Test Q's

Question 1

LTD Inc., a candy manufacturer, is considering the use of sugar futures contracts because sugar is a major ingredient in the manufacturing process. What type of hedge position should LTD take in the sugar futures market, and why?

Answer 1

An investor or producer who enters into a short hedge sells a futures contract; one who enters into a long hedge purchases a futures contract.

A grower owns crops in the field and enters into a short hedge to hedge against declining prices.

A user of the commodity, like LTD, is concerned about rising prices and, therefore, enters into a long hedge to lock in the current price of the commodity.

Question 2

The CFP Board Code of Ethics prohibits a CFP® certificant from doing which of the following activities?

(1) commingling client funds with funds of the financial planning firm
(2) misleading a client
(3) establishing relationships that might compromise the planner’s objectivity (i.e., create a conflict of interest)
(4) using the initials RIA after his or her name

Answer 2

D: (1), (2), and (4) only

A CFP® certificant may not commingle client funds with the funds of the financial planning firm and may not mislead a client. The CFP Board Code of Ethics does not prohibit establishing relationships that might compromise the planner’s objectivity; however, it does require disclosure of these relationships. The use of the initials RIA after one’s name is governed (and prohibited) by the SEC and by CFP Board. (CFP A1)

Question 3

Carrie Johnson purchased an ADR on Volvo. Volvo pays a 2.5% dividend, based on the recent price of Volvo stock. Carrie hopes to hold the stock for several years and experience a capital gain.

A: Carrie will not pay foreign taxes on the dividend income and her investment is subject to exchange rate risk

B: Carrie will pay foreign taxes on the dividend income and her investment is subject to exchange rate risk.

C: Carrie will not pay foreign taxes on the dividend income and her investment is not subject to exchange rate risk.

D: Carrie will pay foreign taxes on the dividend income and her investment is not subject to exchange rate risk.

Answer 3

B: Carrie’s ADR investment of Volvo will pay foreign taxes on the dividend income and her investment is subject to exchange rate risk.

Question 4

Your client has indicated an interest in writing covered call options to produce income on his existing portfolio. Your client owns 1,000 shares of Disney. Disney is currently selling for $33 per share and a three-month call option at $30 is selling for $4.10. Which of the following would describe your explanation to the client regarding the value of the option?

Answer 4

C: The intrinsic value is $3.00 and the time premium is $1.10.

The option is in the money because the stock is selling for more than the strike price and the option price breaks down as follows: time value + in the money amount = total price $1.10 + $3.00 ($33 − $30) = $4.10

Question 5

Which of the following are correct statements about the overall limits on employer contributions to and deductions for qualified plan contributions in 2017?

(1) An employer’s deduction for contributions to a money purchase pension plan and profit sharing plan cannot exceed 25% of the participants’ payroll.
(2) If an employer maintains both a defined benefit plan and a defined contribution plan, and the DB plan is covered by PBGC, then the employer can fund the DB plan and contribute up to 25% of covered payroll to the DC plan.
(3) An employer’s deduction for contributions to a defined benefit pension plan and profit sharing plan cannot exceed the lesser of the amount necessary to satisfy the minimum funding standards or 25% of the participants’ payroll.
(4) A defined contribution plan may lose its qualified status if a participant’s account receives a contribution of more than the lesser of 100% of the participant’s compensation or $54,000 in 2017.

Answer 5

(1), (2), and (4) accurately state the rules regarding the deduction limitation for defined contribution pension and profit sharing plans.

Question 6

Your client, Sally Masters, is considering investing in real estate as a way to diversify her investments. She has heard of active participation rental real estate, but is unsure of the requirements that must be met. What can you accurately tell her with respect to active participation rental real estate?

(1) The interest may not be held through a limited partnership.
(2) A deduction-equivalent tax credit of up to $25,000 is available.
(3) The taxpayer must hold a 10% or greater ownership interest.
(4) The taxpayer must make the major management decisions.

Answer 6

1, 3 & 4

Correct!

The deduction for active participation rental real estate requires that the taxpayer participate in management in a bona fide sense; making the major management decisions. To qualify, the interest may not be held through a limited partnership, and the taxpayer must have at least a 10% or greater ownership interest in the property. The loss is deductible when computing the gross income. Active participation rental real estate generates an above-the-line deduction of up to $25,000 annually, not a credit.

Question 7

Which of the following are correct statements about unrelated business taxable income (UBTI)?

(1) Employer securities purchased with borrowed funds by employee stock ownership plans (ESOPs) are not subject to UBTI.
(2) For purposes of the UBTI rules, a trade or business generally includes any direct business activity carried on for the production of income.
(3) The UBTI rules apply to both active and passive investors who own a partnership interest in an investment enterprise.
(4) Dividends, interest, and similar types of income derived from investments in a business are not subject to UBTI.

Answer 7

1, 2, 3 and 4

The four statements correctly describe the definition of a trade or business for purposes of the UBTI rules, the applicability of the UBTI rules to active and passive partnership investors, and types of income that are excluded from UBTI treatment. An ESOP that purchases employer securities with debt is not subject to the UBTI rules; however, the UBTI rules apply to other types of ESOP investments made with borrowed funds.

Question 8

A taxpayer invested in a real estate limited partnership several years ago. There is a special allocation in effect in the partnership. He is concerned about the deductibility of the losses that are flowing from the partnership. Which of the following rules or doctrines may limit the availability of income tax benefits from his limited partnership investment?

(1) direct participation program
(2) substantial economic effect doctrine
(3) at-risk rule
(4) passive activity loss rule

Answer 8

2, 3, & 4

The substantial economic effect doctrine limits the ability to utilize special allocations in a partnership. The at-risk rule limits the ability to utilize leverage by attacking the use of nonrecourse financing. The passive activity loss rule limits the ability to deduct losses from activities in which the taxpayer does not materially participate. The direct participation program simply refers to a tax conduit.

Question 9

Which of the following are allowable itemized deductions for purposes of computing the alternative minimum tax?

(1) charitable deductions
(2) qualified housing interest
(3) gambling losses to the extent of gambling winnings
(4) property taxes

Answer 9

1, 2 & 4

Option (4), property taxes, is the only itemized deduction listed that is not allowed for AMT purposes.

Question 10

Which of the following items are considered to be gifts subject to the federal gift tax?

(1) gratuitous transfers to a donor’s spouse
(2) contributions to political organizations
(3) gratuitous transfers to a qualified charity
(4) payments directly to a hospital for an individual

Answer 10

1 & 3

Although gratuitous transfers to a spouse and a qualified charity may never be taxable because of the unlimited marital and charitable deductions, respectively, they are considered gifts subject to the federal gift tax. (2) and (4) are statutorily defined exceptions to the federal definition of “gift.”

Question 11

63. Which of the following statements are true?

I. Upon exercise, W-2 income is reported, and payroll taxes due, for NQSOs.

II. Upon exercise, W-2 income is reported for ISOs.

III. Upon exercise, AMT taxable income will be created if the ISO is not sold by the end of the year.

IV. If an ISO is sold in the same year as exercised, there will not be any AMT income reported.

a. I and III only
b. II and III only
c. I, III, and IV only
d. II, III, and IV only

Answer 11

1, 3 & 4

Option II is incorrect, there is no W-2 income reported upon the exercise of an ISO.

Question 12

During the current year, Raymond Gates has Section 1231 gains totaling $12,000. He also has $2,000 of Section 1231 losses. Three years ago, Raymond reported a net Section 1231 loss of $6,000. Two years ago Raymond had Section 1231 gains of $2,000.

Which one of the following correctly describes the amount and treatment of the gain?

A: $10,000 is treated as ordinary income

B: $10,000 is treated as capital gain income

C: $6,000 is treated as capital gain, $4,000 is treated as ordinary income

D: $6,000 is treated as ordinary gain, $4,000 is treated as capital gain

Answer 12

C is the answer.

The current Section 1231 gain ($10,000) is treated as ordinary income to the extent of unrecaptured Section 1231 losses during the five-year lookback period. There are $4,000 of unrecaptured Section 1231 losses ($6,000 loss from three years ago minus the $2,000 gain that was treated as ordinary income two years ago) during the lookback period. Thus, $4,000 is ordinary income, and the remaining $6,000 is treated as long-term capital gain.

Question 13

During the current tax year, Sid has a short-term capital loss of $9,000 from the sale of securities. He also has a long-term capital gain from the sale of an art collection of $5,500 and has unrecaptured Section 1250 income of $14,000 from the sale of a rental property. Sid is in the 35% marginal income tax bracket.

What is the tax result from the capital transactions?

A: $3,500 short-term capital loss carryforward and $14,000 unrecaptured Section 1250 income taxed at 25%

B: $5,000 unrecaptured Section 1250 income taxed at 25% and $5,500 collectibles gain taxed at 28%

C: $10,500 unrecaptured Section 1250 income taxed at 25%

D: $9,000 collectibles gain, $11,000 unrecaptured Section 1250 income, and $6,000 capital loss carryforward

Answer 13

C is the answer.

The short-term capital loss is first used to offset the collectibles gain of $5,500. This leaves a short-term capital loss of $3,500. This is next used to offset the 25% gain. The $14,000 is offset by the $3,500 remaining capital loss. This leaves $10,500 of unrecaptured Section 1250 income, taxed at a maximum 25% rate. This is the most favorable manner of offsetting the capital losses against the capital gains.

Question 14

Mindy Martin has AGI of $300,000. In addition, she currently has passive income of $150,000 and passive losses of $175,000, $150,000 of which she uses to offset the passive income and $25,000 of which is subject to disallowance. She currently is subject to the alternative minimum tax.

Which one of the following activities, if any, has the greatest potential for reducing Mindy’s tax liability?

A: investing in “active participation” rental real estate that is producing a loss

B: investing in a historic rehabilitation project that is producing passive losses and credits

C: investing in an oil and gas limited partnership that is generating losses

D: investing in a newly-formed low-income housing activity that generates credits

Answer 14

D is the answer.

Because Mindy is subject to the AMT, we would expect that any credits that reduce the regular tax to a point below the AMT will be currently disallowed and carried forward. However, the low-income housing credit can offset AMT liability for low-income housing property placed in service after 2007. Remember that for low-income housing property placed in service after 1989, the AGI limitations do not apply. Mindy’s AGI is too high, over $150,000, to qualify for the active participation rental real estate exception. The oil and gas limited partnership could not be a working interest because the form of ownership limits the taxpayer’s personal liability, and would therefore generate more nondeductible passive losses.

Question 15

If Ken sells the VWL 1244 restricted stock at its fair market value, what is the result?

A: The $111,550 loss is a long-term capital loss, deductible up to $3,000 per year.

B: The $111,500 is an ordinary loss, fully deductible against other income.

C: Of the $111,550 loss, $50,000 is an ordinary loss, and $61,550 is a long-term capital loss.

D: Of the $111,550 loss, $100,000 is an ordinary loss, and $11,500 is a long-term capital loss.

Answer 15

C is the answer.

The annual ordinary loss on a sale of Section 1244 stock is limited to $50,000 for single taxpayers or for married taxpayers filing separately. On a joint return, $100,000 of ordinary loss may be deducted. The remainder of the loss (the excess over the ordinary loss) is treated as a capital loss (long term, in this situation).

Question 16

Earl’s executor is computing his estate tax liability. Among other provisions, Earl’s will provides the following relating to his wife, Nanci, who is still alive more than 10 months after Earl’s death:

(1) grants Nanci a life estate in his residence with the remainder at her death to go to Earl’s only son, Jack
(2) establishes Trust No. 1, on the condition that Nanci survive him by at least three months; this trust grants all income to Nanci for life (to be paid at least annually) and grants to Nanci a general power of appointment over the corpus
(3) establishes Trust No. 2, naming Jack and Nanci as income beneficiaries, to receive distributions of income at the trustee’s discretion, with the remainder at Nanci’s death to go to Jack
(4) establishes Trust No. 3, on the condition that Nanci survive him by at least three months; this trust grants all income to Nanci for life (to be paid at least annually) and gives the remainder to a qualified charity

For which of the above-referenced interests left to Nanci by Earl can the executor claim the marital deduction?

Answer 16

1. (1) is a terminable interest, but is eligible for the marital deduction by means of a QTIP election. (TRUE)
2. (2) is a power of appointment or “A” trust—she gets all the income and can use the general power of appointment to appoint all corpus to herself. (TRUE)
3. (3) is a bypass or family trust, which grants Nanci only a terminable interest that terminates at her death. NO MARITAL DEDUCTION (FALSE)
4. (4) The interest given to Nanci is a terminable interest, but is eligible for the marital deduction by means of a QTIP election. The trust in (4) is not a CRAT or a CRUT because Nanci is not given either an annuity or unitrust interest. (TRUE)

Question 17

Which of the following are the tax implications of a 10-year term charitable lead trust with the donor’s children as the remainder beneficiaries?

(1) The donor’s charitable gift tax deduction is determined by the present value of the charity’s right to receive trust assets at the end of the 10-year term.
(2) The donor is liable for gift tax based on the entire value of the gift to the children as discounted to the date of the gift.
(3) The entire value of the assets gifted to the trust will be removed from the donor’s gross estate only if he or she outlives the 10-year term.
(4) Each year, as the trust pays income to the charity, the donor receives a charitable income tax deduction for that amount.

Answer 17

(1) The donor’s charitable gift tax deduction is determined by the present value of the charity’s right to receive trust assets at the end of the 10-year term. (FALSE)
(2) The donor is liable for gift tax based on the entire value of the gift to the children as discounted to the date of the gift. (TRUE)
(3) The entire value of the assets gifted to the trust will be removed from the donor’s gross estate only if he or she outlives the 10-year term. (FALSE)
(4) Each year, as the trust pays income to the charity, the donor receives a charitable income tax deduction for that amount. (FALSE)

In a charitable lead trust, the charity receives the income with the remainder to a noncharitable beneficiary. The present value of this remainder interest is taxable.

Therefore, the charitable gift tax deduction (1) is the present value of the income interest.

(3) is incorrect as the entire value of the trust assets is removed from the grantor’s gross estate no matter when the grantor dies.
(4) is incorrect as the amount of the charitable income tax deduction is based on the value of the gift to the charity in the year the gift is made, not on income earned.

Question 18

Marital Deduction T/F?

(1) The marital deduction is for property that is included in a decedent’s gross estate that passes, or has passed, to the surviving spouse in a qualifying manner.
(2) The marital deduction is allowed for property transferred from the decedent to the spouse only if the spouse survives the decedent by more than six months.
(3) Generally, there is no marital deduction if an interest in property passing from the decedent to the surviving spouse also passes to some other person without full consideration, and that person may enjoy the property after the surviving spouse’s interest terminates.
(4) If the surviving spouse is the only noncharitable beneficiary of a CRAT or CRUT, the marital deduction is not allowed for the interest passing to the spouse.

Answer 18

(1) The marital deduction is for property that is included in a decedent’s gross estate that passes, or has passed, to the surviving spouse in a qualifying manner.
(2) The marital deduction is allowed for property transferred from the decedent to the spouse only if the spouse survives the decedent by more than six months.
(3) Generally, there is no marital deduction if an interest in property passing from the decedent to the surviving spouse also passes to some other person without full consideration, and that person may enjoy the property after the surviving spouse’s interest terminates.
(4) If the surviving spouse is the only noncharitable beneficiary of a CRAT or CRUT, the marital deduction is not allowed for the interest passing to the spouse.

(1) True -
(2) False - is incorrect because the marital deduction is allowed for qualifying transfers even when the spouse survives for six months or less, unless a state statute or will provision requires survival for this minimum period. However, a provision requiring survival for more than six months would deny the marital deduction under federal law.
(3) True
(4) False - is incorrect because a marital deduction for the present value of the income interest is allowed in these circumstances.

Question 19

Which of the following statements regarding a sale-leaseback transaction are correct?

(1) This type of transaction almost always involves business property.
(2) If the sale is for fair market value (FMV), the Chapter 14 valuation rules will not apply even if this type of transaction is between family members.
(3) The sale portion of this type of transaction can involve either a lump-sum payment or an installment sale.
(4) The lease payments will constitute ordinary income to the purchaser.

Answer 19

(1) This type of transaction almost always involves business property.
(2) If the sale is for fair market value (FMV), the Chapter 14 valuation rules will not apply even if this type of transaction is between family members.
(3) The sale portion of this type of transaction can involve either a lump-sum payment or an installment sale.
(4) The lease payments will constitute ordinary income to the purchaser.

1 True

2 True

3 True

4 True

Question 20

Impact of actuarial assumptions on the funding of the plan?

Life Expectancy ?

Expected Inflation ?

Expected Investment Returns ?

Expected Mortality ?

Expected Wage Increases ?

Expected forefeiture/employee turnover ?

Answer 20

Question to ask is “IF blank goes up, THEN what happens to plan costs?

Life Expectancy (Direct Relationship)

Expected Inflation (Direct Relationship)

Expected Investment Returns (Indirect Relationship)

Expected Mortality (Indirect Relationship)

Expected Wage Increases (Direct Relationship)

Expected forefeiture/employee turnover (Indirect Relationship)

Question 21

What are the three Monetary Policy Tools by the Fed?

Answer 21

• Open Market Operations
• Discount Rate Changes
• Reserve Requirement Changes

Question 22

What are Expansionary Monetary Policy Tools?

Answer 22

Open Market Operations - Purchase Government Securities

• Fed creates dollars to buy securities on the open market
• Dollares transferred from the Fed to the Public and Banks

Discount Rate - Lower Discount Rate

• Encourages banks to borrow from the Fed to lend to their customers

Reserve Requirements - Lower Reserve Requirements

• Allows banks to expand lending

Question 23

What are Contractionary Monetary Policies?

Answer 23

Open Market Operations - Sell Government Securities

• Fed sells securities on the open market
• Dollars transferred from the Public and Banks to the Fed

Discount Rate - Raise Discount Rate

• Discourages banks to borrow from the Fed to lend to their customers

Reserve Requirements - Raise Reserve Requirements

• Discourages banks from expand lending

Question 24

Patty Glover has a $10,000 passive loss carryforward from Beta limited partnership that is publicly traded. She also has a $15,000 passive loss carryforward from Alpha limited partnership that is nonpublicly traded. In the current year, she has $6,000 of income from Beta. She also has $11,000 of income from Gamma LP. Gamma is not publicly traded.

What is the total amount of passive losses that Patty may deduct during the current year?

A: $6,000

B: $11,000

C: $17,000

D: $25,000

Answer 24

C = $17,000 is the answer

You can net a Public and Non-Public Traded LP

Of the $10,000 passive loss carryforward from the Beta limited partnership, only $6,000 may be utilized in the current year due to the $6,000 of current year passive income. A total of $11,000 in losses from the Alpha limited partnership may be utilized against the $11,000 of income from the Gamma limited partnership in the current year because both are nonpublicly traded. Thus, the total of passive losses that are allowed for the current year is $17,000.

Question 25

Within how many days must a CFP® certificant notify CFP Board in writing of any conviction of a crime, except misdemeanor traffic offenses or traffic ordinance violations, unless such offense involves the use of alcohol or drugs, or of any professional suspension or bar?

A: 5 business days

B: 10 calendar days

C: 20 business days

D: 30 calendar days

Answer 25

According to the Rules of Conduct section 6.4, a certificant shall notify CFP Board in writing of any conviction of a crime, except misdemeanor traffic offenses or traffic ordinance violations unless such offense involves the use of alcohol or drugs, or of any professional suspension or bar within 30 calendar days after the date on which the certificant is notified of the conviction, suspension, or bar. (CFP A1)

Question 26

Which of the following correctly describe the tax implications of a self-insured accident or medical plan where the employer reimburses the employee directly?

(1) In a discriminatory plan, the employer cannot deduct the reimbursements paid to the employee.
(2) In a discriminatory plan, benefits received by a nonhighly compensated employee are generally tax-free without limit.
(3) In a nondiscriminatory plan, the benefits received by the employee are generally tax-free without limit.
(4) In a nondiscriminatory plan, the employer can deduct reimbursements to the employee if they are paid to the employee or the employee’s beneficiary and are considered reasonable compensation.

Answer 26

2, 3 & 4

The discriminatory nature of the plan does not affect the taxation of benefits for the nonhighly compensated. Benefits received by the employee via a nondiscriminatory plan are tax-exempt. As long as benefits are deemed reasonable compensation and paid to the employee or his or her beneficiaries, the employer may deduct the payments.

Question 27

Ben Goodman wants to purchase a retail boutique in two years. Stated in terms of today’s dollars, he will need an additional $500,000 (adjusted for inflation) to have sufficient funds to finance this objective. Ben assumes that inflation will average 3% throughout this period and that he can earn a 6.5% compound annual after-tax return on investments. Ben plans to make the first payment one year from today.

What serial payment should Ben invest at the end of each of the next two years to accomplish his goal?

A: $242,648, $252,354

B: $242,925, $249,932

C: $253,198, $260,794

D: $252,354, $262,448

Answer 27

With the calculator in [END] mode, 500,000 is the future value and 2 is the number of compounding periods. Calculate the inflation-adjusted interest rate to determine the interest rate to be used: [(1.065/1.03) − (1)] × 100 = 3.3981. Calculate the first payment as if it were to be made today ($245,823.39) and multiply that number by 1 plus the inflation rate (1.03) to get the payment at the end of the first year ($253,198). Multiply that answer by 1.03 to get the second payment ($260,794). This is the amount necessary to be paid each year (as a serial payment) in order to accumulate enough money to purchase the store in two years. (CFP B13)

Question 28

Which of the following legal requirements apply to money purchase pension plans?

(1) The normal retirement benefit must be specified in the plan.
(2) The plan must provide a definite and nondiscretionary employer contribution formula.
(3) Forfeitures can be reallocated to the remaining participants’ accounts in a nondiscriminatory manner or be used to reduce employer contributions.
(4) A separate employer contribution account must be maintained for each participant.

A: (1) and (2) only

B: (2) and (3) only

C: (1), (2), and (3) only

D: (2), (3), and (4) only

Answer 28

D: (2), (3), and (4) only

Correct!

(2), (3), and (4) correctly state the employer contribution formula rule, the forfeiture reallocation rule, and the separate account rule for money purchase pension plans. (1) is a requirement that applies to defined benefit pension plans but not to money purchase plans.

Question 29

Mike Aspen has a moderate risk tolerance and currently has a portfolio that consists of an S&P 500 index fund and a large cap value fund. Mike wants to further diversify his portfolio.

Which one of the following types of investment options will best achieve a better balance in his portfolio?

A: a large-cap growth fund with a moderate to high covariance with the current portfolio

B: a small-cap growth fund with a low covariance to the current portfolio

C: a high yield bond fund with a moderate covariance to the current portfolio

D: a convertible bond fund with a high covariance to the current portfolio

Answer 29

B: a small-cap growth fund with a low covariance to the current portfolio

When a security with a low covariance, or correlation coefficient, with the current portfolio is added, the portfolio risk, as measured by the portfolio standard deviation, is lowered and systematic risk is reduced. Although systematic risk can never be eliminated, it can be reduced through measures such as this. Because of moderate rather than low covariance, the high yield bond fund will provide less diversification and therefore is less appropriate than the small cap growth fund.

Question 30

Which of the following statements are correct regarding generation-skipping transfer tax (GSTT) filing requirements and liability?

(1) If the generation-skipping transfer is a direct skip, the GSTT will be reported on either IRS Form 706 or IRS Form 709.
(2) If the spouse of the donor is more than 37.5 years younger than the donor, a transfer by the donor to the spouse will be considered a direct skip.
(3) If the generation-skipping transfer is an inter vivos indirect skip, the return computing the GSTT will be due on April 15 of the calendar year following the year in which the transfer was made.
(4) When a taxable termination occurs following an indirect skip, the person responsible for filing a GSTT return is the trustee of the trust (or person in possession of the property if there is no trust).

A: (1) and (4) only

B: (2) and (3) only

C: (2) and (4) only

D: (1), (3), and (4) only

Answer 30

A: (1) and (4) only

When a direct skip is made, the transfer will be subject to either gift or estate tax in addition to GSTT. Both IRS Form 706 (estate tax) and IRS Form 709 (gift tax) have sections for reporting transfers that are also subject to the GSTT. The return on which the GSTT is computed for an indirect skip is due April 15 of the calendar year following a taxable termination or distribution. The trustee of the trust (or person in possession of the property) is responsible for filing the GSTT return for a taxable termination, because this event may not involve any actual distribution of trust funds, and all remaining funds are certain to benefit only skip parties. A generation skipping transfer can never be made to the donor’s spouse.

Question 31

Harriet died in the current year with a federal taxable estate of $8 million. Her estate paid $60,000 in state death taxes.
Which one of the following amounts most closely approximates the deduction for state death taxes that Harriet’s estate can claim on her federal estate tax return?

A: $0

B: $16,100

C: $30,000

D: $60,000

Answer 31

D: $60,000

Correct!

A deduction for state death taxes paid by a decedent’s estate can be taken on the estate tax return.

Question 32

As of November 15, last year, the ADP for the nonhighly compensated employees in the Ace Corp. 401(k) plan was 6.5%. Mark Rich is a highly compensated employee and is meeting with you to discuss his financial plan. He wants your advice on the amount that he should plan to defer into the 401(k) plan for this year. Assume that the ADP for nonhighly compensated employees increases to 6.75% in January this year, and that the ADP test for last year was based upon the nonhighly compensated ADP from the year prior to last year. Ace Corp. does not make any contribution to the 401(k) plan. Mark anticipates that his income for this year will be $9,180 per month. What will be the maximum ADP for Ace Corp.’s highly compensated employees for this year?

A: 6.50%

B: 8.13%

C: 8.44%

D: 8.50%

Answer 32

C: 8.44%

Correct

The ADP this year for highly compensated employees (HCEs) would be based upon the nonhighly compensated employees’ (NHCEs’) ADP of 6.5% for last year. If the ADP of NHCEs is less than 2%, the ADP for HCEs can be 200% of the NHCEs’ ADP. If the ADP of NHCEs is 2-8%, the ADP for HCEs can be the NHCEs’ ADP plus 2%. If the ADP of NHCEs is 8% or more, the ADP for HCEs can be 1.25% of the NHCEs’ ADP. In this case, the ADP of NHCEs was 6.5%; the ADP for HCEs would thus be limited to 8.5%.

Question 33

Which of the following transactions would require your client to include something in his gross estate resulting from a gift made within three years of death?

(1) your client’s release of a retained life interest
(2) a gift of $30,000 in cash to your client’s nephew
(3) a transfer of all incidents of ownership in a life insurance policy in which your client is the insured to an irrevocable life insurance trust (ILIT)
(4) a cash gift of $100,000 to a child after your client had already used up his gift tax applicable credit amount

A: (1) and (2) only

B: (1) and (4) only

C: (2) and (4) only

D: (1), (3), and (4) only

Answer 33

D: (1), (3), and (4) only

Correct!

There are only three circumstances in which the three-year rule applies: (a) when gift taxes were paid out of pocket on a gift made within three years of death, the gift tax paid out of pocket must be included; (b) when the decedent gave up incidents of ownership in a life insurance policy on his own life, the death benefits must be included; and (c) when a decedent gave up a retained right mentioned in the “transfer sections,” the asset subject to the retained right must be included. Option (1) is an example of (c), and Option (3) is an example of (b). In Option (4), the donor would have to pay a gift tax out of pocket since he has exhausted his gift tax applicable credit amount, and it is therefore an example of (a).

Question 34

Nathan Brown has salary of $100,000, dividends of $4,000, and limited partnership income of $10,000. The limited partnership is publicly traded. During January of the current year, Nathan purchased an interest in a nonpublicly traded limited partnership that will generate a $12,000 passive loss during the current tax year.

How much of this passive loss, if any, is deductible by Nathan during the current tax year?

A: $0

B: $4,000

C: $10,000

D: $12,000

Answer 34

A: $0

The general rule is that passive losses are deductible only against passive income. However, passive income from a publicly traded partnership cannot be offset by passive losses arising from any other source. Thus, the passive losses from the new partnership will not be deductible.

Question 35

Gregg Stone has an AGI of $150,000. He donated to the local church some stock valued at $100,000 that was purchased eight years ago. His basis in this stock was $30,000. What is Gregg’s maximum allowable charitable contribution deduction for the current year?

A: $30,000

B: $45,000

C: $75,000

D: $100,000

Answer 35

B: $45,000

The gift of long-term capital gain property to a 50% organization is based on the FMV of the property, with a 30% of AGI limitation. 30% of $150,000 is $45,000. The excess of $55,000 is subject to a five year carryforward.

Question 36

Sally Sulton has established and funded an irrevocable trust for the benefit of her family. She named a bank as trustee. She also gave her husband, Tim, who is one of the income beneficiaries of the trust, “the right to demand that the trustee distribute no more than the greater of $5,000 or 5% of the trust assets to any trust beneficiary during the last three months of any calendar year.”
Which of the following statements regarding this trust arrangement are correct?

(1) Sally has given Tim a special power of appointment.
(2) Sally has given Tim a general power of appointment.
(3) If Tim dies in March, his estate will have to include the greater of $5,000 or 5% of the value of the trust assets.
(4) If Tim has not demanded that the trustee distribute any of the trust assets by December 31 of any year prior to death, he will be deemed to have released his power of appointment.

A: (2) only

B: (1) and (4) only

C: (1) and (3) only

D: (2) and (4) only

Answer 36

A: (2) only

The power of appointment is general since Tim can appoint trust assets to himself without reference to an ascertainable standard and without the consent of the creator of the power or someone with an adverse interest. The holder of a general power of appointment must include in his gross estate whatever assets he could have taken for himself immediately prior to death. Since Tim could exercise his power of appointment only during the last three calendar months of the year, he need not include the greater of $5,000 or 5% of the trust assets in his gross estate if he dies in March. Tim’s inaction in Option (4) describes a lapse.

Question 37

Which of the following statements correctly describe requirements for a Section 457 plan in 2017?

(1) Distributions from the plan are not permitted until age 701⁄2.
(2) To avoid adverse income tax effects, the agreement must be executed during the same month as the participant’s services are provided.
(3) Eligible participants include employees of agencies, instrumentalities, and subdivisions of a state, and Section 501 tax-exempt organizations.
(4) The deferral limit is the lesser of $18,000 or 100% of compensation.

A: (1) and (2) only

B: (1) and (3) only

C: (2) and (3) only

D: (3) and (4) only

Answer 37

D: (3) and (4) only

Correct!

(3) All of these organizations may establish a Section 457 plan. (4) Deferrals are limited to the lesser of $18,000 or 100% of compensation in 2017. (1) is wrong since one could receive a distribution prior to age 701⁄2 if it was due to separation from service or an unforeseen emergency, and (2) is incorrect as the agreement must be executed before the first day of the month in which the services will be performed. The result will be a loss of the tax deferral for that month if the agreement is made during the month.

Question 38

Concerning Marilyn’s group medical insurance policy, which of the following statements are true?

(1) Her employer can pay and deduct the entire premium, assuming it constitutes reasonable compensation for Marilyn’s services.
(2) Specifically, as soon as the family as a whole has paid $1,500 in covered expenses, the family deductible will be met.
(3) Intensive care room costs (which normally are much higher than two times the semi-private room rate) will probably lead to substantial out-of-pocket costs.
(4) If Marilyn terminates employment and her employer has an average of 20 or more employees during the year, she can continue the insurance under COBRA.

Answer 38

C: (1), (3), and (4) only

Be careful to recognize the difference between a family deductible that is three times the individual deductible and one where the family deductible is three individuals having to meet their deductibles. In this case, the family deductible is only met after each of three family members has personally met their deductible. If this policy used the other method (i.e., three times the individual deductible), then option (2) would be correct. (CFP D24)

Question 39

When the Federal Reserve buys government securities, which one of the following results is most likely to occur?

A: stock prices will rise and bond prices will fall

B: bond and stock prices will rise

C: bond prices will rise and stock prices will fall

D: bond and stock prices will fall

Answer 39

B: bond and stock prices will rise

When the Fed buys securities, it receives paper evidencing debt owed to it from the federal government and it transfers cash to the sellers of those securities. This increases the money supply, causes interest rates to decrease and bond prices to rise, and encourages consumers and businesses to borrow money for purchases. The increasing demand for goods and services, in turn, causes stock prices to increase.

Question 40

Which of the following correctly identify characteristics of methods of informally funding a nonqualified deferred compensation plan?

(1) With a phantom (shadow) stock plan, at retirement the employee always receives actual shares of stock plus accumulated dividends and must include the total value in income.
(2) Term insurance is inappropriate for informally funding these arrangements.
(3) When using a variable annuity, the employing corporation (contract owner) will be taxed annually on the increase in cash surrender value.
(4) The disability premium waiver allows the funds otherwise used to pay life insurance premiums to be paid to the disabled employee and such amounts to be deducted by the employer.

Answer 40

B: (3) and (4) only

Although cash value life insurance is frequently used to informally fund these arrangements, term insurance is sometimes used by employers with a cash flow problem. If using corporate-owned annuities (COAs), the corporation is taxed annually on the accumulating earnings. If the disability premium waiver on a life insurance policy on the life of an employee is selected, the employer will not pay policy premiums during the employee’s disability. The premium dollars saved are used to pay disability benefits to the employee and can be deducted by the employer.

Question 41

The following information relates to the Porter Company, a manufacturer of custom baseball caps.

Al Porter, the owner of the company, earns an annual salary of $95,000.

The Porter Company’s four employees have all worked at the company for at least two years.

Covered payroll is $150,000.

The company has installed a 10% money purchase plan this year.

Al wants to require substantial years of service before employees have fully vested rights to their plan accounts.

Which one of the following vesting schedules would be most appropriate for this plan?

A: 2-year cliff vesting

B: 3-year cliff vesting

C: 5-year cliff vesting

D: 2- to-6-year graded vesting

E: 3- to-7-year graded vesting

Answer 41

D: 2- to-6-year graded vesting

The plan is top-heavy, since Al’s allocation in the first plan year will be 63% of the total contribution (based on an allocation in proportion to relative salaries—$95,000 ÷ $150,000 = 63.3%). Top-heavy plans must use an accelerated vesting schedule, not to exceed 3-year cliff or 2-to-6-year graded. Also, all defined contribution plans must vest at a rate no less than the 3-year cliff or 2- to 6-year graded vesting schedules. Since Al wants to require substantial years of service before employees have fully vested rights, the 2- to 6-year graded schedule would be most appropriate for the plan.

Question 42

Which of the following are characteristics of an age-weighted profit sharing plan?

(1) An age-weighted allocation formula permits contributions to favor older employees compared to younger employees.
(2) An age-weighted allocation formula permits contributions to individual accounts to exceed the Section 415 limitations.
(3) If an age-weighted plan becomes top-heavy, the vesting schedule would be limited to either a three-year cliff or 6-year graded schedule; the plan must also provide a minimum contribution to non-key employees of 3% of pay.
(4) An employer that utilizes an age-weighted allocation formula becomes subject to the minimum funding standards.

A: (1) and (3) only

B: (2) and (3) only

C: (1), (2), and (3) only

D: (1), (3), and (4) only

Answer 42

A: (1) and (3) only

An age-weighted profit sharing plan favors older employees, and is typically used to provide maximum contributions for owner employees and key employees. As a result, an age-weighted plan is frequently top-heavy and must comply with the minimum contribution and vesting schedule of top-heavy plans.

Question 43

Which of the following are requirements of a top-heavy qualified profit sharing plan that has made a contribution of 5% of each participant’s compensation to participants’ accounts?

(1) No additional contribution is required, since the employer contribution already amounts to 5% of each participant’s compensation.
(2) The plan must comply with the vesting requirements for top-heavy plans.
(3) The top-heavy condition must be corrected by the end of the plan year to prevent disqualification of the plan.
(4) An additional 3% of compensation must be contributed to the accounts of non-key employees who are plan participants.

A: (1) and (2) only

B: (2) and (4) only

C: (3) and (4) only

D: (1), (2), and (4) only

E: (1), (3), and (4) only

Answer 43

A: (1) and (2) only

A top-heavy profit sharing plan must provide a minimum level of contributions to non-key employees. The plan must contribute at least 3% to non-key employees, or, if less, the percentage contributed to key employees. Defined contribution plans already comply with top-heavy vesting. Since the plan already contributes 5% to all participants, no additional contribution is required. Top-heaviness is not a condition that must be corrected; qualified plans are required to have written provisions for top-heaviness and to comply with these provisions.

Question 44

Which one of the following factors would be the strongest indication that interest rates might rise?

A: selling of dollar-denominated assets by foreign investors

B: decreasing United States government deficits

C: decreasing rates of inflation

D: weak credit demand by the private sector of the United States economy

Answer 44

A: selling of dollar-denominated assets by foreign investors

When an asset is being sold by investors, the compensation paid to entice an investor to hold that asset must be raised. Raising the interest rate paid on fixed income investments is one method to increase the compensation paid to hold U.S. dollars. Decreasing the deficit might actually lower rates since the holding of U.S. debt becomes less risky; also, government spending would decrease, thereby decreasing the demand for money and decreasing rates. Decreasing inflation also would cause rates to decrease because the Fed generally decreases interest rates when inflation falls. Weak credit would cause banks to decrease interest rates to attract new demand.