Module 2: Investment Vehicle Taxation, NII, Additional Medicare Tax and Education Planning

Question 1

Inside buildup

Answer 1

The tax-deferred accumulation of cash value within a policy until surrender.

Question 2

Are life insurance proceeds taxable to the beneficiary?

Answer 2

Not usually

Question 3

Under what circumstance might a payout be taxable for cash value life insurance? How does it differ based on payment structure?

Answer 3

If greater than the cost basis before death. If proceeds are lump-sum, excess over cost basis is taxable as ordinary income in that year. If spread out, then the cost basis is prorated and the excess is taxed in the year of receipt, like an annuity.

Question 4

What distribution method is used for life insurance?

Answer 4

FIFO.

Question 5

What is the main benefit, to the employee, of having a cash value life insurance plan in a qualified retirement plan?

Answer 5

The survivors receive retirement benefits in the event of the employee’s premature demise.

Question 6

What is the transfer for value rule? What is the formula that accompanies it?

Answer 6

If a life insurance policy is transferred for something of value, a portion of the death benefit is taxable income. The death benefit - premiums paid - sale price = amount taxable.

Question 7

Tax treatment of exchanging life policies?

Answer 7

No gain or loss is recognized. Tax free. However, you cannot change from an annuity to a life insurance contract.

Question 8

What is the tax treatment of single premium life insurance purchased before June 21, 1988?

Answer 8

Tax-deferred, and the death benefit is paid to the beneficiary as tax-free income. The policy must be held until death, or the income will be taxable.

Question 9

Modified Endowment Contract tax treatment? withdrawals, dividends, distribution status?

Answer 9

Withdrawals are treated on a non-favorable basis, and taxed as ordinary income on a LIFO basis. Taking dividends in cash is a taxable event. there is also a 10% penalty on the taxable portion of a distribution if before 59 1/2.

Question 10

What are policy distributions?

Answer 10

Withdrawals/ loans taken as cash or used to pay premiums, and dividends received as cash or used to pay a loan.

Question 11

How are payments from an annuity taxed?

Answer 11

Payments from an annuity are partially return of capital, and partially interest income. The return of capital is nontaxable, and the interest is treated as ordinary income.

Question 12

What is the exclusion ratio for a fixed annuity?

Answer 12

The investment in the annuity contract divided by the total expected return over the life of the contract.

Question 13

What is the exclusion amount for a variable annuity?

Answer 13

Total investment divided by the number of expected payments.

Question 14

What is the formula for total investment in an annuity?

Answer 14

Cost - any distributions reduced from income.

Question 15

Partial annuitization

Answer 15

For nonqualified annuities, you can annuitize a portion of the annuity for a period of 10 years or more, allowing the rest to accumulate on a tax deferred basis.

Question 16

Nonperiodic Distribution tax treatment? Before and after August 13th, 1982?

Answer 16

A lump sum distribution not received as an annuity. Before, used to be tax free return of capital. Now is LIFO.

Question 17

What are the stipulations for a long-term preferential treatment?

Answer 17

Asset must be held for more than 12 months, not counting the day of acquisition. Based on trade date.

Question 18

What is done to the cost basis when a stock is gifted?

Answer 18

Holding period becomes day of receipt, and the basis is stepped up.

Question 19

What is the tax treatment for inherited stock?

Answer 19

Treated as long term.

Question 20

What is the new rule for an inherited IRA?

Answer 20

Now, must be liquidated within 10 years of date of death.

Question 21

What is the maximum tax rate for collectibles?

Answer 21

28% if held for more than one year. If marginal tax rate is less, you pay marginal rate.

Question 22

What is the difference between 1250 gain and 1231 gain, and what are their tax rates?

Answer 22

1250 gain undoes the depreciation that you put onto the account, and 1231 gain is anything above that. 1250 gain has a ceiling of 25%, and 1231 is taxed at long-term capital gains rates.

Question 23

What is the tax aspect of mutual funds?

Answer 23

If sold, there is a tax owed on any gain.

Question 24

What is a telephone transfer?

Answer 24

The switch from one type of fund to another. taxable event.

Question 25

What is the tax treatment for an OID bond?

Answer 25

Phantom income is reported annually over the life of the bond.

Question 26

What is the tax treatment for a market discount bond?

Answer 26

Either can be treated as an OID (with phantom income reported annually), or the gain will be taxed at disposition.

Question 27

What is the tax treatment for a bond purchased at a premium?

Answer 27

The premium may be amortized and used to offset interest income.

Question 28

What is the tax treatment for T-bills?

Answer 28

As they are zero-coupon bonds sold at a discount, the difference between tax basis and value is treated as total return in the year paid out.

Question 29

What is the tax treatment for Treasury notes and bonds?

Answer 29

same as corps.

Question 30

What is the tax treatment for TIPS?

Answer 30

Interest payments and inflation adjustments are taxable in the year they happen.

Question 31

Under what circumstance might the loss in an IRA be deductible? And what kind of loss is it?

Answer 31

If nondeductible contributions were made to an IRA that was subsequently liquidated, and the basis was not able to be recovered. Note: this is an ordinary loss.

Question 32

What is the maximum allowable deduction for taxpayer’s investment interest?

Answer 32

Up to their net investment income.

Question 33

For how long must a stock be held for a dividend to qualify?

Answer 33

It must be held for at least 61 days during the 121 day period that began 60 days before the ex-dividend date. the acquisition date is not counted, but the disposition date is.

Question 34

What are the tax treatments for property dividends?

Answer 34

Generally the same as for cash dividends. The basis is the market value at time of distribution. A corporation may recognize gain on the distribution, but not loss.

Question 35

What is the tax treatment for a stock redemption?

Answer 35

The corporation’s payment is treated as a capital gain.

Question 36

Are stock splits taxable?

Answer 36

Not generally, unless they result in a net increase in ownership of the company.

Question 37

What is the basis treatment if there is a dividend or right and it is tax-exempt?

Answer 37

The basis is allocated between the old and new stocks. If a shareholder exercises the rights, the basis is equivalent to the basis in the stock rights plus the purchase price of the new shares.

Question 38

What is the basis treatment if there is a dividend or right and it is not tax-exempt?

Answer 38

the basis of the new shares in equivalent to the amount of dividend income that they are required to include in their gross income.

Question 39

What is the Additional Medicare Tax?

Answer 39

An additional marginal Medicare tax for high income people. 0.9%, paid fully by the employee.

Question 40

What kind of income is not subject to self employment tax?

Answer 40

Portfolio income (net capital gains, interest dividends, etc.) retain their characteristic as they are passed through. The flow through of net income from a S corp is also not subject, assuming they are receiving a salary.

Question 41

How do you calculate self employment tax?

Answer 41

First, reduce by 7.65%. Then, anything over the wage base ($147,000) is taxed at 2.9% for Medicare. After that, anything above $200k is subject to the additional 0.9% tax.

Question 42

What portion of self employment tax liability is someone allowed to deduct as an adjustment to income?

Answer 42

One half, NOT including the Additional Medicare Tax.

Question 43

What is the net investment income tax?

Answer 43

3.8% of lesser of net investment income or excess of modified AGI over a specific threshold amount.

Question 44

What is included in net investment income?

Answer 44

Income from interest, dividends, annuities, net royalties, and net rental income and short term capital gains. Does NOT include distributions from retirement plans or tax-exempt interest.

Question 45

Are benefits from policies individually owned and paid for by the taxpayer taxable?

Answer 45

No, as they were purchased with after-tax dollars. not the case for policies when the premium are paid for the employer. If partially paid for by each party, then the portion that is taxable is that which was paid by the employer.

Question 46

What is the tax treatment for scholarships?

Answer 46

Tax free.

Question 47

What is the tax treatment for qualified higher education loans?

Answer 47

Tax deductible to reach AGI, up to a maximum of $2,500. You can’t be a dependent of someone else, and there is a phaseout.

Question 48

What two savings bonds can you use to pay for college education without paying tax on the interest?

Answer 48

Series EE and Series I. You must be 24+ to purchase.

Question 49

What is the American Opportunity Tax Credit (AOTC)? How is it calculated?

Answer 49

Provides maximum tax credit of $2,500 for qualified tuition and related expenses. 100% of first $2000 plus 25% thereafter.

Question 50

What is the American Opportunity Tax Credit (AOTC)? How is it calculated?

Answer 50

Provides maximum tax credit of $2,500 for qualified tuition and related expenses. 100% of first $2000 plus 25% thereafter

Question 51

What are the main differences between the AOTC and the Lifetime Learning Credit?

Answer 51

Lifetime Learning Credit is nonrefundable up to $2,000: 20% of up to $10k in qualified expenses. Available for the rest of your life.

Question 52

What is the maximum annual contribution to a Coverdell ESA? Is it dedutible?

Answer 52

$2k, and no.

Question 53

What is the tax treatment for a Coverdell distribution?

Answer 53

Any distribution is for qualified expenses are tax-free. Anything else is subject if over basis, and taxable portion is subject to a 10% penalty.

Question 54

What is the maximum that a 529 beneficiary can use to pay off debt?

Answer 54

$10,000.

Question 55

How are qualified state tuition programs taxed?

Answer 55

Excludible under the annual gift tax exclusion and under the generation skipping transfer tax.

Question 56

Is personal loan interest deductible?

Answer 56

No.

Question 57

What are the two tests, one of which must be met, inorder to classify a product as life insurance for federal income tax purposes?

Answer 57

The cash value accumulation test and the guideline premium and corridor test.

Question 58

What is true of premiums paid when life insurance is held inside a retirement plan?

Answer 58

They are a taxable benefit to the employee.