Chapter 17- (2Qs) Tax Considerations

Question 1

Regressive vs Progressive taxes

Answer 1

Regressive- Levied at the same rate regardless of income level

Eats up a larger fraction of the poor’s expendable income because they spend more of their salable income

Progressive- Increase with income

Marginal Tax rate is the tax rate paid for the next dollar received

Question 2

Alimony

Answer 2

Payment under a divorce court order to an ex-spouse

Usually deductible for spouse making payment and includable for spouse receiving

Eligible to be made as an IRA contribution

Question 3

Child Support

Answer 3

NOT Allimony

Not deductible by parent paying or includable in income by recipient

Question 4

Passive income

Answer 4

Income from rental property, LPs and enterprises where individual is not an active participant

Rental property is not considered so if used for GREATER of 14 days or 10% of total days property is rented

Question 5

Dividend Income

Answer 5

Qualified dividends are taxed at a maximum rate of 15%

Non-Qualified are taxed as ordinary income

Question 6

Interest

Answer 6

Interest received from a debt security is taxed at ordinary income level

Unless it is federal (exempt from state) or a municipal (exempt from Fed and maybe state) issues.

Question 7

Taxation of Reinvested Distributions

Answer 7

Taxable even though the cash is reinvested

Must split out dividends and capital gains (reported on the 1099)

Capital gains distributions are usually taxed as long term gains

Whole amount reinvested is not taxed again, increases cost basis

Question 8

Retirement Plan Distributions

Answer 8

Taxed at ordinary income tax rate unless:

Taken before 59 1/2 (10% withdrawl fee)

Not taken before April 1st the year following reaching 70.5

Roth

Question 9

Alternative Minimum Tax

Answer 9

Items that must be added back into taxable income:

• Accelerated depreciation on property placed in service in 1986
• LPP costs such as research and development
• Local tax and interest on non income producing investments
• Private purpose municipal bonds
• Incentive stock options that are buyable below FMV

Must pay higher of AMT or regular tax unless exempt due to income level

Question 10

Margin Expenses

Answer 10

Margin interest is tax deductible unless margin was used to purchase muni’s

Cannot exceed interest income, dividends and cap gains

Question 11

Effective tax rate

Answer 11

Marginal tax rate is not paid on whole amount

Only paid on amount over a specific level

Effective tax rate is average amount paid on ordinary income

Question 12

Filing Status

Answer 12

Based on marital status as of the last day of the year

Best to file jointly or head of household if those apply

Question 13

Death benefit from an insurance policy

Answer 13

Not taxable to the beneficiary of a policy unless over estate tax limit

Premiums are generally non deductible

IF however the policy is acquired by or transferred to an irrevocable life insurance trust, you may be able to deduct the premium as a gift

Question 14

Insurance policy taxation

Answer 14

Loaned cash is not considered taxable

Cash value over cost basis from a policy surrender is considered taxable

Partial withdrawals are not usually taxable unlike an annuity

Question 15

Net Capital Gains and Losses

Answer 15

Short term Net
Long term Net
=Overall capital gain

Capital Losses can be carried forward if over the maximum 3,000 a year

Question 16

Which Shares are sold

3 methods

Answer 16

FIFO- Shares held longest are sold (not good for rising market)

Share identification- Most commonly used for stock sales, must keep track of cost basis

Average cost basis- May only be used for mutual funds, may not change from without IRS permission

Question 17

Wash Sale

Answer 17

May not use capital losses to offset gains if purchasing the same or subtantially the same security within 30 days

Loss is carried to new cost basis though

Substantially identical= stock rights, call options, warrants and convertible securities

For debt, if one of the following three are different then ok:
Issuer
Maturity
Coupon

Question 18

Gifts

Answer 18

Gifted securities carryover the basis

If it is a charitable gift, the person gifting would receive FMV of securities as deduction

Question 19

Inherited Securities

Answer 19

Heirs receive shares at FMV in date of death

Does not apply with annuities

Question 20

Sale of a residence

Answer 20

If it is the primary residence, you do not recognize the first 500,000 in profit or 250,000 for single

Must live in 2 out of past 5 years

Long term capital gain if over

Question 21

Business Taxations

Answer 21

Sole Proprietor- Report on Schedule C on individuals tax return date

Partnerships- Schedule 1065 is filed with Schedule K-1s for each partner indicating their share of profit/loss

LLC- Not a taxable entity, must file as corporation, partnership or sole proprietorship. Same filing procedure if filling as any of the above

Corporation- C corp would file its own return on form 1120. Dividends are double taxed if paid out.

S corp- Taxed like partnership only file on 1120s

Dividends paid to other corporations holding your stock are 70% tax deductible (avoids triple taxation)

Question 22

Tax filling dates

Answer 22

Partnerships and Multi Member LLCs- Form 1065 and K-1s due on March 15 and are to be paid on March 15th

C Corp- May choose a different fiscal year.
Taxes are due on 4th month 15th day after end of fiscal year
Reported on 1120

Sole P- Schedule C, April 15th

Question 23

Trust taxation

Answer 23

Considered a legal person

Non-distributed income is taxed at highest rate if in excess of 12,400

Distributable Net Income is reduced by fees paid for buying and selling securities

Reinvested capital gains are not distributable income

If not distributed to beneficiaries, beneficiaries are still taxed

Question 24

Portability of unused tax exemption

Answer 24

Allows for both spouses to use federal exemption for estate tax

Each person is given lifetime 5.45 million estate exemption on death

Spouses have unlimited exemption

Gifts during life lower estate exemption

Question 25

Generation Skipping trusts

Answer 25

Allows for assets to be distributed to grandchildren overtime by parents

The value of the estate is calculated based on what the assets were worth going in

If parent distributing dies, the trustee has to pay Generation-skipping transfer tax

Question 26

Direct Skip

Answer 26

Asset left directly to a beneficiary two generations below

Donor has to pay a generation-skipping transfer tax

Question 27

Estate Tax

Answer 27

Imposed on transfer of substantial assets at death

Avoided if to a spouse or charity

Question 28

Gross Estate vs Taxable Estate

Answer 28

Gross Estate -
Funeral expense, charity, and debts of descendent = Adjusted Gross Estate
- unlimited marital and charitable deductions
= Taxable estate

Question 29

Alternative Valuation date

Answer 29

Executor may choose date of death or 6 months later

If asset is sold below appraised value but at FMV then FMV is used.

FMV would not be a forced sale price or a price significantly below actual value

Question 30

Estate Tax Pay date

Answer 30

No later than 9 months after death

Can request extension but will have to pay interest on amount owed

Estate tax computation on form 706

If income and capital gains are generated, the nondistribbuted income will be taxed like a trust (max over 12,300)

Form 1041 is used for estate income tax

Question 31

Taxation of gifts

Answer 31

May give up to $14,000 per year (FMV)

Non-US spouses may be subject to gift tax

May give up to 5.45 during life of donor without incurring gift tax (total)

Anything over 14,000 in a year, donor must file form 709

Question 32

Taxation of Foreign Securities

Answer 32

If taxes are withheld by another country, may use that amount as a credit against current income

Question 33

Stock dividend Taxation

Answer 33

Investors are not subject to tax

Cost basis is shifted downward

100 shares owned at cost of 50
10 share stock dividend
110 share owned at 5000/110