Unit 15 | Tax Considerations Flashcards
In most cases, the tax-filing status that results in the highest income tax is
A. head of household.
B. married filing jointly.
C. qualifying widower with a dependent child.
D. single.
D. In general, for the same amount of income, filing single will result in the highest income tax, while married filing jointly will result in the lowest. Head of household is usually the best for those who are unmarried but have children.
Under current tax law, which of the following would not be a factor in determining an individual’s federal income liability?
A. Age
B. Citizenship
C. Filing status
D. Sex
D. One area in which the federal tax laws do not discriminate is the individual’s sex. Those 65 and older are entitled to an additional exemption; non-U.S. citizens may pay more or less tax based on tax treaties and other factors, and filing status significantly impacts taxes.
One of your customers received a $5,000 year-end bonus. You explain that the bonus is worth $3,250 in after-tax funds. This difference is because
A. the customer’s effective tax rate is 35%.
B. the customer’s marginal tax rate is 35%.
C. the customer’s median tax rate is 35%.
D. the customer’s marginal tax rate is 65%.
B | The definition of the marginal tax rate is “the rate of tax charged on a taxpayer’s last dollar of income.” As you make more money, you pay taxes at a higher rate incrementally. If this customer’s actual benefit is $3,250, it is because $1,750 was paid in income tax. Dividing $1,750 by $5,000 reveals that the tax rate was 35%.
LO 15.a
Which of the following is an example of a regressive tax?
A. Federal fuel excise tax
B. Gift tax
C. Estate tax
D. Income tax
A | Regressive taxes are those where the rate remains the same, regardless of the cost of the item subject to the tax. For example, the federal fuel excise tax is 18.4 cents per gallon. It makes no difference if you are pumping one gallon or 20 gallons—the tax rate is the same 18.4 cents on every gallon. The other choices are progressive taxes, where the tax rate increases as the dollar amount being taxed increases.
LO 15.a
An investor who would like to increase current income from investments and, at the same time, pay taxes on that income at less than her marginal tax rate would probably find which of the following is most suitable.
A. U.S. Treasury bonds
B. Public utility stock
C. Growth stock
D. Money market mutual fund
B. The key to this question is that dividends paid on stock issued by American companies (and certain qualified foreign corporations) generally qualify for a reduced tax rate (maximum 15 to 20%). No such benefit accrues to money market funds (their dividends are generated from interest income), and government bond interest is always taxed as ordinary income (although state income tax-free). The dividends on a growth stock would also qualify, but because the question deals with increasing current income, public utility is a more sensible approach. This question is an example of how the test might present you with two answer choices that could be correct, and you must choose the more correct one.
An investor purchases 100 shares of DERP common stock @ $50 per share and elects to have all cash dividends reinvested through the DRIP being offered by DERP.
After holding the stock for five years, the investor has reinvested $1,200 and acquired 20 additional shares. If the market price of DERP is $55 per share and the investor liquidates the position, the tax consequences will be
A. a loss of $700.
B. a gain of $400.
C. a gain of $600.
D. a gain of $1,600.
B. The investor establishes the position at $5,000. To that, we add the $1,200 cost of the reinvested dividends, bringing the investor’s tax cost basis to $6,200. When all the shares are sold, the proceeds are $6,600 (120 shares x $55). Subtracting the $6,200 cost from the $6,600 proceeds results in a capital gain of $400.
Your customer in the 24% federal income tax bracket would probably pay the most tax on a $5,000 investment into
A. dividends received on domestic common stock.
B. dividends received on domestic preferred stock.
C. interest received on U.S. Treasury bonds.
D. interest received on municipal bonds.
C | Interest received on Treasuries will be fully taxable on a federal basis. That means 24% to this customer. Unless stated otherwise, you can assume that dividends paid on stock (common and preferred) issued by domestic corporations are qualified. That means the tax rate will be 15%. Interest received on municipal bonds will be tax-free.
LO 15.6
A taxpayer has realized short-term capital gains of $50,000 and long-term capital gains of $75,000 during the taxable year. Over the same period, the individual realized short-term capital losses of $40,000 and long-term capital losses of $100,000. The tax consequences of these transactions are
A. a net short-term capital gain of $10,000 and a net long-term capital loss of $25,000.
B. a net long-term capital loss of $15,000 and no gain carryover.
C. a $3,000 deduction from income and a long-term capital loss carryover of $3,000.
D. a $3,000 deduction from income and a long-term capital loss carryover of $12,000.
D | This investor has a $10,000 short-term capital gain ($50,000 minus $40,000) and a $25,000 long-term capital loss ($75,000
minus $100,000). Why isn’t that choice the correct answer? Because the exam will always want the choice that most completely answers the question. In this case, the net of the gain and the loss is a $15,000 long-term capital loss. Why isn’t that correct? Same reason—it is not a complete answer: $3,000 of that $15,000 loss is deductible against earned income, and the balance of $12,000 is a carryover to the following year. This example is a prevalent type of question on the actual exam, where you must select the choice that covers all of the details. By the way, there is no such thing as a carryover of a gain; all net gains are taxed.
LO 15.c
Which of the following is considered a tax preference item to calculate the alternative minimum tax?
A. Incentive stock options (ISOs) to the extent that the fair market value of the employer’s stock is over the strike price of the option
B. Depreciation on property placed in service after 1986
C. Intangible drilling costs to a limited partnership program
D. Tax-exempt interest on general-purpose municipal bonds issued after August 7, 1986
A | The excess of the fair market value of the strike price of an ISO, known as the bargain element, is included as a tax preference item for the AMT. It is accelerated depreciation, excess intangible drilling costs, and interest on private-purpose municipal bonds that are all tax preference items.
LO 15.
