum distributions are eligible for 5-year and/or 10-year averaging.
- Deferred amounts to Section 457(f) plans are subject to Social Security and Medicare taxes at the later of performance of specific goals or employee becomes vested in the benefits.
- Income tax withholding is not required until funds are actually received, not constructively received.
- Cannot exceed the smaller of the indexed maximum employee deferral or 100% includible compensation.
A.I, III and V only.
B.II, IV and V only.
C.I, II, IV and V only.
D.I, II, III, IV and V.
Solution: The correct answer is A.
Statements I, III and V are accurate.
Statement II is inaccurate. Lump-sum distributions from Section 457 plans are not eligible for 5-year and/or 10-year averaging. This special tax treatment is available for certain qualified plans but not for 457 plans.
Statement I is accurate. Benefits taken as periodic payments from a Section 457 plan are indeed treated as ordinary income for taxation purposes. This aligns with the general tax treatment of distributions from most retirement plans.
Statement III is accurate. In Section 457(f) plans, deferred amounts are subject to Social Security and Medicare taxes at the later of when services are performed or when the employee becomes vested in the benefits. This ensures proper timing of FICA taxation. In addition, the vested amount is treated as ordinary income to the participant in the year of vesting, regardless of whether the participant actually withdraws the money.
In contrast, deferrals to Section 457(b) plans are subject to Social Security, Medicare, and applicable unemployment tax in the year of the deferral. These contributions are considered wages for employment tax purposes, even though they are pre-tax for income tax purposes. Amounts withdrawal from the plans are treated as ordinary income in the year of the withdrawal.
Statement IV is accurate. For Section 457 plans, income tax withholding is required when the amounts are made available to the participant, which can include constructive receipt. This differs from the statement’s claim that withholding is not required until funds are actually received.
Statement V is accurate. The contribution limit for Section 457 plans cannot exceed the smaller of the indexed maximum employee deferral or 100% of the participant’s includible compensation. This ensures that contributions are proportional to the employee’s earnings and within legal limits.
June and Bud, both 40 years old, are not covered by a qualified retirement plan. Bud, trying to maximize their IRA deduction, put $14,000 into an IRA with June as the beneficiary on December 15 of the current year. What best describes the result of this transaction?
A.June and Bud receive a tax deduction for the entire $14,000 because both spouses are eligible to contribute $7,000 to the IRA.
B.Bud receives a tax deduction for $7,000 and may be subject to a 6% penalty for over-contribution on the other $7,000.
C.Next year Bud will receive a $7,000 deduction, in addition to the $7,000 deduction for this year.
D.Bud receives a tax deduction for $7,000 and is considered to have made a non-deductible contribution of the other $7,000.
Solution: The correct answer is B.
This question indicates an IRA in only Bud’s name. One individual’s maximum contribution is less than $14,000 for the current year. Amounts contributed over the current year’s maximum contribution are considered excess contributions and subject to a 6% penalty if not removed by the due date of the tax return for the year impacted. The spouse as a beneficiary does not allow excess contributions, nor is there any carryforward feature of IRA contributions. The 6% penalty may be avoided if the excess contribution is withdrawn prior to taxpayer’s filing deadline. Consult the Dalton Education Tax Resource for current IRA contribution maximums.
Maximum IRA contributions and the AGI phase-out numbers are subject to annual increases. Consult the CFP Board Tax Tables Resource, Retirement Plan Limits & Phase-outs for the most current information. The CFP exam questions will likely require knowledge about the tax laws and application of specific annual numbers for the year being tested in that exam cycle.
Qualified retirement plans have which of the following characteristics?
- Employees with one year of service and attained age 21 must be participants in the plan.
- Fund earnings are usually not taxed until distributions are received by the employee.
- All lump-sum distributions are eligible for five-year forward averaging tax treatment.
- Employer contributions to the plan are deductible in the year they are made (or deemed made), subject to IRC Section 415 limits.
A.I and III only.
B.II and IV only.
C.I and II only.
D.III and IV only.
Solution: The correct answer is B.
Maximum waiting period for qualified plans is two years (except for SEPs [employer sponsored tax advantaged plan] which can have a 3-year waiting period). No lump sum distributions are eligible for 5-year averaging after December 31, 1999.
Three years ago, Ernest converted his Traditional IRA to a Roth IRA. He was 35 years of age at the time and had never made a contribution to a Roth IRA. The conversion was in the amount of $60,000 ($10,000 of contributions and $50,000 of earnings). Over the past three years he has also made $15,000 in total annual contributions. This current year, he withdrew the entire account balance of $100,000 to pay for a 1-year trip around the world. Which of the following statements is true?
A.$25,000 of the distribution will be subject to income tax and $85,000 of the distribution will be subject to the 10% early withdrawal penalty.
B.$25,000 of the distribution will be subject to income tax and the 10% early withdrawal penalty.
C.Some of the distribution will be taxable but the entire distribution will be subject to the 10% early withdrawal penalty.
D.None of the distribution will be taxable nor will it be subject to the 10% early withdrawal penalty.
Solution: The correct answer is A.
Roth distributions are tax free if they are made after 5 years and because of 1) Death, 2) Disability, 3) 59.5 years of age, and 4) First time home purchase.
He does not meet the five year holding period or one of the exceptions. His distribution does not receive tax free treatment.
The treatment for a non-qualifying distribution allows the distributions to be made from basis first, then conversions, then earnings. His basis will be tax free. The conversion is also tax free since he paid tax at the time of the conversion on those earnings.
The remaining earnings since establishment of the Roth are $25,000 ($100,000 - $15,000 in basis - $60,000 in conversions) and will be taxed. The 10% penalty applies to this distribution since he does not qualify for any of the exceptions to the penalty. While the contributions escape penalty, the conversions and earnings of $85,000 are subject to the 10% early withdrawal penalty. Remember that in order for the conversions to escape the 10% early withdrawal penalty the distribution must occur after a 5 year holding period beginning Jan 1 in the year of conversion or meet one of the 10% early withdrawal exceptions.
Summary:
$60,000 paid tax at conversion. Subject to penalty
$15,000 in contributions no tax, no penalty
$25,000 earnings. Taxable and subject to penalty
Distribution of 100,000: $25,000 is taxable, $85,000 subject to penalty
Which of the following will be subject to a 10% early withdrawal penalty?
A.Sylvia, age 56, retired from Marshall Corporation. She takes a $125,000 distribution from the Marshall Corporation Defined Contribution Retirement Plan to pay for living expenses until she is eligible for Social Security.
B.Terry quits Shoe Shine Company at age 48. He begins taking equal distributions over his life expectancy from his qualified plan after separating from service. The annual distribution is $2,000.
C.Kevin’s wife had a baby 10 days ago. He withdrew $2,000 from his IRA to cover costs for baby furniture, diapers and carseats.
D.Edward, age 40, takes a $40,000 distribution from his profit-sharing plan to pay for his son’s college tuition.
Solution: The correct answer is D.
There is no provision for a distribution without penalty under this circumstance. Edward is only 40 and education withdrawals are allowed in IRAs, not from qualified plans.
SECURE Act 2019 added penalty free withdrawals up to $5,000 taken within 12 months of birth or legal adoption.
RCM Incorporated sponsors a qualified plan that requires employees to meet one year of service and to be 21 years old before being considered eligible to enter the plan. Which of the following employees are not eligible?
Donald, age 18, who has worked full-time with the company for 3 years.
Rachel, age 22, who has worked full-time with the company for 6 months.
Randy, age 62, who has worked 400 hours per year for the past 2 years.
Theodore, age 35, who has worked full-time with the company for 10 years.
A.IV only.
B.I and II only.
C.III and IV only.
D.I, II and III only.
Solution: The correct answer is D.
RCM cannot exclude anyone who has attained age 21 and has completed one year of service with the company with 1,000 hours during that year. For Randy to be eligible, he would need to be a long-term part-time employee with 500+ hours for the last three years (per SECURE Act).
Angelo’s Bakery has 105 employees. 90 of the employees are nonexcludable and 15 of those are highly compensated (75 are nonhighly compensated). The company’s qualified profit sharing plan benefits 8 of the highly compensated employees and 40 of the nonhighly compensated employees. Does the profit sharing plan sponsored by Angelo’s Bakery meet the coverage test?
A.Yes, the plan meets the average benefits percentage test.
B.Yes, the plan meets the general safe harbor test.
C.Yes, the plan meets the ratio percentage test.
D.Yes, the plan meets ratio percentage test and the general safe harbor test.
Solution: The correct answer is C.
The plan meets the ratio percentage test. The percentage of NHC employees covered by the plan is 53.33% and the percentage of HC employees covered by the plan is 53.33%. The ratio percentage of the NHC employees covered by the plan compared to the ratio percentage of the HC employees covered by the plan is 100% (53.33% / 53.33%) which is greater than the ratio requirement of at least 70%.
Which of the following is not a qualified retirement plan?
A.ESOP.
B.401(k) plan.
C.403(b) plan.
D.Target benefit plan.
Solution: The correct answer is C.
A 403(b) plan is a tax-advantaged plan, not a qualified plan. All of the others are qualified plans.
Wilber receives incentive stock options (ISOs) with an exercise price equal to the FMV at the date of the grant of $15. Wilber exercises these options 3 years from the date of the grant when the FMV of the stock is $35. Wilber then sells the stock 3 years after exercising for $45. Which of the following statements is (are) true?
A.At the date of grant, Wilber will have ordinary income equal to $15.
B.At the date of exercise, Wilber will have W-2 income of $20.
C.At the date of sale, Wilber will have long-term capital gain of $30.
D.Wilber‘s employer will have an income tax deduction related to the exercise of the option by Wilber.
Solution: The correct answer is C.
Choice a is not correct as there is no income at the date of grant because the strike price equals the FMV. Choice b is not correct as there is no regular tax for ISOs. Choice d is not correct because the employer will not have an income tax deduction.
Grant 15
Exercise @35 (AMT adjustment of $20)
Sale $45
$10 LTCG from gain (exercise to sale)
$20 LTCG from exercise
Total $30 LTCG
More information can be found in the inforgraphics posted in Blackboard, under helpful documents and infographics, scroll down for NQSO and ISO.
Kipton is an executive with BigRock. As part of his compensation, he receives 10,000 shares of restricted stock today worth $20 per share. The shares vest two years from today, at which point the stock is worth $30 per share. The vesting schedule is a 2-year cliff schedule. Kipton holds the stock for an additional 18 months and sells at $45 per share. Which of the following is correct?
A.The grant of stock is taxable to Kipton today.
B.The value of the shares is taxable to Kipton when the stock vests.
C.If Kipton were to make an 83(b) election, he would have converted $30 of the gain from ordinary to capital.
D.When Kipton sells the stock for $45 per share, his basis is $30 regardless of whether he files an 83(b) election.
Solution: The correct answer is B.
Choice a is not correct because the stock is forfeitable. Choice c is not correct because it would have converted $10, not $30. Choice d is not correct, because the basis would be different.
Marcus has been employed by GCD Enterprises for 15 years, and currently earns $60,000 per year. Marcus saves $15,000 per year. He plans to pay off his home at retirement and live debt free. He currently spends $12,000 per year on his mortgage. What do you expect Marcus’ wage replacement ratio to be based on the above information?
A.28.41%
B.33.02%
C.47.35%
D.55.00%
Solution: The correct answer is C.
Calculate the Wage Replacement Ratio:
Salary $60,000 100.00%
Payroll Taxes ($4,590) 7.65%
Savings ($15,000) 25.00%
Mortgage Paid-Off ($12,000) 20.00%
Costs in Retirement $28,410 47.35%
Jeff wants to retire in 15 years when he turns 65. Jeff wants to have enough money to replace 75% of his current income less what he expects to receive from Social Security at the beginning of each year. He expects to receive $20,000 per year from Social Security in today’s dollars. Jeff is conservative and wants to assume a 6% annual investment rate of return and assumes that inflation will be 4% per year. Based on his family history, Jeff expects that he will live to be 95 years old. If Jeff currently earns $100,000 per year and he expects his raises to equal the inflation rate, approximately how much does he need at retirement to fulfill his retirement goals?
A.$1,268,887
B.$2,242,055
C.$2,285,172
D.$3,057,348
Solution: The correct answer is C.
$100,000 current earnings x 75% replacement = $75,000 - $20,000 in SS benefits = $55,000 income in retirement.
Kyle is 54 and would like to retire in 11 years. He would like to live the “high” life and would like to generate 90% of his current income. He currently makes $150,000 and expects $24,000 (in today’s dollars) in Social Security. Kyle is relatively conservative. He expects to make 8% on his investments, that inflation will be 4% and that he will live until 104. How much does Kyle need at retirement?
A.$3,631,802
B.$3,423,275
C.$3,554,911
D.$3,480,448
Solution: The correct answer is C.
Salary = 111,000 (150,000* 90%) – 24,000 = 111,000
N = 11 years to retirement
I = 4% inflation
PV = 111,000 in salary
Solve for FV
Answer = 170,879.4003
beg mode
PMT = 170,879.40
N = 39 (104 – 65)
I = 3.8462 Inflation adjusted rate of return = (1.08/1.04) – 1 * 100
Solve for PV
Answer = 3,554,911.3548
Answer a is the wrong payment (150,000 -24,000* 90%) = 113,400
Answer b is ordinary annuity (g end)
Answer d uses 4% for interest (g beg)
Jim, age 32, earns $65,000 per year. When he retires at age 62 he believes his wage replacement ratio will be 80% and Social Security will pay him $12,000 in today’s dollars. How much must Jim save at the end of each year and make the last payment at 62, if he can earn 10% on his investments, inflation is 3% and he expects to live until age 100?
A.$8,513
B.$6,513
C.$3,476
D.$10,543
Solution: The correct answer is A.
Step #1
N = 30 (62-32)
I = 3
PV = (65,000 × .80) – 12,000 = 40,000
PMT = 0
FV = ? = 97,090.50
Step #2 – BEGIN MODE
N = 38 (100 – 62)
I = (1.10) / (1.03) – 1 × 100 = 6.7961
PV = ? = 1,400,288.69
PMT = 97,090.50
FV = 0
Step #3 – END MODE
N = 30 (62-32)
I = 10
PV = 0
PMT = ? = 8,512.70
FV = 1,400,288.69
When calculating the Wage Replacement Ratio (WRR), what percentage of income is subtracted for a self-employed individual, under the Social Security wage base, for Social Security and Medicare Taxes excluding the Additional Medicare Tax?
A.7.65%
B.6.20%
C.15.30%
D.12.40%
Solution: The correct answer is C.
This is an important point to stress as many clients are self-employed and pay both employer and employee portions of the tax, 6.2% social security, 1.45% medicare (7.65%) for the employee portion, and the same for the employer portion for a total of 15.3% (7.65 + 7.65).
The following statements concerning retirement plan service requirements for most qualified plans are correct EXCEPT:
A.The term “year of service” refers to an employee who has worked at least 1,000 hours during the initial 12-month period after being employed.
B.If an employee hired on October 5, 20X1 has worked at least 1,000 hours or more by October 4, 20X2, he has acquired a year of service the day after he worked his 1,000th hour.
C.An employer has the option of increasing the one-year of service requirement to 2 years of service.
D.Once an employee, who is over the age of 21, attains the service requirement of the plan, the employer cannot make the employee wait more than an additional six months to participate in the plan.
Solution: The correct answer is B.
Option B is incorrect because the employee would NOT acquire a year of service the day after he worked his 1,000th hour, but after twelve months AND 1,000 hours.
Packlite company has a defined benefit plan with 200 non-excludable employees (40 HC and 160 NHC). They are unsure if they are meeting all of their testing requirements. What is the minimum number of total employees that must be covered on a daily basis to conform with the 50/40 test?
A.40
B.50
C.80
D.100
Solution: The correct answer is B.
The 50/40 rule requires that defined benefit plans cover the lesser of 50 employees or 40% of all eligible employees.
Here 40% would be 80, so 50 is less than 80. This would be the absolute minimum number of covered employees.
XYZ has a noncontributory qualified profit sharing plan with 310 employees in total, 180 who are nonexcludable (40 HC and 140 NHC). The plan covers 72 NHC and 29 HC. The NHC receive an average of 4.5% benefit and the HC receive 6.5%. Which of the following statements is (are) correct?
- The XYZ company plan meets the ratio percentage test.
- The XYZ company plan fails the average benefits test.
- The plan must and does meet the ADP test.
A.1 only
B.2 only
C.Both 1 and 2
D.1, 2, and 3
Solution: The correct answer is C.
The plan does not have to meet the ADP test because it is a noncontributory plan. The plan meets the ratio percentage test and fails the average benefits test.
Safe Harbor = 72 ÷ 140 = 51% = Fail
Ratio % = (72 ÷ 140) ÷ (29 ÷ 40) = 70.9% = Pass
Average Benefit = 4.5 ÷ 6.5 = 69.2% = Fail
Which of the following statements are reasons to delay eligibility of employees to participate in a retirement plan?
- Employees don’t start earning benefits until they become plan participants (except in defined benefit plans, which may count prior service).
- Since turnover is generally highest for employees in their first few years of employment and for younger employees, it makes sense from an administrative standpoint to delay their eligibility.
A.1 only
B.2 only
C.Both 1 and 2
D.Neither 1 nor 2
Solution: The correct answer is C.
Both Statements 1 and 2 are correct.
While most plans have age 21 and 1 year of service as an entry barrier, some plans do allow a two year eligibility as long as 100% vesting is provided.
An individual has determined utilizing the annuity method of capital needs analysis that he needs $1,045,656 at the beginning of his retirement to meet his retirement life expectancy goals. If this individual would like to be more conservative in his retirement planning forecast and maintain this capital balance throughout his retirement life expectancy of 32 years, given an expected earnings rate of 6%, and an inflation rate of 3% during the period, how much more would he need to have at the beginning of his retirement?
A.$162,032
B.$406,067
C.$417,246
D.$674,023
Solution: The correct answer is A.
N = 32
I = 6%
FV = $1,045,656
PMT = $0
PV = $162,032 (Answer)
Which of the following statements concerning the use of life insurance as an incidental benefit provided by a qualified retirement plan is (are) correct?
The premiums paid for the life insurance policy within the qualified plan are taxable to the participant at the time of payment.
Under the 25 percent test, if term insurance or universal life is involved, the aggregate premiums paid for the policy cannot exceed 25 percent of the employer’s aggregate contributions to the participant’s account. If a whole life policy other than universal life is used, however, the aggregate premiums paid for the whole life policy cannot exceed 50 percent of the employer’s aggregate contributions to the participant’s account. In either case, the entire value of the life insurance contract must be converted into cash or periodic income, or the policy distributed to the participant, at or before retirement.
A.1 only
B.2 only
C.Both 1 and 2
D.Neither 1 nor 2
Solution: The correct answer is B.
Statement 1 is incorrect. The economic value of pure life insurance coverage is taxed annually to the participant. Statement 2 is correct because the 25 percent test is actually a misnomer, for it is really two tests: a 25 percent test and a 50 percent test, depending on which type of life insurance protection is involved.
Robbie is the owner of SS Automotive and he would like to establish a qualified pension plan. Robbie would like most of the plan’s current contributions to be allocated to his account. He does not want to permit loans and he does not want SS Automotive to bear the investment risk of the plan’s assets. Robbie is 32 and earns $700,000 per year. His employees are 25, 29, and 48 and they each earn $25,000 per year. Which of the following qualified pension plans would you recommend that Robbie establish?
A.Target benefit pension plan
B.Cash balance pension plan
C.Money purchase pension plan
D.Defined benefit pension plan using permitted disparity
Solution: The correct answer is C.
Because Robbie does not want SS Automotive to bear the investment risk of the plan assets, the money purchase pension plan or the target benefit plan would be the available options to fulfill his requirements. The target benefit plan would not fulfill Robbie’s desires because as a percentage of compensation, older employees receive a greater contribution in a target benefit plan and one of the employees is older than Robbie. In such a case, the older employee would receive a greater (as a percentage of compensation) contribution to the plan.
Which of the following statements are correct regarding a retirement plan?
Employees don’t start earning benefits until they become plan participants (except in defined benefit plans, which may count prior service).
Since turnover is generally highest for employees in their first few years of employment and for younger employees, it makes sense from an administrative standpoint to delay eligibility.
A tax-exempt educational institution may delay eligibility to age 26 under certain circumstances.
A.I and III only.
B.II only.
C.I, II and III.
D.None of the above.
Solution: The correct answer is C.
All statements are typical potential qualified plan provisions to delay eligibility of employees to participate in a retirement plan.
Packlite company has a defined benefit plan with 200 nonexcludable employees (40 HC and 160 NHC). They are unsure if they are meeting all of their testing requirements. What is the minimum number of total employees that must be covered on a daily basis to conform with the requirements set forth in the IRC?
A.40
B.50
C.80
D.100
Solution: The correct answer is B.
The 50/40 rule requires that defined benefit plans cover the lesser of 50 employees or 40% of all eligible employees. Here 40% would be 80, so 50 is less than 80. This would be the absolute minimum number of covered employees.
All of the following statements concerning cash balance pension plans are correct EXCEPT:
A.The cash balance plan is generally motivated by two factors: selecting a benefit design that employees can more easily understand, and as a cost saving measure.
B.The cash balance plan is a defined benefit plan.
C.The cash balance plan has no guaranteed annual earnings to participants.
D.The cash balance plan is subject to minimum funding requirements.
Solution: The correct answer is C.
A basic component of a cash balance plan is the guaranteed minimum investment return.
Which of the following vesting schedules may a top-heavy qualified profit sharing plan use?
A.2 to 7 year graduated.
B.5 year cliff.
C.2 to 4 year graduated.
D.4 to 8 year graduated.
Solution: The correct answer is C.
As a result of the PPA 2006, qualified profit sharing plans must use a vesting schedule that provides participants with vested benefits at least as rapidly as either a 2 to 6 year graduated vesting schedule or a 3-year cliff vesting schedule. This requirement applies without regard to whether the profit sharing plan is a top-heavy plan. Employers can be more generous, never less. Options a, b, and d all vest less rapidly than the required schedule.
Going Higher Construction sponsors a 401(k) profit sharing plan. In the current year, Going Higher Construction contributed 25% of each employees’ compensation to the profit sharing plan. The ADP of the 401(k) plan for the NHC was 3.5%. If Bob, age 57, earns $100,000 and is a 6% owner, what is the maximum amount that he may defer into the 401(k) plan for this year?
A.$3,500
B.$5,500
C.$13,000
D.$31,000
Solution: The correct answer is C.
Bob is highly compensated because he is more than a 5% owner, so the maximum that he can defer to satisfy the ADP Test requirements is 5.5% (3.5% + 2%) and because he is over 50, he can defer an additional $7,500 (2025) as a catch-up contribution. In summary, Bob can defer $5,500 (5.5% × $100,000) plus $7,500 (the catch-up) for a total of $13,000.
Which of the following qualified plans would allocate a higher percentage of the plan’s current contributions to a certain class or group of eligible employees?
A profit sharing plan that uses permitted disparity
An age-based profit sharing plan
A defined benefit pension plan
A target benefit pension plan
A.1 only
B.1 and 3
C.2 and 4
D.1, 2, 3, and 4
Solution: The correct answer is D.
All of the listed plans would allocate a higher percentage of a plans current cost to a certain class of eligible employees.
XYZ has a noncontributory qualified profit sharing plan with 310 employees in total, 180 who are nonexcludable (40 HC and 140 NHC). The plan covers 72 NHC and 29 HC. The NHC receive an average of 4.5% benefit and the HC receive 6.5%. Which of the following statements is (are) correct?
The XYZ company plan meets the ratio percentage test.
The XYZ company plan fails the average benefits test.
The plan must and does meet the ADP test.
A.1 only
B.2 only
C.Both 1 and 2
D.1, 2, and 3
Solution: The correct answer is C.
The plan does not have to meet the ADP test because it is a noncontributory plan. The plan meets the ratio percentage test and fails the average benefits test.
Safe Harbor = 72 ÷ 140 = 51% = Fail
Ratio % = (72 ÷ 140) ÷ (29 ÷ 40) = 70.9% = Pass
Average Benefit = 4.5 ÷ 6.5 = 69.2% = Fail
Patrick and Kevin own Irisha Corporation and plan to retire. They would like to leave their assets to their children; therefore, they transfer 70 percent of the stock to a trust for the benefit of their 10 children pro rata. Patrick and Kevin then plan to sell the remaining Irisha shares to a qualified ESOP plan. Which of the following is correct?
- The stock transfer to the ESOP is not a 50 percent transfer and therefore will not qualify for non-recognition of capital gains.
- Any transfer to an ESOP of less than 50 percent ownership may be subject to a minority discount on valuation.
A.1 only
B.2 only
C.1 and 2
D.Neither 1 nor 2
Solution: The correct answer is B.
There must have been a sale of at least 30% (not 50%) to the ESOP to qualify for non-recognition of capital gain treatment. In addition, any transfer that is less than 50% of the stock of the corporation might be subject to a minority discount on valuation.
Maximum Performance, Inc.’s defined contribution plan has been determined to be top heavy. Which one of the following statements is NOT a requirement that applies to the plan?
A.The employer must contribute a minimum of 3% of compensation or the contribution rate of the key employees (whichever is lower) per year to non-excludable, non-key employees for each year that the plan is top heavy.
B.If the employer contribution to key employees is 2%, then the employer contribution to non-excludable, non-key employees must be 2%.
C.The plan must use a vesting schedule that does not exceed either a 2-year cliff or 6-year graded vesting schedule.
D.The plan must fully vest after three years of service if the vesting at two years is zero.
Solution: The correct answer is C.
Which of the following is not a requirement for the owner of corporate stock who sells to an ESOP to qualify for the nonrecognition of gain treatment?
A.The ESOP must own at least 55% of the corporation’s stock immediately after the sale.
B.The owner must reinvest the proceeds from the sale into qualified replacement securities within 12 months after the sale.
C.The ESOP may not sell the stock within three years of the transaction unless the corporation is sold.
D.The owner must not receive any allocation of the stock through the ESOP.
Solution: The correct answer is A.
The ESOP must own at least 30% of the corporation’s stock immediately after the sale. All of the other statements are true.
Jared, age 62, earns $360,000 per year and is a participant in his employer’s 401(k) plan. What is the maximum total contribution amount that Jared will have under the 401(k) plan in 2025, assuming his company contributes using a non-elective deferral in a Safe Harbor Plan?
A.$34,000
B.$45,250
C.$45,550
D.$70,000
Solution: The correct answer is B.
The general employee elective deferral limitation for 2025 is $23,500, and Jared can defer an additional $11,250 (2025) as a catch-up contribution because he is in the “enhanced catch-up” ages (60-63). The company match is 3% of $350,000 (covered compensation limit for 2025), giving him an additional $10,500 for a total contribution of $23,500 + $11,250 + $10,500 = $45,250.
You can deduce the company match percentage based on the plan description in the question.
Tom, age 39, is an employee of Star, Inc., which has a profit sharing plan with a CODA feature. His total account balance is $412,000, $82,000 of which represents employee elective deferrals and earnings on those deferrals. The balance is profit sharing contributions made by the employer and earnings on those contributions. Tom is 100 percent vested.
Which of the following statements is/are correct?
Tom may take a loan from the plan, but the maximum loan is $41,000 and the normal repayment period will be 5 years.
If Tom takes a distribution (plan permitting) to pay health care premiums (no coverage by employer) he will be subject to income tax, but not the 10% penalty.
A.1 only
B.2 only
C.1 and 2
D.Neither 1 nor 2
Solution: The correct answer is D.
Statement 1 is incorrect because he can take a loan equal to one-half of his total account balance up to $50,000. Statement 2 is incorrect because the exemption from the 10% penalty only applies to IRAs and only to the unemployed.
Which of the following is true regarding QDROs(qualified domestic relations order)?
A.The court determines how the retirement plan will satisfy the QDRO (i.e., split accounts, separate interest).
B.In order for a QDRO to be valid, the order must be filed on Form 2932-QDRO provided by ERISA.
C.All QDRO distributions are charged a 10% early withdrawal penalty.
D.A QDRO distribution is not considered a taxable distribution if the distribution is deposited into the recipient’s IRA or qualified plan.
Solution: The correct answer is D.
The plan document, not the court, determines how the QDRO will be satisfied. No particular form is required for a QDRO, although some specific information is required. Form 2932-QDRO is not a real form.
Pander’s Box, a shop that specializes in custom trinket and storage boxes, has a 401(k) plan. The plan permits loans up to the legal limit allowed by law and they may be repaid under the most generous repayment schedule available by law. The plan has the following employee information:
Employee 401(k) Balance Outstanding Loan
Karen $400,000 $0
Teddy $250,000 $30,000
Josh $75,000 $0
Justin $15,000 $0
Which of the following statements is correct?
A.If Teddy quit today, state law requires that he repay the loan within five days.
B.The maximum Karen can borrow from her account is $200,000.
C.The maximum Justin can borrow from his account is $10,000.
D.If Josh wanted to borrow money from his plan for the purchase of a personal residence, he would have to pay the loan back within five years.
Solution: The correct answer is C.
Justin can borrow one half of his account balance up to $50,000. Since the balance is below $20,000, he can borrow a full $10,000. State law does not require the repayment of the loan within a specified time; however, the plan can require that Teddy repay the loan immediately. Karen can only borrow one-half of her account balance up to $50,000, thus she can only borrow $50,000. Josh will not have to repay the loan in five years because the loan proceeds are being used for a home purchase and an extended period is available.
Carolyn Smart wanted to volunteer full-time and decided to retire from Lotsa Cash Corporation at the age 57, after 15 years of service. She requested a total distribution of her account in the Lotsa Cash Corporation’s profit sharing plan and received a check, made payable to her. Her account balance was $60,000 on her final day of employment. Which of the following statements describe the consequences of this distribution?
Eligible for 10 year forward averaging.
Subject to 10% penalty.
Eligible for Rollover.
Subject to mandatory 20% withholding.
Exempt from the 10% early withdrawal penalty.
A.I, II and III only
B.II, III and IV only
C.III, IV and V only
D.III and IV only
E.I, IV and V
Solution: The correct answer is C.
She must be born by 1/1/1936 in order to use 10 year forward averaging.
She is not subject to the 10% penalty due to separation of service after age 55.
She is eligible for a rollover.
She is subject to the 20% withhold since the check went to her (indirect rollover)
She is exempt from the 10% penalty, due to separation of services after age 55.
The Third Party Administrator (TPA) of the Flying Trapeze Manufacturing Incorporated‘s Defined Contribution Plan has just informed you, its administrator, that the plan is top heavy. Which one of the following statements is NOT a requirement that applies to your plan?
A.Employees must be 100% vested in the plan after three years of service if the vesting at two years is zero.
B.If the employer contribution to key employees is 2%, then the employer contribution to non-excludable, non-key employees may be reduced to no lower than 2%.
C.Flying Trapeze, Inc. must contribute a minimum of 3% of compensation or the contribution rate of the key employees, if it is lower, to non-excludable, non-key employees for each year that the plan is top heavy.
D.The plan’s vesting schedule must be 100% vested upon participation.
Solution: The correct answer is D.
A is correct because the plan must have no longer than a 3 year cliff or 2-6 year graded vesting. If year 2 is zero, it must be a cliff vesting and year 3 must be 100%.
Christine has been the owner of Chris’ Antique Dolls for the past 15 years. She decided to establish a retirement plan for her corporation. She wants to make all initial contributions to the plan using company stock and she may integrate with social security. Which of the following would be the best qualified plan for them to consider adopting?
A.Defined benefit pension plan
B.New comparability plan
C.401(k) plan with a match
D.Profit sharing plan
Solution: The correct answer is D.
A profit sharing plan will allow a stock contribution and integration with social security. A stock bonus plan would also be an appropriate, but it’s not one of the choices.
A distress termination of a qualified retirement plan occurs when:
The PBGC initiates a termination because the plan was determined to be unable to pay benefits from the plan.
An employer is in financial difficulty and is unable to continue with the plan financially. Generally, this occurs when the company has filed for bankruptcy, either Chapter 7 liquidation or Chapter 11 reorganization.
The employer has sufficient assets to pay all benefits vested at the time, but is distressed about it.
When the PBGC notifies the employer that it wishes to change the plan due to the increasing unfunded risk.
A.2 only
B.1 and 2
C.1, 2, and 3
D.1, 2, and 4
Solution: The correct answer is A.
Statement 2 is the definition of a distress termination. Statement 3 is standard termination. Statement 1 describes an involuntary termination. Statement 4 is simply false.
Tracy, age 46, is a self-employed financial planner and has Schedule C income from self-employment of $56,000. He has failed to save for retirement until now. Therefore, he would like to make the maximum contribution to his profit sharing plan. How much can he contribute to his profit sharing plan account?
A.$9,464
B.$10,409
C.$11,200
D.$14,000
Solution: The correct answer is B.
To calculate the Self Employment Tax:
$56,000 Schedule C net income
× 92.35
= $51,716 Net Earnings Subject to Self Employment Tax
× 15.3% (up to SS wage base)
= $7,913 Self Employment Tax
To calculate the individual contribution:
$56,000 Schedule C Net Income
− $3,957. or 1/2 of Self Employment Tax ($7,913 ÷ 2)
= $52,043 Adjusted Net Self Employment Income
× 0.20 (0.25 ÷ 1.25) maximum contribution rate!!!!!!
=$10,409 Keogh profit sharing contribution amount
All of the following plans may integrate with Social Security EXCEPT:
A.ESOP
B.Profit Sharing Plan
C.Defined Benefit
D.Target Benefit
Solution: The correct answer is A.
Generally, which of the following plans favor older entrants?
Defined Benefit Plan
Cash Balance Pension Plan
401 (k) Plan with a Profit Sharing Plan
Profit Sharing Plan
A.I only.
B.I and III only.
C.II and IV only.
D.I and IV only.
Solution: The correct answer is A.
Company A has been capitalized by MJBJ Vulture Capital, a venture capital company. Company A’s cash flows are expected to fluctuate significantly from year to year, due to phenomenal growth. They expect to go public within three years. Which of the following would be the best qualified plan for them to consider adopting?
A.A profit sharing plan.
B.A new comparability plan.
C.A 401(k) plan with a match.
D.A stock bonus plan.
The answer is D. A stock bonus plan will allow equity participation without the use of cash flows and the public offering will eventually provide liquidity.
Which of the following plans require mandatory funding?
Defined Benefit Plan
Cash Balance Pension Plan
ESOP
Target Benefit
A.I and II only.
B.I , II and III only.
C.I, II and IV only.
D.I, II, III and IV only.
Solution: The correct answer is C.
An ESOP does not have mandatory funding requirements.
Which of the following plan documents provides details of your plan, what the plan provides and how it operates?
A.Individual Benefit Statements.
B.Summary Annual Report.
C.Summary of Material Modifications.
D.Summary Plan Description.
Solution: The correct answer is D.
Marilyn Hayward is the sole proprietor and only employee of unincorporated Graphics for Green Promotions. Last year, Marilyn established a profit-sharing Keogh plan with a 25% contribution formula. As of the end of this year, Marilyn has $140,000 of Schedule C net earnings. Assume for this problem that her self-employment tax is $19,781. What is the maximum allowable Keogh contribution that Marilyn can make for this year?
A.$23,500
B.$25,858
C.$26,022
D.$35,000
Solution: The correct answer is C.
One-half of self-employment tax is subtracted from the net income subject to self-employment tax ($140,000). Therefore, divide $19,781.37 by 2, which equals $9,890.68. Then subtract that from the schedule C amount ($140,000-$9,890.68 = $130,109.32) and multiply the result by 20%.
The contribution of $26,021.88 is 25% of the Keogh base ($130,109 MINUS the Keogh contribution of $26,021 = $104,088 x 25% = $26,022.
Qualified retirement plans that permit the employer unlimited investment in sponsor company stock are:
401(k) plans.
Stock bonus plans.
Profit sharing plans.
ESOPs.
A.III only.
B.IV only.
C.III and IV only.
D.I, II, III and IV.
Solution: The correct answer is D.
All of the listed plans permit 100% stock in the plans. The 401(k) plan is organized as a profit sharing or stock bonus plan.
Amy was divorced in 2017 and is currently age 55. She received alimony of $51,000 in 2025. In addition, she received $1,800 in earnings from a part-time job. Amy is not covered by a qualified plan. What was the maximum deductible IRA contribution that Amy could have made for 2025?
A.$1,800
B.$2,250
C.$7,000
D.$8,000
Solution: The correct answer is D.
The deductible IRA contribution limit is $7,000 for 2025. The additional catch-up amount, for over age 50, is $1,000 for 2025. Alimony counts as earned income for IRA purposes for divorces finalized prior to 12/31/18 (Pre TCJA). She is not covered by a qualified plan and therefore is not subject to AGI phaseouts. Therefore, the total is $8,000 for 2025.
Which of the following cannot be held in an IRA account as an investment?
A.A U.S. gold coin
B.Option contracts (calls)
C.Variable life insurance
D.Municipal bonds
Solution: The correct answer is C.
Life insurance is not permitted in IRA accounts. All of the other choices are permissible.
Jim, who is age 39, converts a $72,000 Traditional IRA to a Roth IRA in 2023. Jim’s adjusted basis in the Traditional IRA is $10,000. He also makes a contribution of $4,000 to a Roth IRA in 2024 for the tax year 2023. If Jim takes a $4,000 distribution from his Roth IRA in 2025, how much total federal income tax, including penalties, is due as a result of the distribution assuming his 2025 federal income tax rate is 22 percent?
A.$0
B.$400
C.$880
D.$1,280
Solution: The correct answer is A.
Any amount distributed from an individual’s Roth IRA is treated as made in the following order (determined as of the end of a taxable year and exhausting each category before moving to the following category):
- From regular contributions;
- From conversion contributions, on a first-in-first-out basis; and
- From earnings.
All distributions from all of an individual’s Roth IRAs made during a taxable year are aggregated. The 10 percent additional tax under IRC Section 72(t) applies to any distribution from a Roth IRA includible in gross income. The 10 percent additional tax under IRC Section 72(t) also applies to a nonqualified distribution, even if it is not then includible in gross income, to the extent it is allocable to a conversion contribution and if the distribution is made within the 5-taxable-year period beginning with the first day of the individual’s taxable year in which the conversion contribution was made.
Which of the following statements is/are correct regarding SEP contributions made by an employer?
- Contributions are subject to FICA and FUTA.
- Contributions are currently excludable from employee-participant’s gross income.
- Contributions are capped at $23,500 for 2025.
A.1 only
B.2 only
C.1 and 2
D.1, 2, and 3
Solution: The correct answer is B.
Statement 2 is the only correct response. Contributions are currently excludable from employee-participant’s gross income.
Statement 1 is incorrect: Employer contributions to a SEP are not subject to FICA and FUTA.
Statement 3 is incorrect: The SEP deferral limits are different than both the 401(k) elective deferral limit and the SARSEP deductible limits of $23,500 for 2025. The SEP limit is 25% of covered compensation, up to a maximum of $70,000 for 2025.
Note the IRS-imposed compensation limits, contribution percentage limits, and absolute dollar limits: The maximum compensation that may be taken into account in 2025 for purposes of SEP contributions is $350,000. The maximum percentage of eligible compensation is 25%. The dollar amount maximum amount that can be contributed to a SEP in 2025 is $70,000 (25% x $350,000=$87,500 is still limited to $70,000).
A SEP is not a qualified plan and is not subject to all of the qualified plan rules. However, it is subject to many of the same rules. Which of the following are true statements?
- SEPs and qualified plans have the same funding deadlines (due date of return plus extensions).
- The contribution limit for SEPs and qualified plans (defined contribution) is $70,000 for the year 2025.
- SEPs and qualified plans have the same ERISA protection from creditors.
- SEPs and qualified plans have identical nondiscriminatory and top-heavy rules.
A.1 only
B.1 and 2
C.2 and 4
D.1, 2, 3, and 4
Solution: The correct answer is B.
SEPs and qualified plans can be funded as late as the due date of the return plus extensions. The maximum contribution for an individual to a SEP is $70,000 for 2025 ($350,000 maximum compensation x 25%, limited to $70,000). Thus, statements 1 and 2 are correct.
Statement 3 in incorrect: Qualified plans are protected under ERISA. IRAs and SEPs do not share this protection.
Statement 4 is incorrect: Both types of plans (SEPs and qualified plans) have nondiscriminatory and top-heavy rules. However, SEPs have simpler and less stringent rules, making the rules not identical.
The early distribution penalty of 10% does not apply to IRA distributions:
- Made after attainment of the age of 55 and separated from service.
- Made for the purpose of paying qualified higher education costs.
- Paid to a designated beneficiary after the death of the account owner who had not begun receiving minimum distributions.
A.I only.
B.I and III only.
C.II and III only.
D.I, II and III.
Solution: The correct answer is C.
The first statement is incorrect because it is an exception to the 10% penalty for qualified plan distributions, not for IRAs. The second statement applies to IRAs, and third statement is an exception for both qualified plans and IRAs.
Donald and Daisy are married and file jointly. They are both age 42, both work, and their combined AGI is $136,000. This year (2025), Donald’s profit sharing account earned over $5,000. Neither he nor the company made any contributions and there were no forfeitures. Daisy declined to participate in her company’s defined benefit plan because she wants to contribute to, and manage, her own retirement money. (Her benefit at age 65 under the plan is $240 a month.) How much of their $14,000 IRA contribution can they deduct? Assume that $7,000 is contributed to each account.
A.$3,500
B.$7,000
C.$10,500
D.$14,000
Solution: The correct answer is C.
Daisy is an active participant. She cannot opt out of a defined benefit plan. Use the phase out formula: AGI - bottom of the phase out range = ? / range of the phase out. The phase out is 126,000 to 146,000 in 2025.
$136,000 – $126,000 = $10,000
$10,000 / $20,000 = .50 or 50%
50% x $7,000 = $3,500
Donald is not active this year; he will follow the spousal phase out of $236,000 - $246,000. He is eligible for the full $7,000.
They can deduct a total of $10,500.
Which statements are correct regarding penalties associated with IRA accounts?
- Distributions made prior to 59½ are generally subject to the 10% premature distribution penalty.
II. RMDs not taken in the required amount will have a 25% excise tax that can be reduced to 10% if taken in a timely manner.
A.I only.
B.II only.
C.I and II.
D.Neither I nor II.
Solution: The correct answer is C.
Statements I and II are both correct.
SECURE 2.0 Act revised the excise tax on Required Minimum Distribution from 50% to 25% and may be decreased to 10% if taken in a timely manner.
Eric, age 53, had the following items of income:
Investment returns as a limited partner in a partnership of $1,200.
Unemployment compensation of $350.
Income from a law practice of $600.
Deferred compensation from a former employer of $14,000.
Alimony of $750 received from a divorce finalized in 2019.
Wages of $1,000.
What is the maximum contribution Eric can make to an IRA this year?
A.$1,600
B.$2,350
C.$7,000
D.$8,000
Solution: The correct answer is A.
Eric is limited to making an IRA contribution equal to the lesser of the annual limit plus the $1,000 catch-up, or his earned income for the year. The following items, totaling $1,600, are considered earned income.
Law Practice Income $600
Wages $1,000
The other items are not considered earned income. Individuals must have taxable compensation, such as wages, salaries, commissions, tips, bonuses, or net income from self-employment. Taxable alimony and separate maintenance payments received by an individual are treated as compensation for IRA purposes. Compensation doesn’t include earnings and profits from property, such as rental income, interest and dividend income, or any amount received as pension or annuity income, or as deferred compensation.
NOTE: Alimony for divorces signed after 12/31/18 is neither taxable by the recipient or deductible by the payor (2017 TCJA).
Which of the following accurately describes a 403(b) plan?
A.A 403(b) plan is a noncontributory qualified profit sharing plan.
B.Because of catch-up provisions, the investment risk of the assets within a 403(b) plan is borne equally by the plan sponsor and the participant.
C.A participant’s contributions will generally vest according to a 3 to 7 year graduated vesting schedule, however, a 5-year cliff vesting schedule may be used.
D.403(b) plan assets can be invested indirectly in stocks and bonds through annuities or mutual funds.
Solution: The correct answer is D.
Answer D is a correct statement accurately describing a 403(b) plan. Answer A is incorrect as a 403(b) plan is an employee deferral plan and is not a qualified plan. Answer B is incorrect as the investment risk is borne by the employee in all cases. Answer C is incorrect as an employee’s contributions within a 403(b) plan is always 100% vested.
Danielle has worked for the City of Buffalo for the last 20 years. She has deferred $23,500 into her 457(b) plan for 2025. She will attain her normal retirement age under the City’s 457(b) plan in 2026. Danielle has prior unused deferral amount of $47,000 as of December 31, 2024. How much can Danielle contribute as her three-year catch-up contribution in 2025?
A.$0
B.$23,500
C.$43,500
D.$47,000
Solution: The correct answer is B.
Since the plan’s normal retirement age for Danielle is 2026, Danielle would be allowed to defer an additional $23,500 in 2025. This is within the three years of the plan’s normal retirement age and Danielle has sufficient prior unused deferral.
The three year catch up allows a participant for 3 years prior to the normal retirement age (as specified in the plan) to contribute the lesser of:
the elective deferral limit, $23,500 in 2025.
the basic annual limit plus the amount of the basic limit not used in prior years (only allowed if not using age 50 or over catch-up contributions)
Kim Cat, age 42, earns $360,000 annually as an employee for CTM, Inc. Her employer sponsors a SIMPLE 401(k) retirement plan and matches all employee contributions made to the plan dollar-for-dollar up to 3% of covered compensation. What is the maximum total contribution (employer and employee) that can be made to Kim’s SIMPLE 401(k) account in 2025?
A.$10,350
B.$10,500
C.$26,000
D.$27,000
Solution: The correct answer is D.
The maximum total contribution is $27,000. ($16,500 maximum employee contribution for 2025 + $10,500 employer match). The maximum employee contribution for 2025 is $16,500. The employer has chosen to make matching contributions up to 3% of compensation (the SIMPLE maximum). Therefore, the employer can make a contribution of up to $10,500 ($350,000 covered compensation for 2025, x 3%), if the plan is a SIMPLE 401(k).
Which of the following statements is/are correct regarding TSAs and 457 deferred compensation plans?
- Both plans require contracts between an employer and an employee.
- Participation in either a TSA or a 457 plan will cause an individual to be considered an “active participant” for purposes of phasing out the deductibility of Traditional IRA contributions.
- Both plans allow 10-year forward averaging tax treatment for lump-sum distributions.
- Both plans must meet minimum distribution requirements that apply to qualified plans.
A.1 only
B.1 and 4
C.2, 3, and 4
D.1, 2, and 4
Solution: The correct answer is B.
Statements 1 and 4 are correct. Statement 2 is incorrect because a 457 plan is a deferred compensation arrangement that will not cause a participant to be considered an “active participant.” Statement 3 is incorrect because 10-year forward averaging is not permitted from either plan.
One of the requirements for SIMPLE plans is that they can only be established for companies who employ 100 or fewer employees that earn $5,000 or more.
A.True
B.False
Solution: The correct answer is A.
Which of the following statements is/are correct regarding TSAs and 457 deferred compensation plans?
- Both plans require contracts between an employer and an employee.
- Participation in either a TSA or a 457 plan will cause an individual to be considered an “active participant” for purposes of phasing out the deductibility of Traditional IRA contributions.
- Both plans allow 10-year forward averaging tax treatment for lump-sum distributions.
- Both plans must meet minimum distribution requirements that apply to qualified plans.
A.I only.
B.I and IV only.
C.II, III, and IV only.
D.I, II and IV only.
Solution: The correct answer is B.
Statements I and IV are correct. Statement II is incorrect because a 457 plan is a deferred compensation arrangement that will not cause a participant to be considered an “active participant.” Statement III is incorrect because 10-year forward averaging is not permitted from either plan.
Which of the following are permitted investments in a 403(b) TSA (TDA) plan?
- An annuity contract from an insurance company.
- An international gold stock mutual fund.
- A self-directed brokerage account consisting solely of U.S. stocks, bonds and mutual funds.
A.I only.
B.II only.
C.I and II only.
D.I, II and III.
Solution: The correct answer is C.
TSA (TDA) funds can only invest in annuity contracts (Statement I) and mutual funds (Statement II). No self-directed brokerage accounts are permitted.
Which of the following statements is/are correct regarding 403(b) plans?
- 403(b)s are eligible for rollover treatment to IRAs, qualified plans, and other 403(b)s.
- Investments in stocks, bonds, and money markets are available.
- Assets in a 403(b) plan are always 100% vested.
A.I only.
B.II only.
C.I and III only.
D.I, II and III.
Solution: The correct answer is A.
Statement I is correct as 403(b) plans are permitted to be rolled over to IRAs, qualified plans, or other 403(b)s. Statement II is incorrect because 403(b) investments are limited to mutual funds and insurance annuities. Statement III is incorrect because, while employee elective deferrals are always 100% vested, employer contributions may be subject to a vesting schedule—typically ERISA limited vesting schedules (2-6 graded or 3-year cliff).
Which of the following is/are correct regarding SIMPLE plans?
- A SIMPLE plan does not require annual testing.
- A SIMPLE IRA must follow a 3-year cliff vesting schedule if the plan is top-heavy.
- A 25% early withdrawal penalty may apply to distributions taken within the first two years of participation in a SIMPLE plan.
- The maximum elective deferral contribution to a SIMPLE 401(k) plan is $23,500 for 2025 and $31,000 in 2025 for an employee who has attained the age of 50 or older.
A.III only.
B.I and III only.
C.I, II and III only.
D.II, III and IV only.
Solution: The correct answer is B.
Statement I is correct.
Statement II is incorrect. A SIMPLE plan is not subject to vesting rules, and contributions are always a 100% vested.
Statement III is correct. The early withdrawal penalty is 25% for distributions taken within the first two years of participation.
Statement IV is incorrect. The maximum elective deferral contribution to a SIMPLE 401(k) plan is $16,500 for 2025’. An employee who has attained the age of 50 -59 or 64 and older can contribute an additional $3,500. In addition, there is an enhanced catch-up provision for participants ages 60-63 of $5,250.
Robert Sullivan, age 61, works for Dynex Corporation, and earns $380,000. Dynex Corp. provides a non-elective contribution to its SIMPLE IRA plan. Which one of the following is the maximum amount that could go into Robert’s account this year? (The Section 401(a)(17) limit on includible compensation is $350,000 for 2025.)
$23,500
$24,100
$28,750
$29,350
Solution: The correct answer is C.
The compensation limit applies to SIMPLE IRAs when non-elective contributions are made. $350,000 x 2% = $7,000 + $16,500 (max EE deferral in 2025) + $5,250 (age 60-63 catch-up for 2025) = $28,750
Choice’ A’ is incorrect.’ ‘ It utilizes’ the correct calculation but does not include the’ catch-up of $5,250.
Choices B and D are incorrect as they calculate the contribution amount’ using’ $380,000 x 2%
SIMPLE elective contributions do not have a compensation limit.
SIMPLE non-elective contributions are limited to 2% of the covered compensation limit.
Betty Sue, age 75, is a widow with no close relatives. She is very ill, unable to walk, and confined to a custodial nursing home. Which of the following programs is likely to pay benefits towards the cost of the nursing home?
- Medicare may pay for up to 100 days of care after a 20-day deductible.
- Medicaid may pay if the client has income and assets below state-mandated thresholds.
A.1 only
B.2 only
C.1 and 2
D.Neither 1 nor 2
Solution: The correct answer is B.
Statement 1 is incorrect because Medicare covers all costs for the first 20 days of skilled nursing home care and cover the next 80 days with a deductible.
Students should know from the Insurance course that Medicaid provides for low income persons.
Hasani died December 31, 2024, at age 50 leaving his wife Jamille (age 49) and 4 children ages 4, 7, 15 and 17. His PIA is $2,500 per month. Assuming Jamille does not work how much approximately in total per month will she receive for 2025 for herself and kids (ignoring family maximums)?
A.$5,000
B.$13,125
C.$12,300
D.$15,000
Solution: The correct answer is B.
2025 Calculation
Jamille is too young to collect as a widow. Widow benefits begin at age 60. Jamille will receive benefit for caring for each of the children under age 16. Each child under age 18 will also receive 75% of the calculated PIA as a payment to them.
3 children x (2,500 x 75%) = 5,625 for care
4 children benefits x ($2,500 x 75%) = 7,500. The 17 year old will receive payments until their 18th birthday or 19th if still in school.
Add the two types of benefits together for a total of $13,125.
Hasani died December 31, 2024, at age 50 leaving his wife Jamille (age 49) and 4 children ages 4, 7, 15 and 17. His PIA is $2,500 per month. How many of these family members are entitled to receive his benefits (assuming direct deposits) in 2025?
A.2
B.3
C.4
D.5
Solution: The correct answer is D.
1 for her and 4 to her for the benefit of each child.
Hasani died December 31, 2024, at age 50 leaving his wife Jamille, age 49, and 4 children ages 4, 7, 15 and 17. His PIA is $2,500 per month. If Jamille goes back to work in 2025 and makes $100,000, how much approximately will she receive for the care of the children (ignoring family maximums)?
A.$3,500
B.$5,625
C.$6,000
D.$7,500
Solution: The correct answer is B.
Jamille will receive a benefit for each child she cares for under age 16. Each child under age 18 (19 if in secondary school - ie high school) will also receive a benefit directly.
For the care of the children, Jamille will receive 75% of Hasani’s calculated PIA.
2,500 x 75% = 1,875 for each of the three children under 16 = $5,625
All of the following statements concerning the Social Security system are correct except:
A.If a worker receives retirement benefits based on his or her own earnings record, the worker’s retirement benefits will continue whether married or divorced.
B.Widows and widowers, whether divorced or not, will continue to receive survivors benefits upon remarriage if the widow or widower is age 60 or older.
C.By providing the name of a country or countries to be visited and the expected departure and return dates, the Social Security Administration will send special reporting instructions to the beneficiaries and arrange for delivery of checks while abroad.
D.A special one-time payment of $1,050 may be made to a deceased worker’s spouse or minor children upon death.
Solution: The correct answer is D.
A special one-time payment of $255 may be made to a deceased worker’s spouse or minor children upon death.
Joyce and Melvin have been married for 30 years. In the current year, they received $22,000 of Social Security benefits and had $12,000 of interest income. What portion of the Social Security benefit is taxable?
A.$0
B.$6,000
C.$10,200
D.$11,500
Solution: The correct answer is A.
The lesser of:
50% of $22,000 = $11,000
or
0.5 [$12,000 + 0.5 ($22,000) - $32,000] < 0
Since the answer calculated is less than $0, none of the Social Security benefits received by Joyce and Melvin are taxable.
MFJ $32k - $44k is 50%, above $44 is 85%
Joe’s full retirement age is 67. He is considering retiring early, at age 62. How much will his retirement benefit be reduced by, if he elects to receive social security retirement benefits at age 62?
A.10%
B.20%
C.30%
D.50%
Solution: The correct answer is C.
Memorize the 30% reduction for FRA 67 to age 62 (most common case)
Be aware of the 8% per year delayed retirement credit from FRA to age 70
Rick has an 18% nonqualified deferred compensation plan that is funded annually by his employer. Payments are made to a separate trustee of a secular trust who was selected by Rick and his employer. The employer contributions are discontinued at Rick’s death, disability, or employment termination. When Rick retires or terminates employment, he will receive the proceeds from the trust. Which of the following is/are correct regarding the deferred compensation plan?
- The contributions are not currently taxable to Rick because they are subject to a substantial risk of forfeiture.
- The contributions to the plan are currently subject to payroll taxes.
- The employer can deduct the contributions to the plan at the time of the contribution.
A.3 only
B.1 and 3
C.2 and 3
D.1, 2, and 3
Solution: The correct answer is C.
Because this arrangement is a secular trust, there is no substantial risk of forfeiture. Thus, Statement 1 is false. Because the trust is not subject to the general creditors of the employer, this is straight compensation. Rick must treat the payments as constructively received, and the employer may deduct the payments as compensation immediately. The payments are subject to payroll tax since the compensation is earned.
Which of the following are characteristics of a phantom stock plan?
Benefits are paid in cash.
There is no equity dilution from additional shares being issued.
A.1 only
B.2 only
C.1 and 2
D.Neither 1 nor 2
Solution: The correct answer is C.
The employee does not actually receive stock in a phantom plan. Instead, the employee receives credits for the stock and the benefits are later paid in cash.
ABC has an Employee Stock Purchase Plan (ESPP). Which statements regarding an ESPP are correct?
The price may be as low as 85% of the stock value.
When an employee sells stock at a gain in a qualifying disposition, all of the gain will be capital gain.
There is an annual limit of $25,000 per employee.
A.1 only
B.1 and 2
C.1 and 3
D.2 and 3
Solution: The correct answer is C.
Statement 2 is incorrect because only the gain in excess of the W-2 income will be capital gain.
Biks, Inc grants Janie 1 NQSO on Jan 1, 20X1. The exercise price is $10. The market price on the exercise date (Jan 1, 20X3) is $25. Janie sold the stock on July 1, 20X3 for $100. What are the tax consequences when Janie sold the stock?
A.$15 of W-2 income
B.$75 of short term gain
C.$75 of long term gain
D.$90 of W-2 income
Solution: The correct answer is B.
On Jan 1, 20x3
Mkt price – 25
Exercise Price – 10
Gain – 15 – w-2 income
On July 1, 20x3
Market Price – 100
Basis – 25
Gain – 75 – short term
Ricky receives stock options for 12,000 shares of XYZ Corporation with an exercise price of $10 when the stock is trading on the national exchange for $10 per share. The XYZ company plan is an Incentive Stock Option Plan. Which of the following statements are true regarding the options?
Ricky will be required to hold any ISOs for more than a year after exercise and more than two years from the grant date to have long-term capital gains.
2,000 of the options are considered NQSOs.
A.I only.
B.II only.
C.I and II.
D.Neither I nor II.
Solution: The correct answer is C.
To the extent the fair market value of the stock for which the ISO is exercisable for the first time during any calendar year exceeds $100,000, the excess is treated as a nonstatutory stock option; therefore, 2,000 of the options are NQSOs.
All of the following statements regarding Social Security are correct except:
A.Many private insurance companies sell Medicare supplemental insurance polices.
B.Medicare supplemental insurance policies help pay Medicare’s coinsurance amounts and deductibles, as well as other out-of-pocket expenses for health care.
C.If a worker applies for retirement or survivor’s benefits before his or her 65th birthday, he or she must file a separate application for Medicare.
D.Even if an individual continues to work after turning 65, he or she should sign up for Part A of Medicare.
Solution: The correct answer is C.
If a worker applies for retirement or survivor’s benefits before his or her 65th birthday, there is no need to file a separate application for Medicare.
All of the following statements concerning Social Security beneficiaries are correct except:
A.Monthly benefits can be paid to a disabled insured worker under age 65.
B.Benefits can be paid to the divorced spouse of a retired or disabled worker entitled to benefits if age 62 or over and married to the worker for at least 10 years and 1 day.
C.Benefits can be paid to the surviving spouse (including a surviving divorced spouse) of a deceased insured worker if the widow(er) is age 60 or over.
D.Benefits can be paid to dependent parents of a deceased insured worker at age 59 or over.
Solution: The correct answer is D.
Benefits can be paid to the dependent parents of a deceased worker at age 62 or over.
What benefits are available to the survivors of a deceased worker who was currently insured but not fully insured at death?
Lump sum death benefit of $255.
Mother or father’s spousal benefit for caring for a qualifying child under age 16.
Income benefits to a child under age18.
Survivor benefit to spouse (assume not remarried) at age FRA.
A.I and III.
B.II, III, and IV.
C.I, II, and III.
D.I, II, III, and IV.
Solution: The correct answer is C.
There are no survivor benefits to a surviving spouse with no qualifying child.
All of the following statements regarding Social Security are correct except:
A.The worker who takes early retirement benefits will receive a reduced benefit.
B.Workers entitled to retirement benefits can currently take early retirement benefits as early as age 59 ½.
C.To qualify for retirement benefits, a worker must be fully insured, which means that a worker has earned a certain number of quarters of coverage under the Social Security system.
D.Earning a designated amount of money, regardless of when it was earned during the year, will credit the worker with a quarter of coverage for that year.
Solution: The correct answer is B.
As early as age 62 not 59½.
Marguerite received nonqualified stock options (NQSOs) with an exercise price equal to the FMV at the date of the grant of $22. Marguerite exercises the options 3 years after the grant date when the FMV of the stock was $30. Marguerite then sells the stock 3 years after exercising for $35. Which of the following statements are true?
At the date of the grant, Marguerite will have ordinary income of $22.
At the date of exercise, Marguerite will have W-2 income of $8.
At the date of sale, Marguerite will have long term capital gain of $5.
Marguerite’s employer will have a deductible expense in relation to this option of $22.
A.3 only
B.2 and 3
C.2, 3, and 4
D.1, 2, 3, and 4
Solution: The correct answer is B.
Statements 2 and 3 are correct. Marguerite would not have any taxable income at the date of grant provided the exercise price is equal to the fair market value of the stock. Marguerite’s employer would receive a tax deduction equal to the amount of W-2 income Marguerite would be required to recognize, $8 of W-2 income, at the date of exercise. Marguerite’s long term capital gain is $5, calculated as the sales price of $35, less the exercise price of $30.
Which of the following benefits provided by an employer to its employees is currently taxable to the employee?
A.Employees of the DEF Department Store are allowed a 15% discount on store merchandise. DEF’s normal gross profit percentage is 20%.
B.On a space-available basis, undergraduate tuition is waived by Private University for the dependent children of employees (value of $15,000 per semester).
C.Fly Airline allows its employees to fly free when there are open seats available on a flight (average value of $200).
D.Incidental personal use of a company car.
The correct answer is D.
Personal use of a company car is a taxable fringe benefit. All of the other employer fringe benefits listed may be excluded from the employee’s gross income.
Isse Peking is the manager of Airline Highway Motel. Isse lives in Unit 12. He was given the option to live at the motel if he would also look after the night auditing (the value of his reviews is $400 per month) responsibilities. The value of the motel unit on a monthly basis is $800, but Unit 12 rents on a daily basis for $100 per day. How much, if any, does Isse have to include in his gross income for living on the premises of his employer?
A.$0 lodging for the convenience of the employer
B.$400 per month
C.$800 per month
D.$3,000 per month
Solution: The correct answer is C.
Isse is not required by the employer to live on the premises and therefore must include the value of the lodging in his gross income.
Which of the following most accurately describes how to determine the fair market value of an employer-provided fringe benefit?
A.The amount the employer paid to provide the fringe benefit to the employee.
B.The amount the employee considers the fringe benefit to be worth.
C.The amount the employer would be willing to pay to provide the fringe benefit.
D.The amount an employee would need to pay a third party to purchase or lease the same or comparable fringe benefit on the same or comparable terms in the same geographic area.
Solution: The correct answer is D.
The fair market value of a fringe benefit is the amount an employee would need to pay a third party on the open market to purchase or lease the same or comparable fringe benefit on the same or comparable terms in the same geographic area. This most closely matches the definition of fair market value for tax purposes.
Choice A is incorrect. The fair market value is not based on the employer’s cost to provide the fringe benefit.
Choice B is incorrect. The employee’s perceived value of the fringe benefit does not determine the fair market value.
Choice C is incorrect. The amount the employer would be willing to pay does not impact the determination of the fair market value.
Medical Trials Inc. has a cafeteria plan. Full-time employees are permitted to select any combination of the benefits listed below, but the total value received by each employee must be $6,500 a year or less.
- Group medical and hospitalization insurance for employee only, $3,600 a year.
- Group medical and hospitalization insurance for employee’s spouse and dependents, $1,200 additional a year.
- Child-care payments, actual cost not to exceed $5,000.
- Cash required to bring the total of benefits and cash to $6,500.
- Universal variable life insurance $1,000.
Which of the following statements is true? (All employees are full time)
A.James chooses to receive $6,500 cash because his wife’s employer provides medical benefits for him. James has $2,900 of taxable income ($6,500 - $3,600).
B.Matt chooses 1, 2, 5, and $700 cash. He must include $700 in taxable income.
C.Randy chooses 1 and 2 and $1,700 in child care. He must include the $1,700 in gross income.
D.Robin chooses 1 and 2 and $1,700 cash. Robin must include $1,700 in taxable income.
Solution: The correct answer is D.
Option D is correct because cash must be included in income. Option A is incorrect because the entire cash distribution will be taxable. Option B is incorrect because the universal variable life insurance premiums of $1,000 cannot be excluded from Matt’s gross income. Option C is incorrect because child care payments are excludable benefits.
Jane is covered by a $90,000 group-term life insurance policy, her daughter is the sole beneficiary. Jane’s employer pays the entire premium for the policy; the uniform annual premium is $0.60 per $1,000 per month of coverage. How much, if any, is W-2 taxable income to Jane resulting from the insurance?
A.$0
B.$24
C.$288
D.$648
Solution: The correct answer is C.
$50,000 of group-term life insurance is nontaxable.
$90,000 - 50,000 = 40,000 × $0.60 per thousand × 12 = $288 taxable.
Endorsement Split-dollar life insurance is:
A.An insurance arrangement in which the employee pays the cost of the premium and the employee names the employer as the beneficiary.
B.An insurance arrangement in which the employer and the employee share the cost of the life insurance on the employee and the portion of the premium that is paid by the employer is the value of the term life portion of the policy.
C.An insurance arrangement in which the employee pays the majority of the premium while the employer names the beneficiary.
D.An insurance arrangement in which the employer is the owner of the policy and is also the beneficiary to the extent of the premiums paid by the employer.
Solution: The correct answer is D.
The employer is the owner of an endorsement split-dollar policy and will be repaid the total of the premiums it has paid for the insurance.
A business valued at $3,000,000 has 3 partners. Each of the 3 partners buys a $500,000 life insurance policy on each of the other partners. Which of the following is true?
This is an example of an entity purchase plan.
This is an example of a cross purchase plan.
The policies are under funded.
A.1 only
B.2 only
C.1 and 3
D.2 and 3
Solution: The correct answer is B.
This is a cross-purchase life insurance plan. Each person has a one-third interest. Therefore, when the first partner dies, the other two partners will each need to pay $500,000 for a total of $1,000,000 (1/3 of $3,000,000). Thus, the policies are not underfunded.
Which of the following statements concerning rabbi trusts is (are) CORRECT?
A rabbi trust is a trust established and sometimes funded by the employer that is subject to the claims of the employer’s creditors, but any funds in the trust cannot generally be used by or revert back to the employer.
A rabbi trust calls for an irrevocable contribution from the employer to finance benefits promised under a nonqualified plan, and funds held within the trust cannot be reached by the employer’s creditors.
A rabbi trust may not be held off-shore as a result of the American Jobs Creation Act of 2004.
The American Jobs Creation Act of 2004 prohibits “springing irrevocability” for a rabbi trust if there is a change of control or ownership.
A.I and IV.
B.I and III.
C.II and III.
D.I only.
Solution: The correct answer is D.
II describes a secular trust. III is incorrect because off-shore Rabbi trusts may still create and hold assets but there is no tax benefit for doing so. Realistically, these are no longer created because of the loss in preferential tax treatment. However, any off-shore Rabbi trust previously created is grandfathered so as long as there are no material changes to the plan it may maintain the pre-AJCA ’04 treatment (the preferential tax deferral). IV is wrong because AJCA 2004 does allow springing irrevocability in these circumstances, but not for bankruptcy.
Joe Liner works at a company that is considering options regarding its future legacy payments and it needs to find current tax deductions. One option the company is considering is funding a VEBA this year. Joe is uneasy but open to the idea because he has heard that more benefits may be funded in the VEBA. Which of the following are permitted under a VEBA?
Life, sickness and accident benefits
Retirement benefits
Severance and supplemental unemployment
Job training
Commuter benefits
A.I, II and III only.
B.II and IV only.
C.I, III and IV only.
D.II, III and V only.
Solution: The correct answer is C.
Retirement benefits and commuter benefits cannot be included in a VEBA.
All of the following events qualify for 36 months of COBRA coverage EXCEPT:
A.The group health plan terminates.
B.Death of the employee.
C.Employee reached Medicare age.
D.Normal termination.
Solution: The correct answer is D.
All of the following are considered Qualified Benefits for a cafeteria plan EXCEPT:
Adoption Assistance
Education Assistance
Dependent Care Assistance
Athletic Facilities
A.I only.
B.I and IV only.
C.II and III only.
D.II and IV only.
Solution: The correct answer is D.
Deepak made a contribution to his Roth IRA on April 15, 2023 for 2022. He was 58 years of age at the time and decided it was time he made his first contribution to a Roth IRA. Over the years he has contributed $30,000 between a small conversion (2023) and some contributions. On May 15, 2025 the entire account balance was $50,000 and he took out $45,000 to pay for his wedding and honeymoon. Which of the following statements is true?
A.He will not include anything in income and will not be subject to the 10% early withdrawal penalty.
B.He will include $15,000 in income and will be subject to the 10% early withdrawal penalty on $15,000.
C.He will include $15,000 in income but will not be subject to the 10% early withdrawal penalty.
D.He will include $20,000 in income but will not be subject to the 10% early withdrawal penalty.
Solution: The correct answer is C.
Roth distributions are tax free if they are made after 5 years and because of 1) Death, 2) Disability, 3) 59.5 years of age, and 4) First time home purchase. He does meet a qualifying reason because he is over 59.5 in the year of the withdrawal, given he was 58 years old three years ago.
However, he did not meet the 5 year holding period. He only has about 4 years. (Note: The contribution on April 15th for the previous year’s contributions counts as if it were contributed on January 1st of the prior year.) His distribution does not receive a full tax free treatment. The treatment for a non-qualifying distribution allows the distributions to be made from basis first, then conversions, and finally earnings.
Of the $50,000 account balance, his basis and conversion will be tax free ($30,000), leaving only the earnings ($20,000) as potential taxable income. Since he only withdrew $45,000 of the $50,000 account balance, the first $30,000 is tax free (not subject to the 5-year rule since he is over 59.5 years old), and only the additional $15,000 of earnings will be subject to income tax (because of the 5-year rule not being met). The 10% penalty does not apply to this distribution since he qualifies for the 59.5 year old exception to the penalty.
A client turned age 72 on February 1, 2023. The value of the account at the beginning of the current year was $53,000. His spouse, age 63, is the beneficiary of the IRA account. When must the client’s first RMD be taken?
A.December 31, 2023
B.April 1, 2024
C.December 31, 2024
D.April 1, 2025
Solution: The correct answer is D.
SECURE Act 2.0 revised Required Minimum Distributions to age 73 as a start date for anyone turning 72 after 12/31/22. The client turns 73 on February 1, 2024.
Participants have until April 1 following the year they turn 73 to take their first RMD. Therefore, his first-year distribution must begin by April 1, 2025.
Kevin, a 55-year-old corporate executive, wants advice as to when he can retire. His current salary is $240,000 and he receives an annual bonus of $300,000; he also has annual stock options and restricted stock awards valued at $100,000. His employer contributes to a cash balance pension plan and matches his contributions to a 401(k). Kevin owns a whole life insurance policy with a $500,000 death benefit and is considering the purchase of a term policy with a $2,000,000 death benefit. He and his wife, Anne, also age 55, believe they can live on an after-tax income of $180,000. Assume a federal income tax rate of 35%.
Kevin’s non-qualified stock options are as follows:
2,000 shares, strike price $34
5,000 shares, strike price $30
Current stock price: $65
Kevin’s tax bracket: 42% (federal and state)
Kevin has decided to exercise the above stock option awards which will expire in the next 2 years. Assuming he exercises them today, what is his tax liability (CFP® Certification Examination, released 8/2012)?
A.$35,550
B.$68,250
C.$91,660
D.$99,540
Solution: The correct answer is D.
Non-qualified stock options are taxed on the “bargain element” (difference between the market price and the strike price) as ordinary income when exercised. (Market Price – strike price) × Number of Shares × Tax Rate = Tax
Therefore, on the first NQ grant of 2,000 shares the tax is:
($65-34) × 2,000 shares = $62,000 in ordinary income. At 42% tax rate the tax is $62,000 × .42 = $26,040.00
And
On the second NQ grant of 5,000 shares the tax is:
($65-30) × 5,000 = $175,000 in ordinary income. At 42% tax rate the tax is $175,000 × .42 = $73,500.00
Total tax therefore is $26,040.00 + $73,500.00 = $99,540.00
Starfish Capital would like to offer their employees some additional benefits. The first step is for them to identify who their key employees are. Which of the following employees is a key employee?
- Doug, an officer of the company, who earns $145,000 per year and owns 3% of the company.
- Dan who earns $49,000 per year and owns 4% of the company.
- Diane, a sales director who earns $295,000.
- Dirk, a 10% owner of the company who earns $19,000 per year as a mail room attendant.
A.4 only.
B.3 and 4.
C.1 and 3.
D.None of the above are key employees.
Solution: The correct answer is A.
Only Dirk is a key employee due to a 5%+ owner and the compensation above the threshold for a 5%+ owner.
A key employee is potentially anyone who is an owner. a high-level officer, and above the IRS compensation thresholds for the current year. More specifically, a key employee is any one with (1) ownership greater than 5% regardless of compensation, or (2) ownership greater than 1% with compensation in excess of current annual compensation amount for a 1%+ owner set by the IRS , or (3) a high-level officer position with compensation in excess of the current year annual amount for an officer set by the IRS.
Doug is an officer, but compensation is under the current year’s threshold for key employee officer.
Dan is an owner greater than 1%, but compensation is under the threshold for 1%+ ownership.
Diane is not listed as an officer of the company, so the compensation is not considered.
Do not confuse title with position. Officers typically include high-level management such as the CEO, treasurer and CFO. The corporation may appoint other officers which complicates the employee/officer distinction. Someone with the title “vice president” may be an officer or merely an ordinary employee with a title.
