Clients, Portfolio Management, Tax (Client type) Flashcards Preview

Series > Clients, Portfolio Management, Tax (Client type) > Flashcards

Flashcards in Clients, Portfolio Management, Tax (Client type) Deck (71):
1

Keisha Killingsworth has three married children, each with children of their own, and wishes to leave equal shares of her estate to each of her children. What happens if one of those children dies before Keisha?

A) The estate is divided equally between the two surviving children and the children of the deceased child.
B) The estate is divided on a per capita basis.
C) The estate is divided equally among the two surviving children.
D) The share belonging to the deceased child is distributed per stirpes.

D) The share belonging to the deceased child is distributed per stirpes.

Unless specified otherwise, assets in an estate are distributed per stirpes (sometimes called in stirpes). Stirpes is a Latin word meaning “branches” and, in this context, it is used to determine how the “next generation” receives a share in an estate when their parent pre-deceases the grandparent. As an example, if Mrs. Killingsworth had child A, B and C, and C died having 2 living children, the estate would be divided as follows:

Child A gets 1/3rd, Child B gets 1/3rd and the two children of Child C receive 1/6th each. If you selected, “the estate is divided equally between the two surviving children and the children of the deceased child”, that would mean that everyone would receive 1/4th and that is not the way it is done.

2

A limited liability company is

A) a limited partnership
B) an insurance company
C) traded on major exchanges
D) a company with tax consequences similar to a partnership

D) a company with tax consequences similar to a partnership

A limited liability company (LLC) is a form of business entity in which the shareholders (called members) are taxed individually at their respective tax rates as is the case in a partnership.

3

Which of the following is NOT a characteristic of a C corporation?

A) Double taxation of dividends
B) Limited liability
C) Retains and reinvests earnings
D) Generally not liable for federal income tax on profits

D) Generally not liable for federal income tax on profits

Regular corporations are subject to federal income taxation because the earnings are not passed to the shareholders, as is the case in an S corporation or a partnership. Dividends are taxed twice: first at the corporate level and then at the individual level. Limited liability is a basic characteristic of all corporations. A regular corporation retains and reinvests earnings that are not distributed to shareholders as dividends.

4

Which of the following is among the most important reasons to form an S corporation?

A) Ability to retain and reinvest earnings in a growing business
B) Avoiding the double taxation of dividends
C) Ability to enjoy corporate tax rates
D) Enjoying the same legal status of a general partner in a partnership

B) Avoiding the double taxation of dividends

One of the most beneficial features of the S corporation is that the earnings pass through to the shareholders in proportion to their share of ownership and are taxed at the individual level (as opposed to the corporate level). Dividend distributions are not taxed twice as with the regular form of corporate ownership (C corp).

5

The type of business organization in which one person owns the entire business and there is no legal distinction between that individual and the business is a:

A) general partnership.
B) limited partnership.
C) corporation.
D) sole proprietorship.

D) sole proprietorship.

A sole proprietorship is the simplest form of business organization, because one person owns the entire business and there is no legal distinction between the owner and the business. This means that the owner is personally responsible for the business's debts. A partnership always requires two or more owners. Although one person can own an entire corporation, a corporation is a legal entity separate and distinct from its owner(s).

6

One of your clients is in the process of forming a new business venture with a friend and is considering whether to operate as a partnership or a C corporation. Among the advantages of operating as a partnership are:

1. ease of dissolution.
2. ease of raising additional capital.
3. flow-through of income or loss.
4. limited liability.

1. ease of dissolution.
3. flow-through of income or loss.

Unlike a C corporation, operating income or losses of a partnership flow through directly to the partners. There are several easy ways to dissolve a partnership. However, they do not offer the limited liability protection of a corporation. The corporate form of business is generally the most suitable for raising additional capital.

7

Sam Jones has been a successful businessman and is concerned that his youngest daughter will not be able to live within her means. To protect this from happening, Mr. Jones places a certain sum of money into a trust for the benefit of the daughter. Because Mr. Jones knows he won't live forever, he arranges for the Fidelity Bank and Trust Company to have control over the assets. In this case:

1. Sam Jones is the grantor.
2. Sam Jones is the trustee.
3. Fidelity Bank and Trust Company is the trustee.
4. Sam Jones's daughter is the beneficiary.

1. Sam Jones is the grantor.
3. Fidelity Bank and Trust Company is the trustee.
4. Sam Jones's daughter is the beneficiary.

The person who funds the trust is the grantor or settlor. The bank has been appointed to be trustee, and the daughter is the beneficiary of the trust.

8

When opening an account for a trust, which of the following sets of terms are synonymous?

A) Trustee- settlor.
B) Beneficiary - trustee.
C) Settlor - grantor.
D) Grantor - trustee.

C) Settlor - grantor.

The settlor, sometimes referred to as the grantor, is the person who establishes the trust. The trustee administers the trust and could be the grantor but does not have to be.

9

In a trust, the person who establishes the trust and decides on its terms is the:

A) trustee.
B) beneficiary.
C) fiduciary.
D) grantor.

D) grantor.

The grantor, sometimes referred to as the settlor, is the person who establishes the trust and specifies its terms. The person who administers the trust is the trustee, and the person who receives distributions from the trust is the beneficiary. Interestingly, trust law would permit the grantor to also be the beneficiary and/or the trustee.

10

In a trust account, the person who makes the account management decisions is the:

A) nontrustee custodian.
B) investment adviser representative.
C) beneficiary.
D) trustee.

D) trustee.

A trust is a legal entity that designates a person (the trustee) to manage the trust's assets for the benefit of another person (the beneficiary or beneficial owner).

11

A professional tennis player comes to you seeking advice on setting up a trust. She is interested in giving to charity and also wants discretion as to when income is distributed to the beneficiaries, her parents. Which trust do you advise she use?

A) Simple trust.
B) Charitable remainder trust.
C) Charitable lead trust.
D) Complex trust.

D) Complex trust.

Only a complex trust allows the two features which she requires. Simple trusts may not make charitable contributions, and provide no discretion on income distribution. The two types of charitable trusts mentioned provide no ongoing discretion as to when income is distributed or who the beneficiaries are.

12

Which of the following statements relating to trusts is CORRECT?

A) A simple trust may distribute principal during the year.
B) A complex trust may only distribute principal during the year in which the trust terminates.
C) A simple trust is required to distribute all of its income in the year earned.
D) A complex trust is required to distribute all of its income in the year earned.

C) A simple trust is required to distribute all of its income in the year earned.

A simple trust is one that is required to distribute all accounting income in the year earned, has no charitable beneficiaries, and does not distribute principal in the current year. A complex trust is one that is allowed to accumulate income, has a charitable beneficiary, or distributes principal. All trusts are complex in their final year because all principal must be distributed when the trust terminates.

13

The type of trust created in the grantor's will is a

A) living trust
B) beneficiary trust
C) limited trust
D) testamentary trust

D) testamentary trust

A testamentary trust is one that is created in the grantor's will ("last will and testament") and that does not become effective until the grantor dies. A trust expressly created during the grantor's life is a living trust.

14

A complex trust has the following income for the year: $1,500 in taxable interest, $2,000 in dividends (reinvested in the stock), and $3,000 in tax-exempt interest. In addition, the portfolio realized $3,500 in capital gains that were reinvested in the corpus. What is the distributable net income (DNI) for the trust?

A) $10,000
B) $6,500
C) $1,500
D) $4,500

B) $6,500

All investment income, regardless of source, will be considered DNI and will be included in the taxable income calculation to the trust unless distributed. That portion of the DNI representing tax-exempt interest maintains its tax-free status. Reinvested capital gains are not part of a trust's DNI.

15

If a trust has been established under which the father is to receive income for life, and his son is to receive the trust principal on the father's death, which of the following statements is TRUE?

A) The trustee is not required to notify the son when an income distribution is made to the father.
B) The trustee must notify the son each time an income distribution is made to the father.
C) The trustee does not need to keep records of the income distribution to the father.
D) The trustee can withhold income distributions to the father to preserve principal to the son.

A) The trustee is not required to notify the son when an income distribution is made to the father.

It is not required that the trust's remainder beneficiary be notified when income is distributed from the trust. The trustee must report distributions from the trust for federal income tax purposes. The trustee must follow the terms of the trust, making distributions as required by the trust instrument.

16

Alvin's spouse is a trustee of a trust established by Henrietta Flood, which directs income from the trust be paid to Alvin, for as long as he lives. Alvin's son, Floyd, will receive the principal upon Alvin's death. Floyd would like to receive some of the principal before Alvin's death and Alvin does not object. How should his spouse, the trustee, act in this situation?

A) Distribute part of the income to Floyd.
B) Follow the trust terms, continuing to distribute the income to Alvin and the principal to Floyd upon Alvin's death.
C) Distribute part of the principal to Floyd.
D) Distribute all of the principal to Floyd.

B) Follow the trust terms, continuing to distribute the income to Alvin and the principal to Floyd upon Alvin's death.

A trustee must follow the terms of the trust. Nothing in the question implies that the trustee has any discretionary powers.

17

A deceased individual with two surviving children and a wife, had established a trust for his family. The trust document appointed both children as co-trustees. The surviving spouse is to receive current income, and his two children will receive equal shares of the remaining principal upon their mother's death. As the adviser to the account, you

A) attempt to generate reasonable income while keeping the principal intact for the children
B) focus on generating income for the spouse
C) follow the instructions of the trustees
D) focus on increasing principal for the children

C) follow the instructions of the trustees

The responsibility of following the trust's instructions is that of the trustee(s). Should they attempt to deviate from that, the adviser should inform them that they face potential liability under trust law. However, in all cases, the adviser must follow the direction of the trustees. As a practical matter (not tested), if the trustees appear to violate the trust's instructions, many advisers would terminate their relationship to avoid any potential liability.

18

If 150 investors want to form a corporation to limit their financial liability to the amount of money they invest and do not want to be responsible for any debt that the corporation incurs, they would most likely form a(n):

A) proprietorship.
B) C corporation.
C) S corporation.
D) general partnership.

B) C corporation.

The investors would form a C corporation. The advantages of the C corporation are stockholders are not liable for corporate debt; it is easier to raise money by issuing stock; it is easier to transfer ownership; and unlike a partnership or proprietorship, a C corporation has a continuous life because it does not terminate on the death of shareholders, officers, or directors. An S corporation is limited to 100 investors.

19

When comparing the similarities shared by C corporations, S corporations, and LLCs, it would be accurate to state that

1. operating profits and losses flow through to the owners
2. owners enjoy limited liability
3. registered personnel opening a brokerage account for any of these would follow similar suitability procedures
4. the Uniform Securities Act considers each of these to be a person

2. owners enjoy limited liability
4. the Uniform Securities Act considers each of these to be a person

Whether organized as a C corporation, S corporation, or LLC, all owners have limited liability. Each of these fits into the very broad definition of person. Only the S corporation and the LLC have the flow-through of profits and losses, and when a C corporation opens a brokerage account, agents do not look through the corporation at the individual owners as they do with S corporations and LLCs.

20

A form of business organization that offers flow-through of income and loss while providing the owner(s) with limited liability is:

1. a sole proprietorship.
2. an LLC.
3. a C corporation.
4. an S corporation.

2. an LLC.
4. an S corporation.

Only an LLC or an S corporation allows for direct participation in the income or losses of the business while offering limited liability. The sole proprietorship has flow-through, but unlimited liability. The C corporation limits liability, but has no flow-through.

21

Which of the following types of business organizations do not protect owners' personal assets from losses incurred by the business?

1. General partnership.
2. Sole proprietorship.
3. S corporation.
4. C corporation.

1. General partnership.
2. Sole proprietorship.

Corporations, whether organized as C or S corporations, afford their owners limited liability which is the protection of their personal assets from losses incurred by the businesses. General partnerships and sole proprietorships subject their owners to personal liability for losses of the business.

22

Which of the following types of business owners has unlimited liability for the business's debts?

A) Shareholder of a corporation.
B) Owner of a sole proprietorship.
C) Limited partner.
D) Member of a limited liability company (LLC).

B) Owner of a sole proprietorship.

The owner of a sole proprietorship has unlimited personal liability for the debts of the business, and this is one of the main disadvantages of sole proprietorships. Limited partners, members of limited liability companies, and shareholders of corporations are not personally liable for the debts of the business.

23

In which of the following business entities is an owner jointly and severally liable for the obligations of the business?

A) A general partnership.
B) A sole proprietorship.
C) A limited liability company (LLC).
D) An S corporation.

A) A general partnership.

Joint and several liability is typical (and a drawback) of the general partnership, in which its partners/owners are jointly and severally liable for the obligations of the partnership. This means that each partner is liable for the wrongdoing of the other. A sole proprietorship is liable but not jointly or severally with anybody else.

24

A man is planning to start his own glass sculpturing business. He wants to be able to deduct his anticipated losses for the first two years. He anticipates that the enterprise will borrow money from lenders and is willing to personally guarantee the debt. He also wants to attract other investors but does not want to give up control of the day-to-day business decisions. What business form do you recommend?

A) Limited partnership.
B) General partnership.
C) C corporation.
D) S corporation.

A) Limited partnership.

A limited partnership with him as general partner would allow for additional investment capital without giving up management control. C corporations do not allow deductibility of losses; S corporations do not allow guaranteed debt to be included in the taxpayer's basis. General partnerships could allow the other partners to more easily control the day-to-day operations than a limited partnership, in which the other investors (presumably limited partners) would not be permitted to take a role in the running of the business.

25

If a businessowner's goal is to establish an entity that features ease in raising capital, which of these entities is the most appropriate?

A) A limited liability company (LLC).
B) A sole proprietorship.
C) A general partnership.
D) An S form of corporation.

A) A limited liability company (LLC).

If a businessowner's goal is ease in raising capital, the limited liability company (LLC) is preferable because it has no restrictions on the number or nationality of investors. While the regular or C corporate form is also preferable, the S form of corporation is limited to a maximum of 100 potential shareholders, none of whom may be a nonresident alien.

26

Which of the following statements about S corporations are CORRECT?

1. S corporation status offers greater opportunity for raising additional capital than do other forms of business structure.
2. Stockholders of S corporations are taxed on the net profits of the corporation, even if they do not receive taxable dividends.
3. An S corporation may have no more than 50 shareholders.
4. An S corporation may have only one class of stock.

2. Stockholders of S corporations are taxed on the net profits of the corporation, even if they do not receive taxable dividends.
4. An S corporation may have only one class of stock.

S corporations are flow-through vehicles, so any earnings are taxable to shareholders, whether or not they are paid out as dividends. An S corporation may have no more than 100 shareholders and may issue only one class of stock so its ability to raise large amounts of capital is rather limited.

27

Several entrepreneurs form an S corporation. Under which of the following circumstances will the entrepreneurs risk losing their tax benefits?

1. 150 new investors buy into the corporation during the year.
2. 1 new member is a nonresident alien.
3. 50% of the corporation's income is derived from passive investments in limited partnerships.
4. The corporation issues several classes of stock.

1. 150 new investors buy into the corporation during the year.
2. 1 new member is a nonresident alien.
3. 50% of the corporation's income is derived from passive investments in limited partnerships.
4. The corporation issues several classes of stock.

S corporations must not have more than 100 stockholders and each stockholder must be a citizen or resident of the United States. The corporation can only have one class of stock, and no more than 25% of the corporation's income can come from passive activities. If you were not sure of this last fact, a useful test-taking technique is recognizing that all of the other choices are correct and there is no way to select them without this one.

28

An S corporation is characterized by:

A) flow-through tax treatment.
B) unlimited personal liability.
C) more than 100 shareholders.
D) limited lifetime.

A) flow-through tax treatment.

Shareholders of an S corporation have limited liability, are limited to no more than 100 shareholders, and receive flow-through tax treatment

29

Samantha Wells, a British citizen temporarily working in the United States, wants to form a business venture with other investors. She is looking for favorable tax treatment of earnings and losses. She also wants to limit the number of investors, but is willing to share control of the enterprise with others to attract them. What business form do you advise to her?

A) Limited Partnership.
B) C Corporation.
C) S Corporation.
D) General Partnership.

D) General Partnership.

Limited partnerships would not work because the other investors have limited say in how the enterprise is run. C corporations do not provide favorable tax treatment of gains or losses. While an S corporation appears to be the right answer, only U.S. citizens or resident aliens can own one.

30

Which of the following statements regarding an S corporation owner and an owner of an LLC are true?

1. Creditors have very limited recourse rights to the owners.
2. They may not be nonresident aliens.
3. They both are considered stockholders.
4. Both receive the tax benefit of owning flow-through entities.

1. Creditors have very limited recourse rights to the owners.
4. Both receive the tax benefit of owning flow-through entities.

Creditors don't have recourse to the owners of either entity unless the owners have specifically allowed it. Both are flow-through or conduit entities. Owners of S corporations are stockholders, whereas those in an LLC are members. Nonresident aliens may not own an S corporation.

31

The president of a business entity opens an account in the name of the business. When determining the suitability of recommendations to the account, knowing the president's personal financial condition is necessary for each of the following forms of business structure EXCEPT:

A) a C corporation.
B) an LLC.
C) a sole proprietorship.
D) an S corporation.

A) a C corporation.

Only in the case of the C corporation are the income and losses of the investment account taxed at the corporate level rather than passed through to the owners.

32

A corporation organized as a C corporation:

1. is taxed on the corporate level and then again to its shareholders when dividends are paid.
2. is limited to a maximum of 100 shareholders.
3. provides limited liability to its owners.
4. may not have any trusts as shareholders.

1. is taxed on the corporate level and then again to its shareholders when dividends are paid.
3. provides limited liability to its owners.

C corporations are taxable on the corporate level and then again to the shareholder when income is distributed in the form of dividends. Shareholders' liability is limited to the amount of their investment. The S corporation is limited to 100 shareholders. Trusts may own shares of both C and S corporations.

33

One of your clients, No More Leaks Plumbing Company, is organized as a sole proprietorship. The owner would be responsible for:

1. filing routine paperwork common to all forms of business.
2. filing an annual K-1 for income tax purposes.
3. completing a Schedule C.
4. none of the company's liabilities over and above his original investment.

1. filing routine paperwork common to all forms of business.
3. completing a Schedule C.

A business organized as a sole proprietorship is basically nothing other than the owner himself. As a business, routine paperwork must be completed, but in this case, the tax reporting is on the owner's Schedule C of Form 1040.

34

A Form K-1 would be used for tax reporting to the owners by which of the following business entities?

1. Sole proprietorship
2. S corporation
3. C corporation
4. LLC

2. S corporation
4. LLC

Legal entities that pass through income or loss use the Form K-1 to indicate the amount of that income or loss attributable to the individual shareholder/member/partner. Sole proprietorships generally complete Schedule C of the individual Form 1040, and C corporations are taxed themselves by filing a Form 1120 (S corporations file a Form 1120s along with a K-1 for each shareholder).

35

Which of the following is NOT a characteristic of a corporation?

A) Ownership interests are evidenced by shares of stock.
B) Existence terminates when an owner dies.
C) Owners have no personal liability for corporate debts.
D) It is considered an entity apart from its owners.

B) Existence terminates when an owner dies.

A corporation is an entity that has an existence separate from its owners. Therefore, the existence of a corporation does not terminate when an owner dies. Also, because the owners and the corporation are distinct entities, the owners are not personally liable for the corporation's debts.

36

Which of the following statements about C corporations are TRUE?

1. A C corporation pays income tax on its earnings at the corporate level.
2. The income of C corporations is subject to double taxation.
3. Dividends paid by a C corporation are not subject to income tax at the shareholder level.

1. A C corporation pays income tax on its earnings at the corporate level.
2. The income of C corporations is subject to double taxation.

A C corporation pays tax on its earnings at the corporate level. Its earnings are also taxed at the shareholder level when they are paid out as dividends. As a result, the income of C corporations is subject to double taxation.

37

Small corporations that satisfy certain criteria can elect not to pay income tax at the corporate level but instead pass their earnings through to their shareholders. These corporations are known as:

A) Q corporations.
B) R corporations.
C) S corporations.
D) C corporations.

C) S corporations.

The type of small corporation that can elect not to be taxed at the corporate level but to pass its earnings through to its shareholders is an S corporation. The term "S corporation" comes from the subchapter of the Internal Revenue Code that governs these corporations (Subchapter S). The other type of corporation-the C corporation-is one that has not elected to be treated under Subchapter S. Its earnings are taxed at the corporate level and again at the individual level when they are paid out as dividends.

38

To maintain the proper portfolio balance for a client, it would be most appropriate to review the portfolio at least:

A) annually.
B) every two years.
C) every ten years.
D) client and portfolio review is not necessary.

A) annually.

Most advisers would suggest that a client's life situation and portfolio should be reviewed at least annually. More frequently would not be inappropriate.

39

An investment policy statement would likely include:

1. expected returns of the recommended strategy and the expected range of these returns.
2. recommended allocations among differing asset classes.
3. strategies used for selecting specific stocks in the equity portion of the portfolio.
4. disclosure of the fees that the adviser will earn for implementing the recommended strategy.

1. expected returns of the recommended strategy and the expected range of these returns.
2. recommended allocations among differing asset classes.
3. strategies used for selecting specific stocks in the equity portion of the portfolio.

An investment policy statement prepared for clients delineates the allocation percentages for each asset class and the expected returns from each class, and outlines strategies that may be used for timing the market and choosing specific investments within each class, but fees the adviser may earn are not included in the policy statement; they are disclosed separately.

40

When a trustee is managing the trust assets, which of the following is the most important consideration?

A) Minimizing expenses.
B) The purposes, terms, distribution requirements, and other circumstances of the trust.
C) Preservation of capital.
D) Reasonable income.

B) The purposes, terms, distribution requirements, and other circumstances of the trust.

Although there certainly is a case for preservation of capital, reasonable income, and minimizing expenses, the most important consideration is to follow the design and objectives of the trust.

41

Mrs. Wright wishes to set up a trust where income must be annually distributed to her son. She wants the son to pay any income taxes since he is in a lower tax bracket than she is. What should she do?

A) Use a complex trust with him as irrevocable beneficiary.
B) Use a complex trust with him as revocable beneficiary.
C) Use a simple trust with him as revocable beneficiary.
D) Use a simple trust with him as irrevocable beneficiary.

D) Use a simple trust with him as irrevocable beneficiary.

Simple trusts must annually distribute income to the beneficiaries. Complex trusts do not. If Mrs. Wright makes the beneficiary revocable, the trust is subject to grantor trust rules and the income will be taxed to Mrs. Wright.

42

Mr. Hawkins sets up a trust for the benefit of his adult daughter, Madeleine. His wife may draw from it only if she needs to. Income on the trust will be taxed to:

A) Mr. Hawkins as the donor.
B) Madeleine as the primary beneficiary.
C) Mrs. Hawkins as the contingent beneficiary.
D) the trust as it is a separate legal entity.

A) Mr. Hawkins as the donor.

As Mrs. Hawkins has an economic interest, this is a grantor trust. Thus, all income will be taxed to the donor, Mr. Hawkins.

43

Tax considerations are frequently an important factor when determining appropriate recommendations for advisory clients. In which of the following accounts is the tax status of the individual a critical factor?

1. An account opened in the name of the XYZ Corporation, organized as a C corporation, by their chief investment officer.
2. An account opened by a sole proprietor in the name of the company.
3. An account opened in the name of ABC Corporation, an S corporation by one of its shareholders.
4. An account opened in the name of the GHI fund, a Regulated investment company, by the fund's portfolio manager.

2. An account opened by a sole proprietor in the name of the company.
3. An account opened in the name of ABC Corporation, an S corporation by one of its shareholders.

Sole proprietorships and S corporations have their income and losses pass through to the owners. Therefore, an account opened in the name of the business will create tax consequences for the owners. Regular, or C corporations, pay taxes on their earnings and, even though a Regulated investment company passes through at least 90% of its earnings to shareholders, the tax situation of each individual shareholder of the fund is of no consideration when making recommendations to the fund's portfolio manager.

44

Which of the following statements regarding grantor trusts are CORRECT?

1. If the grantor has the power to revoke the trust, he is treated as the owner of the trust.
2. If the grantor or a non-adverse party can control the beneficial enjoyment of the trust, he is treated as the owner of the trust.
3. The grantor may be taxed on trust income only if the grantor actually received the income.
4. If the grantor can receive income from the trust, he is treated as the owner of the trust.

1. If the grantor has the power to revoke the trust, he is treated as the owner of the trust.
2. If the grantor or a non-adverse party can control the beneficial enjoyment of the trust, he is treated as the owner of the trust.
4. If the grantor can receive income from the trust, he is treated as the owner of the trust.

As long as the grantor has the power directly or indirectly to control the trust, he is treated as the owner. The grantor may be taxed on trust income if the grantor either actually or constructively receives the income.

45

The type of trust created by a will that becomes operative at death is a:

A) living trust.
B) testamentary trust.
C) Q-tip trust.
D) revocable trust.

B) testamentary trust.

As in “last will and testament”.

46

An estate planning tool that may be used to take advantage of the lifetime estate tax exclusion is the:

A) testamentary trust.
B) bypass trust.
C) complex trust.
D) living trust.

B) bypass trust.

The bypass trust is most commonly used to maximize estate tax savings by having the first to die of a married couple leave the lifetime exclusion (currently $5.34 million for 2014) to their children with the balance taken against the unlimited marital deduction. This results in saving estate taxes on that $5.34 million. With the "portability" provisions of the tax law signed on December 17, 2010, this is currently of limited value.

47

Which of the following vehicles make use of the unified estate tax credit?

1. bypass trust.
2. generation skipping trust.
3. living trust.
4. simple trust.

1. bypass trust.
2. generation skipping trust.

Both the bypass trust and the generation skipping trust are tools used by estate planners to reduce estate taxes. They do so by passing the amount in the unified credit (currently $5.34 million for 2014) to heirs other than the spouse, usually grandchildren in the case of the GST.

48

One of your clients approaches you about setting up a trust. If your client assumes the role of grantor, what additional roles may be taken?

A) Beneficiary.
B) Trustee.
C) As the grantor, there are no other roles that may be taken.
D) Trustee and beneficiary.

D) Trustee and beneficiary.

Under trust law, the grantor of a trust, sometimes referred to as the settlor, may also be the beneficiary and the trustee.

49

One of your clients has named you as the trustee for a trust he has established. The beneficiary of the trust approaches you with a request for a disbursement that is contrary to the provisions of the trust document. In accordance with the provisions of the Uniform Prudent Investor Act, you should:

A) follow the terms of the trust.
B) contact the grantor.
C) follow the wishes of the beneficiary.
D) do nothing.

A) follow the terms of the trust.

Trust law requires that the trustee act in accordance with the terms of the trust document at all times.

50

There are many sources of taxable income to an individual. Included might be money received from which of the following?

1. Sole proprietorship.
2. Subchapter S corporation.
3. Investments.
4. Death benefits.

1. Sole proprietorship.
2. Subchapter S corporation.
3. Investments.

An individual can generate income from running a sole proprietorship or being a shareholder in an S corporation (the exam will probably use the obsolete term, Subchapter S). Of course, taxable income can be generated by investments in the form of dividends, interest and capital gains. The assumption here must be that the death benefits are from a life insurance policy because those, unlike the death benefit from an annuity, are not subject to income tax.

51

There are many different legal ways to structure a new business entity. One of these is the general partnership. Among the benefits of using this structure would be:

A) substantial capital can be raised with little effort and low cost.
B) ease of formation.
C) limited liability.
D) taxation at a lower rate than a corporation.

B) ease of formation.

Compared to a corporation, it is generally easier to form (and dissolve) a partnership. General partners have full liability and there is no tax – it is passed on to the partners, to be taxed at a rate that might exceed the corporate tax rate. Corporations are the entity for raising a lot of capital.

52

Benefits of structuring a business as a General Partnership would include:

A) the ability to raise large sums of money.
B) longevity.
C) avoidance of taxation at the entity level so the partners are not taxed twice.
D) general partners are only liable to the extent of their investment.

C) avoidance of taxation at the entity level so the partners are not taxed twice.

General partnerships file a Form 1065 and pay no tax. Instead, each partner's share of the income is reported on Form K-1 making for a single rather than double layer of tax.

53

There are provisions in the IRS Code which allow certain forms of business to avoid being subject to income tax on the business level. The list would include all of the following EXCEPT:

A) LLC.
B) S corp.
C) limited partnership.
D) sole proprietorship.

D) sole proprietorship.

In the case of a sole proprietorship, the owner reports any income on his personal Form 1040, Schedule C. The other entities do not pay tax themselves - any income flows through to the members (LLC), stockholders (S corp) and partners (ltd. Partnership).

54

A feature of which of the following business entities is limited liability for owners as well as flow-through of income:

A) general partnership.
B) sole proprietorship.
C) C corporation.
D) limited partnership.

D) limited partnership.

Limited partnership interests offer both flow-through of income (or loss) along with limited liability. The general partnership has full liability as does the sole proprietorship. C corporations have limited liability, but no flow-through.

55

A feature of which of the following business entities is limited liability but no flow-through of earnings or losses?

A) Corporation.
B) LLC.
C) Limited partnership.
D) Sole proprietorship.

A) Corporation.

The corporation (always assume C corp unless it says different on the test) offers limited liability to its shareholders, but there is no flow-through of income or loss. LLCs and limited partnerships offer both and the sole proprietorship has unlimited liability.

56

An investment adviser should develop an investment policy based on the needs and objectives of the client. When the client is a business entity structured as a general partnership, the investment policy would have to consider the

A) number of limited partners
B) objectives of all of the partners on a collective basis
C) liability of the general partner
D) mean requirement of the wealthiest and the poorest partner

B) objectives of all of the partners on a collective basis

Because all income and gains pass through to the partners, and because there is unlimited personal liability for all general partners, we must examine the objectives of each of them to determine proper suitability.

57

An investment adviser representative (IAR) prepares a comprehensive financial plan for a new client. Part of the plan includes detailed portfolio recommendations. Seeing a negative reaction from the client, it becomes obvious to the IAR that he is dealing with an ignorant person who is filled with many market misconceptions. It would be reasonable for the IAR to:

A) prepare a new portfolio that is more in line with what the customer has indicated he is comfortable with.
B) tell the client he will make some changes, but keep the original portfolio because that really is in the client’s best interest.
C) drop the client.
D) attempt to educate the client to correct those misconceptions, but leave the final decision up to the client.

D) attempt to educate the client to correct those misconceptions, but leave the final decision up to the client.

All decisions are ultimately up to the client, but there is nothing wrong with the IAR attempting to educate the client, especially when it could lead to greater investment success.

58

An investment adviser representative prepares a detailed portfolio restructuring for a new client. The client is not impressed with the recommendation and, at least to the IAR, it appears that the rejection is more due to a lack of understanding than a valid dislike. What should be the first step taken by the IAR?

A) Go ahead with the recommendation anyway because the client's lack of understanding should not stand in the way of potentially superior results.
B) Suggest that if the client will not follow the IAR's recommendations, it would be best to engage the services of another firm.
C) Attempt to educate the client as to what this portfolio is trying to accomplish for the client while at the same time recognizing that the final decision is clearly in the hands of the client.
D) Prepare a new set of recommendations that will hopefully be received more favorably by the client.

C) Attempt to educate the client as to what this portfolio is trying to accomplish for the client while at the same time recognizing that the final decision is clearly in the hands of the client.

Even when the IAR is convinced that the optimal recommendations have been made, the final decision is always that of the client. However, there is nothing in the laws or policies dealing with ethical conduct that prohibit the IAR from attempting to "sell" the client, especially through an educational approach.

59

Your client recently sold his business for $5 million. He is 55 and feels that he is too young to retire. He plans to start a new business venture and will be funding the $250,000 start-up costs with his own funds. With substantial personal assets, he could limit his personal exposure by using which of the following business structures?

1. Sole proprietorship
2.General partnership
3. Limited liability company
4. S corporation

3. Limited liability company
4. S corporation

Both the limited liability company (LLC) and the S corporation offer the benefit of limited liability to the owner(s). If the business is structured as a sole proprietorship or general partnership, personal assets are put at risk.

60

One respect in which an LLC differs from an S corporation is that

A) an LLC can be formed with as little as a single investor
B) there is more favorable tax treatment afforded to members of an LLC
C) not only income, but losses, if generated, pass through to investors in an LLC
D) there is no statutory limit on the number of investors in an LLC

D) there is no statutory limit on the number of investors in an LLC

There is no limit to the number of investors (members) in an LLC, while current regulations limit the number of investors (shareholders) in an S corporation to 100. The tax treatment is the same and both can be formed with a single owner.

61

A business organized as a sole proprietorship wishes to open an advisory account. When preparing an investment policy statement, the IA would have to consider the objectives of

A) the members
B) the sole proprietor
C) the partners
D) the stockholders

B) the sole proprietor

A sole proprietorship only has one owner. Therefore, the account would focus on the needs of that individual.

62

A form of business structure that exposes all personal assets of the owner to creditors is the

A) C corporation
B) LLC
C) sole proprietorship
D) limited partnerships

C) sole proprietorship

One of the reasons why few businesses are organized as sole proprietorships is the fact that all personal assets, not just those of the business, are placed at risk if the business fails. In each of the other choices, the maximum potential loss is the amount of the investment.

63

An investment adviser’s client’s objective is to save for her child’s college education. The child will be going to college in five years. When preparing appropriate recommendations, the IA would look at this five-year time frame as

A) unimportant
B) an investment constraint
C) a capital need
D) opportunity cost

B) an investment constraint

Investment constraints are those factors which must be considered when planning portfolio recommendations. Included are time horizon (the primary one involved in this case), need for liquidity, tax concerns, and so forth. On this exam, capital need will generally be referring to a capital needs analysis to determine the proper amount of life insurance a client needs.

64

Among the advantages of forming an S corporation rather than a C corporation for a new business enterprise is

A) unlike the C corporation which is limited to 100 investors, there is no such limit for an S corporation
B) shareholders’ losses are limited to the amount of their investment
C) the ease in raising substantial amounts of capital.
D) any losses flow-through to the investors

D) any losses flow-through to the investors

An S corporation offers the benefit of flow-through of both income and losses (losses being a particular benefit for a start-up because they usually take some time to become profitable). It is the S corporation rather than the C corporation that is limited to 100 investors. Both offer the benefit of limited liability. The C corporation is superior for raising large amounts of capital.

65

A client approaches an agent about investing in a risky security and insists on doing so even when told by the agent that the security is not suitable for that client. What should the agent do?

A) The agent should refuse the transaction because it is unsuitable for the client
B) The agent should contact a supervisor and accept the order only with the supervisor’s approval
C) The agent should suggest that the client engage the services of another broker/dealer
D) The agent should explain the risks of investing and, if the client still insists, place the order and mark it unsolicited

D) The agent should explain the risks of investing and, if the client still insists, place the order and mark it unsolicited

When a client wishes to enter an order for a security that, at least in the eyes of the agent handling the account, is unsuitable, an attempt should be made to educate the client as to the risks involved. However, if the customer still insists, the order may be placed but should be marked unsolicited.

66

You are an investment adviser representative with the firm of Total Wealth Management Associates, an investment adviser registered in four states. One of your clients approaches you seeking advice on saving for college expenses for his 13-year-old child. In determining the proper course of action, this is an example of a client giving you

A) an investment constraint
B) a capital need
C) a recommendation
D) an investment policy statement

A) an investment constraint

Once investment objectives have been quantified (in this case, saving for college), the next step is to analyze investment constraints. These are limitations on the ability to make use of specific investments. Some of the most common investment constraints are: time horizon (the one in this case; with about five years until entering college, we must recognized this as a relatively short time horizon), liquidity, tax concerns, and unique circumstances, such as health needs, ethical, or social issues.

67

An advantage of structuring a business operation as an S corporation rather than a C corporation would be

A) avoiding double taxation
B) limited liability
C) the C corporation is limited to a maximum of 100 shareholders while no such limit exists for the S corporation
D) simplicity when raising capital through a public offering

A) avoiding double taxation

Because an S corporation is taxed like a partnership, all earnings (or losses) flow directly through to the shareholders. This avoids the double taxation inherent in receiving a share of the profits (through dividends) from a C corporation. It is the S corporation that is limited to 100 shareholders. That is why it is not suitable for raising capital through a public offering. The shareholders of both S and C corporations enjoy the benefit of limited liability.

68

Suzie McQueen has a very successful interior design shop she has run as a sole proprietorship. She has just celebrated her 60th birthday and has been giving thought to an eventual sale of the business. She wants your opinion on whether she should incorporate or change to a partnership. You might respond

A) the corporate form of business structure would be the easiest for ultimate transfer of ownership
B) the corporate form of business structure would be the least expensive to form
C) the partnership form of business structure would be the easiest for ultimate transfer of ownership
D) the partnership form of business structure would enable Suzie to maximize her sale price

A) the corporate form of business structure would be the easiest for ultimate transfer of ownership

In general, the corporate form of business leads to the easiest transfer of ownership. Since Suzie would probably own 100% of the stock, all she would have to do is sell that stock to a new purchaser and the corporation could continue just as before. In the case of a partnership, even though Suzie would be the only partner, transfer is not as easy as with the sale of stock.

69

An investment adviser has a client who wants to save for college for her child. The child will be entering college in five years. This would be an example of

A) tactical asset allocation
B) an investment constraint
C) a capital need
D) planning too late

B) an investment constraint

Time constraints include such conditions as liquidity and time horizon, both of which are in play here. It may be true that the client has started too late, but that is not what the exam would be looking for as the correct answer.

70

An investment adviser representative meets with a couple who explains that they wish to be able to pay for their daughter’s college education. The IAR is told that the child will be starting school in five years.

This would be considered

A) an investment constraint
B) a capital need
C) a Section 529 Plan
D) an investment policy statement (IPS)

A) an investment constraint

Investment constraints are limitations on the ability to make use of particular investments. They can be liquidity, time horizon, tax concerns, legal and regulatory factors, and unique circumstances (ethical objectives or social responsibility considerations). The easiest way to determine if it is a constraint or a capital need is if a dollar amount is stated. When a specific sum is mentioned, it is a capital need. The education may be funded through a Section 529 Plan, and this may be part of the client’s IPS, but neither of those answers the question posed.

71

Among the differences between C corporations and S corporations is

1. the liability assumed by the shareholders
2. the number of allowable shareholders
3. the tax treatment of the corporation’s earnings
4. residency requirements of shareholders

2. the number of allowable shareholders
3. the tax treatment of the corporation’s earnings
4. residency requirements of shareholders

Unlike C corporations, there is a limit placed on the number of shareholders in an S corp. At the time of this printing, that maximum is 100, none of whom may be a non-resident alien (C corps have no residency restrictions). The primary practical difference is the fact that S corporation earnings (and losses) flow through to the shareholders, whereas C corporation earnings are only received by shareholders when dividends are paid.

Decks in Series Class (76):