2019 CFA level 3 qbank reading 12 estate planning in a global context answers

10/11/2018 Learning Management SystemStudy Session 5, Module 12.3, LOS 12.d > Related Material SchweserNotes - Book 2 Question #3 of 46 With respect to the e ectiveness of life insurance

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Question #1 of 46

Concerning a married couple, which of the following statements is most accurate? When one of

them dies:

A) the value of the estate in excess of the estate tax exemption is transferred to the

surviving spouse on a tax-free basis

B) estate taxes are assessed to their half of the estate, and the net estate is

transferred to the surviving spouse on a tax-free basis

C) their half of the estate is transferred to the surviving spouse on a tax-free basis.

Hans, 70, is considering gifting up to the tax-free limit of €200,000 to his son to help reduce the

estate tax (25%) that would be payable when he passes away Hans' e ective tax rate is 20%

and his son's e ective tax rate is 30% If Hans is expected to pass away in 10 years, what is the

relative value of making the gift? Assume both Hans and his son earn a 5% annual pretax rate

of return on the funds

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10/11/2018 Learning Management System

(Study Session 5, Module 12.3, LOS 12.d)

>

Related Material

SchweserNotes - Book 2

With respect to the e ectiveness of life insurance for individual investors, it is:

A) tax e cient, and the degree of control over the management of the assets is

unlimited

B) tax ine cient, and the degree of control over the management of the assets is

limited

C) tax e cient, and accessibility of assets held inside the policy can be either good or

poor, depending upon the terms of the policy

Explanation

With respect to the e ectiveness of life insurance for individual investors, it is tax e cient,

accessibility of assets held inside the policy can be either good or poor depending upon the

terms of the policy, and the degree of control over the management of the assets is limited

Depending upon the type of policy some of the value of the policy may be withdrawn as a tax

free loan Death bene ts paid to bene ciaries are generally tax free with no reporting

= [1+0.05(1−0.30)] 10

(1−0.25) [1+0.05(1−0.20)] 10

= 1.4106 = 1.27

1.1102

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A 40-year-old investor is considering setting up an account separate from her personal account

for tax purposes In the following list of estate planning tools, which of the following categories

of accounts would generally have the shortest term?

A) Foundation.

B) Generation-skipping trust.

C) Revocable trust.

Explanation

In a revocable trust the settlor, person who transferred assets into the trust, has the right to

regain control of the trust assets thus this category would generally have the shortest term

Foundations have a potentially in nite term Generation-skipping trusts are very long-term

(Study Session 5, Module 12.4, LOS 12.g)

When an investor makes a charitable gift of appreciated securities:

A) usually no gift transfer taxes are assessed.

B) the tax rate is based upon the gifting rate.

C) the recipient must pay the capital gains taxes.

Explanation

When an investor makes a gift of appreciated securities usually no gift transfer taxes are due,

the investor donating the securities is allowed to take an income tax deduction in the amount

of the fair market value of the securities, and no capital gains taxes are assessed so the

investment continues to grow tax free at the charitable organization

(Study Session 5, Module 12.4, LOS 12.f)

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When an investor makes a charitable gift of appreciated securities, in most instances the

investor is:

A) not able to take a deduction.

B) able to take a deduction in the amount of the current fair market value of the gift.

C) able to take a deduction in the amount of the capital gain.

Explanation

When an investor makes a gift of appreciated securities to a charitable organization, in most

countries the investor is able to take a deduction in the amount of the current fair market

value of the gift

Maddie, 77, is wondering whether it would be wise to help her granddaughter, Emily, reduce

her mortgage with funds Maddie plans to leave to Emily in her will Maddie has $150,000

available to gift today and has a life expectancy of two years If Maddie holds onto the funds

she expects to earn 3.0% annually, subject to an e ective rate of tax of 18% The rate of return

that Emily will receive is expected to be 4.5% annually which is e ectively the rate of interest on

the mortgage Emily's e ective tax rate on these funds will be 0% If the tax on gifts is 40% and

the tax on estate bequests is 35%, should Maddie gift the funds now assuming Emily pays the

gift tax

A) No, as the relative value of the taxable gift is less than 1.

B) No, as the estate tax is less than the gift tax.

C) Yes, as the relative value of the taxable gift is greater than 1.

Explanation

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The relative value of the gift is less than 1.0, it would be more bene cial for the transfer to

occur upon Maddie's death Note that the answer choices all focus on RV considerations only

so do not bring up other issues (e.g there is another bene t in that by waiting, Maddie

retains the ability to change her mind) Also the assumption of 0% tax on the mortgage

interest was explicitly given and also reasonable Interest is often tax deductible so $100 of

interest costs $100 of pretax income and reduces after-tax disposable income by $100, an

e ective tax on the deductible interest of 0%

(Study Session 5, Module 12.3, LOS 12.e)

Deemed disposition is a taxation method in which a country can mitigate against lost revenue

by applying a tax to the:

A) estimate future income of citizens who move to another country.

B) unrealized gains on assets of citizens who move to another country.

C) total value of assets owned by citizens and the estimated future income of citizens

who move to another country

Explanation

Deemed disposition is a kind of exit tax and it is normally applied to any unrealized gain on

the assets Exit taxes in the form of taxing income for some speci ed number of years after

moving is a di erent kind of exit tax, but it is not deemed disposition and the taxes are based

on actual future income as earned, not estimated future income

(Study Session 5, Module 12.5, LOS 12.j)

= [1+0.045(1−0.0)] 2 (1−0.40)

(1−0.35) [1+0.03(1−0.18)] 2

= 0.6552 = 0.96 0.6824

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A wealth owner is most likely to make a trust the bene ciary on a life insurance policy in which

of the following circumstances?

A) The tax on gifts is high.

B) The wealth owner wishes to leave money to a charity.

C) The ultimate bene ciary is a minor.

Explanation

The trust can be structured to allow the trustee to use the trust assets to provide for the

bene ciary's needs, but delay transfer of the assets until the minor is old enough to take

responsibility for the assets Given the case facts there is no particular reason not to make a

direct distribution to the charity It might even be better to make an outright gift now and get

a tax deduction now There is no information to assume gift tax rates would be treated

di erently for a direct payout or payout to a trust

(Study Session 5, Module 12.4, LOS 12.h)

A) Location of the family home.

B) Foreign language pro ciency.

C) Percentage of income earned within the country.

Explanation

Residency refers to where you are treated as living for tax purposes Having a residence or

how long you spend in the country are objective plausible indicators of residency Language

skills are more subjective and not generally considered Percentage of income is not a factor

because it is not unusual for income to be earned from multiple countries, hence the

existence of tax treaties to deal with multiple income sources

(Study Session 5, Module 12.5, LOS 12.i)

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Using the credit method and assuming an individual is taxed on foreign income at a rate of 50%

and their domestic tax rate is 40% what percentage of taxes would they pay to their resident

country on the foreign income?

A) 10%.

B) 0%.

C) 40%.

Explanation

Under the credit method the residence country allows the individual to take a tax credit for

taxes paid to a source country The tax rate paid by the resident on the foreign source

income is the greater of the domestic and source tax rates

If the individual lives in a residence jurisdiction that charges 40% taxes on world-wide

income, and they have income from a foreign country that enforces source jurisdiction and

charges 50% income tax, the individual will end up paying 50% income tax to the foreign

country If the tax rates were reversed (i.e., 50% domestic, 40% foreign) the individual would

still pay tax on the foreign source income at 50%, but the taxes will be split between the

resident and source countries: 10% to the residence country; 40% to the source country

(Study Session 5, Module 12.5, LOS 12.k)

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Equation #1 below shows the relative value of a tax free gift if it is gifted today (numerator)

compared to if it is gifted as part of an estate (denominator)

1

Equation #2 below shows the relative value of a taxable gift (numerator) when the gift is

subject to gift taxes compared to if it is gifted as part of an estate (denominator)

2

Equation #3 below shows the relative value of a taxable gift when the donor pays the gift

taxes (numerator) compared to if it is gifted as part of an estate (denominator)

The type of jurisdiction where a country taxes the income of its residents regardless of where

they live and where the income was generated is called:

A) territorial tax jurisdiction.

B) residence jurisdiction.

C) source jurisdiction.

Explanation

Under residence jurisdiction, the most prevalent type of jurisdiction, a country taxes the

income of its residents, whether generated inside or outside the country Citizens of

residence jurisdiction countries pay taxes on their worldwide income, regardless of their

current place of residence (i.e., whether currently living in the country or not)

Under source jurisdiction (a.k.a territorial tax system) a country levies taxes on all income

generated within its borders, whether by citizens or foreigners

(Study Session 5, Module 12.5, LOS 12.i)

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In which of the following circumstances would an insurance policy most likely be bene cial for

estate planning?

A) There is not likely to be any legal challenge to the will.

B) The estate has a relatively large and illiquid asset.

C) The jurisdiction where the estate lies has no estate or inheritance taxes.

Explanation

Life insurance policy payouts can provide cash to meet obligations If the other assets are

illiquid, this will be more useful With no estate or inheritance tax, liquidity needs will be

lower, not higher Insurance payouts can also be structured to avoid probate and so would

be more useful if legal challenges were expected

(Study Session 5, Module 12.4, LOS 12.h)

The type of jurisdiction where a country taxes assets transferred from one person to another

within a country regardless of whether or not they are citizens or foreigners is called:

A) source jurisdiction transfer taxes.

B) residence jurisdiction transfer taxes.

C) territorial tax jurisdiction transfer taxes.

Explanation

Under source jurisdiction transfer taxes are levied on assets located within (e.g., real estate)

or transferred within a country, whether by citizens or foreigners Under residence

jurisdiction citizens and residents pay transfer taxes, regardless of the world-wide location of

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The primary motivation for estate planning is to minimize taxes

Investors use estate planning tools for all of the following reasons EXCEPT to:

A) maximize wealth for heirs or others.

B) maximize investment returns.

C) increase the e ciency of the transfer of assets to others.

Explanation

Investors often use estate planning tools such as trusts, foundations, and life insurance, to

minimize taxes and increase the e ciency of the transfer of assets to others In so doing,

they will maximize the value of wealth given to heirs or others but has little or no impact

upon investment returns

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When one spouse dies, the tax-free transfer of assets between spouses means that the

surviving spouse will continue to receive dividends and interest from the entire estate:

A) with the exception of that which would have been lost to estate taxes.

B) including that which would have been lost to estate taxes.

C) but half of the principal is placed in a trust.

Explanation

When one spouse dies, the tax-free transfer of assets between spouses means that the

surviving spouse will continue to receive dividends and interest from the entire estate,

including that which would have been lost to estate taxes

Mary, who usually resides in Country A, has recently transferred ownership of a home that she

owns in Country B to her son, Warren She had been renting out the property and had paid

taxes on the rental income to Country A She is also liable to pay a gifting tax in Country A on

the transfer Which of the following statements is most likely to be correct?

A) Country B has a source jurisdiction.

B) Country B must not have a wealth transfer tax system.

C) Country A has residence jurisdiction.

Explanation

She usually resides in A and A is taxing income generated in B This describes A as a

residence taxation country We have no information about what is happening in Country B

(Study Session 5, Module 12.5, LOS 12.j)

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Which of the following statements regarding life expectancy and life span is CORRECT?

A) One-third of all people in a given pool fail to reach their life expectancy.

B) One-half of all people in a given pool reach their life span.

C) One-half of all people in a given pool reach their life expectancy.

Explanation

One-half of all people in a given pool reach their life expectancy By de nition, 100% of

people reach their life span, what ever its length may be

(Study Session 5, Module 12.2, LOS 12.c)

Arthur and Doris are married with 4 adult children and $2,400,000 in marital assets Doris is

just about to receive an inheritance of $600,000 in separate property from her late Uncle's

estate and is wondering how to structure her will They live under a community property

regime, where the surviving spouse has a right to half the marital estate The forced heirship

rule also entitles a surviving spouse to one-third of the total estate and entitles the children to

split another one-third of the total estate Can Doris legally bequest $1,000,000 to the local

Arthur would be entitled to half of the marital assets (50% x $2,400,000 = $1,200,000) Arthur

would be entitled to one-third of the total estate (33.3% x ($2,400,000 + 600,000)=

$1,000,000)

Arthur is entitled to the greater of these two amounts and will therefore receive at least

$1,200,000 The children would be entitled to one-third of the total estate (33.3% x

$3,000,000 = $1,000,000 combined)

Thus, Arthur and the children will be entitled to at least $2,200,000 between them and only

$800,000 is left for other distributions

(Study Session 5, Module 12.1, LOS 12.b)

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Estate taxes are an example of a tax on:

A) capital gains on assets transferred.

B) a percentage of assets gifted.

C) the value of assets owned.

Explanation

Estate taxes are a tax based upon the value of assets owned by the decedent

The four main targets of taxation are: income tax, spending tax, wealth tax, and wealth

transfer taxes Of the four main targets taxes on spending (expenditures) are ordinarily least

relevant to the investment process

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The legal process that takes place at death in which a court is involved is known as:

A) the testamentary process in which the decedent’s assets are transferred according

to their will

B) the intestate process in which the decedent’s property is inventoried and claims

against the decedent are resolved

C) probate in which among other things the validity of the decedent's will is

determined, and their remaining property is distributed

Explanation

Probate is a legal process that takes place at death, during which a court determines the

validity of the decedent's will, inventories the decedent's property, resolves any claims

against the decedent, and distributes remaining property according to the will The most

common tool used to transfer assets is a will (also known as a testament) A will is the legal

document that states the rights others will have to your assets at your death If a person dies

without a will or their will is determined to be invalid, then they are said to have died

Serge, a resident of Country C, is looking to reduce his taxes by not declaring income he has

earned from an o shore investment trust domiciled in Country D If Country C has a residence

jurisdiction, which of the following statements is most likely correct?

A) If there is a credit method tax treaty, Serge will only owe taxes in Country D.

B) Serge would likely be guilty of tax evasion.

C) Serge is attempting legal tax avoidance.

Explanation

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