Risk and Tax Considerations - Tax Considerations

The following list is composed of various items that are (and are not) subject to taxation according to the Internal Revenue Service, and should be remembered for the Series 7 exam.

Dividends: paid by a corporation, dividends are taxed as ordinary income. Some dividends qualify for the 0% or 15% tax rate, if they are paid by a U.S. or qualified foreign corporation and the investor meets holding period requirements.

2. Interest Income: interest income from treasury bills, notes and bonds is subject to federal income tax, but exempt from state income tax.

3. Municipal Bond Interest: interest income on state and local government obligations is tax-exempt.

4. Capital Gains: included in taxable income and resulting from gain on the sale of a stock or bond, most are taxable at a lower rate, usually not exceeding 15%.

5. Retirement Plan Distributions: distributions from all manner of IRAs (SEP, SIMPLE) and ERISA qualified plans are taxed as ordinary income.

6. Discount Bonds: bonds issued and sold at a discount pay not semi-annual interest. The accretion or increase in value, however, is subject to ordinary income tax on an annual basis.

7. Mutual Funds: pass through interest, dividends and net realized capital gains each year to investors. This income is reported on Form 1099-DIV. Distributions retain their character from the fund to the individual investor (e.g., what the fund receives as dividends, it passes to the investor as dividends)

8. Annuities: earnings on distributions from non-qualified annuities are taxable as ordinary income to the annuitant. Any after-tax contributions are a non-taxable return of capital to the investor on a pro-rata basis, as a general rule.

9. Step-up In Basis: securities inherited from the decedent acquire a step-up in basis. This means that the legatee's basis in the securities is their value, as of the decedent's date of death. For example, if the decedent had paid $17 a share for a stock which was worth $34 on the date of death, the recipient's basis would be $34, not $17.

10. Taxation of securities received as a gift: the transfer will be tax-free up to $13,000. Amounts exceeding this threshold are subject to gift tax. The following gifts may be given without triggering the gift tax, to wit: gifts to a spouse, charity, political organization for its use, education expenses with payment made directly to the educational institution for tuition only (books, supplies and living expenses do not qualify) and medical expenses paid directly to the medical facility.

11. The Unified Credit: because federal gift and estate taxes are unified into one system, a donor who exceeds the annual gift tax exclusion in a given year may either pay tax on the excess or utilize the unified credit, to avoid paying the tax. The Unified Credit enables the donor to give away up to $5,000,000 during his or her lifetime, without having to pay any gift tax. Use of the unified credit during life reduces the amount available to offset estate tax upon death.

Foreign Securities and Taxation
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