Special Circumstances and Economic Concepts

Question 1

Divorce - Prior to 2019

Answer 1

For divorces finalized by December 31, 2018 only, alimony is deductible by payor and taxable to payee if
the following requirements are met:
* The taxpayers cannot file a joint tax return or live together at the time of payment
* Payments must be made in cash (see next area)
* Payments must be received by or for the benefit of the payee spouse (i.e., not treated as child
support)
* The payments cannot extend beyond the death of the recipient spouse by decree or by state law

Question 2

Alimony test for deductibility—cash payments

Answer 2

Qualifies as alimony (tax deductible)
- Cash payments from the payor spouse to third parties such as payments of the ex-spouse’s rent, mortgage, tax, or tuition liabilities
- Premium payments made by the payor spouse for life insurance owned by the
payee spouse where the payor is the insured

Does not qualify as alimony (not tax deductible)
- Any payments to maintain property owned by the
payor spouse and used by the payee spouse (including mortgage payments, real estate taxes, and insurance premiums)
- Transfers of non-cash items, including services, property or the use of property, or promissory notes

Question 3

Divorce - After 2019

Answer 3

• alimony will not be deductible by the payor nor includible in the gross income of the payee

Question 4

Child support

Answer 4

Child support payments are non-taxable to the payee and nondeductible by the payor regardless of whether the divorce settlement occurred before or after the TCJA went into effect. Any amount tied to a contingency or occurrence of an event relating to a child is considered to be child support and not
alimony.

Question 5

Divorce - Property settlements

Answer 5

The 1984 Tax Act provides that any transfer of property between spouse’s incident to a divorce is gift tax-free. The transferor’s basis in the property is “carried over” to the transferee

Question 6

Divorce - Tax Privileges

Answer 6

While the dependency exemption (personal exemption) was eliminated under the Tax Cuts and Jobs
Act, certain privileges, such as the ability to deduct a child’s medical expenses is generally awarded to the custodial parent. However, if the parties agree and the instrument stipulates, the non-custodial parent
may claim the expense.

Question 7

Disability

Answer 7

Other possible
sources of coverage include:
* Social Security disability benefits
* Workers’ compensation (job-related)
* Employer-provided disability insurance
* Medicare or Medicaid benefits
All individuals should review the financial exposures and the benefits available and then plan accordingly.

Question 8

Terminal illness

Answer 8

Many questions should be asked before the planning can be done. Is the terminal illness treatable? How
long is the client expected to live? Is the client incompetent? Is incompetence anticipated? Consider the following financial matters:
* How much will be provided by insurance (disability or LTC policies)?
* Will the individual qualify for disability or LTC benefits?
* Will the individual qualify for Medicare or Medicaid benefits?

Certain legal documents that should be prepared or reviewed:
* A living will
* A durable power of attorney for health care
* A living trust

Question 9

Non-traditional families - Single Parent

Answer 9

• Budget for additional childcare
• Prepare for time off from work when children are sick
• Social Security survivor benefits for his/her children and himself/herself
• Income replacement using life insurance and trusts
• Guardianship for the child

Question 10

Non-traditional families -unmarried domestic partners

Answer 10

• Titling of assets
• Beneficiary designations (insurance, annuities, or retirement plan beneficiary)
• Employer retirement plan beneficiary designations
• No intestacy rights

The best transfer arrangements for the exam for unmarried domestic partners are a revocable trust and tenancy-in-common. Wrong answers for the test are a will (can be contested by family members).
Trusts are private. Other wrong answers are no will (intestacy) or joint tenancy with rights of survivorship. A disgruntled partner can siphon the entire account.

Question 11

COBRA (Consolidated Omnibus Budget Reconciliation Act) provisions

Answer 11

• Under COBRA, employers providing group or self-funded health coverage are required to offer terminated employees the right to buy continued health coverage.
• Small companies (fewer than 20 employees for at least half of the prior year) are exempt from the federal legislation.

Question 12

COBRA coverage and periods

Answer 12

• Voluntary or involuntary
  termination; change from fulltime to part-time
• • coverage offered to: Terminated employees and
    other dependents
• • period: up to 18 months
• Employee’s death, divorce, legal separation or eligibility for Medicare
• • coverage offered to: Spouses and other dependents
• • period: up to 36 months
• Loss of dependent status
  (marriage, reaching dependency age limit specified by plan)
• • coverage offered to: Dependents whose status
    changed
• • period: up to 36 months

Question 13

The Affordable Care Act (ACA)

Answer 13

provides guaranteed enrollment with no preexisting conditions
exclusions. Upon separation from service, the former employee may choose COBRA for a specified number of months or purchase an Affordable Care Act policy through an exchange
until reaching Medicare eligibility generally at age 65.

Question 14

Structured settlements

Answer 14

A structured settlement is a voluntary agreement between the personal injury victim and the defendant
who was deemed to be negligent. Under structured settlements, injury victims do not receive the compensation award for their injuries in one lump sum, instead, they will receive a stream of tax-free
payments perhaps tailored to meet future medical expenses and living needs. A structured settlement may be agreed to privately (for example, in a pretrial settlement), or it may be required by court order
which typically happens in judgments involving minors.

Question 15

Compensatory damages

Answer 15

• Compensatory damages received because of personal physical injuries or physical sickness are generally
  tax-free. However, interest paid on a tax-free damage award is taxable (however, see “Annuity”exception.
• Damages received in discrimination (age, sex, or race) or other non-physical injury cases are taxable with one exception: damages up to the amount of actual medical care expenses
  attributable to emotional distress like psychiatric care are tax-free.

Question 16

Punitive damages

Answer 16

Punitive damages generally are taxable, regardless of the nature of the claim. Punitive damages do not provide compensation for injuries but rather are intended to punish wrongdoing by the highly negligent defendant who was sued. Exception: Damages paid to a beneficiary in conjunction with wrongful death are received tax-free

Question 17

Annuitizing the Award

Answer 17

If a lump sum payment representing the present value of the future damages (the award) is invested for
the benefit of a claimant who has actual or constructive receipt or the economic benefit of the lump sum,
only the amount of the lump sum payment received as compensatory damage is excludable. None of the
income from the investment is income tax excludable. However, where the damages are to be paid periodically and the injured person retains no right to the discounted present value of the payments or
any control over the investment of the present value, the entire amount of each periodic payment is
excludable, including earnings on the fund.

Question 18

Prizes and awards

Answer 18

Under the principle of constructive receipt, the winner of a contest (generally a lottery) having the
option of receiving either a lump sum or an annuity has to include the full value of the award in gross income, even if he or she takes the annuity. However, if that winner has a choice of either cash or an
annuity (60-day window) and chooses an annuity payout over at least 10 years, then the payouts are taxable as received (called the “qualified prize option”).

Question 19

Supply and demand

Answer 19

Supply is the amount of a good or service that producers are willing to sell. The supply of a particular
good depends on:
* Price
* Costs of production (such as labor costs)
* The level of technology (Current technology may make the good obsolete).

Demand is the amount of a good or service that buyers are willing to purchase. The demand for a specific product depends on several variables, such as:
* Price
* Prices of other goods, especially substitute goods
* Consumers’ incomes and tastes

Question 20

Fiscal policy

Answer 20

Fiscal policy represents federal taxation and spending designed to level out the business cycle and
achieve full employment, price stability, and sustained growth in the economy. Fiscal policy is independent of monetary policy

Question 21

Monetary policy

Answer 21

The Federal Reserve Board has the power to influence the “supply” of credit in the U.S. economy. The Fed meets to analyze economic trends and to decide on actions relative to the money supply. The Fed can use its
influence to either tighten credit or to loosen credit. Monetary policy is action taken by the Federal
Reserve to influence the growth of the money supply.

Question 22

Tools of the Federal Reserve

Answer 22

• Reserve requirements: The Fed sets the level of reserve that its member banks must
  maintain. For example, if the reserve requirement is 10%, then the bank can lend
  90% of its deposits. The Fed rarely changes the reserve requirement due to the “multiplier effect.”
  —–Expansionary policy: Reduce the reserve requirement
  —–Contractionary policy: Increase the reserve
  requirement
• Discount rate: The discount rate is the rate the Federal Reserve charges its member
  banks to borrow to meet reserve requirements. The discount rate should not
  be confused with the prime rate which is the interest rate that commercial banks charge their most creditworthy corporate customers. Prime rate is often an option for exam
  questions about monetary policy and is always wrong.
  —–Expansionary policy: Lower the discount rate
  —–Contractionary policy: Raise the discount rate
• Open market operations: The Federal Reserve trading desk adjusts credit availability daily through repurchase and
  reverse-repurchase agreements with
  government securities dealers. Under a “repo,” the Fed gives the dealer funds in
  return for a temporary pledge of government securities (buys bonds). Under a “reverserepo,” the Fed gives the dealer a temporary
  pledge of government securities in return for
  cash (sells bonds).
  —–Expansionary policy: Repo/buy bonds
  —–Contractionary policy: Reverse Repo/sell bonds

Margin rates: The Fed sets initial margin rates for securities under Reg. T.
—–Expansionary policy: Decrease the margin
percentage required
—–Contractionary policy: Increase margin
percentage required

Question 23

Leading Economic Indicators

Answer 23

Leading economic indicators are analyzed by economists to forecast the business cycle because they usually “anticipate” or move before changes in the economy. Leading indicators include the following.
1. Average weekly hours for production workers in manufacturing
2. Initial claims for unemployment insurance
3. New manufacturing orders
4. Vendor performance measured as a percentage of companies reporting slower deliveries
5. Contracts and orders for plants and equipment
6. New private housing units
7. Interest rate spread
8. Stock prices, 500 common stocks
9. Money supply
10. Index of consumer expectations

Question 24

Coincident Indicators

Answer 24

Coincident indicators move in tandem with the broad economy. They include the following.
1. Number of employees on non-agricultural payrolls
2. Personal income less transfer payments (e.g., Social Security, welfare)
3. Industrial production

Question 25

Lagging Indicators

Answer 25

Lagging indicators usually respond after the economy has already begun to change. They are sometimes called “confirming indicators.” They include the following.
1. Average duration of unemployment
2. Average prime rate charged by banks
3. Commercial and industrial loans outstanding
4. Ratio of consumer installment credit outstanding to personal income
5. Change in the consumer price index for services

Question 26

Recession/Depression

Answer 26

A recession is defined by most economists as at least two consecutive quarters of decline in real GDP.
Another definition is a significant decline in economic activity spread across the economy, lasting more than a few months. A severe or long recession is generally regarded as an economic depression. (6
quarters)

Question 27

Gross Domestic Product (GDP)

Answer 27

GDP measures the U. S. economy’s total production of goods and services. It measures the dollar value
of all final goods and services newly produced within the country’s boundaries. Cars made by Mercedes
in Alabama are included, but cars made by GM in Germany are not. GDP counts economic activity
without regard to yearly price fluctuations (i.e. inflation).

Question 28

Consumer Price Index (CPI)

Answer 28

The CPI is a “market basket” of selected goods and services in various cities across the country. [The
CPI-U (Urban Consumers) is the number that is widely reported.] The CPI has eight major categories:
* Food and beverages
* Housing
* Recreation
* Apparel
* Transportation
* Medical care
* Education and communication
* Other goods and services

Question 29

Producer Price Index (PPI)

Answer 29

The PPI is an index of the price of various items such as farm products and industrial commodities. This index does not include the value of services as does the CPI. The leading indicator of inflation trends is the PPI. As producer costs rise, they are then passed on to consumers and ultimately reflected in the
CPI

Question 30

Business cycles

Answer 30

The business cycle reflects movements in economic activity. The economy experiences periods of
expansion and contraction. The transition points across cycles are called peaks and troughs. The peak is
the transition from the end of expansion to the start of a contraction. A trough occurs at the bottom of a recession just as the economy enters a recovery.

As the economy passes through different stages of the business cycle, the relative performance of
different industry groups will vary. For example, at a trough, right before the economy begins to
recover from a recession, cyclical industries (those with above-average sensitivity) tend to outperform other industries. Examples include automakers and appliance manufactures. Why? Consumers don’t buy high-ticket items during recessions.

In contrast to cyclical industries, defensive industries have little sensitivity to the business cycle. Defensive industries include food producers, certain pharmaceuticals, and public utilities. These
industries will outperform cyclical industries when the economy enters a recession.

Question 31

Durable vs. non-durable goods

Answer 31

Durable goods or hard goods are items which do not wear out quickly. They are cyclical.
Examples of consumer durable goods include cars, appliances, business equipment, electronic
equipment, home furnishings and fixtures, houseware and accessories, photographic equipment, recreational goods, sporting goods, toys and games.

Non-durable goods or soft goods (consumables) may be used up immediately or have a short life span. They would not be affected by recession because they do not last. People always need them.
Examples of nondurable goods include FMCGs (fast moving consumer goods) such as cosmetics and
cleaning products, food, fuel, office supplies, packaging and containers, paper and paper products, personal products, rubber, plastics, textiles, clothing and footwear.

Question 32

Inflation, deflation, and stagflation

Answer 32

Inflation is the rise in prices of goods and services, as is likely when spending increases relative to the supply of goods on the market. In other words, it is too much money chases too few goods. Two
primary U. S. indicators of the inflation rate are the Consumer Price Index and the Producer Price Index.

Deflation is the decline in the price of goods and services. Deflation is the reverse of inflation.

Stagflation is the combination of slow economic growth and high unemployment (stagnation) with rising prices

Question 33

Yield curve

Answer 33

The direction in which interest rates are moving determines what will happen to bond prices. The
curves show the market rates of interest for bonds of different maturities with the same credit ratings

Question 34

Normal or positive yield curve

Answer 34

The “normal” shape of the yield curve shows that as maturities lengthen, yields increase. Yields typically increase as maturities lengthen because investors demand a premium for the extra risk associated with longer term maturities.

Question 35

Inverted or negative yield curve

Answer 35

The “inverted” shape of the yield curve is the opposite of the normal curve. If the Federal Reserve tightens short-term credit to slow the economy, then short-term rates can rise above long-term rates (like 1981). This happens when the economy appears to be “overheating,” increasing inflation fears.