Taxes

Question 1

Progressive Taxes

Answer 1

These taxes affect high-income individuals more than they affect low-income individuals; the more taxable income individuals have, the higher their income tax bracket.

Question 2

Regressive Taxes

Answer 2

These taxes affect individuals earning a lower income more than they affect people earning a higher income; everyone pays the same rate, so individuals who earn a lower income are affected more because that rate represents a higher percentage of their income. Examples of regressive taxes are payroll, sales, property, excise, gasoline, and so on.

Question 3

Earned (Active) Income

Answer 3

People generate this type of income from activities that they’re actively involved in. Earned income includes money received from salary, bonuses, tips, commissions, and so on.

Question 4

Passive Income

Answer 4

When you see the words passive income on the SIE exam, immediately start thinking that the income comes from a direct participation program (DPP). Passive income is in a category of its own and can be written off only against passive losses.

Question 5

Portfolio Income

Answer 5

This type of income includes interest, dividends, and capital gains derived from the sale of securities.

Question 6

Corporate Bond Interest

Answer 6

Interest received from corporate bonds is taxable on all levels (federal, state, and, local, where local taxes exist).

Question 7

Municipal Bond Interest

Answer 7

Interest received from municipal bonds is federally tax-free; however, investors may be taxed on the state and local levels, depending on where the investor lives and the municipality of the issuer of the bonds

Question 8

U.S. Government Securities Interest

Answer 8

Interest received from U.S. government securities, such as T-bills, T-notes, T-STRIPS, and T-bonds, is taxable on the federal level but exempt from state and local taxes.

Question 9

Dividends

Answer 9

Dividends may be in the form of cash, stock, or product. However, cash dividends are the only ones that are taxable in the year that they’re received.

Question 10

Cash Dividends

Answer 10

Qualified cash dividends received from stocks are taxed at a maximum rate of 0 percent, 15 percent, or 20 percent, depending on the investor’s adjusted gross income (AGI). Qualified dividends are ones in which the customer has held onto the stock for at least 61 days (91 days for preferred stock). The 61-day holding period starts 60 days prior to the ex-dividend date (the first day the stock trades without dividends). If the investor has held the stock for less than the 61-day holding period, the dividends are considered nonqualified, and investors are taxed at the rate determined by their regular tax bracket.

Question 11

Stock Dividends

Answer 11

Stock dividends don’t change the overall value of an investment, so the additional shares received are not taxed (for details, see Chapter 6). However, stock dividends do lower the cost basis per share for tax purposes. The cost basis is used to calculate capital gains or losses.

Question 12

Dividends from Mutual Funds

Answer 12

Dividends and interest generated from securities that are held in a mutual fund portfolio are passed through to investors and are taxed as either qualified (see the earlier section “Cash dividends”) or nonqualified. The type(s) of securities in the portfolio and the length of time the fund held the securities dictate how the investor is taxed.

Question 13

Cost Basis - for Taxes

Answer 13

The cost basis is used for tax purposes and includes the purchase price plus any commission

Question 14

Taxes with Capital Gains

Answer 14

Capital gains on any security (even municipal and U.S. government bonds) are fully taxed on the federal, state, and local levels.

Question 15

Appreciation, or Unrealized Gain

Answer 15

A capital gain isn’t realized until a security is sold. If the value of an investment increases, it’s considered appreciation or an unrealized gain, and if the investor doesn’t sell, the investor doesn’t incur capital gains taxes.

Question 16

Short Term Capital Gains

Answer 16

These gains are realized when a security is held for one year or less. Short-term capital gains are taxed according to the investor’s tax bracket.

Question 17

Long Term Capital Gains

Answer 17

These gains are realized when a security is held for more than one year. To encourage investors to buy and hold securities, long-term capital gains are currently taxed at a rate in line with cash dividends (0, 15, or 20 percent depending on the investor’s adjusted gross income).

Question 18

Net Capital Loss

Answer 18

When an investor has a net capital loss, he can write off $3,000 per year ($1,500 per year if married and filing separately) against his earned income and carry the balance forward the next year. For test purposes, assume $3,000 per year.

The loss can be carried forward to subsequent years until used up or the investor dies.

Question 19

Wash Sale Rule

Answer 19

According to this rule, if an investor sells a security at a capital loss, the investor can’t repurchase the same security or anything convertible into the same security for 30 days prior to or after the sale and be able to claim the loss.

However, the loss doesn’t go away if investors buy the security within that window of time; investors get to adjust the cost basis of the security. If an investor were to sell 100 shares of ABC at a $2-per-share loss and purchase 100 shares of ABC within 30 days for $50 per share, the investor’s new cost basis (excluding commissions) would be $52 per share (the $50 purchase price plus the $2 loss on the shares sold), thus lowering the amount of capital gains he would face on the new purchase.

Question 20

Tax Qualified Plan

Answer 20

A tax-qualified plan meets IRS standards to receive a favorable tax treatment. When you’re investing in a tax-qualified plan, the contributions into the plan are made from pretax dollars and are deductible against your taxable income.

Question 21

Non-Qualified Plans

Answer 21

Nonqualified plans, such as deferred compensation plans, payroll deduction plans, and 457 plans, do not meet IRS and ERISA standards for favorable tax treatment.

The investor is taxed only on the amount that exceeds the amount of the contributions made.

Question 22

Traditional IRA

Answer 22

IRAs are tax-qualified retirement plans, so deposits in the account are made from pretax dollars (they’re tax-deductible). IRAs are completely funded by contributions that the holder of the account makes. Regardless of whether individuals are covered by a pension plan, they can still deposit money in an IRA.

$6,000 per year (2022) and $1,000 catch up (50 or greater)

Question 23

IRA Withdrawal

Answer 23

When an investor starts to withdraw funds from an IRA, the investor is taxed on the entire withdrawal (the amount deposited, which was not taxed, and the appreciation in value). The withdrawal is taxed as ordinary income.

Question 24

Required Beginning Date and RMD

Answer 24

Withdrawals must begin by April 1 of the year after the investor reaches age 72 (the required beginning date, or RBD. Investors who don’t take their required minimum distribution (RMD) by that time are subject to a 50 percent tax penalty on the amount they should have withdrawn

Question 25

Roth IRA

Answer 25

Anyone whose income is below the IRS modified adjusted gross income limit can open a Roth IRA. The key difference between a traditional IRA and a Roth IRA is that withdrawals from a Roth IRA are not taxed. However, deposits made in the Roth IRA are not tax-deductible (made from after-tax dollars). Provided that the investor has held onto the Roth IRA for over five years and has reached age 59½, he can withdraw money from the Roth IRA without incurring any taxable income on the amount deposited or on the appreciation in the account.

Question 26

Roth IRA income levels

Answer 26

As of 2022, investors who have an adjusted gross income of more than $144,000 per year ($214,000 married, filing jointly) can’t contribute to a Roth IRA.

Question 27

SEP IRA Contributions and Limits

Answer 27

As of 2022, the maximum employer contribution to each employee’s SEP-IRA is 25 percent of the employee’s compensation (salary, bonuses, and overtime) or $61,000 (subject to cost-of-living increases in the following years), whichever is less. Employees who are part of the plan may still make annual contributions to a traditional or Roth IRA.

Question 28

Simplified Employee Pensions (SEP IRA)

Answer 28

An SEP-IRA is a retirement vehicle designed for small-business owners, self-employed individuals, and their employees

Question 29

401k Plans

Answer 29

As stated previously, a 401(k) is a corporate retirement plan. With this type of plan, employees can contribute a percentage of their salary up to a certain amount each year (as such, it’s a defined contribution plan). Because it’s a qualified plan, the amount contributed by the employee to the 401(k) is deducted from the employee’s gross income.

Question 30

Roth 401k Plan

Answer 30

If a company offers a 401(k) plan, it may also offer a Roth 401(k) plan. Contributions to a Roth 401(k) come from after-tax contributions. Withdrawals are tax-free provided that the account is open for at least five years and the investor is at least 59½ years old.

Question 31

403b Plans

Answer 31

These are salary reduction plans for public school (elementary school, secondary school, college, and so on) employees, employees of certain 501(c)(3) tax-exempt organizations, and certain ministers.

unlike with 401(k)s, the employer doesn’t match a percentage of the contributions.