CLU Income Taxation Principles 5 — Questions and Answers
Question 1: Under the passive activity loss rules of IRC Section 469, losses from a passive activity can generally be deducted against:
- Any type of income without limitation
- Passive income only, with excess carried forward (Correct answer)
- Portfolio income such as dividends and interest
- Earned income up to $25,000 annually
Correct answer: Passive income only, with excess carried forward
Passive activity losses can only offset passive activity income; unused losses are suspended and carried forward to future years.
Question 2: When a corporation redeems its stock from a shareholder, the tax treatment to the shareholder depends primarily on whether the redemption qualifies as:
- A Section 303 redemption to pay estate taxes
- A sale or exchange versus a dividend distribution (Correct answer)
- A partial liquidation of the corporation
- A redemption under Section 302 safe harbors
Correct answer: A sale or exchange versus a dividend distribution
A qualifying stock redemption is treated as a sale or exchange (capital gain/loss treatment), while a non-qualifying redemption is taxed as an ordinary dividend.
Question 3: The alternative minimum tax (AMT) was primarily designed to ensure that:
- High-income taxpayers pay at least a minimum amount of federal income tax (Correct answer)
- Corporate tax rates remain below individual rates
- Self-employed individuals pay their share of payroll taxes
- Estate and gift taxes are coordinated with income taxes
Correct answer: High-income taxpayers pay at least a minimum amount of federal income tax
The AMT was created to prevent high-income individuals from eliminating their tax liability through excessive use of deductions and preferences.
Question 4: Under the constructive receipt doctrine, a cash-basis taxpayer must recognize income when:
- They actually receive the cash in hand
- The income is made available to them without substantial restriction (Correct answer)
- A check clears their bank account
- Their employer reports the income on a W-2
Correct answer: The income is made available to them without substantial restriction
Constructive receipt occurs when income is credited to an account, set apart, or made available to the taxpayer without restriction, even if not physically received.
Question 5: Which of the following best describes the tax treatment of a 'return of capital' distribution from a corporation to a shareholder?
- Taxable as ordinary income to the full extent received
- Reduces the shareholder's stock basis and is taxable only after basis reaches zero (Correct answer)
- Taxed at the qualified dividend rate regardless of basis
- Excluded from income permanently under IRC Section 101
Correct answer: Reduces the shareholder's stock basis and is taxable only after basis reaches zero
A return of capital distribution reduces the shareholder's adjusted basis in the stock; once basis reaches zero, further distributions are taxed as capital gain.
Question 6: For income tax purposes, which of the following fringe benefits provided by an employer is fully excludable from an employee's gross income?
- A company car used 40% for personal use
- Group term life insurance coverage of $75,000
- Employer contributions to a qualified pension plan (Correct answer)
- Cash bonuses tied to performance metrics
Correct answer: Employer contributions to a qualified pension plan
Employer contributions to qualified retirement plans are excludable from the employee's gross income under IRC Sections 401 and 402 until distributed.
Question 7: A taxpayer in the 32% marginal bracket receives $10,000 of qualified dividend income. This income is taxed at:
- 32%, the same as their ordinary income rate
- 20%, the maximum qualified dividend rate for higher earners
- 0%, because qualified dividends are always tax-free
- 15%, because they are below the top bracket threshold for the 20% rate (Correct answer)
Correct answer: 15%, because they are below the top bracket threshold for the 20% rate
A taxpayer in the 32% ordinary income bracket is subject to the 15% qualified dividend rate, since the 20% rate applies only to those in the 37% or 20%-threshold brackets.
CLU Income Taxation Principles 5
Under the passive activity loss rules of IRC Section 469, losses from a passive activity can generally be deducted against: