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Flashcards in A - Taxation Deck (40):
1

The maximum tax-free gift a parent can give his child in a given year is:

A. $1,500 B. $4,000 C. $5,500 D. $14,000

Incorrect! The correct answer is: D. $14,000

$14,000. $14,000 (for tax year 2013) is the maximum amount of a gift one person can give another without paying a gift tax, although the amount may increase depending on inflation. The donor must be an adult, while the donee can be either an adult or a minor. [Module 17, Taxation, Sections 1.4 & 6.8]

2

An investor buys 100 shares of Coors Beer stock on April 30, 2010, at $22 per share and sells them for $32 per share on November 1, 2012. The investor is in the 28% tax bracket. What is the tax consequence to the investor in 2012?

A. Long-term gain at 15% B. Long-term gain at 28% C. Ordinary income at 28% D. Short-term gain at 28%

Correct Answer: A. Long-term gain at 15%

Long-term gain at 15%. You will not be required to determine the actual dollar amount; rather, the exam tests you on the difference between ordinary income, short-term gain, and long-term gain. This is a long-term capital gain of $1,000 (buy at $22, sell at $32, or $10 per share gain x 100 shares) that is taxed at 15%. [Module 17, Taxation, Section 3.1]

3

The interest from bonds issued by the U.S. government is exempt from:

I. Local tax
II. State tax
III. Federal tax

A. II B. III C. I and II D. II and III

Correct Answer: C. I and II

I and II. The interest from bonds issued by the U.S. government is exempt from local and state taxation. However, U. S. government bond interest is subject to federal taxation. [Module 17, Taxation, Section 4.2]

4

An investor purchases 10 municipal bonds at 106 with a coupon of 8%. The bonds mature in 10 years. What is the amount of loss the investor will be able to take at maturity?

A. $0 B. $6 C. $60 D. $600

Incorrect! The correct answer is: A. $0

$0. When purchasing municipal bonds at a premium, whether as a new issue or in the secondary market, the buyer of the bond may not deduct any of the premium, neither at maturity nor each year during the life of the bond. The IRS deems that the premium paid for a municipal bond is not deductible. If this question had involved corporate or government bonds, which are fully taxable, the loss would have been fully deductible to the investor. [Module 17, Taxation, Section 5.1]

5

How much capital loss can the investor deduct from ordinary income this year?


Last year's carryover: $16,000 long-term capital loss
This year: $9,000 long-term capital gain, $2,000 short-term capital gain


A. $3,000 B. $5,000 C. $7,000 D. $9,000

Correct Answer: A. $3,000

$3,000. The maximum investment loss allowed in any one year for either a long-term or short-term capital loss is $3,000. If we begin with last year's carryover of the $16,000 long-term capital loss and then deduct this year's $9,000 long-term capital gains and $2,000 short-term capital gain, the result is a net $5,000 capital loss. However, the maximum capital loss that the investor can deduct from income in a year is $3,000. [Module 17, Taxation, Section 3.2]

6

An investor purchases a municipal bond at a premium and holds the bond to maturity. At maturity, the customer will have:

A. A capital loss B. An ordinary loss C. A capital gain D. A nondeductible loss

Incorrect! The correct answer is: D. A nondeductible loss

A nondeductible loss. The IRS mandates that since the interest received from muni bonds is not taxable, and a person knowingly buys the bond at a premium, the loss of the premium amount was anticipated by the investor at the time of purchase. Therefore, no write-off of the premium amount is allowed as a capital loss. [Module 17, Taxation, Section 5.2]

7

After owning a stock for three years, a customer donates the stock, which is now worth $15,000, to a charity. The original cost of the stock was $6,000. The customer will have a tax deduction of:

A. $6,000 B. $9,000 C. $15,000 D. $21,000

Correct Answer: C. $15,000

$15,000. A donation of stock to a charity is valued at the market price of the stock at the time it is given, if it is held for more than one year. However, if the stock is held for one year or less, only the cost basis of $6,000 can be deducted. [Module 17, Taxation, Sections 1.4 & 6.9]

8

In a one-year period, a customer has transactions that result in the following:


Short-term capital gain: $14,000
Short-term capital loss: $19,000
Long-term capital gain: $5,000
Long-term capital loss: $3,000

Based upon the above information, what will the customer's tax consequences be for the year?


A. $2,000 long-term capital loss deduction and $5,000 short-term capital gain added to the customer's income B. $2,000 long-term gain taxed at the long-term capital gain rate and $5,000 short-term capital loss deduction C. $3,000 short-term capital gain added to the customer's income D. $3,000 short-term capital loss that is fully deductible

Incorrect! The correct answer is: D. $3,000 short-term capital loss that is fully deductible

$3,000 short-term capital loss that is fully deductible. You net the short-term gains and losses to arrive at a short-term loss of $5,000, and then you net the long-term gains and losses to arrive at a $2,000 long-term gain. Next, net the short-term results with the long-term results which equal a short-term capital loss of $3,000. This can be fully deducted because $3,000 is the maximum deduction allowed per tax year. [Module 17, Taxation, Sections 3.1 & 3.4]

9

A customer purchases a municipal bond at a discount in the open market. The bond will mature in six years. All of the following statements regarding the purchase are true, except:

A. The interest is exempt from federal income tax. B. The customer will have a gain if the bond is held to maturity. C. The customer may have a capital gain or loss if the bond is sold prior to maturity. D. The customer will have to pay a tax on the prorated amount of discount each year.

Incorrect! The correct answer is: D. The customer will have to pay a tax on the prorated amount of discount each year.

Correct answer (false statement): The customer will have to pay a tax on the prorated amount of discount each year. This statement is false -- the customer only pays tax upon the sale of the bond, or when the bond matures. The customer will have a gain if the bond is held to maturity, but the gain will be taxed as ordinary income, not capital gain. Gain does not necessarily mean capital gain. Any increase in value is a gain, and how it is treated for tax purposes depends on how the bond is sold. If the bond is sold prior to maturity, the customer will only have a capital gain or capital loss if the selling price is other than the accreted amount. If the bond is sold for the exact amount that the bond has accreted, the customer will only have to claim the gain from the purchase price, which is then taxed as ordinary income. Original issue discounts are capital gains, which are treated as interest and, therefore, tax-free. [Module 17, Taxation, Section 5.2]

10

The federal tax-exemption for municipal bonds was established by:

A. The Internal Revenue Service B. A U.S. Supreme Court decision C. An act of Congress D. The U.S. Treasury Department

Incorrect! The correct answer is: B. A U.S. Supreme Court decision

A U.S. Supreme Court decision. The federal tax-exemption of municipal bonds was established by a Supreme Court decision. This decision held that states cannot tax the federal government, and the federal government cannot tax the state governments. [Module 17, Taxation, Section 4.3]

11

This year a husband and wife have earned $1,100 in dividends on their shares of IBM stock, a U.S. corporation. They are in the 28% tax bracket on their ordinary income. How are the dividends treated for tax purposes?

A. Ordinary income taxed at 28% B. Ordinary income taxed at 15% C. Portfolio income taxed at 28% D. Portfolio income taxed at 15%

Incorrect! The correct answer is: D. Portfolio income taxed at 15%

Portfolio income taxed at 15%. Dividends are considered portfolio income, not ordinary income and, if received from stock of U.S. corporations, are taxed at 15%. Yes, this looks like it is a long-term gain; however, it is portfolio income taxed at the same percentage as a capital gain. Please note that each answer states "income" and not capital gain. [Module 17, Taxation, Section 3.4]

12

If an investor purchases a 10-year municipal bond at a discount and holds the bond to maturity, the result will be:

A. No loss B. A capital gain C. Ordinary income D. A capital loss

Incorrect! The correct answer is: C. Ordinary income

Ordinary income. The Internal Revenue Code now mandates that the discount in the purchase of all bonds must be claimed as ordinary income upon sale or upon maturity. If the bonds mature, the discount can be claimed each year or in the year of maturity. If the bond is sold and the interest is not received, the accretion of the interest creates a new tax basis. The accretion is taxed as ordinary income, and the gain or loss will be determined from the new cost basis. [Module 17, Taxation, Section 5.1]

13

The interest from bonds issued by which of the following is exempt from both federal and state taxes?

A. Hawaii B. U.S. government C. City of San Francisco D. Puerto Rico

Incorrect! The correct answer is: D. Puerto Rico

Puerto Rico. Interest on bonds of territories and protectorates is exempt from both federal and state taxes. Interest from bonds issued by state and city governments, such as Hawaii and the City of San Francisco, respectively, is only exempt from federal taxes. The interest from bonds issued by state and city governments is only exempt from state taxes to those investors living within those particular states. All other investors outside of that city or state have state tax liability. The interest from U.S. government bonds is only exempt from state taxes. [Module 17, Taxation, Section 4.4]

14

What is the maximum deduction from an active income that an investor can take as a capital loss on his stock in a year?

A. $1,000 B. $3,000 C. $6,000 D. Unlimited

Incorrect! The correct answer is: B. $3,000

$3,000. This is the maximum amount of loss that anyone can take, provided the investor has at least a $3,000 loss for the year. If the loss is less than $3,000, that amount is all that can be taken. [Module 17, Taxation, Section 3.2]

15

Three years ago on November 29, an investor purchased 2,000 shares of Dreyfus Mutual Fund at $12 per share. Each month this year she has received a dividend distribution from the U.S. corporation at $0.10 a share, and last January she received a capital gain distribution of $.50. She is in the 28% tax bracket. For tax purposes, the investor reports the following for the year:

A. $0 capital gain/loss and $2,400 portfolio income taxed at her tax bracket B. $1,000 short-term gain and $2,400 ordinary income taxed at her tax bracket C. $1,000 short-term gain and $2,400 portfolio income D. $1,000 long-term gain and $2,400 portfolio income

Incorrect! The correct answer is: D. $1,000 long-term gain and $2,400 portfolio income

$1,000 long-term gain and $2,400 portfolio income. The capital gains distribution is treated as a long-term capital gain no matter how long the stock is held. The dividends of $200 per month for 12 months, or $2,400, are taxed at the investor's tax bracket, 28%. The capital gain distribution is 2,000 shares × $.50 per share or $1,000 long-term gain. In the 28% tax bracket, the tax on long-term gains is 15%. [Module 17, Taxation, Section 6.6]

16

In the following scenario, if the investor takes the maximum loss this year, how much long-term loss will be carried over into the next year?


Last year's carryover: $16,000 long-term capital loss
This year: $9,000 long-term capital gain, $2,000 short-term capital gain


A. $0 B. $2,000 C. $3,000 D. $5,000

Incorrect! The correct answer is: B. $2,000

$2,000. If we begin with last year's carryover of the $16,000 long-term capital loss and then deduct this year's $9,000 long-term capital gain and $2,000 short-term capital gain, the result is a net $5,000 capital loss. However, the maximum capital loss that the investor can deduct from ordinary income in a year is $3,000. If the $3,000 maximum deduction is taken, the remaining $2,000 will be carried over to the next year. [Module 17, Taxation, Section 3.2]

17

An investor has a $10,000 long-term gain and a $7,000 short-term loss on her investments. She is in the 28% tax bracket. How much tax will the investor have to pay on these investments?

A. Short-term gain of $3,000 taxed at 28% B. Short-term gain of $3,000 taxed at 15% C. Long-term gain of $3,000 taxed at 28% D. Long-term gain of $3,000 taxed at 15%

Correct Answer: D. Long-term gain of $3,000 taxed at 15%

Long-term gain of$3,000 taxed at 15%. To determine the tax liability, first net the long-term gain against the short-term loss ($10,000 - $7,000 = $3,000 long-term gain.). Since the gain is greater than the loss, the whole amount is treated as a long-term gain and taxed at the maximum long-term rate of 15%. [Module 17, Taxation, Section 3.3]

18

An investor in the 28% tax bracket has the opportunity to buy a 5% municipal bond yielding 6.3%. What yield would the investor require in a corporate bond to realize the same after-tax return?

A. 3.60% B. 4.53% C. 6.94% D. 8.75%

Incorrect! The correct answer is: D. 8.75%

8.75%. Use the municipal bond yield and divide it by the difference of 100% and the investor's tax bracket: 6.3% divided by (100% - 28%) = .063 divided by .72 = .875 = 8.75%. The question is asking for the yield, not the coupon -- always use the yield of the bond, not the coupon rate of the bond, to determine the corporate equivalent yield. [Module 17, Taxation, Section 4.3]

19

All of the following statements are true regarding municipal bond taxation, except:

A. Capital gains are subject to state taxes. B. Capital gains are subject to federal taxes. C. Interest is exempt from federal taxes. D. Interest is exempt from state taxes.

Incorrect! The correct answer is: D. Interest is exempt from state taxes.

Correct answer (false statement): Interest is exempt from state taxes. This is a false statement regarding municipal bond taxation. Municipal bond interest is always exempt from federal taxes and usually from its own state taxes, but not from all state taxes in general. All capital gains are taxed by both state and federal taxing agencies. [Module 17, Taxation, Section 4.3]

20

The maximum tax that can be levied on long-term capital gains is:

A. 15% B. 28% C. 33% D. 50%

Incorrect! The correct answer is: A. 15%

15%. The maximum tax that can be levied on long-term capital gains is 15%. Short-term gains are taxed at the person's tax bracket, but they are not ordinary income since they can be offset against long term losses. [Module 17, Taxation, Section 3.1]

21

An investor in the 28% tax bracket can buy a 13% corporate bond that is yielding 14.20%. The investor would need to obtain what yield from a municipal bond to match the after-tax yield on the corporate bond?

A. 9.36% B. 10.22% C. 18.05% D. 19.72%

Correct Answer: B. 10.22%

10.22%. To calculate the same after-tax yield for a corporate bond, multiply the corporate yield (14.2%) by 100 - 28%, the investor's tax bracket: 14.2% x (100% - 28%) = .142 x .72 = .1022 = 10.22%. [Module 17, Taxation, Section 4.3]

22

An older customer purchases 1,000 shares of Dow Chemical, Inc. stock for $26 per share. After the customer has held the stock for over five years, he dies. At the time of death, the stock is selling for $62 per share. By the time the customer's son inherits the stock, it has risen to $64. Later, the son sells the stock for $69 per share. What is the cost basis of the stock upon the sale?

A. $26,000 B. $62,000 C. $64,000 D. $69,000

Incorrect! The correct answer is: B. $62,000

$62,000. The cost basis of stock received in an inheritance is the value on the date of the death certificate. It does not matter what the price is when the son finally gets the stock, nor the price when the son sells the stock. The cost basis of the original shareholder is not relevant in this case, because it is the value at the time of death that is important to the estate. If the customer had given the shares to the son prior to his death, then the son would have had a cost basis of the original cost to his father. [Module 17, Taxation, Section 6.8]

23

In the following scenario, how much of a loss can the investor deduct this year?


This year: $12,000 long-term capital loss
$4,000 long-term capital gain


A. $3,000 B. $4,000 C. $6,000 D. $8,000

Correct Answer: A. $3,000

$3,000. The maximum loss anyone can deduct in a given year is $3,000. The remaining portion of the loss must be carried over to the following year. [Module 17, Taxation, Section 3.3]

24

An investor buys a 10-year corporate zero-coupon bond for $400. Two years later, the investor sells the bond for $600. What type of investment return does the investor have in the year he sells the bond?

A. Capital gain only B. Ordinary income only C. Passive income and capital gain D. Ordinary income and capital gain

Incorrect! The correct answer is: D. Ordinary income and capital gain

Ordinary income and capital gain. Since the bond was purchased at a discount and is a zero-coupon bond, the purchase price is an original issue discount. The discount has to be accreted (amortized up) over the length of maturity and claimed each year as interest. Therefore, there is interest or ordinary income each year. Since the bond was held for two years, $120 of interest had accrued ($1,000 - $400 = $600 discount divided by 10 years, or $60 per year x 2 years). Since the bond sold for $600, this amounts to an $80 capital gain, plus the interest that must be claimed for the year. [Module 17, Taxation, Section 5.2]

25

An investor wishes to establish a tax loss but still wants to maintain her ownership in the same security. The investor sells the security and repurchases it two weeks later. The tax loss is:

A. Postponed B. Restarted C. Established D. Not allowed

Incorrect! The correct answer is: D. Not allowed

Not allowed. This is considered a wash sale. In essence, anytime a security is sold for a loss and then the same security, or a substantially similar security, is repurchased within 30 days, the IRS deems the investor has not really lost anything; therefore, no loss is allowed. This is also true if the investor purchases a call option on the same stock within that period of time. [Module 17, Taxation, Section 6.4]

26

An investor has incurred margin expenses of $2,500 in a convertible bond account, $7,600 in a stock account, and $5,600 in a municipal bond account. According to IRS rules, the customer can deduct all of the expenses, except:

A. $2,500 margin expense on the convertible bond B. $5,600 margin expense on the municipal bond C. $7,600 margin expense on the stock D. Only margin expenses for stocks and bonds can be deducted.

Incorrect! The correct answer is: B. $5,600 margin expense on the municipal bond

Correct answer (false statement): $5,600 margin expense on the municipal bond. This cannot be deducted. Because municipal bonds pay interest that is tax-free, the interest expense (or margin expense) that is incurred in purchasing municipal bonds cannot be deducted. Stock and corporate bond loan interest (or margin expense) that is incurred can be deducted. Remember, any expense in a margin account is always an interest expense. Therefore, the margin expenses of $2,500 in a convertible bond account and the $7,600 expenses in a stock account are both deductible interest expenses. [Module 17, Taxation, Section 6.5]

27

An investor writes a DOW Oct 60 call for a premium of 9. The investor has previously purchased 100 shares of Dow stock at 54. Later, when the market is at 76, the option is exercised against the investor. For tax purposes, what are the investor's proceeds?

A. $6,000 B. $6,300 C. $6,900 D. $7,600

Incorrect! The correct answer is: C. $6,900

$6,900. To determine both cost basis and proceeds, always add the premium to the strike price on a call, and subtract the premium from the strike price in a put. Do not even look at the stock position. In this case, 60 + 9 = 69. 69 x 100 shares = $6,900 in proceeds. Remember -- CALL UP! [Module 17, Taxation, Section 6.1]

28

An investor in the 28% tax bracket has completed transactions during the year that resulted in the following:


Short-term capital gain: $8,000
Long-term capital loss: $6,000

How will the transactions be taxed?


A. $2,000 ordinary income at 28% B. $2,000 short-term gain at 28% C. $2,000 short-term gain at 15% D. $2,000 long-term gain at 15%

Incorrect! The correct answer is: B. $2,000 short-term gain at 28%

$2,000 short-term gain at 28%. The short-term is a gain and the long-term is a loss, so net them out for a $2,000 short-term capital gain. The investor's tax bracket is 28%; therefore, the $2,000 gain is taxed at 28%. [Module 17, Taxation, Section 3.3]

29

An investor has contributed to two limited partnership investments. One of the partnership investments reports income of $8,000. The other partnership investment reports losses of $10,000 from depreciation. What does this investor report for tax purposes?

A. $0 B. $2,000 loss C. $10,000 income D. $18,000 deduction

Incorrect! The correct answer is: B. $2,000 loss

$2,000 loss. The depreciation loss is partially offset by the income. If the question had asked how much could be deducted from ordinary income, the answer would have been $0. However, the taxpayer still must report the loss; therefore, at a later time, the investor can deduct the loss from any future proceeds. [Module 17, Taxation, Section 2.2]

30

A customer donates $17,000 worth of stock to a charity eight months after buying it. The cost of the stock when purchased was $12,000. As a result of this donation, a customer will have a tax deduction of:

A. $3,000 B. $5,000 C. $12,000 D. $17,000

Correct Answer: C. $12,000

$12,000. Since the stock was held for less than one year, the investor can only deduct the cost basis -- regardless of whether this value is greater or less than the present value of the stock being donated. In this case, the investor "loses" the $5,000 appreciation that cannot be deducted. If the stock had gone down in price since the time of its purchase, the investor would have received a higher deduction than the current value of the stock. [Module 17, Taxation, Section 6.9]

31

An investor writes an EGG June 30 put for a premium of 5. Later, when the market is at $24, the put is exercised against the investor. For tax purposes, what is the investor's cost basis?

A. $2,400 B. $2,500 C. $3,500 D. $3,600

Incorrect! The correct answer is: B. $2,500

$2,500. When the question asks for cost basis or proceeds, add the premium to calls and subtract the premium from puts. In this case, there is a 30 put for 5, so subtract 30 - 5 = 25. The investor writes the EGG June 30 put for a premium of 5; therefore, the investor's costs basis is 25 or $2,500. Remember -- PUT DOWN! [Module 17, Taxation, Section 6.1]

32

Corporations are partially tax-exempt from the investment income received from:

I. Municipal bonds
II. Corporate bonds
III. Preferred stock
IV. Common stock

A. I B. I and IV C. III and IV D. II and III

Correct Answer: C. III and IV

III and IV. Investment income from common and preferred stock is the only form of passive income with a 70% exclusion on the amount of income taxed for corporations. In essence, 30% is added to the corporation's taxable income and then taxed at the corporate percentage. Corporations have no exclusion for tax purposes on corporate bonds, and corporations have full tax-exempt status on interest from municipal bonds. [Module 17, Taxation, Section 6.7]

33

A 10-year, zero-coupon treasury receipt is purchased for $600. If the treasury receipt is held to maturity, which of the following statements is true?

A. At maturity, the appreciation will be all capital gain. B. At maturity, the appreciation will be all ordinary income. C. At maturity, the appreciation will be one year's interest. D. At maturity, there will be no interest or capital gain.

Incorrect! The correct answer is: C. At maturity, the appreciation will be one year's interest.

At maturity, the appreciation will be one year's interest. If a 10-year, zero-coupon treasury receipt, also called a treasury STRIP, is purchased for $600 and held to maturity, the appreciation will be one year's interest at maturity. This is because the discount of $400 is amortized and taxed each year over the 10 years and added to income each year. That only leaves one year's interest in the maturity year. [Module 17, Taxation, Section 5.2]

34

An investor in the 28% tax bracket has made stock transactions during the year. The investor sells 500 shares of stock that were purchased two years ago resulting in a capital gain of $25,000. The investor's tax liability will be:

A. Ordinary income at 28% B. Short-term gain at 28% C. Long-term gain at 28% D. Long-term gain at 15%

Incorrect! The correct answer is: D. Long-term gain at 15%

Long-term gain at 15%. Long-term gains are currently taxed at a maximum rate of 15%. [Module 17, Taxation, Section 3.1]

35

A municipal bond is purchased in the secondary market at a discount and is later sold prior to maturity at a premium. For tax purposes, how will this investor treat the appreciation on the bond?

A. All ordinary income B. All capital gain C. All tax-free D. Part ordinary income and part capital gain

Incorrect! The correct answer is: D. Part ordinary income and part capital gain

Part ordinary income and part capital gain. Any bond, including a municipal bond, purchased in the secondary market at a discount is accreted (amortized up) and treated as ordinary income. If the bond is held to maturity, the total appreciation is ordinary income. If the bond is sold prior to maturity, then the investor has a new basis based on the accretion, and any amount above the new basis is considered a capital gain. If the bond is sold for less than the new basis, the investor will have a capital loss in addition to the ordinary. In this case, the bond was sold at a premium; therefore, it is taxed as ordinary income up to the new cost basis and capital gain above the cost basis to the proceeds. [Module 17, Taxation, Section 5.2]

36

An investor in the 28% tax bracket buys a municipal bond in the secondary market with a nominal yield of 6.25% and a yield to maturity of 7.25%. The investor holds the bond until it matures. The investor's after-tax yield will be:

A. Less than 6.25% B. More than 6.25%, but less than 7.25% C. Over 6.25% D. 6.25%

Incorrect! The correct answer is: B. More than 6.25%, but less than 7.25%

More than 6.25%, but less than 7.25%. This is because the investor receives the 6.25% nominal yield tax-free; however, the bond has an effective yield of 7.25% because it was bought at a discount. You can tell that the bond is purchased at a discount because the yield is higher than the coupon; therefore, the price is lower than par (1,000). Since the bond is purchased at a discount in the secondary market, the gain is going to be taxed as ordinary income. The investor does not really receive the benefit of the full amount of the gain since some of the gain goes to taxes. [Module 17, Taxation, Sections 4.3 & 5.2]

37

An investor buys an IBM April 120 put for a premium of 2. The investor also owns 100 shares of the underlying stock at 123. When the IBM market is at 115, the investor exercises his put. What are the investor's proceeds upon exercising?

A. $11,500 B. $11,800 C. $12,300 D. $12,500

Incorrect! The correct answer is: B. $11,800

$11,800. To determine proceeds or cost basis when investing in and exercising options, calculate the breakeven of the option only. For calls, add the premium to the strike price; for puts, subtract the premium from the strike price. In this case, the investor has a 120 put for 2 -- "put down." When the investor exercises, the proceeds are 120 - 2 = 118; 118 x 100 shares = $11,800. Remember -- PUT DOWN! [Module 17, Taxation, Section 6.1]

38

Your customer trades heavily in foreign stocks on foreign exchanges. Your firm holds the shares and passes the dividends through to your customer when the dividends are paid. In one of the countries, the government withholds 12% of the dividend for taxes. How is your customer affected by this taxation?

A. The customer just loses that amount of the income. B. The customer is not affected. C. The customer receives a tax credit for the amount withheld. D. The customer is refunded the amount by the company.

Correct Answer: C. The customer receives a tax credit for the amount withheld.

The customer receives a tax credit for the amount withheld. The dividends are added to the customer's income and taxed at the appropriate tax bracket. Then, the tax paid to the foreign country on that dividend becomes a tax credit against the income tax owed by the customer on his U.S. income tax form. The foreign tax paid is fully deductible as a tax credit, so the customer is not double taxed on the dividend. [Module 17, Taxation, Section 6.10]

39

An investor owns two limited partnership investments to which he has contributed. One of his partnerships reports $12,000 in income. The other partnership reports losses from depreciation of $16,000. How much does this investor deduct from his ordinary income?

A. $0 B. $1,000 C. $3,000 D. $4,000

Incorrect! The correct answer is: A. $0

$0. The limited partner cannot deduct any passive losses from his ordinary income. If the income had been greater, the limited partner would have had to add that to his income; however, he cannot take passive losses. The limited partner can only take capital losses up to $3,000. He can take all of the passive loss against income or capital gains from other partnerships, but that was not the question. [Module 17, Taxation, Section 2.2]

40

An investor buys an IBM April 80 call for a premium of 3. When the market of IBM is at 87, the investor exercises his call. What is his cost basis upon exercising?

A. $7,800 B. $8,000 C. $8,300 D. $8,700

Correct Answer: C. $8,300

$8,300. Cost basis on a call being exercised is the premium plus the strike price. For calls, add the premium; for puts, subtract the premium. In this case, 80 + 3 = 83 x 100 shares in the call option = $8,300, which is the investor's cost basis upon exercising. Remember -- CALL UP! [Module 17, Taxation, Section 6.1]