(Top 10) A CFP certificant is practicing financial planning or material elements of it if:
1. The client's understanding or intent
2. Comprehensiveness of data gathering
3. Breadth and depth of recommendations
4. Degree to which multiple subject areas are involved
Principles
I Can Obtain CFP Designation
I - Integrity
C - Competency
O - Objectivity
C - Confidentiality
F - Fairness
P - Professionalism
D - Diligence
(Top 10) Rule 1.3 - Agreement in Writing (financial planning)
1. The parties to the agreement
2. The date of the agreement and its duration
3. How and on what terms each party can terminate the agreement
4. The services to be provided as part of the agreement
(Top 10) Rule 2.2 - Disclosures
(oral or in writing if not financial planning / in writing if financial planning)
1. How CFP is compensated
2. Conflicts of interest
3. Contact information
4. Material information that can impact client's decision
*Disclosures under form ADV may not satis
Commingling
Commingling is only permitted if the clients give written authorization and the certificant keeps accurate records
Confidential information from the client can be disclosed when:
1. The client consents
2. Disclosure is compelled by a legal process
3. The certificant is required to make a disclosure to defend against an accusation or wrongdoing
4. A civil suit arises between the client and certificant
5. As needed to perform servic
Days to know:
1. Time to report conviction of a DUI - 30 calendar days
2. Time to report change of address - 45 days
3. Max term of suspension of use of CFP marks - 5 years
4. Time to appeal a DEC decision - 30 days
Conviction
(not 'charged with,' 'pulled over,' or 'arrested') of a serious crime or professional suspension results in immediate suspension
Grounds for Discipline
-Any act or omission that violates the provisions of the Code of Ethics and/or Rules of Conduct
-Any act or omission that fails to comply with the Practice Standards
-Any act or omission that violates the criminal laws of any State or of the US or of any
Forms of Discipline
-The DEC has the right to require the Respondent to complete additional continuing education or other remedial work (retake the CFP exam, completing the coursework). May be ordered instead of, or addition to, any discipline listed below. Where grounds for
FDIC Insurance
-Up to $250,000
-Deposits maintained in different categories of legal ownership (individual, joint with others, irrevocable trust, testamentary account) are separately insured
-Separate insurance is also provided for accounts held for retirement purposes
Must register as an Investment Advisor with SEC if:
(all 3)
A = Advice (securities)
B = in the Business
C = Compensation
Exceptions from registering
Bank
Lawyer, Accountant, Teacher, and Engineer
Broker-Dealer
Publisher
Gov't Securities Adviser
Big Plate (Bank, Incidental Services, Gov't Securities, Publisher, Lawyer, Accountant, Teacher, Engineer)
Brochure rule
The ADV, Part 2A (narrative form) must be delivered before or at the time of signing (includes business, conflicts of interest, disciplinary history, other info to help client make decision)
Elements for a valid contract
(CLOC):
Competent Parties
Legal Purpose
Offer and Acceptance
Consideration
Bankruptcy: Exempt Properties and Nondischargable debts
Exempt Property:
Life insurance
Qualified retirement plans
Homestead
Limited equity in car or personal property
Nondischargable debts:
Taxes
Alimony
Child support
Student and gov't loans
Crimes, fines, penalties, etc.
CFP Fiduciary
Place the interest of the client ahead of their own. "One who acts in utmost good-faith, in a manner he or she reasonably believes to be in the best interest of the client.
(Top 10) 6 Steps in Financial Planning Process
(EGADIM)
Establish and define the relationship
Gather client data, including goals and objectives
Analyze information
Develop the plan
Implement the plan
Monitor the plan
Confidentiality
Step 4 (Develop) - oral or written permission from client when working with other other professionals
Step 5 (Implement) - no confidentiality issue since the plan has already been agreed upon
Step 6 (Monitoring)
If new areas of planning arise that were not part of the original scope of the engagement, the planner and client will need to go back to Step 1 and redefine the scope of the engagement
Divorce
1. Evaluate whether the planner is able to continue to represent both
2. Advice on how income is to be shared (alimony, child support, retirement, SS)
3. Advice on how assets are to be shared under divorce decree or prenup
4. Income tax consequences of wh
Diminishing capacity - At what level is this?
Does the client recognize property and loved ones, and understand what is being done in the plan?"
Keep POA current and have agent in meetings
Debt management percentages
Monthly mortgage payment (PITI) - 28% of gross income or 1-weeks take-home
Monthly payment on all debt - 36% of gross income
Consumer debt payment (non-mortgage) - 15% of net income
Yield curve - downward sloping
It is often thought to predict an upcoming recession
(Top 10) - Fiscal Policy
(Congress and President)
level of economic activity
Restrict economic activity (tighten)
Decrease government spending
Increase taxes
Stimulate economic activity (loosen)
Increase government activity
Decrease taxes
(Top 10) - Monetary Policy
(Federal Reserve)
money supply
Tighten money supply
Raise reserve requirement
Raise discount rate
Sell government securities
Loosen money supply
Lower reserve requirement
Lower discount rate
Buy government securities
(Top 10) Calculate PV of a bond (Ex: How much to pay if 9% coupon that matures in 7 years yielding 10%?)
2 P/Y
N: 7 x 2
I: 10
PMT: 45 (90/2)
FV: 1000
PV: $951
Risk tolerance: sources of information
1. Direct inquiry by planner
2. Quantitative methods and questionnaires
3. Client's past actions
4. Demographic (characteristics)
Structured communication
Interviewing
Advising
Counseling *Do more counseling (educating) than advising
(Top 10) 529 Plans
-Can set aside larger amounts of money for college savings
-Can be taken out tax-free if used too pay qualified education expenses, including tuition, room and board, travel (to college), and computer (if institution requires it).
-Moneys withdrawn for pu
(Top 10) 529 Front-loading
Up to $70,000 ($140,000 for married couple) can be contributed to an account in a single year with no gift tax consequences. If the donor dies before the full 5 years have passed (ex: lives 2 years), $42,000 (3 years of annual exclusions) will be brought
(Top 10) ESAs
-Coverdell ESA must be rolled over or distributed by age 30 (529 has no age limit)
-Tax-free for qualified education expenses at private elementary and secondary schools. No other tax-advantaged plan applies to these levels of schooling.
$2,000/year/child
(Top 10) Tax Credits
(Top 10) Tax Credits - 1098-T form required from school
-American Opportunity Tax Credit (go-to/use 1 per student)
---Up to $2,500 tax credit (dollar-for-dollar in your pocket) for at least $4,000 of qualifying education expenses
---Only eligible for firs
(Top 10) UGMA/UTMA
-Should have small amounts of money for child
-Kiddie tax is present
-Irrevocable gift - must be given rights to assets at 18 (must submit paperwork, not automatic)
-Can cause ineligibility for financial aid if unearned income exceeds $2100 - to avoid thi
Equation to determine college student's need
Need = Cost of Attendance (COA) - Expected Family Contribution (EFC)
Different types of financial aid
-Pell Grants and Supplemental Educational Opportunity Grants (SEOGs)
Undergraduate only - Must show need
-Perkins Loans
Administered by college - Graduate and undergraduate - Must show need
No interest charged while student in school and for 9 months afte
Present interest gifts eligible for the gift tax annual exclusion
Present interest gifts are eligible for the gift tax annual exclusion ($14,000, $28,000 if splitting gifts with spouse)
-Direct to student
-529 plan (only plan that can front-load 5 years of annual exclusions)
-UGMA/UTMA
-2503(b) or 2503(c) trusts
-ESA
Gifting highly appreciated property
Gifting highly appreciated property or income producing property can shift income taxation to the student, who is in a lower tax bracket than the donor (kiddie tax limits this)
Tuition paid directly to a school
Tuition paid directly to a school is exempt from both the gift tax and the GST tax and they can also give annual exclusion gift on top of this
Risk Management Techniques
-Avoidance - Don't take it on, or if necessary, get rid of it (no swimming pool). High severity and high frequency.
-Retention - Keep it, in whole or in part (increase deductible). Low severity and low frequency.
-Noninsurance transfer - Shift it to someo
COBRA
-Mandates continuation coverage for terminated employees whose employers have 20 or more employees (not gross conduct)
-Must elect continuation coverage within a 60-day period
18 months if terminate employment, 29 months if become disabled, 36 months for
Taxation of Disability Insurance
-Individual policy - premiums are not deductible. Benefits are free of income tax.
-For partnership, S corporation, over-2% shareholder - deductible by business. Amount of premiums paid will be added to taxable income of partner or shareholder. Benefits p
Summary Plan Description
-Outlines the coverage under both short-term and long-term disability through the employer (important since DI is nondiscriminatory). If client doesn't provide this, assume that there is no DI coverage at work or go back to step one in the planning proces
Medicare Limitations
-Medicare doesn't pay for any of the costs of a stay after 100 days at a skilled nursing facility
-Medicare doesn't generally pay for custodial care
Long-Term Care Insurance Partnership Program
-To encourage more people to purchase private long-term care insurance and relieve some of the burden on Medicaid
-Rather than having to "spend down" assets to reach poverty level, allows the client to retain assets equal to the LTC benefits provided by t
Taxation of Premiums and Benefits
-Premiums - Deductible as medical expense on Schedule A. Self-employed medical expense deductible above-the-line. Both have limits based on age. C-corporation can deduct as expense without dollar limits based on age.
-Benefits are generally tax-free
LTC Premiums
May be paid from HSAs. They may not be paid from FSAs and cafeteria plans.
Annuity Uses
Suitable for:
-A client who already accumulated a significant amount of money who wants to liquidate in a scientific manner
-Seeking income guaranteed to last lifetime (superannuation)
-Who hasn't yet accumulated a significant amount of money but who wish
Annuity Taxation
-Noncontributory plans - All employer money (tax deduction) - Full amount of each payment is included in gross income
-Contributory plans - employee puts after-tax money in as well - part of each payment is excluded and part is included in gross income
Ex
Transfer-for-Value
-If a policy is sold, the death benefit in excess of the amount paid for the transfer, including subsequent premiums, is received as ordinary income. They do not create a problem when made to the following persons or entities:
--The insured (ER buys key-p
Term Insurance
-Advantages - Cheap, temporary solution, can match needs for a fixed time period (until children graduate, mortgage is paid off
-Disadvantages - No cash value, no permanent insurance, increasing premiums in future years.
Whole-Life Insurance
-Advantages - Permanent protection, forced savings, substantial flexibility due to the cash value (loans)
-Disadvantages - premium payments for life, limited payment policy doesn't coincide with when an individual has maximum income, no hedge against infl
Variable Life Insurance
-Advantages - Policyowner selects the investment allocation between funds, policy is part insurance/annuity and part security investment (inflation hedge)
-Disadvantages - Actual rate of return may be lower than that of standard insurance policies
Universal Life Insurance
-Advantages - Policy's cash value earns investment income on the basis of current market rates, tax-deferred investment income, premium flexibility
-Disadvantages - Not the most competitive insurance -coverage or most competitive savings vehicle, lack of
Taxation of Life Insurance
-Policy dividends - free of income tax. When dividends exceed premiums paid, they are included as ordinary income
-Policy loans are not taxable unless policy is a MEC (ordinary income plus 10% penalty if under age 59 �)
-Withdrawals - No tax is owed until
Modified Endowment Contracts
-Created to eliminate single-premium life insurance purchased for income tax deferral after 06/01/1988
-7-pay test - If at any time during the first 7 years of a life insurance policy, the cumulative premiums exceed the 7-pay premium times the number of y
Nonqualified Deferred Compensation
-May discriminate
-Employer receives no federal income tax deduction until benefits are paid to the employee. All benefits are taxable to employee as ordinary income.
-Salary Reduction - Employee gives up some current compensation (elect by 12/31 of prior
Nonqualified Deferred Compensation Plans - Life Insurance
-Employee has no rights or security interest in the life insurance
-Policy is owned by the employer.
-Premiums not deductible by the employer
-CV grows tax-deferred and the basis can be recovered tax-free
-Employer is the beneficiary
-DB paid to the emplo
Cross-Purchase Vs Entity
-Cross-Purchase will assure greater equity of results:
--If there is a disproportionate amount of ownership interest held by one participant
--If there is a wide difference in the ages of the owners
-Stock-redemption plan (entity agreement) preferred if:
Homeowner's Insurance
-The minimum amount of insurance that should be carried is not the full replacement cost; it is 80% (or other coinsurance %) of the replacement cost. However, you will need 100% of the replacement cost if you want to be fully covered in the event your ent
Commercial/Professional Liability Insurance
-Occurrence basis - Policy covers claims arising from events happening during the policy period, regardless of when the claim is filed
-Claims-made basis - Policy covers claims made during the policy period, regardless of when the injury or damage occurre
Split limits (auto insurance)
$100,000 (per person) / $300,000 (per accident) / $50,000 (property damage)
Umbrella Liability Insurance
-No umbrella = weakness
-Self-insured retention applies to losses covered by the umbrella policy but not by a required underlying policy. Works like a deductible if there's no underlying policy (auto or homeowners). If there is, then they will use the und
Treasury Notes and Bonds
-Direct debt obligations of the federal gov't
--U.S. Treasury notes mature in 1 to 10 years
--U.S. Treasury bonds mature in 10 to 30 years
-$1,000 face amount
-Semiannual coupon payments
-Actively traded in secondary market
Treasury STRIPS
-U.S. Treasury-issued bonds with 2 components: 1. Interest 2. Repayment of principal
-Components are separated and sold individually as zero-coupon bonds
-Separate Trading of Registered Interest and Principal Securities
-Good for qualified accounts since
Treasury Inflation-Protected Securities (TIPS)
-Sell at FV with a predetermined coupon rate
-Principal adjusted semiannually relative to CPI percentage movement
-Taxable (ordinary) income on any principal gains and on coupon interest - good for qualified accounts!
-Real returns protected in tax-deferr
Series Bonds
-EE: Issued at discount, interest rate fixed for at least 20 years, interest income not taxed until redeemed (may be excluded if used to pay for college expenses post-1989 and AGI is within limits)
-HH: Discontinued as of 08/31/04, issued at par in exchan
Ginnie Maes
-Backed by the full faith of the U.S. gov't
-Pool of FHA/VA guaranteed mortgages
-Pay interest and principal monthly
-Fully taxable - federal, state, and local
Freddie Macs and Fannie Maes
-Historically, not guaranteed by the U.S. gov't
-Pool of mortgages
-Pay higher interest rates than Ginnie Maes
-Fully taxable - federal, state, and local
Municipal Bonds
-Issued by state and local government
-Federal tax-free interest. If resident of state and local, tax-free as well. This is only the interest but not for capital gains.
-Types: General obligation bonds - backed by the entire gov't unit / Revenue bonds - b
Mortgage Bonds (CMOs)
Mortgage payments received are looked at on a "cash flow" basis.
Based on expected cash flow to be received over the life of the pool, separate classes of securities called "tranches" are created.
The typical CMO has A to Z tranches, representing fast pay
Exchange-Traded Funds (ETFs)
-Index-type shares that offer investors the ability to invest in a basket of stocks that mirror closely an underlying benchmark (ex: NASDAQ 100)
-They trade daily just like stock shares - priced in real time throughout the trading day
Foreign Bonds
-Foreign gov't bonds are not guaranteed, but are generally safer than foreign corporate debt
-Investment risks: 1. Exchange rate risk 2. Political risk
-To reduce risk, they are denominated in dollars (Yankee bonds are issued in the U.S. by foreign banks
American Depositary Receipts (ADRs)
-Issued by a bank in a foreign country representing an ownership interest in a foreign security on deposit at the bank
-An alternative way for a domestic investor to invest in non-U.S. companies without going into a foreign market
-Prices are quoted in U.
Unit Investment Trust
-Unit Trust
-Fixed capitalization
-Passive; portfolio is fixed
-Units offered by trust require a prospectus
-Units are redeemable with a trust at NAV
-Sales charges by fund
Open-End Investment Company
-Mutual fund
-Capitalization constantly changing
-Active; portfolio changes
-Prospectus required; each sale is an offering by the fund
-Shares are redeemed by a fund at NAV, no trading on exchanges
-Sales charges by fund
Closed-End Investment Company
-Publicly traded fund
-Fixed capitalization
-Active; portfolio changes
-After initial offering, buying on exchanges through a broker doesn't require a prospectus
-Shares trade on exchanges above or below NAV; shares aren't redeemable
-Commission to broker
Black-Scholes Option Valuation Model
Uses 5 variables to value the option of a non-dividend paying stock. Think "call up."
-The price of the underlying stock
-The exercise price (strike price) of the option
-The time remaining to the expiration of the option
-The interest rate
-The volatilit
Stock Options (general definitions)
Intrinsic Value - The minimum price the option will command as an option. It is the difference between the market price of the stock and the exercise price of the option
Exercise price (strike price) - The price at which the stock can be purchased or sold
Mutual Fund Prospectus
-Information found in the prospectus
--The fund's investment objectives or goals - strategies for achieving those goals
--The principal risks of investing in the fund
--The fund's fees and expenses
--The fund's past performance - year-to-date, 1-year, 3-y
Privately Managed Accounts
-Investor actually owns the underlying shares of stock rather than shares of a mutual fund
-Higher min investment required - $100,000 or higher
-Higher investment fees
-Investment firm running the privately managed account will have an investment objectiv
Separately Managed Accounts
-Account manager selects stocks to meet the individual client's investment goals and preferences
-Investor actually owns the underlying shares of stock rather than shares of a mutual fund
-Higher minimum investment required - $100,000 or higher
-Higher in
Guaranteed Investment Contracts (GIC)
-Typically issued by an insurance company that guarantees that the principal interest will be paid as required under the terms of the contract
--Pays a lower interest rate than bonds due to lower risk of failure to pay the interest, but a higher rate than
Original Issue Discount Bond (OID)
-Bond is discounted from par value at the time of issue
-Most are zero-coupon sold far below par value and paying not interest until maturity.
-Each year the portion of the discount that has been "earned" is included as taxable interest income, and the bo
Unbiased Expectations Theory (UET) Formula
Provided - implies that long-term investors will choose to purchase debt instruments based on whether forward interest rates are more or less favorable than current short-term rates.
Ex: One year Treasury bill currently has a 3.06% rate. You expect one ye
Net Operating Income
Gross rental receipts
+ Nonrental income (such as laundromat equipment)
= Potential gross income (PGI)
- Vacancy and collection losses
- Operating expenses (excludes interest and depreciation)
= Net operating income (NOI)
This helps to arrive at the intri
Real Estate Investment Trust (REIT)
-Invests in real estate, short-term construction loans, and mortgages
-Achieves diversification and marketability which isn't typically found in real estate investments
-Either listed on an exchange or traded over-the-counter
-Equity REITs invest mainly i
Bond Risks
D=Default Risk
R=Reinvestment Risk
I=Interest rate risk
P=Purchasing Power Risk
Corporate and Municipal bonds = DRIP
Zero-coupon bonds = DIP
Government bonds = RIP
STRIPS = IP
Puts
-An option to sell a specified number of shares during a specified time at a specified price (strike or exercise price)
-Bought by one who expects the stock price to fall
-Written by one who expects the stock price to rise or remain steady
Calls
-An option to buy a specified number of shares during a specified time at a specified price
-Bought by one who expects the stock price to rise
-Written by one who expects the stock price to fall or remain steady
Buy a Call (wins and losses with options)
Breakeven - Exercise price + premium
Max Gain - Unlimited
Max Loss - Premium
Sell a Call (wins and losses with options)
Breakeven - Exercise price + premium
Max Gain - Premium
Max Loss - Unlimited
Buy a Put (wins and losses with options)
Breakeven - Exercise price - premium
Max Gain - Exercise price - premium (if stock price is zero)
Max Loss - Premium
Sell a Put (wins and losses with options)
Breakeven - Exercise price - premium
Max Gain - Premium
Max Loss - Exercise price - premium (if stock price is zero)
Stock and Option Combo
Protect = long option
Income = short option
Long Stock Combo
Protect = long put
Income = short call
Short Stock Combo
Protect = long call
Income = short put
Long-Term Equity AnticiPation Securities (LEAPS)
-Operate in a similar manner to short-term options, but
--Have a maturity of up to 3 years
--Are restricted to a much smaller number of stock selections
Purchasing Power Risk
The damaging effect a rising rate of inflation would have on the future purchasing power of an investor's investments
-Also called inflation risk
-Type of systematic risk
Reinvestment Risk
Risk that interest or earnings from a selected investment will not be reinvested at current rates of return
-Type of systematic risk
-Zero-coupon bonds don't experience this risk, as all payments are made at the time of maturity
-If the coupon on a bond i
Interest Rate Risk
-Uncertainty for the investor as to the future market value of securities because of the possible variation in the market interest rates
-Type of systematic risk
-When interest rates change, the price for a fixed income investment changes inversely to the
Market Risk
-Possibility of losses arising from factors affecting the market as a whole (recessions, loss of confidence, 9/11)
-Type of systematic risk
Exchange Rate Risk
-Risk arising from adverse fluctuations in the value of the dollar relative to a foreign currency
-Type of systematic risk
-Ex: While doing business in Mexico, the dollar strengthens against the peso. The pesos generated by the investment are not worth as
Business Risk
-Riskiness of a specific business
-Type of unsystematic risk
-Includes: speculative nature of the business, management of the business, philosophy of the busines
Financial Risk
-Risk due to use of leverage (heavy debt financing)
-Type of unsystematic risk
Liquidity Risk
-The risk of the inability to sell an investment quickly with only a slight loss or no loss of principal
-Type of unsystematic risk
-Real estate is marketable, but not liquid
-A savings account is liquid, but not marketable
Marketability Risk
-The risk of the inability of an investor to find a ready market to sell an investment
-Type of unsystematic risk
-Real estate is marketable, but not liquid
-A savings account is liquid, but not marketable
Tax Risk
-Risk due to changes in tax laws
-Type of unsystematic risk
-Ex: The risk that Congress will change the 15% capital gain rate
Investment Manager Risk
-Risk due to a change in investment managers on a particular mutual fund or managed account
-Risk that the investment manager does not act in the best interest of the investors when managing the account
-Type of unsystematic risk
Standard Deviation
Absolute measure of the variability of results around the average or mean of those results
-Measures total risk
--Systematic and unsystematic
When finding sample standard deviation in calculator (historical returns):
1. Enter each return and then click si
Normal Distribution
In a normal (bell-shaped distribution)
-68% of all results will fall within +/- one standard deviation of the mean
-95% of all results will fall within 2 standard deviations of the mean
-99% of all results will fall within 3 standard deviations of the mea
Skewness
-Measures the symmetry of the bell curve
--If the tail to the right of the mean is larger than the tail to the left of the mean, the curve has positive skewness
---Investors are risk averse and will prefer positive skewness
-No skewness means it's a norma
Kurtosis
-Measures the tallness or flatness of the bell curve
--Bell curves with high peaks around the mean and fat tails have a high kurtosis (leptokurtic)
--Bell curves with low peaks around the mean and skinny tails have a low kurtosis (platykurtic)
---Investor
Coefficient of Variation (CV)
-Provides a relative measure of risk
--Standard deviation is an absolute measure
-Formula is CV = Std dev (risk) / Mean return (reward)
-Lower is better
Covariance
-The relationship between and among stocks that includes not only the individual stock's variability, but also its effect on and interaction with other portfolio securities
--It is the reason a portfolio's standard deviation cannot simply be its weighted
Correlation Coefficient
(R)
-Measures the relationship between stocks
+1.0 (perfectly positive correlation)
-1.0 (perfectly negative correlation) - perfect diversification
-A correlation coefficient of 0 means there is no relationship between the returns of the two investments (
Coefficient of Determination
(Rsquared) (Correlation of Coefficient squared)
The square of the correlation coefficient calculated for a given portfolio in relation to the market portfolio
-It reveals the extent of diversification in a fund
--An Rsquared of less than .70 suggests that
Beta
-Measure of risk to use with a diversified portfolio in which unsystematic risk has been removed by diversification
--Measures only systematic (nondiversifiable) risk
B=.75 - only 75% as volatile as the market
B=1.0 - just as volatile as the market
B=1.70
Capital Market Line
-Adds a risk-free asset used in combination with the risky asset portfolios on the efficient frontier
rp (req rate of return) = rf (risk-free ROR) + std dev of portfolio(market of returnxrisk-free ROR/std dev of market)
Capital Asset Pricing Model
CAPM
-It defines the relationship between a portfolio's (or a security's) rate of return and its risk
-It's represented by the security market line (SML) if the questions asks you to use the CAPM mode, use the SML formula ri = rf + (rm - rf)B
-Uses beta,
Arbitrage Pricing Theory
APT
-The premise behind APT is that pricing of securities in different markets cannot differ for any significant length of time
--Any unanticipated changes that can cause pricing inefficiencies will be eliminated at some equilibrium point
-Arbitrage oppor
Geometric/Arithmetic Average Return
-Arithmetic average return - like what we learned in grade-school - sum of a group of numbers divided by the number of number in group
-Geometric average return - correctly adjusts the average to reflect the positive and negative numbers in the group
Ex o
Time-Weighted Return
-Measures an investment's performance without regard to cash flows
-Preferred method of evaluating a portfolio manager's actual rate of return
-Use Geometric Mean Return to calculate (How much time did you spend on your geometry homework?)
Ex: 20%, 6%, 10
Dollar-Weighted Return
-Measures the total return on a portfolio based on cash inflow and outflow activity until the end of the time period also known as IRR
-More appropriate calculation when attempting to measure the earnings on a client's actual invested dollars
-Use cash fl
Real Return
Incorporates the impact of inflation (inflation-adjusted)
-Use short-cut in calculator (1.05 INPUT 1.07 shift %CHG)
Nominal Return
Ignores inflation
Total Return
-The total return from an investment is the income it produced, plus or minus any capital appreciation or depreciation, divided by the purchase price paid
Ex: If stock was bought one year ago for $52, paid a dividend during the year for $4, and was sold t
Holding Period Return
-Same as Total Return
-Can produce misleading results because it doesn't take into account the length of time needed to achieve that total return
Ex: A total return of 12% achieved during a two-year holding period is not as good as if it were achieved dur
Internal Rate of Return
-It is the discount rate that produces a net present value of zero for an investment's cash inflows and outflows
-Use cash flows and solve for IRR
Current Yield
-The annual income (coupon or dividend) the investment provides divided by its current price.
CY = Annual income / CMV
Yield-to-Call
Use TVM like YTM, but the call price is used as the future value and the first date on which it may be called is used to measure the value of n.
Taxable Equivalent Yield
-Tax-free yield / (1 - tax rate) - Taxes you save
-Don't forget to add in 3.8% Unearned Income Medicare Contribution Tax if AGI is above $200,000 for single and $250,000 for married.
After-Tax Rate of Return
-Taxable yield x (1 - tax rate) - Taxes you pay
-Don't forget to add in 3.8% Unearned Income Medicare Contribution Tax if AGI is above $200,000 for single and $250,000 for married.
Sharpe Ratio
Si = rp - rf / std dev of p - provided on formula sheet
-Uses the arithmetic averages for portfolio and risk-free rates
-AKA reward / variability ratio (fluctuations around the security's own mean or average)
-Higher is better
-Uses standard deviation (sy
Treynor Ratio
Tp = rp - rf / Bp - provided on formula sheet
-Uses the arithmetic averages for portfolio and risk-free rates
-AKA reward / volatility ratio (fluctuations around the market mean or average)
- Higher is better
-Use is R2 is greater than .70
-Uses beta (sys
Jensen Ratio
ap = rp - (rf + (rm - rf)Bp) - provided on formula sheet
-Absolute measure of performance (how well did the fund do compared to the market?)
-Alpha > or = 0 - Continue to hold the asset
-Alpha < or = 0 - Sell the asset as the client didn't earn required r
Information Ratio
IR = (Rp - Rb)/std dvA - provided on formula sheet
-Incorporates a risk adjustment to alpha
-Provides investors with a way to evaluate the return earned by a fund manager, based on the given risk of the fund (active return rather than investing in the mar
Convexity
-Measures ALL of a bond's price sensitivity to interest rates that is not measured by duration. Accounts for larger changes in bond yields
-Prices of bonds with high convexity increase more when yields decrease and decline less when yields increase (given
Wash Sale Rule
-The sale of a particular security at a loss, immediately followed by (or preceded by) the repurchase of the same or a "substantially identical" security. The loss is disallowed for tax purposes.
-The wash sale period lasts for 61 days
30 days before the
Rate Anticipation Swap
-A type of bond swap
-Exchange bonds to take advantage of expected change in interest rate levels
-Interest rates rise, prices go down, makes client sad, moves to short-term
-Interest rates go down, prices rise, makes client happy, moves to long-term
Efficient Frontier
-Shows the optimum combinations of risk and return
-For a given level of risk, the highest available return, or
-For a given level of return, the lowest available degree of risk
-Points inside the frontier are available but inefficient
-Points outside the
Constant Dividend Growth Model
-Formula is included on formula sheet, but D(1+g) is listed as D1, which stands for the next year's dividend
-May have to calculate SML to find r.
-Use this when they ask, "Is client willing to buy stock at $x?" or "What is the intrinsic value?"
-Securiti
Yield to Maturity of a Bond
-Its IRR per year throughout a known holding period. Frequently used to compute the yield on a bond that has been or will be held until it matures.
-What is the YTM for a bond with a 6% coupon and 10 years to maturity, that is currently selling for $960?
After-Tax Return
-What is the rate of return they earn after taxes than with the pretax rate?
-After-tax return = Taxable Return (1 - Tax Bracket)
-For single investors with AGI above $200,000 and married with AGI above $250,000, add in 3.8% Unearned Income Medicare Contr
Taxable-Equivalent Yield
-What do you save in taxes?
-If an investment such as a municipal bond provides a tax-free rate of return, it may be useful to calculate its taxable-equivalent yield by dividing the tax-free yield by the quantity one minus the investor's marginal tax rate
Short Selling
-The investor sells borrowed stock in the expectation that it can be repurchased for delivery at a lower price
1. Borrow the stock
2. Sell borrowed stock
3. Repurchase later at a lower price
4. Return the borrowed stock
5. Pocket the difference
Collars
-An investor creates a collar by selling a call and buying a put. Use when a stock has climbed rapidly and is not expected to continue much higher
-The collar locks in a sales price within a given range
-The investor locks in a gain with the purchase of a
Protective Call Position
-An investor enters a protective call position when the investor anticipates a large decline in the price of the underlying stock
1. The investor shorts the stock
2. The investor purchases a call
-Profit is made as the stock price decreases
-Loss is limit
Protective Put Position
-An investor enters a protective put position when the investor wants to maintain the stock position, but protect against a decline in value
1. The investor buys the stock
2. The investor purchases a put
-As the stock price decreases, the value of the put
Weak Form
-Security prices reflect price and volume data
-Doesn't support technical analysis
-Supports fundamental analysis
--Recommend active management because of this.
Semi-Strong Form
-Security prices reflect public knowledge
-Doesn't support technical or fundamental analysis
-Can only beat the market with insider information but this is illegal so recommend index funds
Strong Form
-Security prices reflect public and insider knowledge
-Doesn't support technical or fundamental analysis
-There is absolutely no way to beat the market so recommend index funds
Immunization
-A mostly passive investment strategy that has the objective of safeguarding a bond portfolio from both 1. reinvestment rate risk and 2. interest rate volatility
-Get them to exactly off-set each other with no change in prices
-By matching the bond portfo
Rate Anticipation Swaps
-Exchange bonds to take advantage of expected change in interest rate levels
-As interest rates rise, prices decrease, this makes the client sad so move to short-term bonds
-As interest rates decrease, prices increase, this makes the client happy to move
Alternative Investments
Advantages
-Diversification (low correlation with traditional asset classes)
-Use of varied investment strategies
-Inefficiency (potential ability to outperform with active management)
Disadvantages
-Illiquid
-High minimum investment
-Potentially high fee
Private Placements
Regulation D - Private Placement
-Reg D provides exemptions allowing companies to sell their securities without registering them with the SEC
-Call sell to any number of accredited investors and up to 35 non-accredited investors
--"accredited investors" i
Individual Income Tax Calculation
Individual Income Tax Calculation
1. Gross Income
2. Subtract adjustments = AGI
3. Reduce AGI by the greater of the itemized deductions or the standard deduction
4. Determine and subtract personal exemptions = Taxable Income
5. Times appropriate tax rates
Above the Line Deductions
-IRA contributions
-One-half of self-employment taxes
-Self-employment health insurance deduction
-SEP, SIMPLE, and Keogh contributions by self-employed taxpayers
-Alimony payments
-Moving expenses
-Contributions to MSA and HSAs
-Higher education loan int
Itemized Deductions
Medical expenses in excess of 10% of AGI (take total and subtract 10% of AGI)
-7.5% floor for ages 65 or older
Property taxes plus state and local income taxes**
-There is an option to deduct state and local sales taxes instead of income
Qualified mortgag
Kiddie Tax
-Children under age 19 (24 if a student) are taxed on unearned income as follows
--First $1,050 of unearned income is tax-free (Child's std deduction)
--Next $1,050 is taxed at the child's tax rate
--The remaining unearned income is taxed to the child at
Sole Proprietorship
-Advantages
--Easy to establish - there are no legal requirements
--No separate tax returns - Income and expenses reported on the taxpayer's Form 1040, Schedule C
--If business loss exceeds other income, they can carry the excess loss back two years and f
General Partnership
-1065
-Advantages
--Formal partnership agreement is not required although highly recommended
--No double taxation at the partnership level
--All income and expenses flow out to the partners who then report them on their individual returns (K-1)
-Disadvant
Limited Partnership
-Advantages
--Each limited partner is liable only up to his or her capital contributions
--No double taxation at the partnership level
--Somewhat easier to raise capital due to limited partner
-Disadvantages
--Formal partnership agreement is required
--Ea
Limited Liability Partnership (LLP)
-Advantages
--Each partner is liable only for his or her torts and not those of the other partners
--No double taxation at the LLP level
--All partners may participate in management and voting
-Disadvantages
--Annual registration
Limited Liability Company (LLC)
-Advantages
--Each member is liable only up to his or her capital
--No double taxation at the LLC level (taxed as partnership if 2+ owners, sole proprietorship if 1 owner)
--No limit on the number of members
--Ease of formation
--All members may participa
S Corporation
-1120S
-Advantages
--Each shareholder is liable only up to his or her capital contributions (cash plus loans made - recourse/direct loans increase basis - not corporate debt)
--No double taxation at the S Corp level (flow-through)
-Disadvantages
--Formal
C Corporation
-Advantages
--Each shareholder is liable only up to his or her capital contributions
--Perpetual life of the C Corporation
--Generally free transferability of ownership
--Ability to raise capital easily
-Disadvantages
--Formal articles of incorporation an
Basis
-Original basis - what you paid for it
-Adjusted basis - what you paid for it (depreciation claimed)
-Amortization basis - what you paid for it (amortization claimed)
-Gift tax rule - Basis of recipient
--Basis of giver + gift tax paid on appreciation
--B
Like-Kind Exchanges (Section 1031)
-Reporting Requirements - File Form 8824 of the year of exchange
-Allowed for assets held for use in business or as an investment (must be like-kind) (not inventory or personal residence)
-A liability assumed by another property is treated as a cash payme
Alternative Minimum Tax
-Preferences
--Permanent items that are taxable or nondeductible for AMT purposes
---State and local income taxes
---2% miscellaneous itemized deductions - add back item/below the line
---7% gain on small business stock
---Tax-exempt interest on private a
Sale of a Principal Residence
-Taxpayer must have owned and used the home as a principal residence for at least 2 out of the last 5 years
--At least one spouse must meet the ownership test
--Both spouses must meet the use test
--Increases to 5 years if the taxpayer acquired the home i
Supporting an Elderly Parent or Adult Child
-Exemptions
--Available for relatives and nonrelatives who share the taxpayer's household, including elderly parents and adult children if the support test is met (50% including SS) and the parent or adult child has income below the exemption amount ($4,0
Types of Authority - Primary
-Internal Revenue Code - the tax law
-Treasury Regulations - have the force of law
-Revenue Rulings and Procedures - May be relied on but are not law
-Private Letter Rulings - May be relied on only by the taxpayer who requested it
-Court Cases - May be re
Gross Income
-Compensation for services
-Income from businesses after expenses
-Gains from dealings in property
-Interest
-Rents less expenses
-Dividends
-Alimony received
-Unemployment compensation
-Annuities
-Income from life insurance and endowment contracts
-Pensi
Grantor Trusts
-A trust established by the grantor where the grantor is deemed to be the owner of income tax purposes
-The grantor reports all of the trust's income and expenses on his or her own individual income tax return
-If it can benefit the grantor or spouse in s
Simple Trusts
-Must distribute all income annually to the beneficiaries (capital gains are generally not considered to be income)
-Trust income is taxable to the beneficiaries
-Simple trusts may not accumulate income
-No standard deduction at the trust level
-$300 exem
Complex Trusts
-Not required to distribute all income annually to the beneficiaries
-Trust income is taxable to the trust if not distributed to beneficiaries. Income distributed is taxed to the beneficiary.
-May accumulate income
-No standard deduction at the trust leve
Tax Reduction/Management Techniques
-Income Shifting
--Shifting taxation to the family member in the lowest tax bracket, so as to reduce the overall taxation to the family unit as a whole
---Hire family members to work in the family business
--Transfer ownership of income-producing assets t
Wash Sales
-The sale of a particular security at a loss, immediately followed by the repurchase of the same or a "substantially identical" security
-Disallowed for tax purposes
-The wash sale period lasts for 61 days
--30 days before the sale
--The day of the sale
-
Installment Sales
-Tax treatment is automatic unless the taxpayer elects out of the installment sale method
-Tentative gross profit = sales price - transaction costs - adjusted basis
-Gross profit percentage = tentative gross profit / sales price
-Amount included in income
Passive Activity Rules
-Active
--Taxpayer materially participates in the activity of generating income
--Losses are deductible
--Examples: salary, general partnerships, self-employment income
-Passive
--Taxpayer doesn't materially participate in the activity of generating incom
Alimony
-Deductible for the payer and taxable to the receiver if
--Legally required by decree and paid in cash or like cash
--Continues only until the death of the receiver
--Payer and receiver cannot be in the same household
-Excess alimony in the first two year
Tax Penalties
-Frivolous return - $5,000
-Negligence - 20% of the underpayment
-Civil Fraud - 75% of the underpayment
-Failure to file - 5% of the tax due per month with a max of 25%
-Failure to pay - .5% each month the tax is unpaid
-Estimated tax - Taxpayer pays 90%
Tax Forms
Schedule A - Itemized Deductions
Schedule B - Interest and Ordinary Dividends
Schedule C - Profit or Loss from Business (Sole Prop)
Schedule D - Capital Gains and Losses
Schedule E - Supplemental Income and Losses
Schedule H - Household Employment Taxes (
Self-employment Tax
-14.13%
-Doesn't include:
--Real estate income or rents paid
--Distributive share of income or loss of a limited partner
--Wages from an S Corporation (FICA wages)
--Distributions (K-1 income) from an S Corportation
-Does include:
--Net Schedule C income
FICA Taxes
-Employee and employer each pay (6.2% + 1.45%) or a total of 15.3% up to $118,500. After they reach this, each pays Medicare taxes of 1.45% or a total of 2.9% (unlimited)
Child and Dependent Care Credit
-Until age 13
-Limited to $3,000 for one dependent. 20% = $600
-Limited to $6,000 for two or more dependents. 20% = $1200
Child Tax Credit
-$1,000 for each qualifying child under 17
-Son, daughter, stepchild, or foster child
-Phased out above $110,000 MAGI for MFJ
Net Operating Loss
-If a firm's business operations for a taxable year result in an excess of deductible expenses over gross income, this excess is labeled a NOL and is reported as such on its tax return. Because it reports no taxable income, the firm obviously incurs no cu
Section 1244 Qualified Small Business Stock
-The best of both worlds
-Only applies to the first million dollars of stock (C or S) issued after incorporation
-Loss of $100,000 per year (JT) ($50,000 otherwise) is ordinary, not capital loss
Ex: Bob loses $150,000 after closing his business - Can take
Section 179 Deduction
-This is an election to expense up to $500,000 of qualifying property in the year of acquisition.
-It's tangible personal property (1245 property).
-It cannot create a loss
Amortization
-A business may own a variety of assets with no physical substance, like goodwill.
-Intangibles are amortized under a tax section called Section 197 intangibles.
-Similar to straight-line method
Publicly Traded Partnership
-AKA master limited partnerships (MLP)
-Partnership is publicly traded if the interests in such partnership are traded on an established securities market or readily tradable on a secondary market
-Income may not be sheltered by passive losses from any ot
Non-Publicly Traded Partnership
-Referred to as RELPs (real estate limited partnership)
-Losses from these nonpublic limited partnerships (called passive activity losses or PALs) can only be used to offset income from nonpublic limited partnerships (called passive income generators or P
Material Participation vs Active Participation
-Material Participation: A taxpayer will be treated as materially participating in an activity only if the taxpayer is involved in the operation of the activity on a regular, continuous, and substantial basis
-Active Participation: A less demanding standa
Renting Your Vacation Home
Personal use cannot exceed the longer of 14 days or 10% of the rental use
Low Income Housing Programs
-Those that are held as passive activity may generate a deduction-equivalent tax credit up to $25,000. No income phaseout.
-Take marginal tax bracket (39.6%) and multiply by $25,000 - $9,900 credit.
Housing Credit (low-income)
-Allowed annually over a 10-year "credit period." -Depreciation is straight-line over 27.5 years.
Oil and Gas Working Interests
-Exempted from PAL rules
-Losses for which the taxpayer is personally liable are deductible against active or portfolio income without limits and w/out respect to AGI.
-To qualify, the form of ownership may not limit the taxpayer's personal liability.
-If
Phantom Income (Real Estate)
-Occurs in a tax shelter where real estate properties, having declined in market value, are refinanced or the debt is forgiven.
-Income arises from portions of debt that are forgiven and recaptured.
Divorced Filing Status
-A taxpayer divorced under a final decree by the last day of the year is considered unmarried the entire year.
-They should file as a single person (no children) or HOH (children).
Alimony Recapture Calculations
-If there is no alimony paid in the 3rd year, subtract the total of the 1st and 2nd year payments by $37,500
-If there is a 3rd year payment, take the third year payment multiply it by 2 and add it do $37,500. Then subtract total of 1st and 2nd year payme
Qualified Charitable Distributions (QCDs)
-Can be made only if the distribution is made on or after the date the IRA owner or beneficiary actually reaches 70 1/2.
-Apply to IRAs and after-tax Roth IRAs
-Do not apply to employer plans
-Are capped at $100,000 per person per year
-Apply only to taxa
Benefits for Spouse, Children, and Dependent Parents
Retirement and Disability Survivor (Fully Insured)
Worker Based on PIA X (dead)
Spouse @ FRA 50% of PIA 100% of PIA
Spouse @ age 62 35% of PIA 81% of PIA
Spouse @ age 60 x 71.5% of PIA
Spouse caring for child < 16 50% of PIA 75% of PIA
Child < age 18 50%
Social Security Tax Percentages
-Social Security Tax (FICA tax)
--6.2% by employers
--6.2% by employees
--12.4% by self-employed individuals
--$118,500 in 2016
-An additional 1.45% is paid by both employers and employees (2.9% if self-employed) on wages for Medicare
--Employees pay an a
Working After Retirement - Earnings Test
-Benefits reduced by $1 for every $2 earned over $15,720 in 2016 for workers less than FRA.
--If you earn $17,720, your benefit will be reduced by $1,000
--Special monthly test: If you collect in July, 1/12 of the annual limit is applied each month
---$15
Taxation of Social Security Benefits
Single MFJ
$34,000 $44,000 ----->If above these, 85% subject to tax
------> If combined income is between these, then 50% is taxed
$25,000 $32,000 ----> If combined income is less than these, then none of SS is taxed
*Combined income (Provisional Income)
Distributions Exempt from 10% Penalty for IRA/SEP/Roth IRA (SIMPLE IRAs-25% during first 2 years of participation)
-Death of participant/owner
-Disability of participant/owner
-Substantially equal periodic payments (72t)
-Medical Expenses (over 10% of AGI)
-QDRO for alternate payee
-Medical insurance for the unemployed
-Higher education costs
-First-time home buyer co
Distributions Exempt from 10% Penalty for Qualified Plan/403(b)
-Death of participant/owner
-Disability of participant/owner
-Substantially equal periodic payments (72t)
-Medical Expenses (over 10% of AGI)
-QDRO for alternate payee
-Separation from service after age 55
Defined-Contribution Plans (DC)
-Employer contributes an amount
-Individual accounts established for employees (accounts may be pooled)
-Employees bear all investment risk
-Favors younger employees who have a longer period of time to accumulate funds for retirement
-Older employees will
Money-Purchase Plan
-Employer required to make contributions based upon contribution formula
-Plan is subject to minimum funding standards
-Employer minimum funding contributions are deductible - limited to 25% of participating payroll
-Annual additions limited to lesser of
Target Benefit Plan
-Combines DC and DB plan features
-Employee still bears investment risk
-Employer makes annual contributions
-Amounts are actuarially allocated based upon participant's age and compensation
-Plan allows older employees to accumulate wealth faster
-Deducti
Safe Harbor 401(k) Plan
-Employee contributions
--Pre-tax salary reductions up to $18,000 (catch-up and Roth)
-Employer contributions
--Employer must either 1. Match 100% of employee's deferral on the first 3% deferred and 50% on the next 2% deferred or 2. Contribute 3% to all e
Stock Bonus Plan
-Employer contributions either made in company stock or used to purchase company stock
-Nondiscriminatory allocation of contributions
-Distributions from plan usually made in stock
--Basis in stock treated as ordinary income and all appreciation taxed as
Employee Stock Ownership Plan (ESOP)
-Leveraged stock bonus plan (LESOP)
--Employer establishes a trust
--Trustee purchases company stock with a bank loan secured by the employer
--Employer makes tax deductible contributions to bank to pay off loan
-Ideal client: Is a business owner who want
New Comparability Plan
By using cross-testing, it considers:
-The employee's age
-The employee's salary
-The employee's job
--Every group is able to have a different allocation formula based on the age and compensation of the employees within the group
Ideal client: older busin
Thrift of Savings Plan
-Operate similarly to 401(k) plans, except
--Employee contributions are not tax deductible
--Employer contributions are fully deductible provided the plan remains qualified
--Lesser of 100% of compensation or $53,000 per participant per year in 2016
-Idea
Defined-Benefit Plans (DB)
-Employer promises to pay specified benefit at retirement
-Employer bears investment risk
-Individual accounts are not established
-Employer is allowed to deduct contributions up to the required funding amount
-Employee allowed to defer income
-Employee (
Traditional DB Plans
-An actuary determines the annual normal cost of funding benefits promised under the plan
--The employer is required to make minimum contributions
-Ideal client: Owns a family business (needs lots of money saved fast due to reinvesting in business for so
Cash-Balance Plans
-Hybrid DC and DB plan (it is a DB plan)
-Employer bears only the investment risk up to a set rate of return (guarantees 7%)
-Individual accounts not established, but they are hypothetical so that investors can better understand how much they can expect i
412(i) Plan
-A DB plan funded solely with life insurance and annuities (guaranteed rate is low)
--It is possible to contribute more to this plan due to low guaranteed returns
-Ideal client: Small business owner where the owner is typically within 10 years of retireme
Incentive Stock Option Income Tax Implications
At grant
-No regular or AMT income
At exercise
-No regular income
--Regular basis = exercise price
-AMT income equal to the bargain element
--Bargain element
---FMV at exercise - exercise price (+AMT adjustment)
--AMT basis
---FMV at exercise
At sale
-Reg
NSO Income Tax Implications
At grant
-No regular or AMT income
At exercise
-The employee includes in salary (subject to withholding) the amount equal to the bargain element
--Bargain element (OI/W-2 salary bonus)
---FMV at exercise - exercise price
--Regular basis
---FMV at exercise
Net Unrealized Appreciation (NUA)
If a lump-sum distribution includes employer securities, the NUA in the value of the securities is not taxed to the employee at the time of distribution
-This amount of appreciation will be taxed to the employee when the employer securities are sold
--At
Medicare Eligibility
Anyone age 65 or over who is eligible for Social Security benefits will be covered by Part A at no charge
-Including a nonworking spouse eligible for SS spousal benefits
Everyone eligible for the no-cost Part A coverage is also able to purchase Part B cov
Medicare Enrollment - Part A
-Those receiving SS benefits prior to age 65 are automatically enrolled in Medicare Parts A and B at age 65
--Will receive a Medicare insurance card in the mail three months before turning age 65 to start in month you turn 65.
-Those not yet receiving SS
Medicare Enrollment - Part B
-When you apply for Part A, you automatically get Part B as well unless you opt out of it
-Anyone who doesn't apply for Part B when they are initially eligible can apply later, during general enrollment periods, which are the first 3 months of each year
-
Medicare Part D
-Provides coverage for prescription drugs
-The client can select from a wide range of policies
-Enrollment in the Part D prescription drug plans is not automatic and is separate from enrollment in Parts A and B
Taxation of IRA Distributions
-Traditional deductible IRAs - 100% taxed as OI
-Traditional nondeductible IRAs
--Pro rata allocation of return of capital and earnings based upon account balance
---Return of capital not taxed
---Earnings taxed as OI
-Required Beginning Date: Distributio
Roth IRA Excess Contributions
-There is a 6% nondeductible excise tax on all excess contributions each and every year the excess remains in the IRA
--Taxpayers can receive back an excess contribution for this year prior to April 15th of next year in order to avoid this 6% excise tax
-
Roth IRA Conversions
-Taxpayers can convert a traditional IRA to a Roth IRA if they pay ordinary income taxes on the accumulated earnings and previously deducted contributions (no 10% penalty)
-There are no AGI limitations or filing status requirements in 2016
-Recharacteriza
Taxation of Roth IRA Distributions
-Nontaxable distributions if
--Made 5 years after initial contribution to Roth IRA, and
--The distributions are:
---After the taxpayer turns age 59 1/2
---After the taxpayer dies
---After the taxpayer becomes disabled
---For a first-time home purchase of
Simplified Employee Pension Plan (SEP)
-Must cover all employees who
--Are over 21
--Worked for the employer 3 out of the last 5 years
--Earned at least $600
-Funded exclusively by employers
--Lesser of 100% of compensation or $53,000 per participant per year
--Up to 25% of participating payro
Salary Reduction SEP (SARSEP)
-May NOT be established after 1996
-Existing plans with up to 25 employees may continue, provided at least 50% of the eligible employees elect to participate
--Same employee eligibility requirements as a SEP
-Employee contributions in form of salary reduc
SIMPLE 401(k) Plans
-Employer may not
--Have more than 100 employee
--Sponsor any other type of qualified plan, tax deferred annuity of SEP plan
-Plan is exempt from discrimination tests (ACP and ADP)
-Loans are available
-Employees eligible to participate at the later of ag
SIMPLE IRAs
--Employer may not
--Have more than 100 employee
--Sponsor any other type of qualified plan, tax deferred annuity of SEP plan
-Plan is exempt from discrimination tests (ACP and ADP)
-Employees eligible to participate at the later of age 21 or 1 year of se
403(b) Plan
-Also called TDA and TSA (tax-sheltered annuity)
-Can be established only by 501(c)(3) tax-exempt organizations and public school districts
-Not considered qualified plan, although subject to similar restrictions
-Plan investments limited to annuity contr
Section 457 Plans
-Funded plans for gov't and tax-exempt employees (not religious organizations)
-Employee deferral limited to $18,000 or 100% of compensation **In addition to 401(k)/403(b) contributions
--Roth option
--Can make deductible IRA contribution
-Catch-up contri
Keogh (HR-10) Plans
-Either DC or DB plans for self-employed employees (sole proprietors and partners in partnerships)
-Matching contributions are not considered part of elective employee contribution
-Adjusted percentage formula for owner/employee
--Plan contribution % / (1
Required Beginning Date (RBD)
-RBD is April 1st of the year following the year of employee's 70 1/2 birthday
--Can be delayed for any qualified plan, 403(b), or 457 plan until employee retires (not IRAS) and provided they are <5% owner
---If an employee is still working for the compan
Required Minimum Distributions
-RMD During Lifetime
--Calculated under Uniform Lifetime Table unless designated beneficiary is the taxpayer's spouse more than 10 years younger
--The ULT assumes joint life expectancy of taxpayer and a designated beneficiary 10 years younger
---Regardles
No named beneficiary, trust, estate for IRA death before RBD
-Full distribution required by December 31 of the year containing the 5th anniversary of the participant's death
-5 year rule
Named non-spouse for IRA death before RBD
-If distributions begin by December 31 of the year following the year of death, can stretch over lifetime.
-Account title must include both the name of the deceased participant and the name of the beneficiary. For example, "Ima Deadman's (deceased) IRA fo
Named non-spouse - did not start distributions by December 31 of the year following the year of death for IRA death before RBD
-Full distribution required by December 31 of the year containing the 5th anniversary of the participant's death
-5 year rule
Spouse who is older than deceased participant for IRA death before RBD
-Do not roll to own IRA - can leave in and delay distributions until December 31 of the year the participant would have reached age 70 1/2
Spouse who is younger than deceased participant and over age 59 1/2 for IRA death before RBD
-Roll to own IRA and RMD will begin based on surviving spouse reaching age 70 1/2
Spouse who is younger than deceased participant and under age 59 1/2
-Leave in deceased participant's account to access penalty-free then roll to own IRA upon reaching age 59 1/2
-Doing this allows no penalty since death is an exception
No named beneficiary, trust, estate for IRA death after RBD
-Use deceased participant's life expectancy in the year of death; reduce by one each year (or choose lump-sum distribution)
Named non-spouse younger than deceased participant for IRA death after RBD
-Use beneficiary's age as of December 31 of the year following the year of death and the One-Life Table. Creates a fixed period for distribution (each year is one year less) even if this beneficiary subsequently dies.
-If son is beneficiary and life expec
Named non-spouse older than deceased participant for IRA death after RBD
-Can use deceased participant's life expectancy to stretch
Spouse for IRA death after RBD
1. Roll to own IRA and RMD will begin based on spousal beneficiary reaching age 70 1/2; then the spouse's beneficiary can stretch over own lifetime
2. Leave in and distribute using spousal beneficiary's age as of December 31st of the year following the ye
Financial Needs Example
-Need $50,000/year in retirement in today's dollars. How much will they need in their first year if they retire in 10 years from today and inflation is 4%?
N=10
I=4
PV=50,000
PMT=0
Solve for FV
-How much will they need in their account the day they retire
Medicaid
-Provides medical assistance to those without resources to pay
-Federal government from the Centers for Medicare and Medicaid Services (CMS) - State administered - Program details can vary state-to-state
-Jointly funded by federal and state governments
-P
Medicaid Eligibility - Assets
-Max $2,000 ($3,000 for married couple) of countable assets
-NOT countable assets
--Home
--Car and personal property
--Term life insurance or whole life with little cash value
--Retirement assets that cannot be withdrawn as a lump sum (annuitized)
-Real o
Medicaid Lookback on Asset Transfers
--Medicaid has a look-back period of 60 months for asset transfers when entering a nursing home (gifts to loved ones)
--The following transfers can be made without causing a period of Medicaid ineligibility:
---Transfer to a spouse ($119,200)
---Transfer
Medicaid Spend Down Strategies
-Client uses assets to buy exempt property, such as a car or home for the community spouse
-A Medicaid qualified annuity can be purchased for the spouse of a nursing home resident
--Immediate annuity with payments to the community spouse
--To qualify, the
Qualified Plan Age and Service Requirements
-Employees must be eligible within six months after reaching the later of age 21 or one year of service
--Employers can require 2 years of service if the employees fully vest immediately
--Employers can exclude employees covered by collective bargaining a
Qualified Plan Vesting Schedules
-Employee contributions - Always 100% vested
-Employer contributions
--DC plans and Cash Balance DB plans
---Cliff vesting - 100% vested after 3 years, 0% prior to 3 years
---Graded vesting - 20% vesting after 2 years and vesting increases an additional 2
Loans from Qualified Plans
-IRAs don't allow loans (SEP, SIMPLE IRA)
-Up to 5 year term
--Except for home mortgages (max 30 years)
-Maximum loan up to lesser of $50,000 (in the same year even if loan is repaid) or 50% of vested balance
-$10,000 minimum without regard to percentage
Qualified Plan Fiduciary Considerations
-Fiduciaries must not select investments that involve prohibited transactions
-The fiduciary is relieved of responsibility for losses that may arise from the participant's direction of investments if the plan gives participants at least 3 appropriate inve
401(k)
-Allow employees to contribute
-Contribute up to $18,000 + $6,000 catch-up
-Employer can choose to match, make a non-elective contribution, make a PS contribution, or do nothing
-Can have vesting schedule
-Any number of employees
-Higher admin cost
-Subje
SIMPLE IRA
-Allows employees to contribute
-Employee can contribute up to $12,500 and $3,000 catch-up
-Employer must either match or make non-elective contribution
-Immediate vesting
-Max 100 employees
-Lower admin cost
-No ADP/ACP or top heavy testing
-No loans
Defined Benefit
-Owner is older and wants to skew benefits or contributions to himself
-Mandatory contributions
-Employer can take tax deduction for whatever amount the actuary indicates needs to be contributed to the plan
-Contribution amount is calculated by the actuar
Age-Weighted Profit Sharing
-Owner is older and wants to skew benefits or contributions to himself
-Discretionary contributions
-Employer tax deduction limited to 25% of aggregate participant payroll
-Max contribution to any participant account is $53,000
-No PBGC
*People choose thi
SEP
-Plan sponsor seeking discretionary contributions
-Contributions are fully discretionary (can make a contribution one year and never again)
-Immediate vesting
-Can be established up to the due date of the tax return, including extensions
-No employee cont
Profit Sharing
-Plan sponsor seeking discretionary contributions
-Contributions are discretionary but must be substantial and recurring
-Can have vesting schedule
-Must be established by end of year
-Can allow employee contributions via a 401(k) provision in the plan do
Substantially Equal Payments (72t)
-Methods
--Minimum distribution method
--Amortization method over life expectancy
--Annuity method - this and amort are fixed so if market goes down, this depletes the account
-Payments must be made at least annually and the amounts cannot change before t
Hardship Withdrawals
-The "hardship" must be for a heavy and pressing financial need due to illness, college expenses, mortgage, or to prevent eviction
--All other resources must be exhausted in order for a "hardship" withdrawal to be granted
-The max amount that can be withd
Lump Sum Distributions
-May be taken by employee
--Who has attained age 59 12/2
---Need not be retired
--Who has separated from the employer's service
--Who is disabled
Annuity Options from Retirement Account
-Options
--Pure or straight life annuity
--Life annuity with period certain
--Refund life annuity
--Joint-and-survivor annuity
-Amount included in income
--100% for noncontributory annuities
--Percentage based upon basis for contributory annuities
Ex: Jan
Rollover
-A rollover occurs when an employee physically receives the distribution and then deposits the amount in a rollover IRA, another qualified plan or another SIMPLE
-Rollovers are tax-free if made within 60 days of distribution
--Subject to 20% federal withh
Direct Transfer
-The direct rollover or transfer is accomplished by the trustee making payment directly to another qualified plan or rollover IRA (a trustee-to-trustee transfer)
--The taxpayer doesn't receive the cash
--Not subject to a 20% federal withholding
--No limit
Qualified Domestic Relations Order (QDRO)
-An order under state law order recognizing the right of a former spouse to benefits under the participant's qualified plan
--Former spouse is an alternate payee
--Describes the spouse's interest in the plan benefits
--Cannot override plan rules (if QDRO
Portfolio Withdrawal Strategies
-Flat amount of income
--Fixed dollar income throughout entire lifetime
-Inflation-adjusted income
--Annual income increased based on prior year inflation or a flat pre-selected inflation amount
-Performance-based income
--Annual income determined by perf
Appropriate Investments for Tax-Advantaged and Taxable Accounts
Tax-Advantaged
-Should hold:
Corporate bonds
Zero Coupon bonds
TIPS (these are all OI)
-Should not hold:
Municipal bonds
Investments that would be taxed at LTCG or qualified dividend rates if not held in a tax-advantaged account
Investments that violate r
Types of Buy-Sell Agreements
Cross Purchase agreement
-Each owner purchases a life and disability insurance policy on each of the other owners
Entity purchase (stock redemption) agreement
-The business entity purchases a life and disability policy on each other
Wait-and-see agreement
Elements of a Buy-Sell Agreement
Triggering events:
-Most common are death, disability, and retirement
-Other triggers may include divorce, bankruptcy, loss of professional license, or an inability to contribute to the ongoing success of the business (e.g. due to incarceration or disappe
Social Security Retirement Benefits
Depends on
-Average highest 35 years of the worker's earnings subject to FICA tax (AIME)
-Age at which the worker starts receiving benefits
-Inflation
-Avg wage increases
AIME - A workers AIME is their avg indexed monthly earnings
-It is determined by ind
Social Security Disability Benefits
Long-term benefit if the worker is unable to do any work for which they are suited
-Disability must last longer than one year or death
-Five month waiting period
--Benefits begin in 6th month
Not eligible if the worker earns $1,130 or more per month
Max b
Impact of Early or Late Retirement (Social Security)
Early retirement (permanent reduction)
-3 years early - 20% reduction
-4 years early - 25% reduction
-5 years early - 30% reduction
Late retirement
-8% increase in PIA benefit for one year delay in retirement (simple interest, up to age 70)
Qualified Plan Coverage Requirements
The DC and DB plans must pass at least one of the following three tests:
-Percentage test - At least 70% of non-HCEs covered by plan
-Ratio test - Percentage of non-HCEs covered equals at least 70% of HCEs covered (If the plan covers 90% of HCEs, it must
Definition of HCE Employees
Use for evaluating a plan for coverage rules!
-Employee owns more than 5% of company or
-Employee's compensation
--$120,000 in 2016 and
--Among the top 20% highest paid employees
ADP Test for 401(k) Plans
Max HCE deferral percentage:
NHCE's contribute 1-2% x 2 to find HCEs (2% and 4%)
NHCE's contribute 3-7% + 2 to find HCEs (5% to 9%)
NHCE's contribute 8% + x 1.25 to find HCEs (10%, 11.25%, ...)
ACP Test for 401(k) Plans
-Same three tests as ADP test, but total contribution is used
--Employee after-tax contribution and-or employer matching contributions
-Employer will be deemed in compliance with the above tests if
--They match 100% of employee contributions up to 3% plus
Key Employees
-Use for top-heavy rules!
Any of the following:
-Officers of the company who earn more than $170,000
-A 1% owner of the company with annual compensation of $150,000 or more
-A more than 5% owner of the company
Top-Heavy
-A qualified retirement plan when 60% or more of either the present value of the cumulative accrued benefits (DB plans) or the aggregate account balances (DC plans) are the benefit of key employees
Unrelated Business Taxable Income (UBTI)
Includes business income not related to the purpose of the trust
-Includes debt-financed real estate (excludes REITs), some limited partnerships, dividends on marginal stock
-Doesn't include interest, dividends, rents, royalties, and sale of capital asset
Social Security Eligibility
40 credits (quarters of coverage) for workers born after 1929
-Need one less credit for each year worker born before 1929
-Minimum of six credits regardless of age
To earn one credit in 2016, a worker must earn $1,260
-Maximum of 4 credits earned per year
Integration with SS for DB Plans
Integration level typically at covered compensation
-Avg wage for 35 years ending with year reach full retirement age
Higher benefit percentage up to the lesser of
-2 times the lower benefit percentage
-Lower benefit percentage plus
--.075% per year of se
Integration with SS for DC Plans
Max integration level must be the yearly SS wage base
Higher contribution up to the lesser of
-2 times the lower contribution rate
-Lower contribution rate plus 5.7%
Ex:
If 3% contribution below $118,500, then multiply by 2 and contribute 6% for earnings
Solo 401(k)
-AKA uni-401(k)
-Not subject to coverage testing and nondiscrimination rules
-Elective deferral up to $18,000 plus employer contribution with cap of $53,000
-The company can only have you and your spouse, or two partners. Part-time under 1,000 doesn't cou
Life Insurance in Retirement Plans
-Must be "incidental" to the plan. Must meet either of the tests:
1. DC plans use "percentage" limits
Whole Life - 50%
Universal Life - 25%
Term Life - 25%
2. DB plans use the "100 times" limit
The participant's DB must be no more than 100 times the expec
Funded vs. Informally Funded Plans
If a deferred compensation plan is not a naked promise to pay (nor is informally funded), for income tax purposes it may be "funded."
--The employee can freely transfer the taxable interest or
--The employee has no risk of a "substantial risk of forfeitur
Nonqualified Stock Option Definition
The right to purchase a specified number of shares of the employer's stock at a given time and a given price. No taxation occurs as long as a substantial risk of forfeiture exists.
Incentive Stock Option Definition
-Known as a qualified stock option
-A tax-favored plan for compensating executives by granting options to buy company stock
-It has limited usage relative to a nonqualified stock options because only the first $100,000 worth of ISOs granted to any employe
Thrift Savings Plans
Law Enforcement Officers, Firefighters, Custom and Border Protection Officers, and Air Traffic Controllers will be able to withdraw funds from the TSP in the amount of their choosing as long as they separate from federal service during the year in which t
4 Ways Assets Pass at Death
1. By operation of law - Property held in joint tenancy with right of survivorship will pass to the survivor
2. By contract - Retirement plans and life insurance proceeds pass according to the terms of the beneficiary designation document
3. By trust - Al
Fee Simple (sole ownership)
-100% included in gross estate
-Included in probate
-Qualifies for marital deduction if you leave it to spouse
Advantages: Full control and flexibility
Disadvantages:
-All income taxed to the sole owner
-Full inclusion in the sole owner's gross estate
-Su
Tenants in Common
-% you own is included in gross estate
-Included in probate
-Doesn't automatically pass to spouse
-Qualifies for marital deduction if you leave it to the spouse
Advantages:
-Control over the fractional interest
-Can bequeath the fractional interest at dea
Joint Tenancy with Right of Survivorship (JTWROS)
-Included in gross estate? Spouse - 50% Non-spouse - % you contributed
-Not included in probate
-Automatically passes to spouse if you leave it to spouse
-Qualifies for marital deduction if you leave it to spouse
-Partitionable without consent during life
Tenants in Entirety
-50% included in gross estate
-Not included in probate
-Automatically passes to spouse and qualifies for marital deduction
-Not available in community property states
Advantages:
-Avoids probate
-Income shared between tenants
-Consent of both spouses requ
Community Property
-50% included in gross estate and full step-up in basis
-Included in probate
-Qualifies for marital deduction if you leave it to the spouse
Advantages:
-Income shared between spouses
-Retain control over disposition of the interest at death
-Step-up in ba
Quasi-Community Property
Property acquired by the spouses while they were domiciled in states that follow the common law, and the property interest became community property when the spouses moved to a quasi-community property state
California, Idaho, Washington, Arizona, or Wisc
Advantages of a Lifetime Gift Program
-Donor can take advantage of annual exclusions, unified credit, and gift splitting
-Gifts can be leveraged using life insurance trusts, GRATs, GRUTs, and QPRTs
-The gift tax is tax exclusive, while the estate tax is tax inclusive
-Income and appreciation
Gifting Life Insurance
-New (<1 year) - Value is gross premiums paid (if you owned the policy, the full DB would be in your gross estate)
-Term - Value is unused premium (unearned premium)
-Paid-up or Single Premium - Replacement cost
-Premium-Paying Cash Value Policy (ordinary
Probate Estate
Advantages: Minimizes the possibility of future claims against the estate by heirs and creditors
Disadvantages: Delays distributions, increases costs of estate administration, all info available to public
-Includes all assets passing under the Will plus a
Ancillary Probate
An additional probate proceeding that must be repeated in any state in which the decedent owned real estate. This will cause a higher estate administration expense.
Best to avoid this by having the real estate pass under trust, contract, or operation of l
Annual Gift Tax Exclusion
-$14,000 per beneficiary per year
-Can double amount to $28,000 if spouse agrees to gift split
-Created by Congress to cover birthday, anniversary, holiday, graduation, and other gifts during the year
-Gifts that qualify for the $14,000 annual exclusion
-
GST Generation Skipping Transfers
Triggers:
Direct skip - Lifetime gift or testamentary gift to a skip person (donor pays)
Taxable distribution - Payment from a non direct skip trust to a skip person (from trust to grandson, grandson pays)
Taxable termination - All non skip interests term
Generation Skipping Transfer Tax
-Imposed on transfers to a person two or more generations younger than the donor
--Grandchildren or unrelated individuals 37.5 years younger than the donor
--In the event the grandchild's parent has pre-deceased, the grandchild steps up to the parent's ge
Irrevocable Life Insurance Trust (ILIT)
-Requirements to avoid death benefit being taxed as part of the gross estate
--Trustee applies for the life insurance policy, OR
--Grantor gifts the life insurance policy to the trust - Grantor must live 3 years after date of transfer in order for the lif
Gifts to Minors
2503(b) Trust
-Beneficiary must have a present interest in the trust income
-Income is a present interest and the remainder interest (corpus) is a future interest.
2503(c) Trust
-Trustee may accumulate income until the beneficiary reaches age 21, at which
A, B, and C Trusts
B - Bypass Trust
-AKA Family Trust, Credit Shelter Trust, Exemption Equivalent Trust, CEBT
-Typically set up under the will to receive assets that will take advantage of the applicable credit amount (put highly appreciating assets in this trust so that wh
Power of Attorney
Authorizes a person named in the document to act on behalf of the person signing the document (property, healthcare, or both)
General vs. Special POA
-A general POA will allow the person to act in all matters
-A special POA will allow the person to act on
Gift Tax Calculation
Take value of gift
-Split adjustments (divide by 2 if gift splitting)
-Annual exclusion
-Marital deduction (if applicable)
-Charitable deduction (if applicable)
= Taxable gift
Income in Respect of a Decedent (IRD)
-Income a decedent was entitled to be paid but did not receive before their death
-Asset is included in the gross estate of the decedent but there is no step-up in basis
-Income tax must be paid by the recipient
Assets qualifying:
-All IRAs and qualified
Gifts within 3 years
-Lifetime gifts made by the decedent are not included in the gross estate
Exceptions - The following gifts made by the decedent within 3 years of death will be included:
-Life insurance
-Retained interests
-Gift taxes paid (included in gross estate)
Assets Included in Gross Estate
Property owned by the decedent
General powers of appointment
Life insurance (own and someone else's_
Joint tenancy property
Joint and survivor annuities
Dower and curtesy
Retained life interests
Retained power to amend or revoke
Reversionary interest
Gift
Sources for Estate Liquidity
1. Sale of assets
-The executor can sell any assets the heirs don't want to keep
--Decedent's home
--Decedent's personal property
--Buy-sell agreements for business interests
--Section 303 redemption - allows capital gain treatment, rather than dividend t
Use and Purpose of Powers of Appointment
-A power of appointment is a way to provide flexibility in an estate plan because decisions over the disposition of property can be delayed and delegated to other persons:
--The donor can choose the property that will be subject to the power
--The donor m
5 and 5 Power
-A release or lapse of a general power in excess of $5,000 or 5% of the trust assets is deemed to be a taxable gift
--The taxpayer may owe gift taxes depending on remaining annual exclusion and unified credit
-A decedent with a 5 and 5 power will include
Ascertainable Standard
-Distributions made subject to an ascertainable standard include distributions for:
Health
Education
Maintenance
Support
-Distributions made not subject to an ascertainable standard include
Comfort
Welfare
Happiness
Crummey Power
A general power over contributions to a trust for a period of a reasonable time
-Typically at least 30 days
-Used to qualify the trust for the annual gift tax exclusion
Charitable Remainder Annuity Trust (CRAT)
-Fixed payments to the grantor (or another non-charitable beneficiary) for life or for a term of years (20 or less)
--Percentage must be between 5% and 50%
--Invasion of principal required if income insufficient
-Remainder passes to the named charitable b
Charitable Remainder Unitrust (CRUT)
-Fixed percentage of assets (revalued annually) paid to grantor for life, or a term of years (20 or less)
--Percentage must be between 5% and 50%
--May provide for invasion of principal or "make up" provision
---Net income makeup charitable remainder unit
Charitable Lead Annuity Trust (CLAT)
-Fixed payments to the charity for a term of years
--Percentage must be at least 5%
--Invasion of principal required if income insufficient
--No limit on the term of years
-Remainder passes to the named beneficiary
--Must be at least 5% (based on initial
Charitable Lead Unitrust (CLUT)
-Fixed percentage of assets (revalued annually) paid to charity for a term of years
--Percentage must be at least 5%
--Invasion of principal required if income insufficient
--No limit on the term of years
-Remainder passes to the named beneficiary
--Must
Marital Deduction
-Taxpayers may claim an unlimited marital deduction for gifts and property included in the estate passing to the surviving spouse, provided
--Surviving spouse is a U.S. citizen
---Assets passing to a non-US citizen spouse will need to be placed in a QDOT
Installment Note
-Installment sales are appropriate vehicles when the property owner is seeking income, security, and income tax deferral
-Capital gain on the sale is spread over several years, deferring tax liability over that period
-The present value of remaining payme
SCIN
-An owner can accept an SCIN installment note in a sale of assets when seeking an income stream, income tax deferral, and estate tax deduction
-The buyer can depreciate assets based on the purchase price
-The buyer (obligor) can deduct the interest paid o
Private Annuity
-Private annuities are appropriate vehicles for a sale when the property owner is seeking an income stream, income tax deferral, and estate tax reduction
-The property is transferred to the recipient for a promise (payments are not secured)
-No value of t
GRAT
Grantor Retained Annuity Trust
Fixed payments to the grantor for a term of years
Remainder passes to the named beneficiary
No additional contributions allowed
Use if
-Grantor wants fixed income
-Have hard to value assets
-Assets are expected to appreciate
GRUT
Grantor Retained Unitrust
Fixed percentage of assets (revalued annually) paid to grantor for a term of years
Remainder passes to the named beneficiary
Additional Contributions Allowed
Use if
-Grantor wants inflation protection
-Have easy to value assets
-
QPRTs
The grantor transfers a personal residence to an irrevocable trust and retains the right to live in the property for a term of years
At the end of the term of years, the trust beneficiary receives full title to the residence
-If the grantor survives the t
FLP and LLC
-The owner can make gifts of limited partnership interests or LLC interests to family members
--Owners can retain general partnership interests or controlling LLC interests to maintain control over the property or business
--Future appreciation of the pro
Corporate Stock Redemption (Section 303)
35% of the adjusted gross estate must be closely held corporation stock
Advantages:
-Stock can be redeemed to pay death taxes, estate administration expenses, and funeral expenses
-Redemption is treated as a sale, not a dividend
Special Use Valuation (Section 2032A)
An executor may elect to value real estate used in a closely held business or for farming for its actual use rather than its highest and best use
-Max reduction in value is $1,110,000 in 2016
-Real estate must be at least 25% of the gross estate
-Farm or
Adjusted Gross Estate
The gross estate less funeral expenses, administrative expenses, debt, and gift tax due, and casualty losses
Taxable Estates
-The adjusted gross estate less the marital and charitable deductions
-An "unlimited" amount of property passing to the surviving spouse can pass estate tax free if:
-The property must be included in the decedent's gross estate
-The property must actually
Gift Giving Strategies
Highly appreciated property - good to gift to a charity or donee in a lower tax bracket
Property likely to appreciate - Good to gift to remove future value from donor's estate
Income-producing property - Good to gift only if donee is in a lower tax bracke
Gift Valuation
Gift FMV is greater than the donor's adjusted basis
1. The value of the gift for gift tax purposes is its fair market value at the date of the gift
2. If the gift FMV is greater than the donor's adjusted basis, then use the donor's adjusted basis for inco
Form 709
It must be filed when and individual donor gave the following:
1. More than $14,000 to any non-spouse donee
2. More than $28,000 from a joint or community property account to any non-spouse donee
3. A gift of a future interest in any amount
4. A gift for
Irrevocable Grantor Trusts
-These are called defective or tainted trusts
-A grantor of the trust (rather than the trust itself or the trust beneficiary) will be taxed on the income produced by the trust
Violations that create a defective trust for income tax purposes:
1. A reversio
Elements of a Trust
-There must be trust property (trust principal or corpus)
-There must be a grantor (or trust or). This is any person who transfers property to and dictates the terms of a trust. The grantor must be competent.
-There must be a trustee. This is a party to w
QDOT
Qualified Domestic Trust (simple trust)
Normally all property passing outright to the surviving spouse qualifies for the marital deduction unless that spouse is not a U.S. citizen. Limitations imposed on non-citizen spouses are the following:
1. There is
Dynasty Trust
A "B" trust where transfers are made to a trust that benefits multiple future generations. A dynasty trust, free of estate, gift, and GST taxes, can last for the lives in being plus 21 years and 9 months (rules against perpetuities) or as long as local la
Achieving a Better Life Experience (ABLE - 529A)
Individuals can contribute up to $14,000. Account-holders could take distributions, provided they are for the beneficiary's disability expenses. The money is exempt from the $2,000 limit on personal assets for individuals who wish to qualify for public be
Disclaimer
A refusal by a primary beneficiary to accept the property.
No transfer is considered to have been made by the disclaiming for federal gift, estate, or generation-skipping transfer tax purposes. The following requirements must be met:
1. The disclaimer mus
Disclaimer Trust (D Trust)
Simple trust, only for marrieds
The spouse can disclaim the property yet receive a stream of income from the disclaimed bequest
Included as a clause in the decedent's will, making it testamentary in nature
The disclaimed bequest must be irrevocably transf
Section 303 stock redemption
Allows a corporation to make a distribution of a portion of the stock of a decedent that will not be taxed as a dividend.
-The business must be a regular corporation or an S corporation (closely held)
-The value must be more than 35% of the adjusted gross
Installment Method (6166)
If the estate property qualifies, the estate tax attributable to the closely held business interest (sole proprietorship, partnership, or corporation) can be paid in 10 equal installments beginning 4 years after the decedent's death. An additional advanta
Testamentary Trust
Set up by transferring assets from the decedent's estate into a trust specified under the will.
The estate will pay any estate taxes owed on the assets that pass into the trust.
No additional estate taxes will be owed by the testamentary trust after it is