WMS Tax Planning & Strategies 2 — Questions and Answers
Question 1: A Roth IRA conversion is generally most advantageous when which of the following conditions exists?
- The client expects to be in a higher tax bracket in retirement than they are currently (Correct answer)
- The client expects to be in a lower tax bracket in retirement than they are currently
- The client is currently in the lowest 10% tax bracket with little future income
- The client plans to withdraw the converted funds within five years of conversion
Correct answer: The client expects to be in a higher tax bracket in retirement than they are currently
Converting to a Roth IRA is most beneficial when the client expects higher future tax rates, since paying tax at today's lower rate is preferable to paying more tax on larger distributions later.
Question 2: What is the Net Investment Income Tax (NIIT) and who is subject to it?
- A 1% surtax on all investment income regardless of income level
- A 2.9% Medicare surtax on earned income above $200,000 for single filers
- A 3.8% surtax on net investment income for taxpayers whose modified AGI exceeds certain thresholds (Correct answer)
- A 5% excise tax imposed exclusively on dividend income
Correct answer: A 3.8% surtax on net investment income for taxpayers whose modified AGI exceeds certain thresholds
The NIIT is a 3.8% surtax on the lesser of net investment income or the excess of modified AGI above $200,000 (single) or $250,000 (married filing jointly).
Question 3: Which strategy allows a high-income client who exceeds the Roth IRA income limits to still fund a Roth IRA?
- Increase 401(k) contributions to reduce AGI below the income limit
- Backdoor Roth IRA: make a non-deductible Traditional IRA contribution and convert it to Roth (Correct answer)
- Open a SEP-IRA and convert it directly to a Roth IRA
- Contribute to a Roth 403(b) and roll it into a Roth IRA after retirement
Correct answer: Backdoor Roth IRA: make a non-deductible Traditional IRA contribution and convert it to Roth
The backdoor Roth IRA is a two-step strategy where a high-income taxpayer makes a non-deductible Traditional IRA contribution and then converts it to a Roth IRA, bypassing the income limits on direct Roth contributions.
Question 4: Under IRC Section 1031, which type of exchange allows a real estate investor to defer capital gains taxes?
- A like-kind exchange of real property held for investment or business use for other qualifying real property (Correct answer)
- An exchange of publicly traded stocks for investment real estate
- A charitable exchange of appreciated property for a charitable gift annuity
- An exchange of personal-use property such as a primary residence for a rental property
Correct answer: A like-kind exchange of real property held for investment or business use for other qualifying real property
A Section 1031 like-kind exchange allows investors to defer capital gains taxes by reinvesting proceeds from the sale of investment real property into another qualifying real property of equal or greater value.
Question 5: What is 'asset location' as a wealth management tax-planning strategy?
- Choosing the state of domicile to minimize state income taxes
- Strategically placing different asset classes in the most tax-efficient account type (taxable, tax-deferred, or tax-exempt) (Correct answer)
- Selecting investments based primarily on their geographic market exposure
- Registering assets under a lower-income spouse's name to reduce the household tax burden
Correct answer: Strategically placing different asset classes in the most tax-efficient account type (taxable, tax-deferred, or tax-exempt)
Asset location involves placing assets in account types where their tax characteristics are most advantageous, such as holding tax-inefficient bonds in tax-deferred accounts and tax-efficient equities in taxable accounts.
Question 6: A client who does not need their Required Minimum Distribution (RMD) for living expenses wishes to reduce their tax burden. Which strategy is most effective?
- Reinvest the RMD proceeds back into a Traditional IRA immediately
- Use a Qualified Charitable Distribution (QCD) to send up to $105,000 directly from the IRA to charity (Correct answer)
- Delay taking the RMD until the following tax year to defer the income
- Convert the RMD amount to a Roth IRA to avoid current taxation
Correct answer: Use a Qualified Charitable Distribution (QCD) to send up to $105,000 directly from the IRA to charity
A QCD allows individuals age 70½ or older to transfer up to $105,000 per year directly from their IRA to a qualified charity, satisfying the RMD while excluding the amount from gross income.
Question 7: What is the primary tax advantage that makes a Health Savings Account (HSA) uniquely powerful for wealth management clients?
- Contributions are after-tax but all withdrawals at any time are tax-free
- Contributions are tax-deductible, growth is tax-deferred, and qualified medical expense withdrawals are tax-free (Correct answer)
- There is no annual contribution limit, making it superior to all other savings accounts
- HSA funds invested in equities receive a special 0% capital gains tax rate
Correct answer: Contributions are tax-deductible, growth is tax-deferred, and qualified medical expense withdrawals are tax-free
HSAs offer a triple tax advantage: pre-tax contributions (reducing current taxable income), tax-deferred investment growth, and tax-free withdrawals for qualified medical expenses.
WMS Tax Planning & Strategies 2
A Roth IRA conversion is generally most advantageous when which of the following conditions exists?