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

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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.

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

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Explanation

When one of them dies, their half of the estate is transferred to the surviving spouse on a
tax-free basis.

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SchweserNotes - Book 2

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Question #2 of 46

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

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

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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

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

A) 1.27
B) 1.57
C) 1.33
Explanation

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[1+rg (1−t ig )]
RV tax-free =

n

[1+re (1−t ie )] (1−Te )

[1+0.05(1−0.30)]
=

[1+0.05(1−0.20)]
=

1.4106
1.1102

10

10

(1−0.25)

= 1.27

(Study Session 5, Module 12.3, LOS 12.d)
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SchweserNotes - Book 2

Question #3 of 46

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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

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limited.

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

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Explanation

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poor, depending upon the terms of the policy.

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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
required.
(Study Session 5, Module 12.4, LOS 12.h)
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SchweserNotes - Book 2

Question #4 of 46
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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

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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.

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(Study Session 5, Module 12.4, LOS 12.g)
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Question #5 of 46

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SchweserNotes - Book 2

When an investor makes a charitable gift of appreciated securities:

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A) usually no gift transfer taxes are assessed.

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

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C) the recipient must pay the capital gains taxes.
Explanation

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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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SchweserNotes - Book 2

Question #6 of 46
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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.

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(Study Session 5, Module 12.4, LOS 12.f)
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Question #7 of 46

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SchweserNotes - Book 2

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

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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

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

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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

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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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n

[1+rg (1−t ig )] (1−T g )
RV taxable =

n

[1+re (1−t ie )] (1−T e )
2

[1+0.045(1−0.0)] (1−0.40)
=

2

[1+0.03(1−0.18)] (1−0.35)

=

0.6552
0.6824

= 0.96

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Question #8 of 46

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SchweserNotes - Book 2

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

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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%.

by applying a tax to the:

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

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

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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

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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)
Related Material
SchweserNotes - Book 2

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Question #9 of 46
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

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

SchweserNotes - Book 2

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Question #10 of 46

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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.

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Which of the following is most likely to be a factor in determining a tax payer's tax residency

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country?

A) Location of the family home.

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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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SchweserNotes - Book 2

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Question #11 of 46
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%.

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Explanation

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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.

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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.

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SchweserNotes - Book 2

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

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Question #12 of 46

Which of the following equations represents the relative value of a tax free gift?

A)

[1 - Tg  + (Tg T e x g/e)][1 + r g (1 - t ig )]

n

n

[1 + r e (1 - t ie )] (1 - Te )

B)

(1−T g )[1+rg (1−tig )]

n

n

[1+re (1−tie )] (1−T e )

C)

[1 + r g (1 - t ig )]

n

n

[1 + r e (1 - t ie )] (1 - Te )

Explanation
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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.

[1 + rg (1 - tig )]

FVtax-free gift
RV tax-free gift  = 

FVbequest

 = 

n

n

[1 + re (1 - tie )] (1 - Te )

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).
n

2.

(1−T g )[1+rg (1−t ig )]

FVtaxable gift
RV taxable gift =

FVbequest

=

n

[1+re (1−t ie )] (1−T e )

[1 - Tg  + (T g T e x g/e)][1 + rg (1 - tig )]
RV taxable gift  = 

n

[1 + re (1 - tie )] (1 - Te )

(Study Session 5, Module 12.3, LOS 12.d)
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Question #13 of 46

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SchweserNotes - Book 2

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3.

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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

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they live and where the income was generated is called:

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A) territorial tax jurisdiction.
B) residence jurisdiction.

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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)
Related Material
SchweserNotes - Book 2
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Question #14 of 46
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.

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Explanation

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

SchweserNotes - Book 2

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Question #15 of 46

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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.

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

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

A) source jurisdiction transfer taxes.

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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
the assets.
(Study Session 5, Module 12.5, LOS 12.j)
Related Material
SchweserNotes - Book 2

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Question #16 of 46
The primary motivation for estate planning is to:

A) minimize taxes.
B) maximize returns.
C) match investment horizon objectives.
Explanation

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The primary motivation for estate planning is to minimize taxes.
(Study Session 5, Module 12.4, LOS 12.f)

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Question #17 of 46

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SchweserNotes - Book 2

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

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A) maximize wealth for heirs or others.

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B) maximize investment returns.

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

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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.
(Study Session 5, Module 12.4, LOS 12.f)
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SchweserNotes - Book 2

Question #18 of 46
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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.

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(Study Session 5, Module 12.4, LOS 12.f)
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Question #19 of 46

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SchweserNotes - Book 2

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

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

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

A) Country B has a source jurisdiction.

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

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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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SchweserNotes - Book 2

Question #20 of 46
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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)

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SchweserNotes - Book 2

Question #21 of 46

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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

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

animal shelter?

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

B) Yes.

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A) No, only $800,000.

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C) No, only $500,000.
Explanation

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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SchweserNotes - Book 2

Question #22 of 46
Estate taxes are an example of a tax on:

A) capital gains on assets transferred.
B) a percentage of assets gifted.

Explanation

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C) the value of assets owned.

Estate taxes are a tax based upon the value of assets owned by the decedent.
(Study Session 5, Module 12.1, LOS 12.b)

SchweserNotes - Book 2

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Question #23 of 46

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professional?

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Of the principal targets of taxation, which is ordinarily least relevant to the investment

A) Assets transferred.

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B) Assets owned.

C) Expenditures.
Explanation

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.
(Study Session 5, Module 12.1, LOS 12.b)
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SchweserNotes - Book 2

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Question #24 of 46
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.

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Explanation

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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
intestate.
(Study Session 5, Module 12.1, LOS 12.a)
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SchweserNotes - Book 2

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Question #25 of 46

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

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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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Hiding income is normally illegal. Depending on the tax situation he may owe taxes to C or D
or both, but a blanket decision not to report the income is unwise without much more
speci c tax law knowledge (which is not covered in the CFA material). Thus it cannot be called
legal tax avoidance Tax avoidance refers to knowing the laws and selecting legal methods to
lower the tax burden, such as extending the holding period to defer capital gains taxation. If
there were a credit method treaty and D taxes the income at the source, he would likely still
owe additional taxes to C as the credit method provides only partial tax relief.
(Study Session 5, Module 12.5, LOS 12.l)
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SchweserNotes - Book 2

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Question #26 of 46
Which of the following best describes estate planning?

A) Transferring your assets during your lifetime or at death in the most e cient

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manner to the individuals you intend to receive them.

B) Transferring your assets at death to the individuals you intend to receive them in
the most e cient manner.

C) Delineating how your assets will be transferred so a court does not decide for you.

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Explanation

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Estate planning is the planning process associated with transferring your estate to others
during your lifetime or at death so the assets go to the individuals or entities you intend and
in the most e cient way.
(Study Session 5, Module 12.1, LOS 12.a)

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Related Material

SchweserNotes - Book 2

Question #27 of 46
Which of the following equations represents the relative value of a gift when it is subject to

taxes?

A)

[1 + r g (1 - t ig )]

n

n

[1 + r e (1 - t ie )] (1 - Te )
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B)

(1 - Tg  + T g T e )[1 + r g (1 - t ig )]

n

n

[1 + r e (1 - t ie )] (1 - Te )

C)

[(1 - Tg )][1 + r g (1 - t ig )]

n

n

[1 + r e (1 - t ie )] (1 - Te )

Explanation
Equation #1 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).
n

RV tax-free gift  = 

FVbequest

[1 + rg (1 - tig )]
 = 

n

[1 + re (1 - tie )] (1 - Te )

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1.

FVtax-free gift

2.

[PV(1 - Tg )][1 + rg (1 - tig )]

FVtaxable gift
RV taxable gift  = 

FVbequest

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Equation #2 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).

 = 

n

n

PV[1 + re (1 - tie )] (1 - Te )

3.

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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).
[1 - Tg  + (T g T e x g/e)][1 + rg (1 - tig )]
RV taxable gift  = 

n

n

[1 + re (1 - tie )] (1 - Te )

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SchweserNotes - Book 2

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

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Question #28 of 46

Using legal tax reduction strategies with the intention of avoiding paying taxes altogether is:

A) expected of any tax paying entity or individual and is legal.
B) considered tax evasion which is illegal.
C) anticipated by government taxing authorities which prosecute such individuals for
not paying taxes.
Explanation

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Tax avoidance is legal. Any tax-paying entity or individual would be expected to minimize the
amount of taxes paid through various legal tax-reduction strategies. Tax evasion, on the
other hand, is hiding, misrepresenting, or otherwise not recognizing income so as to illegally
avoid taxation.
(Study Session 5, Module 12.5, LOS 12.l)
Related Material
SchweserNotes - Book 2

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In relation to trusts, which of the following is least correct?

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Question #29 of 46

A) In a discretionary trust the trustee has complete discretion to distribute the assets
and income earned in the trust.

B) In a revocable trust the settlor who funds the trust is likely to be responsible for the

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trust’s tax liabilities.

C) An individual concerned with future legal liabilities should most likely consider an
irrevocable trust.

Explanation

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The trustee of a discretionary trust has discretion to make decisions consistent with the
directions in and intent of the trust document; not unlimited discretion. Thus the statement
of complete discretion is least correct. The other statements are true. Revocable trusts
normally have no tax advantages and the grantor remains responsible for the tax liabilities of
the trust. An irrevocable trust may have legal advantages in sheltering the trust assets from
claims on the grantor.

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(Study Session 5, Module 12.4, LOS 12.g)
Related Material
SchweserNotes - Book 2

Question #30 of 46
Which of the following methods results in a partial resolution to the residence-source con ict
on foreign sourced income taxes?

A) Exemption method.
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B) Deduction method.
C) Credit method.
Explanation
The Deduction Method provides only partial resolution of the residence-source con ict.
Under the deduction method, the individual pays the full tax to the source country, and is
only allowed to deduct the amount of taxes paid to the source country in calculating total
world-wide income.
The Credit Method provides complete resolution of the residence-source con ict. 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.

Related Material
SchweserNotes - Book 2

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Question #31 of 46

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

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The Exemption Method also provides complete resolution of the residence-source con ict.
Under the exemption method, the country of residence charges no income tax on income
generated in a foreign country that enforces source jurisdiction (i.e., that income is exempt
from domestic taxation). This e ectively eliminates the residence-source con ict, because
foreign-generated income is taxed by the source country, only.

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

A) Life expectancy is unknown, and life span is unknown.

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B) Life expectancy is unknown, but life span is known.
C) Life expectancy is known, but life span is unknown.
Explanation
Life expectancy is known, but the actual life span for an individual is unknown.
(Study Session 5, Module 12.2, LOS 12.c)
Related Material
SchweserNotes - Book 2

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Question #32 of 46
Joint ownership with rights of survivorship, living trusts, retirement plans, and life insurance are
all means of:

A) avoiding probate and transferring assets without the use of a will.
B) transferring assets through probate without the use of a will.
C) avoiding probate with the use of a will.
Explanation

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

SchweserNotes - Book 2

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Question #33 of 46

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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. Since probate
can be expensive, time consuming, and open to the public, individuals can avoid going
through probate without a will by using joint ownership with rights of survivorship, living
trusts, retirement plans, and life insurance.

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Once an individual reaches the retirement age a main concern is:

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A) safety of principal, with investment income being secondary.
B) establishing a spending rate that will not result in their outliving their assets.

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C) reallocating nancial assets to adopt a more conservative pro le.
Explanation

When an individual reaches retirement age the primary issue is to establish a spending rate
(i.e., an income distribution plan) that will not result in their outliving their assets.

(Study Session 5, Module 12.2, LOS 12.c)
Related Material
SchweserNotes - Book 2

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Question #34 of 46
When foreign sourced income is taxed by the foreign country and not the resident country this
is called the:

A) Exemption method.
B) Credit method.
C) Deduction method.
Explanation

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The Exemption Method provides complete resolution of the residence-source con ict. Under
the exemption method, the country of residence charges no income tax on income generated
in a foreign country that enforces source jurisdiction (i.e., that income is exempt from
domestic taxation). This e ectively eliminates the residence-source con ict, because foreigngenerated income is taxed by the source country, only.

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The Deduction Method provides only partial resolution of the residence-source con ict.
Under the deduction method, the individual pays the full tax to the source country, and is
only allowed to deduct the amount of taxes paid to the source country in calculating total
world-wide income.
The Credit Method provides complete resolution of the residence-source con ict. 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.

Related Material

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SchweserNotes - Book 2

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

Christine Davis is single, 31 years old, and is the chief nancial o cer of a small aerospace

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parts rm located in the Midwest U.S., Oshkosh Aerospace. Davis has approached William
Weinke, her nancial planner, for help in preparing an investment policy statement and
accompanying asset allocation. Tom Johnson is Weinke's assistant.
Davis would like to retire when she is 63 years old. She has stated that, relative to her mortgage
and college loans, she does not have assets of signi cant size and does not expect to receive an
inheritance. She has had di culty accumulating signi cant savings because she only recently
was promoted to CFO and before that did not receive a signi cant salary. Despite her new job
and title, Davis does not expect to have much exibility in her retirement contributions as she
has just adopted her sister's four children due to some unfortunate circumstances. She expects
to keep working at Oshkosh Aerospace until retirement because she enjoys the quality of life in
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her job. Weinke states that given Davis's age, he believes that Davis's investment policy should
emphasize mostly equities.
Given her level of comfort with the service and advice Weinke has provided, Davis has
recommended Weinke's services to the former president of her company, Frank Brooks. Franks
is 69 years old and retired two years ago from his position as the CEO and chairman of the
board of Oshkosh Aerospace. He is very wealthy with a portfolio of $14 million and very little
debt. The income from his portfolio and pension income is $600,000 annually after tax. His
living expenses consist of necessities, vacations, discretionary spending on luxuries, and gifts to
family and charities. His expenses total $400,000 annually. Weinke states that given his age and
retired status, he believes that the investment policy for Brooks should emphasize mostly

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investment grade bonds.

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Given that Johnson has only been working in portfolio management for less than a year,
Weinke likes to test his knowledge of investment principles before letting Johnson consult with
clients on his own. He asks Johnson, between Davis and Brooks, who is at the most risk for
outliving their assets, and what is the most e ective method of controlling for it. Johnson states

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that Davis is at the most risk and that the most e ective method of controlling for it would be
to recommend a life annuity for her when she retires.

In a later discussion the next week, Weinke and Johnson discuss the assets available to
investors in general. Weinke states that tax e ciency is an important consideration and that

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the tax e ciency of assets varies considerably. Weinke states that high net worth individuals
minimize taxes by transferring assets to their heirs which contain a valuation discount like

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partnerships and family businesses. Johnson states that valuation discounts are additive, for

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example, a 10% liquidity discount can be added to a 10% minority discount to equal a total
valuation discount of 20%.

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Weinke and Johnson often receive sales calls from investment bankers who are attempting to
sell an issue of securities. A recent call focused on an issue of investment grade bonds.
Discussing their attractiveness for their clients in general, Johnson states that wealthy investors
should be concerned about the tax implications from holding bonds as part of their taxable
investment portfolio. Speci cally, he states that because the coupon income from bonds
cannot be deferred, bonds are often unattractive investments from a tax standpoint for
wealthy individuals. Weinke states that if investors want to minimize the tax implications of
their investments in the taxable portion of the their portfolio they should buy equities because
they allow the investor to defer the capital gains over extended periods of time.
Brooks is considering selling some of his equity holdings because he would like to make a
major donation to his alma mater and have a building named after him. One of the stocks he
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would like to liquidate is Dumas Environmental, his former father-in-law's company. He
accumulated the shares over time and has asked Weinke to help him decide which shares to

sell.
Weinke states that instead of liquidating the stock himself, Brooks may want to gift the shares
to his alma mater. If the stock is gifted, capital gains taxes would be avoided entirely. In this
way, Weinke states that Brooks would not have to liquidate as much stock to provide the
university with the same e ective gift. Johnson adds that the gift can also provide a deduction
against ordinary income for Brooks. The advantage here, Johnson states, is that instead of

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incurring taxes by liquidating the stock, Brooks could actually save on taxes.

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Question #35 of 46

Are Weinke's statements concerning the investment policy for Davis and Brooks CORRECT?

Davis

Brooks
Incorrect

B) Incorrect

Incorrect

C) Correct

Correct

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Explanation

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A) Correct

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Weinke is incorrect regarding Davis's investment policy. Although she is young, the
investment policy for her should be more conservative than his recommended equity
allocation. She is not wealthy, does not expect an inheritance, has scant retirement savings,
and does not have the exibility to increase her retirement savings. These factors outweigh
her age and thus her investment policy should be conservative. Weinke is incorrect regarding
Brooks's investment policy. Although he is older and retired, the investment policy for him
should be more aggressive than his recommended investment grade bond allocation. Brooks
is wealthy, has income that exceeds his expenses, and much of his spending consists of nonnecessities. These factors outweigh his age and retired status, and his investment policy
should be aggressive.
(Study Session 5, Module 12.4, LOS 12.f)
Related Material
SchweserNotes - Book 2

Question #36 of 46
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Are Johnson's statements concerning outliving their assets CORRECT?

Identifying the party most at
risk

Indentifying the solution
to it

A) Correct

Incorrect

B) Correct

Correct

C) Incorrect

Correct

Explanation

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

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Outliving one's assets is a valid concern since 50% of all individuals will live longer than their
projected life expectancy based on actuarial tables. Given Davis's nancial situation, she is at
the most risk for it. The most e ective method of controlling for it would be to recommend a
life annuity for Davis when she retires. A life annuity is essentially a life insurance policy in
reverse. The investor pays a lump sum and receives a series of payments over his or her
lifespan. The investor cannot outlive the annuity unless the insurance company fails and is
unable to make the promised payments.

Related Material

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SchweserNotes - Book 2

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Question #37 of 46

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Are Weinke's and Johnson's statements regarding transferring assets with valuation discounts
CORRECT?

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Weinke

Johnson

A) Incorrect

Correct

B) Correct

Incorrect

C) Correct

Correct

Explanation

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Weinke is correct because certain assets such as partnerships and closely held family
businesses will trade at a discount due to their illiquidity and di culty in being able to
accurately value the business which reduces transfer taxes such as estate, gift, and
inheritance taxes. Johnson is incorrect because valuation discounts are not additive but are
subject to court approval and are inversely related to the size of the business being
transferred.
(Study Session 5, Module 12.4, LOS 12.f)
Related Material

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SchweserNotes - Book 2

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Question #38 of 46

Are Weinke's and Johnson's statements concerning the relative merits of stocks and bonds
from a tax basis perspective CORRECT?

Weinke

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Johnson
Correct

B) Correct

Incorrect

C) Correct

Correct

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A) Incorrect

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Explanation

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Johnson is correct because wealthy investors are in high marginal tax brackets and because
the coupon income from bonds cannot be deferred, bonds are often unattractive
investments for wealthy individuals from a tax standpoint for the taxable portion of their
investment portfolio. Weinke is correct because the capital gains on the stock would only be

taxed when the stock is sold and if the stock had been held for a long enough time period
qualifying the gain as long term the gain would be taxed at a lower rate than short term
capital gains or interest income.
(Study Session 5, Module 12.4, LOS 12.f)
Related Material
SchweserNotes - Book 2

Question #39 of 46

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In comparing tax deferred accounts versus tax free accounts which of the following statements
is most accurate?

A) Assuming equivalent rates of return between the tax free and tax deferred
investments, the tax free investment will always result in a greater accumulated
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B) If the investment returns and tax rates are equal for both the tax deferred and tax
free accounts the future accumulated value will be the same.
C) If the current tax rate is less than future tax rate then you are better o investing in
a tax deferred account.

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Explanation

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When comparing taxable, tax deferred, and tax free investment accounts the taxable account
which is taxed every year will result in the smallest accumulated value in the future. To invest
in a tax free investment one must pay income taxes rst and then invest in the tax free
investment using after tax dollars. If the current and future tax rates are the same the future
accumulated value of the tax deferred and tax free investments will be the same. If the
current tax rate is projected to be greater than the future tax rate then the investor is better
o investing in the tax deferred investment now and paying taxes at the lower tax rate in the
future. The opposite would be true if taxes were projected to be lower now then one would
be better o paying the lower taxes now and investing in a tax free investment thereby
avoiding the higher taxes in the future.
(Study Session 5, Module 12.4, LOS 12.f)

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SchweserNotes - Book 2

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Related Material

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Question #40 of 46

Are Weinke's and Johnson's statements concerning the gifting of Brooks' stock to his alma
mater CORRECT?

Weinke

Johnson

A) Correct

Incorrect

B) Correct

Correct

C) Incorrect

Correct

Explanation

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