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Series 66 Exam > Unit 21: Tax Considerations > Flashcards

Unit 21: Tax Considerations Flashcards

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Series 66 flashcards
1
Q

Regressive taxes

A

levied at the same rate, regardless of income (sales, payroll, property taxes)

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2
Q

Progressive taxes

A

increase the rate as income increases

Marginal tax rate → the highest rate paid on income

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3
Q

The other most important factor in determining an individual’s income tax bill is the choice of filing status.

There are five different filing statuses:

A
  1. Single
  2. Married filing jointly
  3. Married filing separately
  4. Head of household
  5. Qualifying widow(er) with dependent child
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4
Q

In the case of a single parent with dependent children, it will generally be most advantageous to use the filing status,

A

“head of household”

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5
Q

In general, filing single will result in the

A

highest income tax.

While married filing jointly, will result in the lowest.

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6
Q

How does age affect your taxes?

A

Taxpayers who are 65 or older receive an addition of $1,300 each if married and filing a joint return or $1,650 if single

This amount is also available to those who are blind or disabled

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7
Q

How does your state of residence affect your taxes?

A

If the taxpayer lives in a state with a state income tax, up to certain limits, the amount paid can be taken as a deduction on the federal return.

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8
Q

How does citizenship affect your taxes?

A

An individual who is not a citizen of the U.S. may pay taxes at a different rate than citizens and may also receive certain tax credits due to tax treaties.

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9
Q

Earned income

A

salary, bonuses, tips, and income derived from active participation in a trade or business.

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10
Q

Alimony

A

payment made under a court order to an ex-spouse

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11
Q

Effective Jan 1, 2019, exes paying the alimony

A

won’t get to deduct the payment and the ex receiving the alimony won’t report it as income. This only applies to divorce decrees entered into Jan 1, 2019 and onward.

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12
Q

Child support

A

legal obligation of a parent to provide financial support for a child

Child support is not deductible by the parent who pays it, nor is it includable in income by the recipient

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13
Q

Passive Income and Losses

A

come from rental property, limited partnerships, and enterprises in which an individual does not actively participate. Passive losses may be used to offset only passive income

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14
Q

Portfolio Income

A

includes dividends, interest, and net capital gains derived from the sale of securities

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15
Q

Dividend Income

A

qualified dividends are generally taxed at a max 15% but can be higher for high-income taxpayers. For the exam, assume that any dividend from a U.S. corporation, including stock and mutual funds, is qualified.

Remember: Dividends paid on stock issued by American companies generally qualify for a reduced tax rate (max 15-20%).

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16
Q

Interest Income

A

interest on debt securities (other than tax-free muni issues) is always taxed at ordinary income rates. Interest on U.S. Treasuries is exempt from state taxation, but not federal (except GMNA and FNMA debt). Income distributions from bond funds are NOT qualified and are taxed fully as ordinary income.

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17
Q

Remember: capital gains from any source are always

A

taxable

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18
Q

In the case of TIPS, the taxation is a bit different. Being Treasury securities, they are exempt

A

from state and local income tax. However, the annual interest payment received is taxable on a federal basis as ordinary income and the annual increase to the principal is taxed as well.

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19
Q

Dividend and interest income received from foriegn securities, including ADRs, is normally subject to

A

withholding tax, typically about 15%, by the issuer’s country of domicile.
Current U.S. tax law allows many investors to reclaim the withhold tax as a credit against taxes owed on their tax returns.

In almost all cases, income from foreign securities is taxed in the U.S. at all levels (federal and state).

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20
Q

Taxation of Reinvested Distributions

A

The issuer must disclose whether each distribution comes from income or realized capital gains

Form 1099 details tax information related to distributions for the year.

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21
Q

Interest - on - interest

A

a typical bank savings account where your interest compounds. This interest is taxable in the year received.

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22
Q

Dividend Reinvestment Plans (DRIPS)

A

the opportunity to purchase additional shares of the company’s common stock using their cash dividend

Investor pays little or no commission and often at a discount to market price

The amount of reinvested dividends increases the investor’s cost basis, thereby reducing the amount of capital gains if the position is later sold at a profit.

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23
Q

The Effect of Reinvestments on Cost Basis

A

Because the taxes have already been paid on any income reinvested, when the investor sells the asset, the cost basis is increased so that the income is not taxed again.

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24
Q

Regardless of fluctuations in the market price, as long as a dividend is paid, investors participating in DRIP will always

A

have more shares in their account at the end of the year than at the beginning.

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25
Q

Retirement Plan Distributions

A

Qualified retirement plan distributions are, with few exceptions, taxed at the investor’s ordinary income tax rate when funds are withdrawn from the plan.

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26
Q

Margin expenses

A

tax-deductible expense. The one exception is interest expenses incurred in the purchase of muni securities.

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27
Q

Effective Tax Rate

A

the overall rate of tax you pay on your total taxable income

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28
Q

Capital Gains

A

occurs when capital assets are sold at prices that exceed the adjusted cost basis

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29
Q

Adjusting Cost Basis

A

A lower cost basis results in a larger capital gain

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30
Q

Capital Loss

A

occurs when capital assets are sold at prices that are lower than the adjusted cost basis

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31
Q

Short-term gains are investments held

A

12 months or less and are taxed at the investor’s ordinary income tax rate

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32
Q

Long-term capital gain occurs

A

after the investor has held the investment for a period exceeding 12 months

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33
Q

If the result is a net long-term capital gain,it is taxed at the capital gains rate, currently at

A

currently at 15% for most taxpayers.

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34
Q

Capital losses that exceed capital gains are deductible against earned income up to a maximum of

A

$3,000 per year

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35
Q

Any capital losses not deductible in a taxable year may be

A

carried forward indefinitely as a deduction to offset capital gains in future years.

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36
Q

If the investor fails to choose, the IRS assumes the investor liquidates shares on

A

FIFO basis

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37
Q

Share identification

A

The investor keeps track of the cost of each share purchased and uses this information to liquidate the shares that would provide the lowest capital gain

May result in more advantageous tax treatment, most commonly used with stock sales

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38
Q

Average cost basis

A

when redeeming mutual fund shares.

The investor would calculate average basis by dividing the total cost of all shares owned by the total number of shares.

The shareholder may not change the decision to use the average basis method without IRS permission.

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39
Q

Wash Sale

A

an investor may not use capital losses to offset gains or income is the taxpayer sells a security at a loss and purchases the same or a substantially identical security within 30 days before or after the trade date establishing the loss.

The loss that was disallowed is added to the repurchased shares’ cost basis.
Applies only to realized losses

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40
Q

After selling a bond, an investor can buy another bond

A

with either a different maturity, coupon, or issuer without violating the wash sale rule.

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41
Q

Sale of Primary Residence

A

There are special tax benefits available to those selling their primary residence as long as is has been lived in as the primary residence for at least 2 of the past 5 years.

For a couple, the first $500,000 in profit is excluded from capital gains taxation. For a single person, the first $250,000.

42
Q

Alternative Minimum Tax (AMT)

A

ensures that high-income taxpayers do not escape federal income taxes. Certain items that receive favorable tax treatment must be added back into taxable income to arrive at the AMTI.

43
Q

To determine if you owe AMT,

A

you must compute your regular tax and then you compute the AMT and pay whichever is the higher amount.

44
Q

Items that must be added back in for the purpose of the AMT computation are sometimes called

A

tax preference items.

45
Q

Premiums for individually purchased life insurance are

A

generally nondeductible for income tax purposes.

46
Q

Generally, income from life insurance policies made to a beneficiary are

A

exempt from federal income tax.

47
Q

If someone named as the insured individual on a policy holds incidents of ownership in that policy,

A

the entire death benefit payable under that policy is included for federal estate tax purposes in the insured individual’s estate.

48
Q

In those cases where the state does have liquid assets such as stocks and bonds,

A

life insurance still may serve as a valuable need in that these income-producing assets will not have to be sold to cover the estate tax liability or other final expenses.

49
Q

Policy Loans

A

when you borrow cash value from your life insurance policy, the funds received are nontaxable (it’s not your money, its borrowed)

50
Q

Policy Surrender

A

if a variable life insurance policy is surrendered, any cash value in excess of the basis in the policy (the premiums paid) is taxable as ordinary income.

51
Q

Withdrawal of Cash value

A

if there is a partial withdrawal of cash value from a variable life insurance policy, the FIFO rules apply. There are no tax consequences until the amount withdrawn exceeds the cost basis in the policy

52
Q

As much as ___ of SS benefits start becoming taxable once a single person’s base income exceeds _______ and a married couple’s exceeds ______.

A

50%

single = $25,000

couple = $32,000

53
Q

Once the income exceeds ______ for a single person and ______ for a couple, it is likely that _____ of the SS benefit is subject to income tax.

A

85%

single = $34,000

couple = $44,000

54
Q

When a donor makes a gift of securities or virtual any asset, the cost basis is

A

the donor’s cost basis. This describes carryover basis.

55
Q

If a gift of securities held more than 1 year, is made to a charity, the tax treatment is

A

more favorable.

Under these circumstances, the deduction is based on the fair market value on the date of the gift.

56
Q

Cost basis to the recipients is usually

A

the fair market value on the date of the owner’s death (step-up cost basis)

57
Q

The step-up provision does not apply

A

with inheriting an annuity

58
Q

Taxation of trusts and estate is based on what

A

is distributed and what is retained.

59
Q

In the case of non-distributed income, the tax consequences can be

A

quite severe because the tax brackets are highly compressed.

60
Q

If the trust or estate has income,

A

it must be reported on the IRS Form 1041.

61
Q

Distributable Net Income (DNI) determines

A

the amount of income that may be taxable to beneficiaries and the balance may be taxed to the trusted

For tax purposes, most trusts and estate distribute their income

62
Q

What is subtracted from DNI?

A

Commissions and other fees charged for buying and selling securities held in a trust

63
Q

What is NOT considered part of DNI?

A

Realized capital gains that are reinvested in the trust

64
Q

If the trust is revocable, who is taxed the income?

A

The grantor

65
Q

Tax-exempt interest from muni bonds remains

A

tax exempt to trust beneficiaries

66
Q

What is a bypass trust?

A

an estate planning tool used to take advantage of the lifetime estate tax exclusion. Commonly used between spouses when both are U.S. citizens and takes advantage of the unified tax credit.

The concept is to enable a surviving spouse to take advantage of the unused lifetime exclusions.

Tax legislation passed in 2010 has largely removed the need for this trust.

67
Q

The Tax Act of 2010

A

permits the surviving spouse to take the unused portion of the first deceased spouse’s federal exemption and aggregate it with the surviving spouse’s unused portion. The exception is $11.4 mil.

68
Q

Generation-Skipping Trust (GST)

A

used to pass money from family members to other members more than one generation removed.

Instead of the assets being taxed upon the death of the parents and then again when their children pass them to the grandchildren, on level of estate taxation is eliminated.

69
Q

Gross Estate

A

includes all interests in property held by an individual at the time of death

70
Q

Adjusted gross estate (AGE)

A

certain expenses are then deducted from the gross estate to arrive at the AGE such as funeral expenses, charitable contributions, and debts of the decedent

71
Q

Taxable estate

A

once the AGE is determined, the unlimited marital and charitable deductions are subtracted to arrive at the taxable estate

72
Q

Alternative Valuation Date

A

the executor of an estate may choose to value the assets in the estate as of date of death or 6 months later - this would be beneficial if the assets have dropped substantially in value following the date of the

73
Q

In the case of mutual funds, FMV is

A

the NAV, not the POP

74
Q

f an asset is sold after death at a greatly reduced price from its appraised value in a transaction that does not meet the definition required under fair market value,

A

the IRS will use the higher value.

75
Q

Payment date of estate taxes

A

state taxes are due no later than 9 months after death. It is possible to get an extension to file the return, but the taxes are due at the 9 months’ time and interest will be charged on any amount owed that is not paid at that time.

76
Q

The computation of the estate tax is done on what form?

A

Form 706

77
Q

Taxation of estate Income

A

taxation to the estate is the same rate regarding trusts and Form 1041 is used to report the income.

The income is taxed using the same compressed brackets as trust income (37% for everything in excess of $12,750).

78
Q

The computation of the estate income tax is done on what form?

A

Form 1041

79
Q

Gift tax

A

is a progressive federal tax imposed on the transfer of property during the lifetime of the donor; up to $11.4 mil in lifetime gifts may be made without incurring gift tax.

80
Q

An individual may give up to

A

$15,000 per year, per person to any number of individuals without generating the federal gift tax. For a married couple, the allowable amount is $30,000 per person per year.

81
Q

Gifts of securities are valued as

A

of the CMV on the date of the gift.

82
Q

There is an unlimited exclusion for gifts between

A

spouses. However, there are limits if your spouse is not a US citizen.

83
Q

Generally, a gift tax return must be filed whenever a gift is made

A

in excess of the annual exclusion. Any excess over the annual exclusion is applied against the lifetime exclusion until it is used up.

84
Q

The gift tax return is filed on

A

Form 709 and is due at the same time as the donor’s income tax return (April 15).

85
Q

Both the taxation of estates and gifts have

A

lifetime exclusion and progressive structure with rates beginning at 18%.

86
Q

What are the taxation differences between estates and gifts?

A
  1. the annual GIFT tax exclusion

2. Gift taxes are due April 15th while estate taxes are due 9 months after death

87
Q

Taxation of Sole Proprietorships

A

the owner computes earnings on the Schedule C of her Form 1040 so anything made (or lost) by the business is reflected directly on her tax return (there is no separate tax return).

88
Q

Taxation of partnerships

A
  • partnerships do not pay taxes, they file an information return (Form 1065) and attach to that a Schedule K-1. This is sent to each partner indicating the amount if income/loss to be inserted on the investor’s personal Form 1040

Remember: partnerships offer flow-through of income and losses.

89
Q

Taxation for a 1 member LLC

A

will use the Schedule C, just as if it was a sole proprietorship.

90
Q

Taxation for LLCs with 2 or more members

A

file as partnerships using the Form 1065 for the IRS and the Schedule K-1 for each member’s share of income/loss.

91
Q

Taxation for a C corporation

A

only entity that files a tax return on which it must pay income (because it’s its own entity). It files on Form 1120 and pays taxes at a rate that generally does not exceed 21%. Experiences double taxation.

92
Q

Internal Revenue Code (IRC) provisions affecting C Corporations as investors the following:

A

Dividend exclusion rule

municipal securities

93
Q

Dividend exclusion rule:

A

Dividends paid from one corporation to another are 50% exempt from taxation.

94
Q

Municipal securities:

A

Corporations do not pay federal taxes on interest received from municipal bonds

95
Q

S corporation is treated (for tax purposes)

A

the same as a partnership except that the return file is the Form 1120S. Shareholders receive a Schedule K-1 indicating their share of income/loss.

96
Q

Filing dates for Sole Proprietorship and Single Member LLC

A

April 15th

97
Q

Filing dates for Partnerships and LLCswith more than one member

A

Form 1065 is due March 15th and taxes are due on April 15th when the individuals file their Form 1040s showing their income/losses

98
Q

Filing dates for c corporations

A

C corporations may choose any convenient date as their year-end. Their tax returns are due and taxes payable on the 15th date of the fourth month after the company’s fiscal year-end.

99
Q

Filing dates for s corporations

A

income/loss is taxed on individual income tax returns. Therefore, the filing date of the Form 1120A is March 15th

100
Q

Sole proprietors and single member LLCs file their business information on

A

a Schedule C of Form 1040

101
Q

Investors in partnerships, members of LLCs, and shareholders in S corporations receive

A

a Schedule K-1 to be inserted on their personal Form 1040.

102
Q

C corporations report their income on

A

Form 1120

Series 66 Exam (18 decks)

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