CFP Case Studies & Practical Application 5 — Questions and Answers
Question 1: A client is executor of her parent's estate. The estate includes 1,000 shares of Apple stock purchased for $40/share and worth $180/share at death. The estate sells the shares 6 months later at $190/share. What is the tax treatment of the $10/share gain?
- Ordinary income of $10/share because the estate is selling the stock
- Long-term capital gain of $10/share due to the stepped-up basis at death (Correct answer)
- Short-term capital gain of $10/share because held less than 12 months post-death
- No tax due because inherited assets are always tax-free
Correct answer: Long-term capital gain of $10/share due to the stepped-up basis at death
Inherited assets receive a stepped-up basis to fair market value at date of death; any subsequent gain is long-term regardless of how long the estate holds the asset.
Question 2: A 45-year-old executive receives NSOs (non-qualified stock options) to buy 5,000 shares at $20/share. The stock is now $60/share. He exercises all options. What is the income tax consequence at exercise?
- No tax at exercise; tax is deferred until shares are sold
- $200,000 long-term capital gain recognized at exercise
- $200,000 ordinary income recognized at exercise, subject to payroll taxes (Correct answer)
- AMT applies; no regular income tax is due
Correct answer: $200,000 ordinary income recognized at exercise, subject to payroll taxes
NSOs trigger ordinary income (and FICA taxes) at exercise equal to the spread: (FMV − exercise price) × shares = ($60 − $20) × 5,000 = $200,000.
Question 3: A couple age 65 has $2.5M in assets and wants $120,000/year in retirement income (inflation-adjusted). Their financial plan uses a 4% withdrawal rate. They also receive $42,000/year in combined Social Security. What annual portfolio withdrawal is needed?
- $120,000
- $78,000 (Correct answer)
- $162,000
- $100,000
Correct answer: $78,000
Social Security provides $42,000, so the portfolio only needs to fund the $120,000 − $42,000 = $78,000 gap.
Question 4: A client with a $4M estate wants to make annual gifts to reduce her estate. She has three children and six grandchildren. What is the maximum she can gift annually without using any lifetime exemption?
- $18,000 total
- $162,000 (9 recipients × $18,000) (Correct answer)
- $54,000 (3 children × $18,000)
- $36,000 using gift-splitting with her spouse to each recipient
Correct answer: $162,000 (9 recipients × $18,000)
The annual exclusion in 2024 is $18,000 per recipient; with 9 recipients (3 children + 6 grandchildren), she can gift 9 × $18,000 = $162,000 annually gift-tax-free.
Question 5: A client holds a variable annuity with a $200,000 account value and a $130,000 cost basis. She is 65 and wants to annuitize. What portion of each payment is taxable?
- 100% of each payment is taxable as ordinary income
- Only the gain portion using the exclusion ratio (Correct answer)
- 100% is excluded from income because annuity payments are always tax-free
- Payments are taxed as long-term capital gains
Correct answer: Only the gain portion using the exclusion ratio
The exclusion ratio (cost basis / expected return) determines what fraction of each annuity payment is a tax-free return of basis; the remainder is ordinary income.
Question 6: A business owner wants to fund a buy-sell agreement for a two-person partnership. Each partner is age 50 and the business is valued at $3M. Which structure avoids estate inclusion for the deceased partner's heirs?
- Cross-purchase agreement funded with life insurance on each partner (Correct answer)
- Entity purchase (redemption) funded with life insurance
- Unfunded installment sale arrangement
- Transfer-for-value agreement using existing policies
Correct answer: Cross-purchase agreement funded with life insurance on each partner
In a cross-purchase agreement, each partner owns and is beneficiary of life insurance on the other, so death proceeds are received income-tax-free and are not owned by the insured's estate.
Question 7: A client is evaluating long-term care insurance at age 55. The policy has a 90-day elimination period, a $5,000/month benefit, 3-year benefit period, and 3% compound inflation rider. She is in good health. What is the primary planning concern for her CFP to address?
- The elimination period is too short — it should be at least 180 days
- Whether the 3-year benefit period is adequate given average LTC stays can exceed 4 years for women (Correct answer)
- The inflation rider is unnecessary for a 55-year-old
- She should self-insure because premiums are too expensive
Correct answer: Whether the 3-year benefit period is adequate given average LTC stays can exceed 4 years for women
Average LTC duration for women exceeds 4 years; a 3-year benefit period could leave a significant coverage gap, especially for cognitive conditions that often last longer.
CFP Case Studies & Practical Application 5
A client is executor of her parent's estate.
The estate includes 1,000 shares of Apple stock purchased for $40/share and worth $180/share at death.
The estate sells the shares 6 months later at $190/share.
What is the tax treatment of the $10/share gain?