Unit 15 Review

Question 1

If an investor swaps identical issues of stock to establish a loss that is disallowed, the transaction is known as

A) a stock swap.
B) a wash sale.
C) a stock cross.
D) a reverse stock split.

The answer is not a stock swap, which is an exchange of equity-based assets during a merger or acquisition

Answer 1

a wash sale

The wash sale rule disallows claiming a tax loss on the sale of stock if the investor purchases a substantially identical security within 30 days either before or after the date of such sale.

Question 2

A U.S. citizen purchases a bond issued by the government of Sweden. The interest payments received are taxed at which of the following levels?

I. Federal
II. State
III. Local

Foreign bonds are not only taxed at the state level

Answer 2

I, II, and III

Interest on foreign bonds is taxed in the United States by federal, state, and local governments.

Question 3

A married couple has lived in the same home for 40 years and now, with the children all gone, they’ve decided to sell and move to a retirement village. They purchased the home for $80,000 and have accepted a contract for $800,000. The tax consequence of this sale is

There are exemptions from capital gains taxes on home sales. This must be incorporated into your calculations

Answer 3

a $220,000 capital gain.

As long as a homeowner has lived in the primary residence at least two of the previous five years, the first $250,000 of profit on a home sale is excluded from tax. In the event it is a married couple, as in this question, the exclusion is doubled to $500,000. The profit on the sale was $720,000 ($800,000 minus the cost of $80,000) and the exclusion of $500,000 reduces the reportable gain to $220,000.

Question 4

An investor would have to pay the alternative minimum tax when

Income from a limited partnership is not enough to be required to pay the AMT

Answer 4

it exceeds the investor’s regular income tax.

A taxpayer must pay the alternative minimum tax (AMT) in any year that it exceeds regular tax liability. Tax-preference items are re-input in figuring the AMT, but the AMT is paid only if that amount is higher than the regular income tax.

Question 5

An investor purchases 1,000 shares of ABC at $42 per share. One year later, the stock is trading at $50 per share and the investor receives 50 shares of ABC as a stock dividend. How will this dividend be currently taxed?

This is a trick question with a presupposition (the questions assumes that the dividend is taxable when it is not) Keep an eye out for these.

Answer 5

The shares are not subject to taxation

Shares received per a stock dividend are not currently taxable. Instead, shareholders who receive stock dividends must adjust their cost basis in the shares downward. The total number of new shares, multiplied by their new adjusted basis, must equal the shareholder’s total interest before the stock dividend was received.

Question 6

If a client has realized a capital gain from the sale of a municipal bond, to reduce tax liability, the capital gain can be offset against a capital loss in which of these?

I. GOs
II. Equity securities
III. Corporate bonds
IV. REITs

You selected I and II, but can a capital loss only be realized on those two types of securities?

Answer 6

I, II, III, and IV

A realized capital gain on a security may be offset by a capital loss realized from the sale of any type of security, including municipal bonds, equities, corporate bonds, or REITs.

Question 7

Which of the following statements about capital gains are true?

I. The minimum holding period required to qualify for long-term capital gains treatment is 1 day longer than 12 months.
II. The highest federal income tax rate on long-term capital gains is less than the highest federal income tax rate on ordinary income.
III. If an investor holds stock for 12 months or less and has no other transactions, any gain on the sale of the stock is taxed at the same rate as ordinary income.

Read option I carefully and compare it to the definition of long-term capital gain.

Answer 7

I, II, and III

If an investor holds stock for more than 12 months and sells it for a gain, the gain will be treated as a long-term capital gain. The advantage of long-term capital gains is that the maximum tax rate on long-term capital gains is lower than the maximum rate on ordinary income. If an investor holds stock for 12 months or less, though, any gain will be considered a short-term capital gain and will be taxed at the same rate as ordinary income.

Question 8

It would be least likely for dividends paid on which of the following investments to meet the requirements to be considered qualified?

A) Equity mutual funds
B) Common stock
C) Preferred stock
D) Bond mutual funds

The answer is not common stock. Consider the requirements that must be met for a dividend to be considered qualified.

Answer 8

Bond mutual funds

Qualified dividends are those eligible for reduced income tax rates. Those rates can be as low as 0% and as high as 23.8%, with most falling within the 15% to 20% bracket. We don’t expect the exam to test on the requirements for a dividend to be considered qualified or how you reach that 23.8% rate. Dividends on bond funds and money market funds are not qualified because the majority of those dividends represent interest earned by the fund and the tax break does not apply to earnings from interest.

Question 9

An investment adviser representative specializes in the senior market. A number of his clients have reached the age where they are contemplating selling their homes and moving into an assisted living facility. The profit made on the sale of their homes will be used to defray the costs of their new residence. Under current tax laws, which of the following are true?

I. A single person pays no tax on the first $250,000 of net profit realized on the sale of a primary residence that has been occupied for at least two of the past five years.
II. A single person pays no tax on the first $500,000 of net profit realized on the sale of a primary residence that has been occupied for at least two of the past five years.
III. A married couple pays no tax on the first $250,000 of net profit realized on the sale of a primary residence that has been occupied for at least two of the past five years.
IV. A married couple pays no tax on the first $500,000 of net profit realized on the sale of a primary residence that has been occupied for at least two of the past five years.

The answer is not I and III - married couples receive a larger benefit

Answer 9

I and IV

When a primary residence that has been lived in for at least two of the past five years is sold at a profit, the first $250,000 for an individual and the first $500,000 for a married couple is not subject to taxation. Everything in excess of that is taxed as capital gain on Schedule D of Form 1040.

Question 10

Which of the following statements regarding the alternative minimum tax is true?

A) The tax bracket will determine whether the regular tax or the alternative tax is paid.
B) The lesser of the regular tax or the alternative tax is paid.
C) The alternative minimum tax is added to the regular tax.
D) The excess of the alternative tax over the regular tax is added to the regular tax.

Tax bracket alone does not determine if you pay the AMT

Answer 10

The excess of the alternative tax over the regular tax is added to the regular tax.

The excess of the alternative tax over the regular tax is added to the regular tax amount. The taxpayer does not have the option of paying the alternative tax or the regular tax depending on his tax bracket. The purpose of the alternative minimum tax is to ensure that certain taxpayers pay a tax consistent with their wealth and income.

Question 11

Your client purchased 1,000 shares of ABC common stock on February 28, 2021. When did that purchase qualify for long-term capital gain or loss treatment?

A) March 1, 2022
B) February 28, 2022
C) March 1, 2021
D) February 29, 2022

A purchase can only qualify for long-term capital gain if it has been held for MORE than one year.

Answer 11

A) March 1, 2022

Long-term treatment applies when a sale is made more than 12 months after the purchase. The best way to compute this is to add one day to the purchase and then use that same date, 12 months in the future. Adding one day to February 28, 2021 is March 1, 2021. Twelve months later is March 1, 2022.

Question 12

All of the following are progressive taxes except

A) gift taxes.
B) excise taxes on cigarettes.
C) personal income taxes.
D) estate taxes.

Consider the definition of a progressive tax and a regressive tax, then ask yourself the following:
- Does one pay the same tax rate on a gift card as a gifted yacht?
- Does one pay the same tax rate on one brand of cigarettes as on another brand of cigarettes?
- Does someone with a $30k/yr income pay the same tax rate as someone with a $500k/yr income?
- When a poor man dies, will his estate be taxed at the same rate as the estate of a billionaire who died?

Answer 12

B) excise taxes on cigarettes.

Progressive taxes are those where the tax rate increases as the amount being taxed increases. The opposite of that is the regressive tax, where the rate remains the same regardless of the dollar amount being taxed. Excise taxes, such as those on cigarettes, are a prime example. Whether someone purchases a pack, a carton, or a case, the tax rate is constant.

Question 13

Investors who are subject to the alternative minimum tax (AMT) will lose the tax benefits normally associated with
A) gains associated with variable annuity portfolios.
B) losses on options positions.
C) capital losses.
D) tax preference items.

The AMT causes the loss of tax benefits on items that would receive favorable treatment under normal tax liability calculations

Answer 13

D) tax preference items.

Certain items receive favorable tax treatment from the IRS. One example is tax-exempt interest on private-purpose municipal revenue bonds. Another example is accelerated depreciation. These types of items are known as tax preference items. For investors who are subject to the alternative minimum tax (AMT), the benefits normally associated with tax preference items are lost, because these items must be added back into the investor’s taxable income.

Question 14

If an employed client has $12,000 of capital gains and $15,000 of capital losses in the most recent taxable year, how much unused loss, if any, is carried forward by the client to the following tax year?

Arrival at the correct answer requires more than subtraction. How can remaining losses be used to offset gains?

Answer 14

D) $0

In this question, the client had $12,000 of capital gains and $15,000 of capital losses.

Step 1: Offset the capital gains with the capital losses ($15,000 – $12,000). This leaves $3,000 remaining in capital losses.

Step 2: Note that the client can apply up to a maximum of $3,000 of any remaining losses against ordinary income. Once all $3,000 in remaining losses is used to reduce ordinary income, this would leave $0 to carry forward to the next year.

Therefore, the reason you would not carry $3,000 to the next year is that it would be used to reduce ordinary income for the current year.

It can be safely assumed than an employed client of a broker-dealer makes at least $3,000 per year.

Question 15

Investors who buy shares in state-specific municipal bond funds may be subject to

A) out-of-state property tax.
B) capital gains tax.
C) federal income tax.
D) no taxation.

State-specific funds are not exempt from taxes when sold

Answer 15

B) capital gains tax

Interest received from municipal bonds and municipal bond funds is generally income tax free on a federal basis but taxable in states other than the state of issue. State-specific funds avoid that problem. These investments are subject to capital gains taxes if sold at prices above investors’ cost.

Question 16

A customer in the 25% tax bracket bought 200 shares of ABC at $93 per share plus commission of $50. Considering the customer’s cost basis, when she sold 100 shares six months later at $96 per share, less commission of $50, her after-tax net was

A) $300.00.
B) $150.00.
C) $56.25.
D) $168.75.

C is how much tax the customer would pay. Calculate how much her income would be after tax is deducted.

Answer 16

D) $168.75

Because the purchase and sale were of different lots, you must compute the net proceeds on a per share basis. Dividing the cost of $93 + commission of $0.25 ($50 ÷ 200 shares) gives you a total per share cost of $93.25. Selling for $96.00 – $0.50 ($50 ÷ 100 shares) = $95.50 proceeds per share. $95.50 – $93.25 = $2.25. $2.25 multiplied by 100 shares sold = $225.00. In a 25% tax bracket, this is a taxable short-term gain and 25% of $225.00 = $56.25. Therefore, her after-tax net was $168.75 ($225.00 – 56.25).

Question 17

A taxpayer’s marginal tax rate is

The marginal tax rate applies to additional levels or brackets of taxable income

Answer 17

B) the rate of taxation on any additional taxable income received

Marginal tax rate is defined as the rate of taxation on any additional taxable income received. It is sometimes referred to as the tax on the next dollar or the last dollar of income. The effective tax rate is the overall rate paid on the total taxable income.

Question 18

One of your clients buys 300 shares of RIF common stock in March at $25 per share. Three months later, the client purchases 200 shares of RIF at $30 per share. One month later, RIF pays a dividend of $1 per share. Then, five months later, another purchase of RIF is made—this time 400 shares at $35 per share. If the client were to sell all RIF at $30 per share, what is the client’s capital gain or loss?

A) $500 gain
B) $500 loss
C) No gain or loss
D) $400 gain

Calculate how much the investor spent to buy shares and subtract the proceeds of the share from that.

The $1 dividend that RIF paid on the shares is irrelevant to the answer

Answer 18

B) $500 loss

The investor’s total cost is $27,500 for the 900 shares purchased. The proceeds of the sale are $27,000 (900 × $30). That results in a capital loss of $500. The cash dividend has nothing to do with capital gain or loss.

Question 19

A customer who sold a bond at a loss must wait how long before he can buy back a substantially identical bond and not have the sale classified as a wash sale?

A) 20 days
B) 31 days
C) 5 days
D) 0 days

Wash sale regulations require a 30-day period before or after the sale

Answer 19

B) 31 days

When a customer sells a security at a loss, he may not buy back the same (or a substantially identical) security from 30 days before to 30 days after the sale that established the loss, without having the loss disallowed.

Question 20

A loss derived from a limited partnership may be offset against income from

A) dividends received from common stocks.
B) other limited partnerships.
C) bonuses received in addition to a regular salary.
D) capital gains from municipal bonds.

Only passive income may be used to offset this loss

Answer 20

B) other limited partnerships.

A limited partner may use only passive income to offset the loss derived from a limited partnership. A passive loss cannot be used to offset dividends received from common stocks. Passive loss from partnerships may be used to offset passive gains from partnerships, not gains from municipal bonds.

Question 21

Which of the following is an example of a regressive tax?
A) Estate tax
B) Income tax
C) Gift tax
D) Sales tax

On which of these taxes does everyone pay the same rate, regardless of the value of the thing being taxed?

Answer 21

D) Sales tax

Regressive taxes are those where the rate remains the same, regardless of the cost of the item subject to the tax. For example, if your state has a 6% sales tax, it makes no difference if you are buying an item for $1 or $10,000—the tax rate is the same 6%. The other choices given are progressive taxes, where the tax rate increases as the dollar amount being taxed increases.

Question 22

If a high-income taxpayer is subject to the AMT, which of the following preference items must be added to adjusted gross income to calculate his tax liability?

A) Interest on a private-purpose municipal bond
B) Dividends paid on preferred stock
C) Distributions from a corporate bond mutual fund
D) Interest on a general obligation municipal bond

Which of these options are considered a tax preference item on the AMT?

Answer 22

A) Interest on a private-purpose municipal bond

The interest received on private-purpose municipal bonds is considered a tax preference item for the AMT. The interest on GO bonds and income received on corporate securities are never considered preference items under the AMT. In the real world, it is not only those with high incomes that are caught by the AMT, but the exam is not likely to go that deep.

Question 23

The alternative minimum tax is designed to ensure that certain high-income taxpayers do not avoid all income tax through the use of various tax preference items. Those preference items are added back to the taxpayer’s ordinary income on IRS Form 6251 and would include

A) intangible drilling costs in connection with an oil drilling program.
B) long-term capital gains in excess of $3,000 annually.
C) straight-line depreciation taken on investment real estate.
D) interest received from specified private-purpose municipal revenue bonds.

Re-read the options carefully. Which of these options are considered a tax preference item?

Answer 23

D) interest received from specified private-purpose municipal revenue bonds.

The Internal Revenue Code provides that interest on specified private activity bonds is an item of tax preference. Therefore, this interest must be added to a taxpayer’s regular taxable income in order to compute the taxpayer’s AMT income. Read the choices carefully. It is accelerated (not straight line) depreciation and excess intangible drilling costs that are preference items. In the real world, it is not only those with high incomes that are caught by the AMT, but the exam is not likely to go that deep.

Question 24

One of your clients invested $10,000 into a mutual fund. The client elected to reinvest all dividends. As a consequence of this,

A) the investor’s cost basis is increased by the amount of the reinvested dividends.
B) the reinvestments will purchase shares at a discount from the NAV.
C) the dividends will be taxed as capital gains once the shares are liquidated.
D) taxes are deferred until those shares are redeemed.

Dividends are taxed as capital gains every year, not just when the shares are liquidated.

Answer 24

A) the investor’s cost basis is increased by the amount of the reinvested dividends.

Because the reported dividends are taxed each year, when the shares are ultimately liquidated, they have already been taxed. So, the investor’s cost basis is increased by the amount of the reinvestment. Reinvested dividends are purchased at the NAV; mutual fund shares are never purchased below the NAV.

Question 25

An investor purchased 500 shares of stock on January 10, 2020, at $50 per share and sold it on August 4 of the following year for $40 per share. As a result, the investor realized

A) long-term capital gain.
B) a long-term capital loss.
C) a short-term capital gain.
D) a short-term capital loss.

C is not the answer. Selling shares for less than they were purchased is not a gain. In addition, the shares were held for over a year, so it is not short-term.

Answer 25

B) a long-term capital loss.

Buying stock at $50 per share and selling it for $40 per share creates a capital loss of $10 per share. In this case, because the holding period was more than a year and a half, the loss is long term. If the purchase was in January 2020 and the sale was in August of the following year, that must be August 2021.

Question 26

Tax preference items are used for the purpose of computing the alternative minimum tax. They include all of the following except

A) straight-line depreciation.
B) certain incentive stock options.
C) accelerated depreciation.
D) excess intangible drilling costs.

Which of these are considered tax preference items by the IRS. Carefully note the adjectives of the options.

Answer 26

A) straight-line depreciation.

Straight-line depreciation is not a preference item. All of the other choices are included in the IRS listing of tax preference items. In the case of the ISO, it is a preference item to the extent that the fair market value of the employer’s stock is in excess of the strike price of the option. As a test-taking tip, when you see two opposites as answer choices, it is likely that one of them is the correct answer. In this case, we have straight-line and accelerated depreciation, only one of which is a preference item.

Question 27

The alternative minimum tax (AMT) is designed to ensure that certain high-income taxpayers do not avoid all income tax. This is done by adding back to the taxpayer’s ordinary income, items such as accelerated depreciation and excess intangible drilling costs. The term used to describe these items used to arrive at the taxpayer’s alternative minimum taxable income (AMTI) is

A) Form 6251 items.
B) AMT taxable items.
C) tax preference items.
D) tax preferred items.

While all of these answers would get the point across, which one is closest to the term used in the IRS Code?

Answer 27

C) tax preference items.

The proper term is tax preference items. Those would include the following:

• Deductions taken for accelerated (but not straight-line) depreciation
• Excess intangible drilling costs
• Capital gains on incentive stock options
• Otherwise tax-exempt interest from specified private activity bonds