Taxation Flashcards
(31 cards)
How are qualified cash dividend from common and preferred stock taxed?
At a maximum rate of 20%. To be considered qualified, the shares must be held for more than 60 days, and they must be unhedged (the 60-day rule also applies to ETF dividends)
How are cash dividends from a REIT taxed?
As ordinary income
Inherited Securities
Cost basis is determined by the market value at the the time of the original owner’s death
Gifted Securities
The costs basis is the lesser of security’s market value or the donor’s cost basis
Variable Annuity Contract Holder Dies During Accumulation Period
Proceeds in excess of cost basis are taxed as ordinary income to the beneficiary
Upon the death of the insured, the proceeds of a variable life policy will…
…pass to the beneficiary free from federal income tax
How are non-qualified cash dividends from preferred and common stock taxed?
As ordinary income
For a cash dividend paid to a corporation that owns less than 20% of the distributing corporation…
…50% of the dividend income will be excluded from corporate income.
For a cash dividend paid to a corporation that owns 20% or more of the distributing corporation…
…65% of the dividend will be excluded from corporate income.
Wash Sale Rule
The IRS doesn’t allow an investor to claim a deduction for a capital loss on an investment if he purchases “substantially the same security” within 30 days of the sale. The period covered by the wash sale rule is actually 61 days since it includes the date of sale and 30 days both before and after the date of sale. If a security is sold for a loss, the seller must wait a minimum of 31 days before repurchasing the same or similar security. If a wash sale is determined to have occurred, the loss is denied and will be added to the cost basis of the new purchase.
Dividends and capital gain distributions in a variable annuity are…
…allowed to accumulate on a tax-deferred basis
How much in losses can be used to offset ordinary income annually?
$3,000, and short-term losses are used first as deductions against ordinary income
Taxable Equivalent Yield
Municipal Yield/(100% - Tax Bracket %)
Alternative Minimum Tax
The Alternative Minimum Tax (AMT) was introduced as a method of calculating tax liability to ensure that wealthy individuals who derived income from certain types of investments pay at least a specified minimum amount of taxes. By applying the AMT, investors are not able to avoid paying taxes altogether.
For purposes of calculating the AMT, some taxpayers are required to adjust their taxable income based on their investment in assets that produce certain tax-preference items. Tax-preference items may include interest on certain municipal bonds, various depreciation expenses, and a variety of events that result from owning limited partnership interests.
Under AMT rules, these taxpayers must compute their income taxes twice. They must first calculate their taxes using the standard method, and then they must recalculate their tax liability using the AMT method. The taxes due will be the greater of the two calculations.
Private Activity or AMT Bonds
If 10% or more of the bond proceeds will be used to finance a project for a private entity (e.g., a corporation or professional sports team) and if 10% or more of the bond proceeds will be secured by property used in the private entity’s business, the bonds are referred to as private activity bonds. The interest earned on a private activity bond is taxable at the federal level unless the bond is deemed to be a qualified private activity bond. To be considered “qualified,” the private activity bond must satisfy certain standards and must be publicly approved. If a bond is qualified, the interest is exempt from federal taxes, but subject to the AMT. Due to the potential tax implication, these bonds may trade with a higher yield than issues that are not subject to the AMT.
AMT & Depreciation
An investment in an oil and gas limited partnership may result in excess depletion and depreciation as well as excess intangible drilling costs. Since these are considered tax preference items, an LP may ultimately be subject to the alternative minimum tax (AMT). These items, though able to be deducted when a person calculates her regular tax liability, are added back when calculating the AMT.
One Mill Equals?
A milk equals 0.001 or $1 for every $1,000 assessed value (for property taxes)
To avoid the wash sale rule on a municipal bond…
…you should purchase a bond with either a different issuer, a different coupon, or a different maturity.
Tax Swap
The sale and purchase of bonds (or other securities) to realize a capital loss that can be offset against a capital gain.
A municipal bond that is issued at par is later purchased at a discount and redeemed for par at maturity. The investor’s profit on the transaction is taxed as…
…ordinary income.
A customer purchases a municipal security in the secondary market at a discount. At maturity, the customer will…
…treat the discount as ordinary income.
Net Yield
Net Yield = Taxable Yield x (100% - Tax Bracket %)
Taxable Equivalent Yield
Taxable Equivalent Yield = Municipal Yield/(100 - Investor’s Tax Bracket)
OID Held to Maturity
Since the accreted amount of a municipal OID is treated as interest, this upward adjustment in the bond’s value is tax-exempt. Each year, the bondholder’s cost basis is increased and, at maturity, the cost basis reaches par. At maturity, since the cost basis is equal to the redemption price (par), there’s no capital gain.
