Student Question from: Jessica W.

Course:  Fundamentals – Calculator

Question:  I am getting confused on when the PV should be entered as a negative or positive number for these calculator problems. If I enter it the wrong way (negative when needs to be positive) I am getting the incorrect answer. Thanks!

Instructor Response:   This is a common question.  So, the easiest way for me personally to think about it is whether cash is coming in or going out.  And you can even think about it from the perspective of coming in or going out of your checking account.  Look at the example on this page, which I’ve copied below…

Example:  Clyde has applied for a fixed-rate mortgage of $220,000 for 30 years at 7%. What is his monthly payment?

Here, Clyde will be having money come IN to his checking account, in theory.  Obviously, the money is not actually going into his checking account, but think of it as the bank gives him money to then purchase the house.  Therefore, money is coming IN, which means $220,000 is a positive PV entry.  Then you do 30 g n, and 7 g i, and you get an answer of negative $1,463,67.  That’s because every month, he must pay (cash going OUT) his mortgage of $1,463.67.

Just think of it from the perceptive of what direction cash is going.  Another example would be buying a stock.  Buy a stock today for $10 and sell it 5 years from now for $35.  The $10 would be the negative entry because cash is going OUT to purchase the stock.  The sell price of $35 would be the positive entry because you have $35 cash coming IN as proceeds from the sale.

Hope that helps!

Student Question from: Susan M.

Course:  Income Tax

Question:  On Question 2  – Why are we adding the $2,500 security in as a capital addition when it does not lengthen the life of the building?  By definition, doesn’t it have to extend the life of the asset by at least 1 year?

2. Madden Incorporated owned the building for five years, during which time the following occurred:

• The building (not the furniture) was depreciated $8,000 per year.
• The fair market value of the building increased by $30,000.
• A $2,500 security system was installed.
• The elevator was repaired annually at a total cost of $5,000.

At the end of the five-year period, what is Madden Inc.’s adjusted basis in the building?

Instructor Response:   Hi Susan!  Yeah, this one could be difficult to determine how to handle.  However, a security system would be seen as a capital addition because it increases the value of the building.  In general, when talking about capital additions, we’re talking about additions that will increase the usefulness of the asset by more than a year – not short-term repairs.  So if you repair a leaky faucet, that’s not a capital addition.  But if you replace an entire bathroom with updated fixtures and such, that is a capital addition.  Again, this includes anything that will add value to the asset.  So in this case, a security system is not just a repair or short-term fix of something.  Having a security system is going to add value to the building and could even be argued it would add to the life of the building (more than a year) by helping protect it from theft and vandalism.

Hope that helps!

In giving a talk to a small audience on the topic of estate planning, someone asks you, as a financial planner, to provide some clarifying comments regarding the recent portability of the Applicable Exclusion Amount between spouses. You would be correct in making any of the following comments EXCEPT:

1.  While the 2012 Tax Relief Act made portability permanent, it has actually been around for some time, beginning in 2001.
2.  Like the Applicable Exclusion Amount, the DSUEA that is received from a deceased spouse is adjusted annually for inflation.
3. While there is portability for estate tax purposes, there is NO portability for GST tax purposes.
4. The DSUEA received from the estate of deceased spouse #1 will be lost if the surviving spouse remarries and is subsequently predeceased by spouse #2.
5.  The surviving spouse’s estate tax exclusion amount is equal to their “basic” exclusion amount plus their DSUEA.

The correct answer is B. The maximum DSUEA is fixed at the time of death and will not increase in subsequent years following death. All the other statements are true.

A financial planner’s work is never done. The administration’s proposed 2014 budget takes aim squarely at the “permanent” estate tax reforms passed in January 2013.  The current $5,250,000 estate tax exemption would plummet $1,750,000 to only $3,500,000. The estate tax rate would jump to 45% from the current 40%.

But that’s not all. The proposal would impose gift tax on gifts in excess of $1,000,000.  Contrast that with today’s rules under which a taxpayer may gift as much as $5,250,000.

But even that’s not all.  Restrictions were proposed that would curtail or eliminate powerful tools such as  grantor-retained annuity trusts, intentionally defective grantor trusts, and dynasty trusts.

Now for the good news. These proposals are merely that.  No laws have been enacted yet.  We conclude with a planning tip.  If your client is planning to transfer a financial legacy, the time to act may be now.

To learn more about how thousands of professionals have taken the next step to obtain the CFP^® certification, visit our website at www.financialplannerprogram.com or contact an Enrollment Counselor for additional information.

Student Question from: Vincent C.

Course:  Fundamentals  – Education Planning

Question:  For the basic rule of only using cash contributions for 529 Plans, can you roll over appreciated stocks from UTMA/UGMA and ESA?  If so, do you have any taxable event tied to the rollover of stocks (if an unrealized gain exists)?

Instructor Response:   Hi Vincent.  This is a really good question.  Let me first say that unless you are a CPA, you will want to consult one before taking any action on something like this.   You don’t want to put a client in a bad situation with the IRS, nor do you want to put yourself at risk.  It’s very important that CFP^® Certificants do not give advice in areas they are not legally qualified to do so.

You can use money from a UGMA/UTMA to open a 529 Plan.  To do so, you must liquidate the assets, which would generally be a taxable event.  Again, it’s very important to consult with a tax professional if doing this because there are a few restrictions to be aware of and procedural steps you need to follow.

In regards to the Coverdell ESA, you can contribute to a 529 with these proceeds.  When you move money from an ESA to a 529, to avoid tax consequences, the transfer must be done in the same calendar year.

One more thing, in case I haven’t already mentioned it, be sure to CONSULT A TAX PROFESSIONAL before taking any action.

Hope that helps!

Student Question from: Harry F.

Course:  Estate Planning

Question:  Dan, given the information on this page, why do Grantor Trusts exist?  What purpose do they serve?

Grantor Trusts

A Grantor Trust is a trust in which the grantor, due to retained control over the income and/or corpus of the trust, is treated as the owner of the property and its income for income tax purposes.

A Grantor Trust is generally not recognized as a separate taxable entity and all of the income and deductions are treated as belonging directly to the grantor. Unless optional filing methods are elected, the fiduciary income tax return (Form 1041) is filed for a Grantor Trust as an “information return.” Dollar amounts are not shown on the return itself, but are reported on attachments to the return.

Instructor Response:   Hi Harry!  This is an interesting question!  Grantor Trusts are typically put in place because the assets can instantly be used for the purposes indicated if the grantor becomes incapacitated or dies. Also, unlike a will, when you die, the assets don’t go through probate and are not open to public disclosure.  Hope that helps!

Al wants to purchase a lake house in 20 years when he retires. The house currently costs $450,000 and inflation is 4%. As his certified financial planner, Al asks for your guidance in identifying how much he should save at the beginning of each year to accomplish his goal of purchasing the house with cash at the end of 20 years. He expects to earn12.5% annually after-tax on his investments.

1.  $5,238
2.  $8,573
3.  $9,645
4.  $11,478
5.  $12,912

The correct answer is D. Two steps are required to solve the problem

1. First, we must find the cost of the house in 20 years by using these inputs: PV=-450,000; n=20; i=4; PMT=0. The mode doesn’t matter as there are no cash flows. Solving for FV, you get a price of $986,005.
2. Leaving the figure from Step 1 as the FV, change the mode to BEGIN and enter these inputs: PV=0; i=12.5. Solving for PMT, you get an answer of $11,478.

Student Question from: Katy U.

Course:  Income Tax

Question:  On the adjusted basis portion in the question below – why is the $25,000 not included? Isn’t that a commission? I thought you are supposed to include the commission or other similar costs.

Nick purchased an office building in Year 1 for $150,000 and sold it ten years later for $350,000. He also had to pay a real estate broker $25,000 for listing and selling the property. In the ten years Nick owned the building, he depreciated it $5,000 per year and he made improvements totaling $65,000.

Adjusted Basis
Nick’s adjusted basis in the property in Year 11 would be calculated as follows.

Instructor Response:   Good question, Katy.  You are correct that, when appropriate, the commission should be included.  However, it is not included here because we are only looking at the time frame before he sold it.  The $25,000 is part of the price he paid when he sold it.  Had he paid $25,000 to an agent when he purchased the building, you would include it. But because we are calculating the basis at the time of sale, you would not include that in the calculation.  Later, if we were to calculate the realized gain, you would absolutely include it then.

Al wants to purchase a lake house in 20 years when he retires. The house currently costs $450,000 and inflation is 4%. As his certified financial planner, Al asks for your guidance in identifying how much he should save at the beginning of each year to accomplish his goal of purchasing the house with cash at the end of 20 years. He expects to earn12.5% annually after-tax on his investments.

1.  $5,238
2.  $8,573
3.  $9,645
4.  $11,478
5.  $12,912

The correct answer is D. Two steps are required to solve the problem

1. First, we must find the cost of the house in 20 years by using these inputs: PV=-450,000; n=20; i=4; PMT=0. The mode doesn’t matter as there are no cash flows. Solving for FV, you get a price of $986,005.
2. Leaving the figure from Step 1 as the FV, change the mode to BEGIN and enter these inputs: PV=0; i=12.5. Solving for PMT, you get an answer of $11,478.

Student Question from: Steve

Course:  Estate Planning

Question:  Hello Dan, The topic of “Transfers within three years of death” has been very confusing to me. My attempts to research this further on the Internet makes it even more confusing because of either incomplete or flat out incorrect information being provided. It seems that a lot of people do not understand this rule, including estate planners. Are all gifts made within 3 years of death, no matter the nature of the gift, brought back into the estate as if the gifts were never made? Or is this done only on gifts where gift taxes were paid within 3 years of death? Thanks, Steve.

Instructor Response:  Hi Steve!  Yeah, there is a lot of misinformation out there in regards to estate planning, and the rule regarding transfers within 3 years specifically.

First, let’s clarify what gifts always get added back to your estate when you die. Second, let’s clarify what gifts get added back only if made within three years of death.  And third, let’s clarify the issue of adding back taxes.

First, ALL lifetime gifts made after 1976 are added back to your estate when you die except for the following:

• Transfers to your spouse
• Annual exclusion gifts
• Gifts to charities
• Direct payment of medical care for someone
• Direct payment of tuition for someone

ALL lifetime gifts outside these exclusions are considered “taxable gifts” and are subject to taxation (much of which, if not all, will be covered by use of your Applicable Credit).

Second, SOME gifts, if made within 3 years of death, are treated as DEATH BED transfers intended to escape taxation and are added back to your estate. For our purposes, the only “gift” you need to be concerned with here is the transfer of ownership of a life insurance policy on your life.

Obviously, life insurance can be transferred at values far less than the face amount of the policy, and often can be classified as annual exclusion gifts.  Getting  such assets out of your estate can be very good estate planning. However, if you make this transfer and die within three years, it raises the suspicion of the IRS that you may have known you were going to die and did this as a “death bed” transfer to avoid taxes. Thus, they make you add back the full date of death value of the policy when you die if you don’t outlive the 3-year rule.

Third, GIFT TAXES, if paid on lifetime transfers made within three years of death, must be added back to your estate.

In other words, while you must add back all lifetime gifts under our first category above, if you made any such transfers within 3 years of death and had to pay a tax on them, then the tax paid must also be added back. Why? The reason is that when you make a lifetime gift on which you have to pay the tax, the money that goes to pay the tax is not part of the tax base (no tax ever gets figured on it).

For example, if you transfer $100,000 on which you must compute a tax, you compute 40% of $100,000 tax base, for a tax of $40,000. However, if you held all that money in your estate, your estate tax will be computed on a $140,000 tax base (for a tax of $56,000), not on a tax base of $100,000. Thus, the IRS says the transfer you made within three years of death may have been in anticipation of your death and an attempt to use a smaller tax base and pay a lesser tax. Therefore, they make you not only add back the gift (as they would have done anyway, regardless of the 3-Year Rule) but also make you add back the tax you paid (just on those transfers within three years of death), thereby requiring you to recalculate the full amount in your estate as if you had never made the lifetime transfer. When it comes time to pay your estate tax bill, you will be given a credit for the gift tax you already paid so that you don’t pay double taxes, but you will end up with a higher tax bill than you would have otherwise incurred.