CERTIFIED FINANCIAL PLANNER CERTIFICATION
PROFESSIONAL EDUCATION PROGRAM
Income Tax Planning
Module 6
Income Tax Aspects of
Securities
©2013, College for Financial Planning, all rights reserved.
Learning Objectives
6–1: Identify characteristics of a form of cash value life
insurance policy.
6–2: Analyze a situation to identify an income tax implication
of an insurance policy.
6–3: Identify characteristics of a form of annuity contract.
6–4: Analyze a situation to identify an income tax implication
of a commercial annuity.
6–5: Analyze a situation to calculate the net capital gain or
loss for a set of security transactions by an individual.
6–6: Analyze a situation to identify an income tax implication
of a security transaction.
6–7: Analyze a situation to calculate the amount of
investment interest expense that is deductible.
6–8: Identify characteristics of a form of real or potential
dividends.
6-2
Questions to Get Us Warmed Up
6-3
Learning Objectives
6–1: Identify characteristics of a form of cash value life
insurance policy.
6–2: Analyze a situation to identify an income tax implication
of an insurance policy.
6–3: Identify characteristics of a form of annuity contract.
6–4: Analyze a situation to identify an income tax implication
of a commercial annuity.
6–5: Analyze a situation to calculate the net capital gain or
loss for a set of security transactions by an individual.
6–6: Analyze a situation to identify an income tax implication
of a security transaction.
6–7: Analyze a situation to calculate the amount of
investment interest expense that is deductible.
6–8: Identify characteristics of a form of real or potential
dividends.
6-4
Payouts from Life Insurance
Payout
Implication
Lump-sum payment of
surrender value before
insured’s death
To extent that surrender
value exceeds insured’s cost,
taxable as ordinary income
in year received
Installment payments of
surrender value before
insured’s death
Insured’s cost prorated over
installment period, with
amounts received in excess
of cost taxable as ordinary
income
6-5
Payouts from Life Insurance
Payout
Implication
Lump-sum payment of policy
proceeds to beneficiary upon
insured’s death
Settlement option payments
of policy proceeds to
beneficiary upon insured’s
death
Exempt from income tax
May be partially taxable
when paid or credited to
beneficiary (annuity
treatment)
6-6
Modified Endowment Contract
MEC Rules
• Life insurance contract
o
o
o
o
meets state law definition
meets IRC definition
issued on or after June 21, 1988
fails to meet the 7-pay test
• Distributions treated on LIFO basis
o withdrawals
o loans
o dividends received as cash or used to pay a loan
• 10% penalty tax on taxable portion
6-7
Disability Insurance Benefits
• If employer paid—benefits fully
•
•
•
taxable
If employee paid—benefits fully
excluded
If employer & employee paid—
benefits partially taxable
If taxable—benefits subject to
FICA and FUTA for first 6 months
6-8
Learning Objectives
6–1: Identify characteristics of a form of cash value life
insurance policy.
6–2: Analyze a situation to identify an income tax implication
of an insurance policy.
6–3: Identify characteristics of a form of annuity contract.
6–4: Analyze a situation to identify an income tax implication
of a commercial annuity.
6–5: Analyze a situation to calculate the net capital gain or
loss for a set of security transactions by an individual.
6–6: Analyze a situation to identify an income tax implication
of a security transaction.
6–7: Analyze a situation to calculate the amount of
investment interest expense that is deductible.
6–8: Identify characteristics of a form of real or potential
dividends.
6-9
Annuity Contracts
• Fixed Annuity: Fixed annuity payment
•
•
•
guaranteed upon payment of level or flexible
premiums
Variable Annuity: Amount of annuity payment
varies according to investment performance of
underlying assets
Deferred Annuity: Annuitant pays now for
future fixed or variable payments
Accumulation of Earnings: Grows on a taxdeferred basis
6-10
Commercial Annuities
Nonperiodic distributions
• Post-August 13, 1982, Contract: Fully taxable
•
interest to the extent that cash surrender value of
contract exceeds the investment (LIFO)
Pre-August 14, 1982, Contract: Nontaxable premium
dollars treated as first distributed (FIFO)
Distribution prior to age 59½
• Inclusion of taxable amount as ordinary income
• 10% premature withdrawal penalty on taxable portion of
withdrawal
6-11
Annuitized Distributions
Fixed Annuity—Exclusion ratio
inv estmentin contract
total expected return
Variable Annuity—Amount excluded
inv estment
number of pay ments
6-12
Learning Objectives
6–1: Identify characteristics of a form of cash value life
insurance policy.
6–2: Analyze a situation to identify an income tax implication
of an insurance policy.
6–3: Identify characteristics of a form of annuity contract.
6–4: Analyze a situation to identify an income tax implication
of a commercial annuity.
6–5: Analyze a situation to calculate the net capital gain or
loss for a set of security transactions by an individual.
6–6: Analyze a situation to identify an income tax implication
of a security transaction.
6–7: Analyze a situation to calculate the amount of
investment interest expense that is deductible.
6–8: Identify characteristics of a form of real or potential
dividends.
6-13
Capital Assets
• Defined by exception; All assets except:
o inventory
o depreciable and real property used in a trade
or business
o a copyright; a literary or artistic composition;
a letter, memorandum, or similar property
held by the author or creator, or by donee
o accounts or notes receivable acquired in the
ordinary course of trade or business
o U.S. government publications
6-14
Net Capital Gain or Loss
• Net loss of $3,000 allowable per year
• Net LTCG taxed at:
•
o 0% if 10% or 15% marginal rate
o 15%, if marginal rate 25%-35%
o 20% if marginal rate of 39.6%
Collectibles (maximum 28%)
o coins, stamps, artwork, etc.
• Depreciation on realty (unrecaptured §1250
•
•
income—maximum 25%)
Netted in most favorable manner
Net STCG treated as ordinary income
6-15
Netting Capital Gains & Losses
Net short-term
capital gains
with short-term
capital losses
Net long-term
capital gains
with long-term
capital losses
If gain and loss,
net again
If the result of
Step 3 is a loss,
the maximum
allowed is the
smaller of
$3,000 or
ordinary income.
If there are
short- and longterm gains, leave
separate.
6-16
Basis in Mutual Fund Shares
Average Cost Method
• Divides total cost of all shares by number of shares
•
owned, resulting in all shares having same cost basis
Gain or loss computed from sales proceeds of shares
sold less average cost times shares sold
First-In, First-Out (FIFO)
• Presumably lower-cost shares purchased first are used
•
in computing gain or loss from sale
Generally least advantageous method to investor
6-17
Basis in Mutual Fund Shares
Specific Identification
• Investor identifies the particular shares that
are being sold (by purchase date)
• Identifying highest cost basis shares results in
lowest gain on sale
• Identifying lowest cost basis shares results in
lowest loss on sale
6-18
Bonds at Premium
Taxable Bond
Tax-Exempt Bond
• election to amortize
premium as an
adjustment to
interest income
• downward
adjustment to basis
• premium must be
amortized
• nondeductible
adjustment to basis
6-19
Bonds at a Discount
Market discount
bonds
Newly issued at
discount
• election to treat
market discount as
income, ratably over
life of the bond
• original issue
discount (OID)
treated as income
over life of the bond
6-20
U.S. Securities
• Generally, no state or local income tax
T-bills
• short term
• sold at discount
• taxable at maturity
Treasury Notes and Bonds
• interest taxable when received
Treasury Inflation-Indexed Securities
• interest payments taxed when received
• inflation adjustments taxed in year of adjustment, although not
paid until maturity
6-21
Wash Sale Rule
• Disallows loss if
•
•
•
substantially identical
securities purchased within
30 days before or after
loss sale
Basis of new securities
increased by disallowed
loss
Not substantially identical
if different issuer or obligor
Effect of Rev. Ruling
2008-5
6-22
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• Wash Sales Rules
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Text chat or
other questions
1-23
Learning Objectives
6–1: Identify characteristics of a form of cash value life
insurance policy.
6–2: Analyze a situation to identify an income tax implication
of an insurance policy.
6–3: Identify characteristics of a form of annuity contract.
6–4: Analyze a situation to identify an income tax implication
of a commercial annuity.
6–5: Analyze a situation to calculate the net capital gain or
loss for a set of security transactions by an individual.
6–6: Analyze a situation to identify an income tax implication
of a security transaction.
6–7: Analyze a situation to calculate the amount of
investment interest expense that is deductible.
6–8: Identify characteristics of a form of real or potential
dividends.
6-24
Investment Interest Expense
• Investment interest expense: deductible up to amount
•
•
•
of net investment income
Investment interest expense: interest on debt incurred
to purchase investments
Investment income: primarily interest; LTCG and
qualified dividends included only if taxpayer elects for
preferential rates to not apply
Net investment income: investment income reduced by
other deductible investment expenses (Tier II
investment expenses AFTER 2% AGI)
No deduction if funds borrowed to purchase muni bonds.
6-25
Investment Interest Expense
Assume:
• investment interest expense of $20,000,
• interest income of $15,000, AGI of $65,000, and
• investment adviser fees of $2,000.
Investment income
Investment expenses (Tier II)
2% AGI
Deductible investment expenses
Net investment income
$15,000
$2,000
1,300
700
$14,300
6-26
Real or Potential Dividends
Ordinary Dividends
• Made out of current-year or accumulated earnings and profits
• Taxable to extent paid out of corporate earnings and profits
• Qualified dividends subject to 0%/15%/20% LTCG rates
Policyholder Dividends
• Paid by mutual life insurance and other life insurance
•
companies
Typically exempt from income tax, except
o to extent dividends received exceed investment in the
contract
o if from MEC and received in cash
6-27
Real or Potential Dividends
Constructive Dividends
• Disguised dividends such as excessive salary
paid to an officer/shareholder or distribution
characterized as a shareholder loan
Stock Dividends
• Distributions by corporation to its stockholders in
•
its own stock
Nontaxable unless considered a property
distribution
6-28
Real or Potential Dividends
Characteristics
Liquidating Dividends
• Redemption of outstanding stock for cash or
•
distribution of assets to shareholders in
exchange for stock
Treated as capital
gain or loss
6-29
Review Question 1
Which one of the following is not a test that
must be met in order for a product to be
defined as life insurance for federal income tax
purposes?
a. the cash value accumulation test
b. the cash guideline premium test and corridor
test
c. the premium value test
6-30
Review Question 2
Which one of the following does not correctly state a
characteristic of a commercial annuity?
a. With an annuity, there is a maximum annual
contribution per year, which is adjusted yearly for
inflation.
b. An annuity is a contract in which investments are
made in exchange for a promise of regular frequent
payments for the rest of a taxpayer’s life or a fixed
period of time.
c. Annuity contracts may vary regarding the payment
time period and the frequency of the payments.
d. An annuity payment is generally part return of
capital and part interest payment.
6-31
Review Question 3
Which one of the following statements is true regarding nonperiodic distributions from an annuity contract prior to the
annuity start date, issued after August 13, 1982?
a. A non-periodic distribution is first considered a tax-free
return of principal and then a taxable interest payment.
b. A non-periodic distribution is prorated equally between a
tax-free return of principal and a taxable interest
payment.
c. A non-periodic distribution is taxed under the exclusion
ratio rules.
d. A non-periodic distribution is taxed first as a taxable
interest payment until the interest payments are
completely exhausted and then as a tax-free return of
principal.
6-32
Review Question 4
Which one of the following methods that are
allowed for calculation of basis is generally the
least advantageous to the investor when
calculating the basis of mutual fund shares and
the resulting gain upon their sale?
a. specific identification method
b. first-in, first-out method
c. average cost method
d. last-in, first-out method
6-33
Review Question 5
Which one of the following is a correct
statement regarding the wash sale rules?
a. The wash sale rules do not apply to dealers.
b. Small differences in the maturity dates of
bonds will not cause them to be classified as
substantially identical.
c. The wash sale rules do not apply to sales
and investments in mutual funds.
d. Basis is generally decreased by the amount
of the loss that is disallowed on a wash sale.
6-34
Review Question 6
Which one of the following statements is incorrect
regarding investment interest expense?
a. Investment interest expense is deductible up to
the amount of the net investment income.
b. Excess investment interest expense cannot be
carried forward into succeeding tax years.
c. Interest paid or accrued to purchase or carry
tax-exempt investments is not deductible.
d. Net investment income is the excess of
investment income over investment expenses.
6-35
Review Question 7
To the extent that a distribution to a shareholder
exceeds the corporation’s current and accumulated
earnings and profits (E&P), how is such a
distribution treated?
a. The distribution is treated as a taxable event,
and the shareholder recognizes it as a capital
gain.
b. The distribution is treated as a taxable event,
and the shareholder recognizes it as an ordinary
gain.
c. The distribution is treated as a nontaxable
distribution of property.
d. The distribution is treated as a return of capital.
6-36
Review Question 8
Which of the following statements correctly defines
inside buildup as it refers to life insurance?
a. During the insured’s lifetime, the accumulations of
cash value within a policy grow on a tax-deferred
basis.
b. During the insured’s lifetime, the accumulations of
cash value within a policy grow on a tax-free basis.
c. During the insured’s lifetime, the accumulations of
cash value within a policy grow on a tax-annuitized
basis.
d. During the insured’s lifetime, the accumulations of
cash value within a policy grow on a tax-preferred
basis.
6-37
Review Question 9
Under the modified endowment contract rule,
which one of the following is not considered a
distribution from a life insurance policy after
June 21, 1988?
a. withdrawals
b. dividends retained by an insurer to pay
premiums
c. loans taken as cash or used to pay
premiums
d. dividends received as cash
6-38
Review Question 10
Which one of the following statements correctly
describes the method for calculating the
exclusion ratio for fixed annuity payments?
a. The investment in the annuity contract is
divided by the number of expected
payments.
b. The number of expected payments is divided
by the investment in the annuity contract.
c. The total expected return is divided by the
investment in the annuity contract.
d. The investment in the annuity contract is
divided by the total expected return.
6-39
Review Question 11
Which one of the following statements correctly
describes the method for calculating the exclusion
amount for variable annuity payments?
a. The investment in the annuity contract is divided
by the number of expected payments.
b. The number of expected payments is divided by
the investment in the annuity contract.
c. The total expected return is divided by the
investment in the annuity contract.
d. The investment in the annuity contract is divided
by the total expected return.
6-40
Review Question 12
Which one of the following is not currently a
long-term capital gains rate?
a. 0%
b. 10%
c. 15%
d. 20%
e. 25%
6-41
Review Question 13
For the current tax year, Bob Phillips, an individual
taxpayer filing a joint return, has $50,000 of investment
interest expense and $20,000 of net investment income
(interest income). Bob paid commissions of $1,500
during the current year.
How much investment interest expense, if any, may Bob
deduct in the current tax year?
a. $0
b. $18,500
c. $20,000
d. $48,500
e. $50,000
6-42
Review Question 14
This year, Ken Bush sold several securities that left him with
the following types of gains and losses:
o long-term capital gain—$8,000
o short-term capital gain—$1,800
o long-term capital loss—$2,200
o short-term capital loss—$1,000
What is the net capital gain or loss on Ken’s security sales?
a. net long-term loss of $1,400
b. net long-term gain of $2,320, and net short-term gain of
$800
c. net long-term gain of $2,640
d. net long-term gain of $5,800, and net short-term gain of
$800
e. net long-term gain of $6,600
6-43
Review Question 15
Derrick Johnson is about to begin receiving payments
from a deferred fixed annuity that he purchased many
years ago. His investment in the annuity contract was
$40,500. He is to receive $300 per month for the rest of
his life. His current life expectancy, based on IRS tables,
is 15 years.
What amount, if any, of each monthly payment is
taxable to Derrick?
a. $0
b. $75
c. $100
d. $225
e. $300
6-44
CERTIFIED FINANCIAL PLANNER CERTIFICATION
PROFESSIONAL EDUCATION PROGRAM
Income Tax Planning
Module 6
End of Slides
©2013, College for Financial Planning, all rights reserved.