CFP Flashcards
(252 cards)
1
Q
Financial Plan Strengths
A
Adequate savings (particularly for retirement).
Appropriate investments.
Appropriate insurance coverage.
Appropriate net worth. Inadequate net worth.
Appropriate emergency fund.
Valid and appropriate will and asset transfer plan.
Well-articulated financial goals.
Excellent cash flow management.
Knowledgeable about investments.
2
Q
Financial Plan Weaknesses
A
Inadequate savings (particularly for retirement).
Inappropriate investments.
Uncovered catastrophic risks:
Life, health, disability, property,
liability, umbrella, long-term care. Inadequate net worth.
Inadequate emergency fund.
No will or invalid will.
Lack of defined financial goals.
Poor spending habits—improper use of cash flow.
Lack of investment knowledge
3
Q
Life Cycle Phases
A
Asset accumulation, conservation/protection, distribution
4
Q
529 Savings Plan
A
Contributions are gifts, gift splitting and 5-year accelerating can be used. Used for qualified elementary and secondary education
5
Q
CESA (Coverdell)
A
$2,000 per year limit, Income phaseout, funds used before student reaches age 30
6
Q
UTMA/UGMA
A
Bonds or income-bearing investments may trigger taxation if the child
qualifies as either a dependent child under the age of 19 or a dependent
child who is a full-time student between the ages of 19 and 24. Unearned
income from children’s investments will be taxed at the parent’s tax rate.
Also, the assets will be part of the contributor’s gross estate if the
contributor is also the custodian. assets are included at the child’s rate of 20% when
calculating the Expected Family Contribution (EFC) for financial aid.
7
Q
Series EE Bonds
A
The bonds are owned by the parents (gross estate issues). Interest earned is not subject to income tax when used to pay qualified
education expenses.
8
Q
College Loans - Higher Income
A
Parent Loan, PLUS Loan, Unsubsidized Stafford Loan
9
Q
College Loans - Need Based
A
Pell grants, Susidized Stafford, Federal Supplement Education Opportunity Grant
10
Q
American Opportunity Tax Credit
A
A) Extended to the first four years of post-secondary education. B) Student must be enrolled at least half-time for the academic period.
C) Refundable up to 40% of credit ($1,000) to qualified taxpayers.
D) Dollar-for-dollar credit in an amount equal to 100% of the first $2,000 of
qualified post-secondary expenses and 25% of the next $2,000 of qualified
expenses.
E) Per student, not per family
11
Q
Lifetime Learning Credit
A
A) Can be claimed for an unlimited number of years.
B) Up to $2,000 per family.
12
Q
CFP Board Code of Ethics Principles
A
a. Act with honesty, integrity, competence, and diligence.
b. Act in the client’s best interests.
c. Exercise due care.
d. Avoid or disclose and manage conflicts of interest.
e. Maintain the confidentiality and protect the privacy of client information.
f. Act in a manner that reflects positively on the financial planning profession and
CFP® certification
13
Q
Standards of Conduct - 6 Sections
A
a. Duties Owed to Clients
b. Financial Planning and Application of the Practice Standards for the Financial
Planning Process
c. Practice Standards for the Financial Planning Process
d. Duties Owed to Firms and Subordinates
e. Duties Owed to CFP Board
f. Prohibition on Circumvention
14
Q
Fiduciary Duty (Standard A.1)
A
A) Duty of Loyalty. Involves placing the client’s interests ahead of
the CFP® professional, the CFP® professional’s Firm, or any
other entity. Includes avoiding or fully disclosing, obtaining
informed consent, and managing Material Conflicts of
Interest.
B) Duty of Care. The CFP® professional must engage the client
with care, skill, prudence, and diligence. Fulfillment of this
duty requires consideration of the Client’s goals, risk tolerance,
objectives, and circumstances.
C) Duty to Follow Client Instructions. CFP® professionals are
obligated to adhere to the Terms of the Engagement and must
follow ‘reasonable and lawful’ Client instructions.
15
Q
Competence (Standard A.3)
A
Regarding Material Conflicts of Interest, a CFP® professional
must provide professional services with competence, which means
with relevant knowledge and skill to apply that knowledge. When
the CFP® professional is not sufficiently competent in a particular
area to provide the Professional Services, the CFP® professional
must gain competence, obtain the assistance of a competent
professional, limit or terminate the Engagement, and/or refer the
Client to a competent professional.
16
Q
Disclose and Manage Conflicts of Interest (Standard A.5)
A
A) avoid, or
B) Fully Disclose (by providing sufficiently specific facts, obtain
informed consent, and manage the conflict.
17
Q
Confidentiality and Privacy (Standard A.9)
A
A) Information used for ordinary business purposes (e.g., personal
information necessary for an estate planning attorney to draft a
will)
B) Information transferred for legal and compliance purposes
(e.g., subpoenas)
18
Q
Duties When Representing Compensation Method
(Standard A.12)
A
Fee-only—CFP® professionals, CFP® professional’s Firm, and
Related Parties receive NO sales-related compensation.
Fee-based—Both financial planning fees and sales-related
compensation are received (fee and commission).
Sales-related compensation receives a separate definition. Salesrelated compensation includes commissions, trailing commissions,
12b-1 fees, spreads, transaction fees, revenue sharing, referral or
solicitor fees, bonuses, and de minimis economic benefit(s).
19
Q
Duties When Recommending, Engaging, and Working With
Additional Persons (Standard A.13)
A
A) have a reasonable basis for the recommendation or Engagement
based on the other professional’s reputation, experience, and
qualifications; and
B) disclose any arrangement by which someone other than the
client will compensate the CFP® professional, the CFP®
Professional’s Firm, or a Related Party for the Engagement or
recommendation
20
Q
Relevant Elements
A
A) developing Client goals;
B) managing assets and liabilities;
C) managing cash flow;
D) identifying and managing risks;
E) identifying and managing the financial effect of health
considerations;
F) providing for educational needs;
G) achieving financial security;
H) preserving or increasing wealth;
I) identifying tax considerations;
J) preparing for retirement;
K) pursuing philanthropic interests; and
L) addressing estate and legacy matters.
21
Q
Practice Standards
A
- Understanding the Client’s Personal and Financial Circumstances
- Identifying and Selecting Goals
- Analyzing the Client’s Current Course of Action and Potential Alternative Course(s)
of Action - Developing the Financial Planning Recommendation(s)
- Presenting the Financial Planning Recommendation(s)
- Implementing the Financial Planning Recommendation(s)
- Monitoring Progress and Updating
22
Q
Annual Renewable Term
A
Pure life insurance, no cash value; initially,
the highest death benefit for the lowest
premium outlay.
Short to intermediate term need;
largest death benefit for initial premium.
Fixed, level death Benefit.
Premium Increasing, exponentially over time.
23
Q
Whole Life
A
Guaranteed premium,
death benefit, cash
value; dividends may
be paid in cash, reduce
premium, accumulate
at interest, purchase
paid-up additions,
or purchase one-year
term.
Lifetime coverage.
Low risk tolerance.
Fixed, level. Fixed, level.
Straight whole
life—payments
go to age 100
or 120. Limited
pay whole life
payments may
end at 65.
24
Q
Variable Life
A
Whole life contract;
choice of subaccounts;
death benefit depends
on investment results,
but guaranteed
minimum (GMDB).
Lifetime coverage.
Desire for
investment
performance.
Assets held in
subaccounts.
Guaranteed
minimum: can
increase based
on investment
performance, but
cannot decrease
below face value.
Fixed, level.
25
Universal Life
A & B
Flexible premium,
current assumption,
adjustable death
benefit policy; policy
elements unbundled;
two death benefit
options (A & B).
Flexibility in
premiums and
benefits:
can be adjusted up
or down. Assets
part of insurance
company’s general
account.
Adjustable;
Option A like
Ord. Life; Option
B like Ord. Life
plus term rider
equal to cash
value.
Flexible.
Policy not
recommended
for fixedincome clients.
26
Variable
Universal Life
Combines features of
both universal and
variable life.
Need for
performance and
flexibility.
Assets are held in
subaccounts.
Adjustable; not
guaranteed.
Flexible
27
Taxation of Life Insurance on Transactions During Life - Dividends
Dividend exceeds premium - ordinary income
28
Taxation of Life Insurance on Transactions During Life - Cash Surrender
Surrender value minus Investment - ordinary income
29
Taxation of Life Insurance on Transactions During Life - Interest Payments
Maturity or cash surrender - ordinary income
30
Taxation of Life Insurance on Death Benefits - Lump Sum
Tax exempt to beneficiary
31
Taxation of Life Insurance on Death Benefits - Interest Payment
Ordinary income
32
Taxation of Life Insurance on Death Benefits- Installment payments
Principal is tax free, earnings are ordinary income
33
Single premium deferred annuity (SPDA)
a lump-sum premium with an
annuitization period deferred until some point in the future. The premium earns
interest that accrues tax deferred
34
Periodic premium deferred annuity (PPDA)
allows periodic, variable contributions
where earnings accumulate tax deferred and are distributed sometime in the future.
35
Single premium immediate annuity (SPIA)
the annuity payments to the annuitant
begin one payment period following the premium payment
36
Fixed period
payments continue to the annuitant for a specified term, and to a
designee if the term exceeds the annuitant’s life. The insurer determines the amount of
the payment based on the period selected.
37
Fixed amount
payments are made periodically in a fixed amount determined by the
annuitant. The insurer determines the length of time for which payments can be
made.
38
Straight life annuity
payments continue until the death of the annuitant
39
Life annuity with period certain
payments continue to the annuitant for the
annuitant’s lifetime. However, if the annuitant dies before the end of the guaranteed
term, payments will continue to the designee or beneficiary for the remainder of the
term.
40
Joint and survivor
payments continue until the death of the last of two annuitants
41
Fixed annuity
Premiums are invested in the general account of the insurer.
a. The insurer bears the investment risk.
b. The annuitant receives a minimum guaranteed interest rate.
c. Upon annuitization, a fixed periodic payment will be determined depending on
the form of the annuity.
d. Suitable for a more conservative investor
42
Variable annuity
Premiums are invested in subaccounts.
a. Each individual subaccount may include stocks, bonds, or a combination of both,
depending on its investment objective.
b. The periodic payments upon annuitization generally vary depending on the
returns of the underlying investment accounts.
c. The contract owner bears the investment risk.
d. Suitable for a more risky investor
43
Equity-indexed annuity
Contract owner is credited with a return based on changes
in an equity index, such as the Standard & Poor’s 500 Index; the insurance company
typically guarantees a minimum return (or floor), which varies depending on the
issuing company.
a. Suitable for clients who want to participate in the equities market without the
investment risks (e.g., downside risk) of a variable annuity
44
Deferred income annuities
also known as longevity annuities, guarantee income for
life or a certain period of time.
a. The future income start dates are selected at contract issuance. Generally, for most
deferred annuity contracts, the contract owner would make that decision at some
point in the future.
b. The elected income start date may be any time after the first contract year and
generally up to age 85.
c. Single premium or flexible premium payments are available.
d. Income start date for annuity benefits will be the same regardless of when the
premium payments were made into the contract
45
Guaranteed step-up death benefit rider
Guarantees that the original premium plus a monthly, quarterly, or annual step-up
in value will be available for the beneficiary as a death benefit.
46
Long-term care coverage rider
May allow for qualified long-term care expense distributions to receive favorable
tax treatment.
47
Guaranteed lifetime withdrawal benefit (GLWB) rider
Guarantees the owner of a variable annuity can make certain systematic
withdrawals for life and be assured of receiving a guaranteed amount of income,
regardless of the annuity contract’s investment performance. Under a GLWB, the
owner can withdraw up to a specific percentage of a protected value each year for
life, even if the contract value drops to zero and the total withdrawals exceed the
benefit base.
48
Guaranteed minimum withdrawal benefit (GMWB) rider
a. Allows the owner to make systematic withdrawals over a specified period and be
assured of receiving at least a return of premium or the benefit base, regardless of
the annuity contract’s investment performance.
b. The key difference between a GMWB and a GLWB is that the GMWB is not
guaranteed for the life of the contract owner
49
Guaranteed minimum income benefit (GMIB) rider.
a. Allows the owner to eventually annuitize a certain minimum guaranteed income
base, regardless of how poorly the contract’s subaccounts perform.
b. The GMIB guarantees a minimum level of annuity payments by the insurance
company, regardless of the contract’s subaccount performance.
c. This rider can be useful for more conservative investors
50
Guaranteed minimum accumulation benefit (GMAB) rider
a. Guarantees the owner of a variable annuity will receive at least a return of principal,
in a lump sum, after a specified waiting period.
b. The GMAB typically provides that if the actual contract value at the end of the
waiting period is less than a guaranteed minimum value, the insurer will make a
one-time contribution sufficient to bring the contract up to the guaranteed value.
51
Disability Income Insurance
Disability insurance provides benefits in the form of periodic payments to a person
who is unable to work due to sickness or accidental injury
52
Own occupation
the inability to engage in your own occupation
(most expensive).
53
Modified own occupation
the insured will qualify for benefits if he is unable to
engage in his own occupation, but the difference is the insured cannot be
gainfully employed in another field to claim benefits under a modified own
occupation definition of disability.
54
Any occupation
the inability to perform the duties of any occupation
for which one is reasonably qualified by education, training, or experience
55
Presumptive disability conditions
i. Blindness.
ii. Deafness.
iii. Loss of speech.
iv. Loss of two or more limbs
56
Social Security definition of disability
the inability to engage in any substantial
gainful activity (SGA) by reason of any medically determinable physical or mental
impairment(s) which can be expected to result in death or which has lasted or can
be expected to last for a continuous period of not less than 12 months.
57
Elimination (waiting) period
acts as a time deductible by making the insured cover
part of the financial loss. Common elimination periods are 30, 60, 90, 180, or
365 days
58
Partial disability rider
Provides coverage for an insured when the insured is unable to perform one or
more important duties of the insured’s own occupation, but the insured is still
able to perform some duties, (usually, only 50% of the insurance benefit is
paid).
59
Guaranteed insurability rider.
Guarantees the insured the right to purchase additional amounts of disability
income coverage at predetermined times in the future without evidence of
insurability.
60
Noncancellable
this policy is continuous, guaranteeing the insured
the right to renew until a specific age or stated number of years at a fixed level
premium (most expensive)
61
Guaranteed renewable
this policy is one where a right to renew is guaranteed,
but the insurance company is allowed to adjust the premiums by policyholder class
(normally on a group basis).
62
Conditionally renewable
this policy is a continuous-term policy that the
insurance company may terminate if certain contractual conditions are met
(e.g., retirement)
63
COBRA - 18 Months
* employees & dependents
for reduction in hours
* employees & dependents
for normal termination
64
COBRA - 29 Months
* employee or qualified
beneficiary meets Social
Security definition of
disabled
65
COBRA - 36 Months
* divorce
* for Medicare (from
event)
* death
* child reaching age of
ineligibility
66
Medicare Part A Benefits
a. Hospital care benefits
i. Medicare pays for hospital services for up to 90 days in each benefit period.
ii. A benefit period ends when the patient is out of the hospital for 60 consecutive
days.
iii. A new benefit period begins upon a subsequent hospitalization, which requires
the insured to pay the deductible again.
b. A lifetime reserve of 60 additional days is also available to individuals who have
exhausted the regular 90 days of benefits.
c. Skilled nursing care benefits are available to individuals who no longer require
continuous hospital care.
67
Medicare Part B Benefits
include physicians’ services, home health services not
requiring a hospital stay, diagnostic tests, medical equipment, and all outpatient
services of a hospital.
68
Medicare Part D Benefits
Prescription Drug Coverage which provides protection for people
who have considerable drug costs.
69
Health Savings Accounts (HSAs)
Qualifying individuals with high-deductible health insurance plans (HDHPs) can
make tax-deductible cash contributions (above-the-line deductions) that may be used
to reimburse the individual tax free for qualifying medical expenses
70
Long-Term Care Insurance
an innovation prompted by the increasing cost of health
care associated with the extension of life provided by today’s technology
71
LTC Eligibility
Unable to perform two of six activities of daily living (ADLs) for at least 90 days:
i. Bathing.
ii. Eating.
iii. Dressing.
iv. Transferring from bed to chair.
v. Toileting.
vi. Continence
or severe cognitive impairment
72
Homeowners Insurance Eligiblity
a. The policy must be for an owner-occupied dwelling.
b. No more than two families may occupy the dwelling.
c. Each family within the dwelling may only have a maximum of two boarders or
roomers.
73
Named-perils coverage
coverage that provides protection from perils that are
specifically mentioned (listed) in the policy. Perils that are not listed are excluded
from coverage.
74
Open-perils coverage
designed to protect against all perils except those
specifically excluded from coverage, resulting in a higher premium for the insured
75
Homeowners Coverage A
Covers the dwelling and structures attached
76
Homeowners Coverage B
Detached garage and other Structures
77
Homeowners Coverage C
Covers personal property
78
Homeowners Coverage D
Covers loss of use of property
79
Homeowners Additional Coverage
Covers debris removal, damage to trees, and credit card loss
80
Homeowners Coverage E
Covers personal liability on or off premises
81
Homeowners Coverage F
Covers medical payments to others
82
Homeowners Policy Exclusions
a. Ordinance or law.
b. Earth movement.
c. Water damage.
d. Power failure.
e. Neglect.
f. War.
g. Nuclear hazard.
h. Intentional loss.
83
HO-2—Broad Form
coverage for damage to buildings and personal property
for loss of use due to damage created by 18 named perils
84
HO-3—Special Form
1. Provides coverage on dwelling and other structures on an open-perils basis resulting in
coverage against all physical losses other than those specifically excluded.
2. Allows loss of use on an open-perils basis and the personal property coverage is 50% of
the insurance on the dwelling.
3. Contains exclusions that apply to all homeowner forms but also excludes losses caused
by weather conditions that contribute to an otherwise excluded peril.
4. Contains exclusions applicable to the open-perils coverage of the dwelling and other
structures.
5. Provides coverage on the same perils as HO-2 but an endorsement can be added so that
personal property is covered on an all-risk basis
85
HO-3—Standard Open-Perils Exclusions
1. Wear and tear, marring, or deterioration.
2. Inherent vice, latent defect, or mechanical breakdown.
3. Rust, mold, wet or dry rot.
4. Smog or smoke from agriculture smudging or industrial operations.
5. Release, discharge or dispersal of contaminants or pollutants unless caused by a named
peril.
6. Settling, cracking, shrinking, bulging, or expansion of pavement, patios, foundations,
walls, floors, or ceiling.
7. Birds, vermin, rodents, or insects.
8. Animals owned or kept by an insured
86
HO-4—Contents Broad Form
1. Designed for tenants, and provides protection for furniture, clothes, and other personal
property against the same perils as HO-2 Broad Form.
2. Loss-of-use coverage is limited to 30% of the amount of Coverage C (personal
property)
3. Tenant’s improvements and betterments coverage protects the insured for the value of
any additions, installations or improvements made by the insured to the rented
dwelling.
a. Coverage is limited to 10% of the amount of personal property coverage
87
HO-5—Comprehensive Form
1. Similar to HO-3, but covers personal property on an open-perils basis
88
HO-6—Condominium Unit Owners
1. Provides coverage for the personal property of the condo owner for the same named
perils as HO-2.
2. Provides for loss-of-use coverage equal to 40% of the amount of Coverage C (personal
property).
89
HO-8—Modified Coverage Form
1. Designed to cover losses to structures where the replacement cost for the home exceeds
the market price for the home.
2. Does not include a standard replacement cost provision but utilizes a functional
replacement cost provision for loss.
3. Theft coverage applies to the premises only and is limited to $1,000 per occurrence.
90
Basic Perils (Perils 1 – 12)
1. Fire.
2. Lightning.
3. Windstorm.
4. Hail.
5. Riot or civil commotion.
6. Aircraft.
7. Vehicles.
8. Smoke.
9. Vandalism or malicious mischief.
10. Explosion.
11. Theft.
12. Volcanic eruption
91
Broad Named Perils (Perils 1 – 18)
1. Basic Named Perils 1 – 12.
2. Falling objects.
3. Weight of ice, snow, sleet.
4. Accidental discharge or overflow of water or steam.
5. Sudden and accidental tearing apart, cracking, burning, or bulging of a steam, hot
water, air conditioning, or automatic fire protective sprinkler system, or from within a
household appliance.
6. Freezing of a plumbing, heating, air conditioning, or automatic fire sprinkler system,
or of a household appliance.
7. Sudden and accidental damage from artificially generated electrical current
92
Futures
An agreement between two parties to make or take delivery of a specific commodity of
a specified quality at a future time, place, and unit price
93
Call options
give the holder the right (not the obligation) to purchase the underlying
security for a specified price within a specified period of time
94
Put options
give the holder the right (not the obligation) to sell the underlying
security for a specified price within a specified period of time
95
Correlation Coefficient (R)
Measures the extent to which the returns on any two securities are related; however, it
denotes only association, not causation
96
Covariance
1. Nonstandardized version of correlation coefficient.
2. Measures the extent to which two variables (the returns on investment assets) move
together, either positively (together) or negatively (opposite)
97
Beta
Relative measure of systematic risk
98
Coefficient of Determination (R2)
Describes the percentage of variability of the dependent variable that is explained
by changes in the independent variable
99
Standard Deviation
An absolute measure of the variability of returns (outcomes) around the mean
100
Kurtosis
Measures whether a distribution is more or less peaked than a normal distribution
101
Leptokurtic
more peaked than a normal distribution
102
Platykurtic
less peaked than a normal distribution
103
Treynor ratio
Relative measure of the risk-adjusted rate of return of a given portfolio based on
systematic risk as measured by beta
104
Sharpe ratio
a. Based on the capital asset pricing model (CAPM) and the capital market line
(CML). This ratio is a relative measure of the risk-adjusted performance of a
portfolio based on total risk (systematic and unsystematic risk).
b. If a portfolio is fully diversified (void of unsystematic risk), this ratio should yield
the same result for a comparison of several investments as would performance
measures that use beta, such as Treynor and Jense
105
Coefficient of Variation
a. Relative measure of total risk (as measured by standard deviation) per unit of
expected return (risk-adjusted return).
b. Used to compare investments with varying rates of return and standard deviations.
c. Serves as a cross-check on an investment decision
106
Jensen’s alpha
Measures the risk-adjusted value added by a portfolio manager.
107
Information ratio
The ratio of expected return to risk as measured by standard deviation
108
Modern Portfolio Theory
a. Investors consider each investment opportunity as being represented by a
probability distribution of expected returns over a specified holding period.
b. Investors estimate the risk of the portfolio on the basis of the variability (i.e.,
standard deviation) of returns.
c. Investors base decisions solely on expected return and risk; therefore, their
indifference curves are a function of expected return and the expected variance of
returns only. (Note: This assumption is often captured by the concept of meanvariance optimization.)
d. Investors base their indifference to alternative investments on the maximization of
wealth over a specified period, and this indifference diminishes as they get beyond
this period.
e. For a given level of risk, investors prefer higher returns to lower returns
109
Efficient Frontier
consists of portfolios with the highest expected return for a given
level of risk.
110
Capital Asset Pricing Model (CAPM) Assumptions
a. All informed investors have uniform expectations regarding the risk-return
relationship of risky assets.
b. Investors can both borrow and lend at a specific positive risk-free rate of return (rf
).
c. Transaction costs are equal to zero.
d. Taxes are equal to zero.
e. At all times, capital markets are in equilibrium establishing a baseline by which to
evaluate the suitability of any investment
111
The Efficient Market Hypothesis
Investors are unable to consistently outperform the market on a risk-adjusted basis.
a. The market’s efficiency in valuing securities is extremely quick and accurate, and
does not permit investors to find undervalued stocks on a consistent basis.
b. Stock prices reflect all available information for a company and rapidly adjust to
reflect any new information
112
Weak form EMH
holds that current stock prices have already incorporated all
historic publicly available market data (i.e., prices, trading volume, and published
financial information).
113
Semistrong form EMH
the current stock price not only reflects all past historical
price data but also data from analyzing financial statements, industry, and the current
economic outlook.
114
Strong form EMH
holds that stock prices reflect all public information and most
private (insider) information. Therefore, even traders using inside information are
unlikely to consistently outperform the market
115
Fundamental Analysis
the process of determining the fair market value (FMV) or
intrinsic value of a security. This value is then compared to the current market value to
determine what course of action will be undertaken: buy, sell, or hold.
116
Intrinsic value
The present value of expected future cash flows discounted at an appropriate
discount rate, taking the risk of the investment into consideration.
117
Technical Analysis
an attempt to predict the demand side of the supply/demand
equation for a particular stock or set of stocks.
118
Current Yield (CY)
a. Measures a bond’s yield based on its annual interest payments and current market
price.
b. CY = annual interest payment ÷ current market price
c. As a bond’s price increases, its current yield declines.
d. As a bond’s price decreases, its current yield increases.
e. The “coupon rate” is the stated rate of interest on the bond. The coupon rate
determines cash flow
119
Yield to Maturity (YTM)
The internal rate of return for cash flows associated with the bond, including the
purchase price, coupon payments, and maturity value
120
Yield to Call (YTC)
Bonds will often be issued with a call feature permitting the issuer to retire the debt
obligation at a future predetermined price and time. This feature is a benefit to the
issuer because it permits the issuer to refinance its debt in the event that interest
rates decline. This feature causes the required yield to increase for investors because
the investment time horizon is no longer certain.
121
When bonds are at par
coupon and current yield (CY) are equal
122
When bonds are at a premium
the CY is less than the coupon
123
When bonds are at a discount
the CY is greater than the coupon
124
Macaulay Duration
provides a measure of a bond’s price
volatility. The duration and YTM of a bond have an inverse relationship. As the YTM
increases, the duration will decline
125
Convertible Securities
a hybrid security that allows the holder to acquire shares of
common stock from the issuing company by exchanging the currently held security
under a specific formula. The conversion will hinge on the value of the stock upon
conversion.
126
The time-weighted return
the geometric annual rate of return measured on the basis
of the current year value of the asset.
a. Measures the rate of return without considering an investor’s size or timing the
investor’s deposits or withdrawals.
b. This return is the preferred method for analyzing the performance of a portfolio
manager
127
The dollar-weighted return
the compound annual rate of return (internal rate of
return) that discounts a portfolio’s future value and cash flows to a present value.
a. The dollar-weighted return may be solved using the basic valuation model.
b. This return provides an assessment of an investor’s actual performance rather than a
portfolio manager. Dollar weighted returns include investor deposits and withdrawals.
128
Asset Allocation
The process of apportioning assets available for investment among various investment
classes, such as money market securities, fixed-income securities, common stock, and
real assets
129
Strategic Allocation
to choose an appropriate asset
allocation based on forecasts of the economy, expectations of selected asset classes, and
the risk tolerance of the client.
130
Tactical Allocation
changing the mix of investment classes based on changing market
conditions
131
Core and satellite
An investment strategy investing in both broad market indexes and higherrisk alternatives
132
Portfolio Immunization
protect a bond portfolio from interest rate risk (rate
fluctuations) and reinvestment rate risk.
133
Substitution swap
involves exchanging bonds with identical characteristics selling
for different prices. Takes advantage of market inefficiencies in the municipal and
corporate bond markets.
134
Intermarket spread swap
involves the exchange of one type of bond (e.g.,
government bond) with another type of bond (e.g., corporate bond). This occurs
when investors believe one type of bond is currently mispriced in relation to the
other. The goal of this type of swap is to capitalize on a YTM disparity across bond
markets.
135
Rate anticipation swap
if rates are expected to increase, long-term bonds should
be swapped for short-term bonds. If rates are expected to decline, long-term bonds
should be purchased to capitalize on the price increases for these bonds.
136
Pure yield pickup swap
involves exchanging a lower YTM bond with a higher
YTM bond. The new bond that replaces the old bond will be either a longer-term
bond or a lower quality bond
137
Tax swap
exchanges motivated by current tax law
138
Incentive Stock Options (ISOs) Taxation
1. No income recognized when option is granted.
2. No tax due when option is exercised.
3. Tax is due when stock is sold. If taxpayer does not dispose of stock within two years
after option grant and holds the stock more than one year (after exercise), any gain will
be capital gain. If taxpayer sells stock within one year after exercise date, gain is treated
as ordinary income. If within the calendar year, then it is W-2 income and there is no
AMT positive adjustment.
4. AMT may require earlier recognition of income and so the difference between the
option price and the FMV at date of exercise is an addback for AMT purposes.
139
Itemized Deductions
Casualty/Charity
Medical
Interest
Taxes
140
Miscellaneous itemized deductions
1. Gambling losses (to the extent of gambling winnings).
2. Unrecovered investment in annuity contract when annuity ceases because taxpayer
died.
3. Pro rata portion of death taxes attributable to income in respect of a decedent (IRD).
141
Kiddie Tax
A child will pay a portion of the tax on unearned income received by the child using the
parents’ applicable top marginal tax rate
a. For 2023, a dependent child who has not attained age 19 before the close of the tax
year, or a full-time student who has not attained age 24 before the close of the
taxable year.
i. Considered a full-time student if they are a full-time student for at least five
months of the taxable year.
ii. Will not apply to individuals age 18 (or students age 19–23) if their earned
income for the taxable year exceeds one-half of their support.
b. Gross income = unearned income + earned income.
c. Unearned income above $2,500 (2023) is taxed at the parent’s marginal tax rate.
d. The net unearned income is the amount taxed at the parent’s top marginal tax
bracket, taxed as follows:
Total unearned income
Less $1,250 for 2023
Less the greater of:
$1,250 for 2023 taxed at the child’s rate
Equals net unearned income
142
Child and dependent care tax credit.
To qualify, taxpayer must meet all eligibility tests.
A) Keep a home.
B) Have earned income.
C) Pay expenses (maid, babysitter, etc.).
D) Have a dependent < 13 or a spouse who is physically or mentally
incapacitated.
143
Child tax credit
i. Not the same as child care credit.
ii. A tax credit of $2,000 (2023) is available for each qualifying child under age 17.
iii. The credit is reduced $50 for each $1,000 by which MAGI exceeds $400,000
(MFJ) / $200,000 (Single).
iv. A qualifying child for the purposes of the child tax credit is the qualifying child
that the taxpayer claims as a dependent.
v. The child tax credit is refundable up to $1,600 per child (2023)
144
Adoption credit
i. Taken in the year the adoption becomes final.
ii. Qualified adoption expenses include adoption costs, court costs, and attorney
fees.
A) Does not include costs of a surrogate parenting arrangement or any costs
incurred for adopting your spouse’s child (i.e., a second family).
B) The credit is nonrefundable for 2023.
iii. For 2023, maximum credit is $15,950.
A) Phased out ratably for taxpayers with modified AGIs of $239,230 and
$279,230 (2023).
B) Any unused credit may be carried forward for up to five years.
145
Sole proprietorship
A business owned by an individual, who is personally liable for the obligations of
the business.
146
General partnership
a. An association of two or more persons, who jointly control and carry on a business
as co-owners for the purpose of making a profit.
b. The partners are personally liable for the obligations of the business
147
Limited partnership
a. A partnership in which at least one partner is a general partner and at least one
other is a limited partner, who does not participate in management and has limited
liability.
b. Limited partners are not material participants; general partners are material
participants
148
Limited liability partnership (LLP)
a. Usually a professional partnership (CPAs, attorneys) wherein the partners have
limited liability to the extent of investment except where personally liable through
malpractice.
b. This form protects the individual assets of the nonmalpracticing partners.
c. Partners generally qualify as material participants.
149
Limited liability company (LLC)
a. An entity where the owners (members) have limited liability for debts and claims
of the business even while participating in management.
b. The governing document is called an operating agreement.
150
C Corporation
a. A separate legal entity that is created by state law and operates under a common
name through its elected management.
b. Owners (shareholders) have limited liability
151
S corporation
a. A corporation with a maximum of 100 shareholders.
b. Must be a domestic company
152
Personal holding company tax
A) The objective of the personal holding company tax is to discourage
individual taxpayers from using the corporate entity solely for tax
avoidance.
B) The personal holding company tax applies only if the corporation is
considered a personal holding company, and the corporation has
undistributed personal holding company income. A corporation will be
considered a personal holding company if it meets both of the following
tests:
1) Ownership test—At any time during the last half of the taxable year,
greater than 50% of the value of the outstanding stock of the corporation is owned (directly or indirectly) by five or fewer individuals, and
2) Passive income test—At least 60% of the corporation’s adjusted ordinary gross income consists of personal holding company income.
a) Adjusted ordinary gross income is the company’s gross income,
with several adjustments. Adjustments include reductions for
property taxes, depreciation, and interest expense.
b)뼁 Personal holding company income is generally defined as passive
income and certain income from services.
c)뼁 The personal holding company tax is applied at a tax rate of 20%
on the undistributed personal holding company income.
153
Accumulated earnings tax
A) The objective of the accumulated earnings tax is to discourage individual
taxpayers from using the corporate entity solely for tax avoidance.
B) The tax applies whenever a corporation accumulates earnings beyond its
reasonable needs, unless the corporation can prove to the contrary by a
preponderance of evidence.
C) The tax rate is 20% on the amounts deemed to be in excess of the
corporation’s reasonable needs
154
Personal Service Corporation (PSC)
A) A corporation where the principal activity is the performance of a personal
service by the owner(s).
155
Taxation of S corporation shareholders
i. In general, the IRS treats S corporation shareholders as partners. Shareholders of
S corporations are required to report pro rata shares of corporate items that flow
through to them.
ii. It should be noted that while partnerships have great flexibility in the allocation
of income and deductions, this advantage is not available to S corporations.
iii. The principal advantage of S corporation status is the avoidance of the double
taxation scheme associated with C corporation status.
iv. The S corporation must file an annual return on Form 1120S.
v. For purposes of the IRC’s fringe benefit provisions, an S corporation is treated
as a partnership, and a shareholder-employee who owns more than 2% of its
stock is treated as a partner.
vi. Accident and health insurance premiums paid by an S corporation for a morethan-2% shareholder-employee are deductible by the corporation and are
included in the shareholder’s gross income. One-hundred percent of the
amount included in income may be deducted by the shareholder-employee.
156
Requirements for S corporation election
A) Shareholders may be individuals, estates, certain trusts, or certain taxexempt organizations. Partnerships and corporations may not be
shareholders.
B) Only citizens or residents of the United States may be shareholders.
Nonresident aliens may not be shareholders.
C) The entity may only have one class of stock issued and outstanding.
1) The rights of the holders must be identical with regards to profits and
assets of the corporation.
2) However, two classes are permitted if the only difference is voting
rights
157
Capital Asset
the taxpayer’s property whether or not it is connected with a trade or
business, except*:
a. Accounts receivable
b. Copyrights
c. Inventories
d. Depreciable property
158
Section 1231
General.
a. Depreciable property and real property used in business are not capital assets.
b. Without §1231, gains on disposition of these assets would always be ordinary
income.
c. Section 1231 gives limited capital gain treatment to these assets if held long term.
2. Section 1231 property losses.
a. If a business is disposing of depreciable and/or real property any loss is treated, as
per §1231, as an ordinary loss (which is deductible for AGI)
159
Section 1245. (Depreciable Personal Property)
1. Recapture.
a. Requires any recognized gain to be treated as ordinary income to the extent of the
lesser of the depreciation taken on the property disposed of or the gain recognized.
Any remaining recognized gain will usually be Section 1231 gain.
b. Includes all depreciable personal property (i.e., furnishings and equipment).
c. Exceptions (also applies to §1250)
i. Gifts—carryover
ii. Death—recapture is eliminated on assets that receive a step-up
iii. Charitable transfers
iv. Nontaxable conversions—carryover
d. Installment sales—recognized in year of sale
e. Related parties—all gain is OI
160
Personal Residence Exemption – Section 121
a. A taxpayer of any age can exclude from income up to $250,000 of gain ($500,000
for joint filers) from the sale of a home.
b. The home must be owned and used by the taxpayer(s) as a principal residence for
at least two of the last five years before the sale and the taxpayer cannot have
claimed this exclusion in the previous two years.
c. For married taxpayers—either spouse can meet the ownership test, but both
spouses must meet the use test
161
Primarily personal use
if property is rented fewer than 15 days per year, it is a
personal residence.
a. Rent is excluded from gross income and normal personal residence deductions
apply (e.g., mortgage interest and taxes).
162
Primarily rental use
if the rental property is rented at least 15 days a year and is not
used for personal use more than the greater of 14 days per year or 10% of rental days,
it is classified as primarily rental use.
a. A loss can be used to offset other taxpayer income.
b. Expenses must be allocated between personal and rental days.
c. Passive activity loss rules may apply.
i. Individuals can deduct up to $25,000 ($12,500 for MFS) of rental real estate
losses against active and portfolio income.
ii. Two tests must be met to qualify for this exception:
A) Active participation in the activity (participates in management decisions,
an easier hurdle to clear than material participation).
B) Ownership of 10% or more (in value) of all interests in the activity during
the taxable year
163
Personal/rental use (mixed use)
a. If the property is rented too much for 1 (above) and used personally too much for
2 (above), expenses can be deducted only to extent of income (i.e., there can be no
deductible loss.
b. The order in which expenses are deducted is interest and taxes, operating expenses,
expenses that affect basis (depreciation).
c. Income and allowable expenses are reported on Schedule E.
164
Section 1033 (involuntary conversions)
a. Destruction, theft, seizure, requisition, or condemnation (or sale/exchange under
threat of)
b. Taxpayer must replace within two years from the end of the year in which
realization occurred for natural disaster (three years for government takings and
condemnation of real property used in a trade or business or held for investment).
c. Realization occurs when the taxpayer can actually determine the amount of gain
that would have been realized if the property had been sold.
d. Amount reinvested ≥ amount realized from conversion, then no gain recognized.
e. Amount reinvested < amount realized from conversion, then up to full gain may
be recognized.
f. Replacement property.
i. Functional use test.
ii. Taxpayer use test
165
Section 1031
a. Gain is deferred if:
i. Exchange of domestic real property for domestic real property.
ii. Held for use in a trade or business or for investment.
iii. The property is like-kind property.
A) Like-kind property.
1) Realty for realty.
B) Not like-kind property.
1) Inventory.
2) Stock.
3) Personal-use assets (autos).
4) U.S. real estate for foreign real estate.
5) Tangible personalty for realty.
6) Livestock of different sexes.
7) Tangible personalty for tangible personalty
166
Boot
i. Property included in a like-kind transaction that is not like-kind (usually cash
or assumption of debt).
A) Boot can be tangible personal property that is not like-kind.
B) If this boot is appreciated property, the person giving boot will realize a
capital gain, LT, or ST, depending on holding period.
ii. The receipt of boot will:
A) Result in the recognition of some gain if there is a realized gain.
iii. Key concept here.
A) If boot is given, add it to the basis of the new property.
B) If boot is received, recognize the boot as gain up to the realized gain and
carryover the basis net of any excess boot.
C) Do not recognize losses if boot received. Gain recognized is the lesser of
gain realized or boot received.
167
Basis of an Asset Acquired by Gift
1. General (carryover donor’s basis).
2. Where the FMV is less than the donor’s basis—double-basis rule is used.
3. When gift tax is paid by donor, add proportional tax on appreciation to donee’s basis.
a. FMV is reduced by any annual exclusion amount the donor used for the gift
168
Basis of an Asset Acquired by Inheritance
1. Fair market value at date of death, or alternate valuation date if properly elected. Most
inherited assets carry a long-term holding period (except IRD assets).
2. IRD assets—carryover basis (annuities, pensions, installment sales)
169
Section 1202 qualified small business stock (QSBS)
a. Noncorporate investors can exclude up to 50% of realized gain.
i. For stock issued 2/18/09–9/27/10 the 50% gain exclusion is increased to
75%.
ii. For stock issued after 9/27/10, 100% of the gain is excluded from both regular
income and alternative minimum taxable income.
b. Any remaining gain is taxed at the 28% capital gains rate.
c. Stock must be issued after August 10, 1993.
d. Stock must be held more than five years.
e. Exclusion limited to greater of $10 million or 10 times the taxpayer’s basis in the
stock.
f. A portion of the excluded amount of gain is a tax preference item for AMT purposes
(see exception above).
170
Installment Sales
The buyer then provides the seller with promissory notes evidencing the remaining
indebtedness (from an investment risk point of view, these notes are like bonds).
The buyer makes installment payments which include return of basis, capital gains,
and ordinary income to the seller (ordinary income is to the extent of the interest
component).
171
DB Pension Plans
Traditional, Cash Balance, DB(k)
172
DC Pension Plans
Money purchase, target benefit
173
DC Profit Sharing Plans
Traditional, Stock Bonus, ESOP, 401(k), TSP, SIMPLE 401(k), Age based, New comparability
174
Other tax advantaged plans
SEP, SARSEP, IRA, Roth IRA, 403b, SIMPLE IRA
175
NQ Plans
Deferred Comp, Section 457
176
Net Unrealized Appreciation
Lump sum distributions that consist entirely or in part of employer securities receive
special tax treatment. Employer securities generally include stock of the employer corporation, but may also
include bonds or debentures of the employer. Securities of a parent or subsidiary may
also qualify as employer securities for NUA treatment.
NUA treatment does not require a minimum number of years of participation in the
plan, but it does require the person to have a triggering event (death, disability, separation
from service, or be at least 59 ½) and to have received a lump sum distribution.
177
Highly compensated
i. Was, at any time, a greater than 5% owner of the employer any time during
the current year or preceding year, OR ii. Made more than $135,000 in 2022 or $150,000 in 2023
178
Key Employee
1. An officer with compensation greater than $215,000 (2023).
2. A greater than 5% owner.
3. A greater than 1% owner with compensation greater than $150,000 (not indexed)
179
Ratio test
Must cover a
percentage of nonhighly
compensated employees that
is at least 70% of the
percentage of highly
compensated employees
covered.
180
Average benefits percentage test
) The nondiscriminatory
component. Classification is
reasonable and based on
objective business criteria
(e.g., job categories,
location, hours, weeks); the
ratio percentage of the plan
can be either ≥ 70% or not
discriminatory based on
facts and circumstances.
2) The average benefit
percentage test. The average
benefit % accrued for
nonhighly compensated
employees as a group must
be ≥ 70% of the average
benefit % accrued for the
highly compensated
employees as a group.
181
The 50/40 Test
All defined benefit pension plans must benefit no fewer than the lesser of the following:
a. 50 employees.
b. 40% or more of all eligible (nonexcludable) employees
182
Defined Benefit Pension Plan Vesting
Employers must provide for specific vesting schedules. Generally, either cliff vesting or
graded vesting will be used. The schedules typically used in defined benefit plans are as
follows Employees are always 100% vested in their own contributions to qualified plans.
Employers may choose to vest employees at 100% immediately upon plan entry for
any qualified plan or choose a vesting schedule that vests at least as fast as either the cliff
or graded schedules
183
Defined Contribution and Top-Heavy Vesting
A top-heavy plan is one that provides more than 60% of its aggregate accrued benefits
or account balances to key employees.
184
Accelerated Vesting
Defined contribution plans and top-heavy defined benefit pension plans must
vest at least as rapidly as one of the accelerated schedules
185
Minimum Funding for Top-Heavy
i. DB Plans—2% times the number of years of service up to 20% (10 years).
ii. DC Plans—3% of total compensation.
186
Actual deferral percentage test (ADP)
a. Section 401(k) plans.
b. Deferrals include:
i. Voluntary pretax employee contributions.
ii. Voluntary after-tax Roth 401(k) employee contributions.
c. ADP = actual deferrals divided by eligible employee compensation.
d. Test 1—the ADP for the eligible highly compensated employees (HC) group must
not be more than the ADP non-highly compensated (NHC) group multiplied by
1.25.
e. Test 2—the ADP for the eligible highly compensated employees group must not
exceed the ADP for non-highly compensated employees group by more than 2%,
and the ADP for the eligible highly compensated employees group must not be
more than the ADP for the eligible non-highly compensated employees group
multiplied by 2
187
Actual contribution percentage test (ACP)
a. All qualified defined contribution retirement plans.
b. ACP = actual contributions divided by eligible employee compensation.
c. The ACP requirement is satisfied if:
i. The ACP for the highly compensated employees group cannot be more than
1.25 times the ACP for the nonhighly compensated employees group.
ii. The average ACP for the highly compensated employees group must not be
more than twice the ACP for the non-highly compensated employees group
and must not exceed the ACP for the non-highly compensated employees
group by more than 2%
188
Safe Harbor Rule
1. Employers can avoid ADP and ACP testing if the plan meets one of the safe harbor
provisions under IRC Section 401(k)(12). Safe harbor contributions made by the
employer must be 100% vested at all times.
189
DB Plan Limits
a. The benefit paid from a defined benefit plan cannot exceed the lesser of:
i. 100% of the participant’s compensation averaged over the three highest
consecutive years of compensation; or
ii. $265,000 for 2023 as indexed for inflation, and is CPI adjusted in $5,000
increments.
190
DC Plan Limits
a. The annual additions limit for all defined-contribution plans sponsored by one
employer cannot exceed the lesser of:
i. 100% of the participant’s annual compensation; or
ii. $66,000 (adjusted for CPI).
b. Annual additions.
i. Employer contributions.
ii. Employee contributions (excludes rollovers).
iii. Forfeitures allocated to a participant’s account.
191
DB Plan
a qualified pension plan that promises a specific benefit at
retirement.
Appropriate when:
a. A primary plan objective is to maximize plan contributions for the benefit of older
employees/owners.
b. The company is established and has a stable cash flow
192
DC Plan
1. Each employee has an individual account in the plan.
2. Plan benefit consists of the amount accumulated in the account at retirement or
termination.
3. Tax-deferred earnings.
4. Annual additions to each employee’s account are limited to the lesser of:
a. 100% of compensation; or
b. $66,000 (2023).
5. Tax-deductible employer contributions limited to 25% of aggregate covered
compensation.
6. Employee bears investment risk.
7. Vesting schedule as generous as 3-year cliff or 2- to 6-year graded.
193
Money Purchase Pension Plan
a. Qualified employer pension retirement plan.
b. The employer makes annual mandatory contributions to each employee’s account
under a nondiscriminatory contribution formula (typically a fixed percentage).
c. Easy to administer.
d. May be integrated with Social Security.
e. Known funding costs.
f. Lack of funding flexibility (mandatory funding).
g. Favor younger employees due to the long compounding periods.
h. There is no mechanism to influence employee retirement and turnover decisions.
i. May include voluntary or mandatory employee contributions.
j. Maximum contribution of 10% into employer securities.
k. The failure to make mandatory employer contributions results in penalty (excise
tax).
l. Less employer flexibility than profit-sharing plans.
194
Profit Sharing Plan
a. There are no mandatory yearly funding requirements, and if the plan document
permits, there may be in-service withdrawals.
b. It is a qualified, defined contribution plan featuring a flexible employer
contribution provision.
c. The employer’s contribution to the plan each year can be either a purely
discretionary amount (or nothing at all if the employer wishes) or can be based on
some type of formula usually relating to the employer’s annual profits.
d. Contributions are generally allocated on the basis of a nondiscriminatory formula.
Age-weighted formulas can be used to allocate contributions.
e. The account balance normally consists of employer contributions, investment
returns, and reallocated forfeitures.
f. Sometimes workers can contribute to a profit-sharing plan (voluntary or mandatory),
and the contributions can be pre-tax or after tax.
g. Profit-sharing plans may permit in-service distributions.
h. For a profit-sharing plan to remain viable, contributions must be substantial and
recurring (IRS standard).
i. Employer profit-sharing contributions must become vested using the accelerated
vesting schedules (3-year cliff or 2- to 6-year graded).
195
Stock Bonus and ESOP
a. The major difference between stock bonus plans/ESOPs and traditional profitsharing plans is that benefits are generally distributed in the form of employer
stock, not cash.
b. In a stock bonus plan, the employer contributes either cash or employer securities
to the plan. The contributions are determined in a variety of ways (a percentage of
either profits or covered payroll).
c. A maximum of 25% of compensation may be deducted by the employer.
d. 25% rule applies to repayment of loan principal in a leveraged ESOP; no limit for
interest payments.
e. Contributions must be allocated to individual participant accounts, subject to
nondiscrimination requirements.
f. Plan assets can be invested primarily in employer stock or securities. Dividends
from this stock can be either reinvested or distributed directly to participants.
g. Stock bonus plans must permit participants to immediately divest any employer
securities that were purchased with employee contributions (including elective
deferrals). This rule is not applicable to ESOPs that do not hold elective deferrals
196
Roth 401(k) Plan
a Section 401(k) plan in which elective deferral contributions are
made on an after-tax basis
197
SIMPLE 401(k) Plan
a. Employers with 100 or fewer employees on any day during the year who earned at
least $5,000 during the preceding year and who do not maintain another employersponsored retirement plan (two-year grace period to continue to maintain plan
when employees > 100).
b. Employees who earned $5,000 during any two preceding years and are reasonably
expected to receive at least $5,000 during the current year are eligible participants.
c. A self-employed person can participate
198
KEOGH (SELF-EMPLOYED) PLAN
qualified retirement plan that covers one or more self-employed
individuals. Self-employed individuals must calculate their retirement plan contribution based
on net earned income instead of W-2 income.
i. Net earned income is the self-employed individual’s net income from the
business after all deductions, including a deduction for contributions to the
Keogh plan
199
Simplified Employee Pension (SEP)
a. Nonqualified plan.
b. An employer-sponsored individual retirement account or individual retirement
annuity arrangement that is similar to a qualified profit-sharing plan (requires a
written plan).
c. Combines simplicity of design with a high degree of flexibility from the employer’s
perspective
200
Tax-Sheltered Annuities (TSAs)/Section 403(b) Plans
a tax-deferred employee retirement plan that is adopted only by certain
tax-exempt organizations and certain public schools and colleges. Employees have
individual accounts to which employers contribute (or employees contribute
through salary reductions).
201
Section 457 Plan
Deferred compensation plan of governmental units, governmental agencies, and also
nonchurch-controlled, tax-exempt organizations
202
Nonqualified Deferred Compensation Plans
1. Not subject to ERISA.
2. May provide benefits in excess of qualified plan limits found in IRC Section 415.
3. Unfunded vs. funded.
203
Employee Stock Purchase Plans (ESPPs)
1. Option to purchase employer stock.
2. The option grant price must not be less than the lesser of:
* 85% of the fair market value on the grant date; or
* 85% of the fair market value of the stock on the exercise date.
3. Restriction—shares must be held by the employee for at least two years from the date
of grant and one year from the date of exercise.
4. Limits—greater than 5% owners not permitted, annual limit of $25,000
204
Estate Planning Objectives
1. Efficient transfer—costs.
2. Effective transfer—goals
205
Fee simple (FS)
complete ownership with all rights (sell, gift, alienate, convey, etc.).
Property will pass through probate process
206
Life estate
interest in property that ceases upon the death of the owner
207
Interest for term
similar to life estate but for a definite term as opposed to a life term.
208
Tenancy in Common
Two or more persons holding an undivided interest in the whole property (relative
ownership percentage may differ)
209
Joint Tenancy with Right of Survivorship. (JTWROS)
Two or more persons holding the same fractional interest (equal owners) a. Property passes to surviving joint owners by right of survivorship.
b. Joint tenants have right to sell or gift interest in property without the consent of
the other joint tenant (results in seller’s interest converting to tenancy in common) c. Interest included in gross estate for estate tax purposes.
d. Gift tax.
i. Gift tax may be triggered if one owner of joint tenancy contributes more than
other(s) to the purchase of the property.
ii. Gift made from greater contributor to lesser contributor.
iii. Annual exclusion generally available.
iv. Basis for capital gain purposes = total basis in property equally divided among
owners.
e. Value for estate tax purposes (non-spouses) = based on amount originally
contributed by each owner.
i. IRS assumes 100% contributed by deceased owner.
ii. Documentation of a different contribution amount must be presented.
f. Value for estate tax purposes (spouses) = 50% regardless of percentage contributed
by each spouse
210
Tenancy by the Entirety (TE)
A type of JTWROS only between spouses.
a. Generally one spouse cannot sever (sell or gift) interest without the consent of the
other.
b. This form of ownership is recognized only in certain states and gives greater
creditor protection than a regular JTWROS.
211
Community Property. (CP)
a. Currently recognized by nine states.
b. Property interest arising from marital relationship, 50% owned by each spouse.
c. Generally, all property acquired during marriage is community property, except
property received as gift or inherited by one spouse individually.
d. Retains its status when marital domicile is moved to a common law state e. No automatic right of survivorship.
f. Estate issues.
i. 50% of FMV at death included in gross estate.
ii. Decedent's 50% interest passes through probate.
iii. Both halves receive a stepped-up basis when the first spouse dies.
212
Totten trusts
a form of trust where the bank account is titled, “depositor” in trust for
“beneficiary.”
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Buy-Sell Agreements
1. Provides for the continuation of the business by employees, family members, or
surviving owners.
2. Guarantees a market for the business interest.
3. Makes the business more attractive to creditors because of the plan for the continuation
of the business.
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Bargain sale
a sale of an asset for less than its full market value, usually made to
related parties or family members, that is considered part sale and part gift.
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Sale/leaseback
an installment sale combined with leasing the property back to
the family business
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Installment sale
allows the taxpayer to spread out
the gain as the payments are received (subject to depreciation recapture rules).
217
Gift/leaseback
fully depreciated business property (vehicles, equipment) is gifted
to a family member in a lower tax bracket by the donor/business owner. It is then
leased back to the donor, providing income to the donee while the donor still has
the use of the asset in the business
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SCIN (self-canceling installment note)
an installment note that cancels at the seller’s death. The unpaid
principal balance that is canceled at the death of the seller is not included in the
seller’s gross estate.
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Private annuity
the sale of an asset (usually to a related party) in exchange for an
unsecured promise to pay a lifetime annuity to the seller
220
Family limited partnership (FLP)
is a partnership with a general partner and at
least one limited partner. FLPs address several purposes: convenient
administration of investments, while retaining control, and a vehicle for annual
gifts for transfer tax planning purposes.
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Recapitalization
an estate freezing technique for corporations
222
GRAT (grantor retained annuity trust)
appreciating assets are transferred to
a trust with the income paid to grantor during the term. It is designed to
produce estate tax savings for the grantor
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GRUT (grantor retained unitrust)
A) Grantor receives payments at least annually of a fixed percentage of the
net fair market value of the trust assets as determined annually.
B) All other characteristics are like a GRAT. Use GRATs for fixed income and
GRUTs to combat inflation.
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Qualified personal residence trust (QPRT)
A) The grantor transfers a personal residence to a trust and retains the right
to live in the residence during the trust term.
B) Value of future-interest gift to remainderman = FMV discounted for
number of trust term years.
C) No limit on trust term, and, if transferor lives beyond term of trust, the
property is not included in the grantor’s gross estate.
D) If the transferor dies before the expiration of the trust term, the property is
included in the gross estate at the FMV at the date of death.
225
Dynasty trust
allows donor to pass wealth from generation to generation without
payment of transfer taxes, including estate and gift tax and the generation-skipping
transfer tax (GSTT)
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Transfers at Death Options
1. By will.
2. By laws of intestacy.
3. By law (jointly held property).
4. By contract (with named beneficiary)
5. By trust
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Transfers to Charities Rules
1. Must be a completed gift to claim a deduction.
2. Direct outright gift— income tax charitable deduction may be subject to AGI limits
and other restrictions (not applicable to gift or estate tax).
3. Partial gifts/exchanges—a sale of property for less than full FMV. The difference
between the sale price and the FMV is the charitable gift.
4. Charitable gift annuity.
5. Pooled income fund.
6. CRT (charitable remainder trust).
7. CLT (charitable lead trust).
8. Private foundation.
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Crummey Provision (Power to Withdraw)
Allows a gift of a future interest to qualify for the annual exclusion by giving the named
beneficiary the power to withdraw funds; right to withdraw funds is a present interest.
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Advantages of Lifetime Gifts
a. Use of qualified transfers for educational and medical expenses.
b. Use of the annual exclusion of $17,000 per donee per year (in 2023).
c. Use of unlimited marital deduction for gifts to spouse.
d. Use of applicable exclusion (lifetime exemption) amount.
e. Gifted property generally is removed from gross estate.
f. Post-gift appreciation on gifts is removed from gross estate.
g. Gift tax paid on gifts prior to three years removed from gross estate.
h. Income shifting on gifts to transferee.
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The Gross Estate
1. The value of all property in which the decedent has an interest at death.
a. Ownership.
b. Receives benefits.
c. Ability to change beneficiaries.
d. Ability to use assets to pay self or creditors.
2. Any gift tax paid on gifts made within three years of death.
3. Annuities, unless payments terminate at death.
4. Certain property held in joint tenancy
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Alternate Valuation Date (Section 2032)
1. Six months after the date of death.
2. Executor must make the election to use alternate valuation date.
3. Must lower both gross estate and the estate tax.
4. Applies to all assets except:
a. Assets disposed of before six months. If the AVD is selected, these assets are valued
at their sales price.
b. Wasting assets and income in respect of decedent (IRD) assets.
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Deductions from the Gross Estate for Adjusted Gross Estate.
1. Funeral expenses.
2. Administrative expenses.
3. Unpaid mortgages.
4. Claims against the estate.
5. Losses incurred in administering the estate
233
Deductions from AGE for Taxable Estate
1. Less unlimited:
a. Charitable contributions.
b. Transfers to surviving spouse (marital deduction).
i. The decedent’s estate can deduct an unlimited qualifying bequest or transfer
of property to a surviving spouse (except noncitizen surviving spouse).
ii. Surviving spouse includes a same-sex spouse.
iii. Direct absolute bequests to the spouse qualify.
2. State death taxes.
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Stepped-up basis (non-IRD assets)
a. FMV at date of death, or
b. If alternate valuation date is elected:
i. FMV six months after death, or
ii. Sale value if sold within six months of death.
c. Holding period is long term.
d. Exception—gifts made to decedent by heir within one year of death.
i. Original basis and holding period
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IRD assets
a. Carryover basis.
b. Income retains character (ordinary, capital gain) to recipient
236
Joint property owned by non-spouses
a. Percentage included in gross estate receives basis equal to FMV on date of death (or
AVD if elected).
b. Percentage included in gross estate depends on percentage originally contributed
by decedent.
237
Joint property owned by spouses
50% of property receives stepped-up basis equal to FMV on date of death (or AVD
if elected).
238
Community property
Both halves receive stepped-up basis equal to FMV on date of death (or AVD if
elected).
239
Qualified Terminable Interest Property (QTIP) Trust
1. Allows a terminable interest to be passed to a surviving spouse and still qualify for the
marital deduction.
2. Election regarding the use of the marital deduction is made on Form 706.
3. Income from the trust must be payable to the surviving spouse at least annually for
life. 4. The value of any assets remaining in the trust when the surviving spouse dies must be
included in the surviving spouse's gross estate.
5. Surviving spouse is not usually given a general power of appointment.
6. Usually the first spouse to die has specified in the trust provisions the ultimate
disposition of the property.
7. Reverse QTIP election—if the remainder beneficiary for the QTIP trust subjects the
remainder interest to GSTT rules, the executor may make a reverse QTIP election.
This allows the trust to be treated as part of the gross estate and take advantage of the
GSTT exemption amount without losing the marital deduction.
8. QTIP trusts are often used for second marriages
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Power of Appointment Trust
1. Allows a terminable interest to be passed to the surviving spouse and still qualify for the
marital deduction.
2. No election required as with QTIP. An A trust automatically gets the marital deduction.
3. Income from the trust must be payable to the surviving spouse at least annually for
life.
4. Any assets remaining in the trust when the surviving spouse dies must be included in
the surviving spouse's gross estate.
5. Surviving spouse is given a general power of appointment over the trust property
during life or at death.
6. The first spouse to die does not control the ultimate disposition of the property.
7. Sometimes called an A trust
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Bypass Trust (B Trust)
1. The purpose of a bypass trust is to take advantage of the applicable credit amount when
the first spouse dies.
2. The property does not qualify for the marital deduction and is included in the estate of
the first spouse to die. There is no estate tax because the trust is covered by the applicable
exclusion amount.
3. A common scenario is for the first spouse to leave everything at death to the surviving
spouse except for the applicable exclusion amount, which is transferred into a bypass
trust.
a. The trust can be designed to allow the surviving spouse to invade the trust for
health, education, maintenance, and support (HEMS).
b. When the surviving spouse dies, assets in the B trust are not included in the gross
estate and pass directly to the children (without estate taxation).
4. A bypass trust can be used instead of an outright bequest to nonspouse heirs who are
not sophisticated or mature enough to handle the property. The choice of the trust over
an outright bequest does not save any tax dollars; it simply provides the transferor with
some peace of mind.
5. Often, highly appreciating assets are placed in a bypass trust to freeze the value for
estate tax purposes at the death of the first spouse. This is especially true of life insurance
policies such as second-to-die policies.
6. Also called a credit equivalency trust, a credit shelter trust, a family trust, or a B trust.
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Direct skips
i. A related individual two or more generations below the donor (e.g., grandchild).
ii. A trust, when all beneficiaries are two or more generations below the donor.
iii. An unrelated individual younger than the donor by 37½ years or more
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Revocable living trusts
a. Avoids probate, publicity, expenses, and delays.
b. Included in the grantor's gross estate.
c. A revocable trust becomes a completed gift when the grantor releases the power to
revoke and the trust becomes irrevocable.
d. Income from trust taxable to grantor because there has been no completed gift
244
Irrevocable living trusts
a. Avoids probate, publicity, expenses, and delays.
b. Excluded from grantor’s gross estate unless the grantor has retained power over the
trust.
c. Gift tax will apply at the time of creation. Completed gifts to beneficiaries/
remaindermen.
d. Beneficiaries/trust responsible for taxes on income derived from trust
245
Testamentary trusts
a. Created by will.
b. Included in gross estate.
c. Gift tax does not apply because transfer occurs at death.
246
Special needs trusts
a. Beneficiary is grantor’s dependent who is developmentally disabled and receiving
Supplemental Security Income (SSI) or other government assistance such as
Medicaid.
b. Purpose is to pay beneficiary’s needs that are not covered by government assistance
without disqualifying beneficiary for assistance.
c. Are not permitted in all states
247
CRAT (charitable remainder annuity trust)
i. No additional contributions are permitted after inception.
ii. Annuity payout rate must be at least 5% but no more than 50% of initial net
FMV.
iii. Annuity is payable for life or for a term of up to 20 years.
iv. Present value of remainder interest at inception must be at least 10% of
original value of trust.
v. Remainder interest is paid to charity.
vi. Annuity must be paid even if trust income is insufficient.
vii. No annual valuation of assets.
viii. Very inflexible.
ix. Charity does not have to know it is named as remainder beneficiary.
x. Trust must be irrevocable.
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CRUT (charitable remainder unitrust)
i. Additional contributions are permitted.
ii. Unitrust payout may be limited to income earned.
iii. May provide for catch-up provisions.
iv. Noncharitable beneficiary receives payments equal to a fixed percentage (at
least 5% but no more than 50%) of the trust assets as revalued annually.
v. Present value of remainder interest at inception must be at least 10% of
original value of trust vi. Very flexible. In fact, the CRUT does not have to make annual payments as
long as there is a make-up provision. This would allow the income from early
years for the CRUT to be stored up for later. This is called a NIM-CRUT (net
income with make-up CRUT). This provision is useful when the donor will
continue working and thus does not need income now.
vii. Charity does not have to know it is named as remainder beneficiary.
viii. Trust must be irrevocable
249
CLT (charitable lead trust)
i. Charity receives annual income payments (annuity or unitrust) from trust.
ii. Remainder passes to noncharitable beneficiary
250
Irrevocable life insurance trusts (ILITs)
a. Removes insurance proceeds from gross estate and probate estate.
b. Must have a Crummey provision to qualify for an annual gift tax exclusion
251
Section 2503(b) trust
i. Trust income must be distributed at least annually for/to the minor.
ii. Trust assets may be held beyond majority.
iii. Gifts will partially qualify for the annual exclusion. The qualifying portion
equals the present value of the income interest that the child will receive over
the term. The balance of the gift is a gift of future interest. For example,
Grandpa set up a 2503(b) trust. He granted his daughter the income for
35 years. Afterward, the trust would be distributed to her children equally.
The daughter has a present interest and her children have a future interest.
iv. Assets removed from grantor’s estate
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Section 2503(c) trust
i. Trust income may be accumulated, it does not need to be distributed annually.
ii. Trust assets must be distributed at age of majority (usually age 21).
iii. If minor dies before receipt, the assets must pass to the minor’s estate.
iv. Assets removed from grantor’s estate.
v. Is a gift of present interest and qualifies for the annual exclusion because the
law defined 2503(c) trusts as being eligible for the annual gift tax exclusion.
