FINRA Series 6 — All Questions

A customer deposits $9,000 in cash on Monday and $9,000 in cash on Tuesday, apparently to stay under $10,000. This pattern is called:

• a.churning, which is excessive trading to generate commissions
• b.integration, which returns the cash as legitimate income
• c.structuring, which may require a suspicious activity report✓
• d.layering, which is the first stage of money laundering

Splitting cash transactions to avoid the $10,000 currency reporting threshold is structuring, a crime in itself, and a red flag for a SAR. Layering and integration are stages of laundering. Churning concerns trading activity.31 CFR 1010.311; structuring

For how long must a firm keep the record of written customer complaints that it must maintain under FINRA Rule 4513?

• a.At least six years
• b.At least two years
• c.Until the firm closes
• d.At least four years✓

Rule 4513 requires a record of written customer complaints to be kept for at least four years. Six years is the general FINRA Rule 4511 default for books and records without a specified period, which a candidate may confuse with it.FINRA Rule 4513

A firm gives a new customer the account record within 30 days of opening the account. At what interval afterward must it furnish an updated account record?

• a.At intervals of no more than 24 months
• b.At intervals of no more than 36 months✓
• c.At intervals of no more than 12 months
• d.At intervals of no more than five years

Rule 17a-3(a)(17) requires the account record to be sent to the customer within 30 days of opening and at least every 36 months after that, with a request that the customer report changes. The other periods are not what the rule sets.SEC Rule 17a-3(a)(17)

A fund company issues a retail communication about a mutual fund. Under FINRA Rule 2210, when must it be filed with FINRA?

• a.Within 30 calendar days after first use
• b.At least 10 business days before first use
• c.Within 10 business days after first use✓
• d.Only when FINRA requests it in writing

Retail communications that promote registered investment companies are filed within 10 business days of first use. A pre-use filing is required only in special cases, such as during a new member's first year of membership.FINRA Rule 2210(c)(2)

A representative's draft mutual fund brochure for the public shows a chart of the fund's projected returns over the next five years. How should the firm respond?

• a.Reject it, because projections of performance are generally prohibited✓
• b.Approve it, once it has been filed with FINRA 10 business days earlier
• c.Approve it, if the chart shows a low estimate and a high estimate
• d.Approve it, because a principal may approve any projection that is labeled

A retail communication must be approved by a registered principal before use, but Rule 2210 prohibits predictions or projections of performance, apart from a few exceptions such as an hypothetical illustration of mathematical principles. Labeling the chart or showing a range does not cure it.FINRA Rule 2210(b), (d)

A representative sends the same market commentary by email to 40 retail customers in one 30-day period. Under Rule 2210, the message is a:

• a.retail communication, because it reaches more than 25 retail investors✓
• b.retail communication, but only when it recommends a security
• c.institutional communication, because it relates to the markets generally
• d.correspondence, because email is an individualized medium of contact

Rule 2210 defines correspondence as communications to 25 or fewer retail investors in 30 days, and a retail communication as one distributed to more than 25. The medium does not decide the category, and a recommendation is not required.FINRA Rule 2210(a)

A fund named the Municipal Income Fund wants to stop investing 80% of its assets in municipal securities. What must it first do?

• a.Give shareholders 60 days' notice before changing the 80% policy✓
• b.Give shareholders 10 days' notice, then change the policy
• c.Rename the fund within 30 days after the change takes effect
• d.Obtain approval from a majority of shareholders at a meeting

Rule 35d-1 requires a fund whose name suggests a type of investment to invest at least 80% of assets that way. It may change the policy only if it gives shareholders 60 days' notice, unless the policy is fundamental, in which case shareholders must approve it.Rule 35d-1 under the Investment Company Act of 1940

Under the SEC's liquidity risk management rule, an open-end fund (other than a money market fund) may not acquire an illiquid investment if, afterward, illiquid investments would exceed:

• a.25% of the fund's net assets
• b.15% of the fund's net assets✓
• c.35% of the fund's net assets
• d.5% of the fund's net assets

Rule 22e-4 caps illiquid investments, those that cannot be sold within seven days without significantly changing their market value, at 15% of net assets. Money market funds follow a separate 5% limit, so 5% is not the general figure.Rule 22e-4 under the Investment Company Act of 1940

A customer's order to redeem fund shares reaches the firm at 4:30 p.m. Eastern, after the 4:00 p.m. NAV calculation. The order is executed at the:

• a.average of that day's NAV and the following day's NAV
• b.next NAV calculated after the fund receives the order✓
• c.last NAV the customer saw, if the customer asks for it
• d.NAV set at 4:00 p.m. that day, if the firm stamps the order

Rule 22c-1 requires forward pricing: orders are priced at the next NAV computed after receipt. Giving a customer the earlier price after the close is late trading, which is illegal.Rule 22c-1 under the Investment Company Act of 1940

A customer is about to invest $48,000 in a fund that offers a lower sales charge at $50,000. A representative knows this and recommends the $48,000 purchase anyway to earn the higher commission. This is:

• a.a normal sale, because the breakpoint is not reached
• b.a rights of accumulation sale, which is permitted
• c.a breakpoint sale, which violates FINRA rules✓
• d.a discount sale, which is permitted for any investor

Recommending a purchase just below a breakpoint so the representative earns the larger commission is a breakpoint sale, which violates FINRA Rule 2342. The rep should tell the customer about the discount available at the next level, and about rights of accumulation or a letter of intent.FINRA Rule 2342

Under typical mutual fund prospectus terms, a customer signs a letter of intent today. How far back may purchases be counted toward the letter of intent total?

• a.90 days before the date the letter is signed✓
• b.30 days before the signing date
• c.Purchases made before the letter cannot be counted
• d.13 months before the signing date, the length of the completion period

Funds commonly let purchases made up to 90 days before the letter of intent is signed count toward it, and then give the investor 13 months to complete it; many prospectuses start that period at the earliest purchase counted. The 13 months run forward, not backward, and the 30-day window belongs to the wash-sale rule, while 13 months is the completion period, not a look-back. Letter-of-intent terms are set by each fund's prospectus, not by a FINRA rule.Fund prospectus terms (letter of intent)

During which hours may a representative make telemarketing calls to a prospect?

• a.Between 8 a.m. and 9 p.m. in the representative's local time
• b.Between 8 a.m. and 9 p.m. in the prospect's local time✓
• c.Between 8 a.m. and 6 p.m. in the prospect's local time
• d.Between 9 a.m. and 5 p.m. in the prospect's local time

Telemarketing calls are limited to the hours of 8 a.m. to 9 p.m. in the called person's local time. A rep calling across time zones must use the prospect's clock, not his or her own.Telemarketing Sales Rule; FINRA Rule 3230

A registered representative is named in a new customer complaint that must be reported. By when must the firm amend the representative's Form U4 for most events?

• a.Within 30 days after the firm learns of the event✓
• b.Within 10 days, the period that applies to every reportable event
• c.At the end of the calendar year in which the event occurred
• d.Within 60 days, once the firm has finished its own internal review

Form U4 must be kept current, and the firm generally has 30 days to amend it after learning of the facts. The 10-day deadline applies only to certain events, such as a statutory disqualification, not to every reportable event. Waiting for the end of the year or for an internal review to finish is not permitted; the clock runs from when the firm learns of the event.FINRA By-Laws, Art. V, Sec. 2(c); Form U4

A 62-year-old opened a Roth IRA with a contribution three years ago and now takes a distribution of earnings. How is it taxed?

• a.Tax-free, but subject to a 10% additional tax because of the account's age
• b.Taxed as long-term capital gains, because the account has been open three years
• c.Taxed as ordinary income, because the five-year period has not been met✓
• d.Tax-free, because the owner is older than age 59 1/2 at the time of withdrawal

A Roth distribution is a qualified, tax-free distribution only if the five-year period has been met and the owner is 59 1/2 or older (or disabled, deceased, or buying a first home up to $10,000). The five-year clock starts on January 1 of the first contribution year, so three years is not enough and the earnings are taxable. The 10% additional tax does not apply at 62.IRC Section 408A; Roth IRA

A 45-year-old with a Roth IRA that holds $20,000 of contributions and $5,000 of earnings withdraws $12,000. How is the withdrawal treated?

• a.All $12,000 is taxable, because earnings are withdrawn first
• b.$7,000 is taxable, because the earnings are taxed at a ratio
• c.Tax-free, but a 10% penalty applies on the whole amount
• d.Tax-free and penalty-free, because contributions come out first✓

For a nonqualified Roth distribution, contributions are treated as coming out first, then conversions, then earnings. The $12,000 is less than the $20,000 of contributions, so it is neither taxed nor penalized. Pro rata treatment applies to traditional IRAs with basis, not Roth IRAs.IRS Publication 590-B; Roth ordering rules

An investor contributes more than the annual IRA limit and leaves the excess in the account. What is the tax on the excess?

• a.No tax, because the excess is simply carried to the next year
• b.A 25% additional tax, charged once at the time of the excess
• c.A 10% additional tax, charged once at the time of the excess
• d.A 6% excise tax for each year that the excess remains in the IRA✓

Excess IRA contributions are subject to a 6% excise tax for every year they remain, though the tax can be avoided by withdrawing the excess and its earnings by the tax filing deadline, including extensions. The 10% and 25% figures belong to other IRA penalties.IRC Section 4973; excess IRA contributions

What is the deadline for making an IRA contribution for the prior tax year?

• a.June 30 of the following year, six months after the end of the tax year
• b.December 31 of that tax year, the end of the calendar year in question
• c.The tax filing due date for that year, including any filed extension
• d.The tax filing due date for that year, not counting extensions✓

Contributions for a tax year may be made until the original due date of the return, usually April 15 of the following year. An extension of time to file does not extend the contribution deadline.IRS Publication 590-A; IRA contributions

A married couple files a joint return. One spouse has no earned income. Can that spouse contribute to a traditional IRA?

• a.Yes, but only to a Roth IRA, never to a traditional IRA for that spouse
• b.Yes, if the working spouse's earned income covers both contributions✓
• c.Yes, but only if the couple files separate returns, never a joint return
• d.No, because only a person who has earned income can fund an IRA

Under the spousal IRA rule, a couple filing jointly can contribute for a nonworking spouse as long as the couple's combined earned income is at least the total contributed. Each spouse still has a separate IRA. Filing separately removes the benefit.IRS Publication 590-A; spousal IRA

An investor takes an indirect rollover distribution from one IRA and completes it within 60 days. How often may this be done?

• a.Without limit, as long as each amount is redeposited within the 60-day period
• b.Once in any 12-month period, counted across all of the investor's IRAs✓
• c.Once each calendar year per type of IRA, with Roth and traditional kept apart
• d.Once per IRA in any 12-month period, so several IRAs allow several rollovers

An owner may make only one indirect (60-day) IRA-to-IRA rollover in a 12-month period, aggregated across all IRAs. Direct trustee-to-trustee transfers have no limit.IRC Section 408(d)(3); IRA rollovers

A participant receives a $50,000 eligible rollover distribution from a 401(k) in a check made payable to the participant. How much is withheld for federal income tax?

• a.24% mandatory withholding, or $12,000
• b.No withholding, since it may be rolled over
• c.10% mandatory withholding, or $5,000
• d.20% mandatory withholding, or $10,000✓

Eligible rollover distributions paid to the participant are subject to mandatory 20% federal withholding. A direct rollover to an IRA avoids it. The participant would need to replace the $10,000 from other funds to roll over the full $50,000 within 60 days.IRC Section 3405; qualified plan distributions

A non-spouse who is not disabled or chronically ill inherits an IRA in 2026 from a parent who died before the required beginning date. The IRA must generally be fully distributed by:

• a.the end of the tenth year following the year of death✓
• b.the end of the fifth year following the year of death
• c.the end of the year of the beneficiary's 73rd birthday
• d.the end of the year following the year of death

Under the SECURE Act, most non-spouse designated beneficiaries must empty an inherited IRA by the end of the tenth year after death. A spouse, a minor child of the decedent, a disabled or chronically ill person, or someone not more than 10 years younger may stretch payouts.IRC Section 401(a)(9); inherited IRAs

An IRA owner misses a required minimum distribution but takes it and files a corrected return in the correction window. The excise tax is generally:

• a.6% of the amount not distributed
• b.50% of the amount not distributed
• c.25% of the amount not distributed
• d.10% of the amount not distributed✓

Under SECURE 2.0, the penalty for missing a required minimum distribution is 25% of the shortfall, reduced to 10% if the owner corrects it within the correction window. The old penalty was 50%. 6% is the excess contribution tax.IRC Section 4974; required minimum distributions

A 74-year-old IRA owner has the IRA trustee send $5,000 directly to a qualifying charity. What is the tax treatment?

• a.Taxable income, with a 10% additional tax charged on the amount sent to charity
• b.Excluded from income, but it does not count toward the required minimum distribution
• c.Taxable income, though the owner may take a charitable deduction for the full amount
• d.Excluded from income, and it counts toward the required minimum distribution✓

A qualified charitable distribution made directly from an IRA by an owner age 70 1/2 or older is excluded from gross income and may satisfy the required minimum distribution. Because it is excluded, it is not also deducted.IRC Section 408(d)(8); qualified charitable distributions

A participant has a vested 401(k) balance of $60,000 and no earlier loans. What is the most the plan can lend?

• a.$30,000, which is 50% of the vested balance✓
• b.$60,000, which is 100% of the vested balance
• c.$50,000, which is the dollar cap by itself
• d.$20,000, which is a third of the vested balance

A plan loan is limited to the lesser of 50% of the vested balance or $50,000, so the limit is $30,000. The $50,000 cap applies only when 50% of the balance would be higher.IRC Section 72(p); retirement plan loans

A 56-year-old leaves her employer and takes a distribution from her 401(k). When is the 10% early distribution tax waived?

• a.When she is at least age 55 and takes withdrawals from an IRA
• b.When she separated from service in or after the year she turned 55✓
• c.When she separated from service in or after the year she turned 50
• d.When the distribution is rolled into an IRA and then withdrawn

The separation-from-service rule (often called the rule of 55) removes the 10% additional tax for distributions from the plan of the employer she left in or after the year she turns 55. It does not apply to IRAs, including IRAs funded by a rollover.IRC Section 72(t)(2)(A)(v); separation from service

An employee defers 6% of pay into a 401(k) and receives a matching contribution under a six-year graded vesting schedule. After two years of service, the employee leaves. Which portion is fully vested?

• a.The employer match, which is vested after two years in all plans
• b.The employee's own deferrals, which are always 100% vested✓
• c.Neither amount, because both follow the vesting schedule
• d.Both amounts, because 401(k) plans use immediate vesting

An employee's elective deferrals and their earnings are always fully vested. The employer match may vest over time under a schedule, and an employee who leaves early may forfeit the unvested part.Retirement plan vesting

An employee takes a distribution from a SIMPLE IRA 18 months after first participating, at age 40. The additional tax on the early distribution is:

• a.10% of the amount distributed
• b.6% of the amount distributed
• c.25% of the amount distributed✓
• d.15% of the amount distributed

For SIMPLE IRAs, the additional tax is 25% instead of 10% if the distribution takes place within two years of first participation. After two years, the usual 10% applies.IRC Section 72(t)(6); SIMPLE IRAs

Under SECURE 2.0, a 529 plan beneficiary may roll unused 529 funds into the beneficiary's own Roth IRA, subject to:

• a.a $10,000 lifetime limit and an account open at least 5 years
• b.no lifetime limit, as long as the account is open at least 10 years
• c.a $35,000 lifetime limit and an account open at least 15 years✓
• d.a $35,000 yearly limit and an account open at least 15 years

A 529-to-Roth rollover is limited to $35,000 over the beneficiary's lifetime, requires the 529 account to have been open for 15 years, and counts against the annual Roth IRA contribution limit. Contributions made in the last five years cannot be rolled over.IRC Section 529(c)(3)(E); 529-to-Roth rollovers

A 529 account owner uses plan assets to repay a beneficiary's qualified student loans. The federal limit on this treatment is:

• a.No limit, if the loans financed tuition
• b.$10,000 over the beneficiary's lifetime✓
• c.$35,000 over the beneficiary's lifetime
• d.$10,000 per year, for each year of repayment

A 529 distribution of up to $10,000 over the beneficiary's lifetime may repay the beneficiary's qualified education loans, and a separate $10,000 applies to each sibling. It is not an annual allowance.IRC Section 529(c)(9); student loan repayment

A beneficiary receives a nonqualified 529 distribution of $8,000, of which $2,000 is earnings. The federal tax treatment is:

• a.The $2,000 of earnings is taxed as income and carries a 10% additional tax✓
• b.The $2,000 of earnings is taxed as income with no additional tax
• c.The $8,000 is a return of contributions, so there is no tax at all
• d.The full $8,000 is taxed as income and carries a 10% additional tax

Only the earnings portion of a nonqualified 529 distribution is taxed, and the 10% additional tax applies to that portion. The contributions come back without tax. The 10% tax is waived in some cases, such as when the beneficiary receives a tax-free scholarship.IRC Section 529(c)(6); nonqualified distributions

A 17-year-old receives $6,000 of unearned income from a custodial UTMA account. Above a threshold, the income is taxed:

• a.at the parents' marginal rate, under the kiddie tax✓
• b.at the child's own rate, however large the income is
• c.at a flat 15% rate, regardless of the parents' income
• d.at the custodian's rate, as the custodian runs the account

Unearned income above the annual threshold is taxed at the parents' marginal rate for children under 19, and for full-time students under 24. The custodian is not the taxpayer.IRC Section 1(g); kiddie tax

A new customer opens a taxable account and does not provide a taxpayer identification number. The firm must apply backup withholding to dividends at:

• a.24%, the backup withholding rate✓
• b.30%, the nonresident alien rate
• c.10%, the default IRA withholding rate
• d.20%, the retirement plan rollover rate

If a customer fails to give a TIN (or the IRS says it is incorrect), the payer must withhold 24% from dividends and other reportable payments. The 30% rate is for nonresident aliens (Form W-8BEN), and 20% is the retirement plan rollover rate.IRC Section 3406; backup withholding

A nonresident alien who files a Form W-8BEN with no treaty benefit receives a U.S. stock dividend. The default withholding rate is:

• a.24% of the dividend, the backup withholding rate
• b.30% of the dividend, before any treaty relief✓
• c.0%, because the dividend is paid to a foreign person
• d.15% of the dividend, the qualified dividend tax rate

Dividends paid to a foreign person are withheld at 30%, unless a treaty provides a lower rate. The 24% backup rate does not apply to a properly documented foreign holder.IRC Sections 1441 and 1442

A parent opens a UTMA account for a child and later wants to take the securities back for the parent's own use. What is the rule?

• a.The parent can with a court order, since the minor is not yet an adult
• b.The parent cannot, because the gift is irrevocable and belongs to the minor✓
• c.The parent can after one year, since gifts may be reversed then
• d.The parent can at any time, because the parent is the custodian

A gift to a UTMA or UGMA account is irrevocable, and the assets belong to the minor. The custodian can use them only for the minor's benefit. At the age set by state law, the child takes control.UTMA/UGMA custodial accounts

A customer's account holder dies and the executor asks to sell the securities. Which documents does the firm need to open an estate account?

• a.A death certificate and the written consent of every heir
• b.A death certificate and letters testamentary from the probate court✓
• c.The signed will alone, even if it was witnessed and notarized
• d.A power of attorney signed by the account holder before death

The firm needs proof of death and court papers naming the executor, called letters testamentary when there is a will, or letters of administration when there is none. A power of attorney ends at the principal's death.Estate accounts

A customer says to a representative, 'Buy 500 shares of ABC today, and use your judgment on the timing.' Absent a written extension signed by the customer, the authority is:

• a.time-and-price discretion only, ending at the close of that business day✓
• b.full discretion, which a principal must approve order by order, in writing
• c.full discretion, which continues until the customer revokes it in writing
• d.time-and-price discretion, lasting a full week unless the customer extends it

Rule 3260 lets a representative choose the time or price of an order the customer has specified without a discretionary authorization, but only until the end of that business day, unless the customer gives a signed and dated written extension. Full discretion needs prior written authority and principal approval.FINRA Rule 3260

A customer's IRA names her sister as beneficiary, but her will leaves everything to her son. At her death, who receives the IRA?

• a.The sister, because the beneficiary form overrides the will✓
• b.The estate, which then distributes it under the will
• c.The son and sister equally, since the documents conflict
• d.The son, because a will controls every asset she owned

Assets with a named beneficiary, such as IRAs, annuities, and life insurance, pass by contract and not through the will. A will cannot override a valid beneficiary form.Beneficiary designations

A 50-year-old municipal employee leaves the job and takes a lump sum from a governmental 457(b) plan. Is the 10% early distribution tax due?

• a.Yes, as for any plan withdrawal before age 59 1/2
• b.No, but the distribution is taxed as ordinary income✓
• c.No, and the distribution is also free of income tax
• d.Yes, unless the employee rolls it over to a Roth

Governmental 457(b) distributions after separation from service are not subject to the 10% additional tax, though they are taxable as ordinary income. This sets them apart from 401(k) and 403(b) plans, where the tax applies.IRC Section 457(b); governmental plans

In one year, an investor has a $12,000 short-term capital loss and a $5,000 long-term capital gain, and no other gains or losses. What is the tax result?

• a.A $3,000 deduction against ordinary income, with $4,000 carried forward✓
• b.A $7,000 deduction against ordinary income, with nothing carried forward
• c.A $3,000 deduction against ordinary income, with $9,000 carried forward
• d.No deduction at all, because losses may only offset capital gains

Short-term and long-term results are netted, so $12,000 of loss against $5,000 of gain leaves a $7,000 net loss. Up to $3,000 may be deducted against ordinary income, and the remaining $4,000 carries forward indefinitely. Losses are not limited to offsetting gains.IRC Section 1211 and 1212; capital loss netting

An investor bought stock on March 15, 2025 and sold it at a gain on March 15, 2026. The gain is:

• a.long-term, because exactly one year had passed by the sale
• b.short-term, unless the stock paid a dividend while held
• c.long-term, because the stock was held across two tax years
• d.short-term, because it must be held more than one year✓

A long-term holding period is more than one year, and the day after purchase starts the count. A sale on the one-year anniversary is still short-term, and a sale on March 16 would be long-term. The number of tax years touched does not matter.IRC Section 1222; holding period

Which statement about the 3.8% net investment income tax is accurate?

• a.It applies to municipal bond interest of taxpayers above the set income thresholds
• b.It applies to wages and salary of taxpayers whose income exceeds set thresholds
• c.It applies to all taxpayers who receive any dividends or interest during the year
• d.It applies to investment income when a taxpayer's income exceeds set thresholds✓

The 3.8% tax applies to the lesser of net investment income or the amount by which modified AGI exceeds a threshold (such as $200,000 for single filers and $250,000 for joint filers). It does not apply to wages, and municipal interest is excluded from net investment income.IRC Section 1411; net investment income tax

For a dividend on common stock to be a qualified dividend, the investor must hold the stock for more than:

• a.More than one year before the ex-dividend date, as for a long-term holding
• b.90 days during the 181-day period beginning 90 days before the ex-dividend date
• c.60 days during the 121-day period beginning 60 days before the ex-date✓
• d.30 days during the 61-day period beginning 30 days before the ex-dividend date

For common stock, qualified dividend treatment requires more than 60 days of holding in the 121-day window around the ex-date. The 90-day and 181-day figures apply to certain preferred stock dividends.IRC Section 1(h)(11); qualified dividends

A resident of a state with an income tax receives interest on Treasury notes. How is the interest taxed?

• a.Exempt from federal income tax, but fully taxed by the state and local governments
• b.Taxed by the federal government and also taxed by the state and local governments
• c.Exempt from federal, state, and local income taxes, like municipal bond interest
• d.Taxed by the federal government, but exempt from state and local income tax✓

Interest on Treasury securities is taxable at the federal level and exempt from state and local income tax. Municipal bond interest has the opposite federal treatment, and is generally exempt from federal tax.State and local taxation of Treasury interest

A New York resident wants income exempt from both federal and New York State income tax. Which fund fits?

• a.A Treasury bond fund, which holds U.S. government bonds
• b.A national municipal bond fund, which holds issuers in many states
• c.A corporate bond fund, which holds investment-grade issuers
• d.A New York municipal bond fund, which holds New York issuers✓

Municipal interest is exempt from federal tax, and it is also exempt from a state's income tax when the bond was issued within that state, so a single-state fund gives a New York resident both. A national fund may pay out income that is taxable by New York, and Treasury interest is federally taxable.Municipal bond funds

An investor in the 22% federal bracket is considering a municipal bond fund yielding 3.9%. The taxable yield that gives the same after-tax return is closest to:

• a.17.7%, found by using 3.9% / 0.22
• b.5.0%, found by dividing 3.9% by 0.78✓
• c.3.0%, found by multiplying 3.9% by 0.78
• d.4.8%, found by adding 22% of 3.9%

Tax-equivalent yield = tax-free yield / (1 - tax bracket) = 3.9% / 0.78 = 5.0%. Adding 22% of the yield gives only 4.8% (a shortcut that understates it), multiplying by 0.78 moves the wrong way, and dividing by 0.22 uses the tax rate itself.Tax-equivalent yield

A fund share was worth $40 at the start of the year and $42 at the end, after paying $2 per share of dividends and capital gains distributions. The total return for the year is:

• a.9.5%, found by dividing the $4 total return by $42
• b.4.8%, found by dividing the $2 rise in price by $42
• c.5%, found by dividing the $2 rise in price by $40
• d.10%, found by dividing the $4 gain plus payouts by $40✓

Total return = (ending value - beginning value + distributions) / beginning value = ($2 + $2) / $40 = 10%. The price change alone leaves out the distributions, and the beginning value is the base.Total return

A fund with an NAV of $19.00 and an offering price of $20.00 pays annual dividends of $1.00 per share. Its current yield is:

• a.10.0%, based on a par value of $10.00
• b.1.0%, based on the $1.00 dividend alone
• c.5.0%, based on the $20.00 offering price✓
• d.5.3%, based on the $19.00 NAV per share

Current yield for a load fund is annual income divided by the public offering price: $1.00 / $20.00 = 5.0%. Using NAV would produce 5.3%, which is a figure for an investor who can buy at NAV. Par value and the bare dollar dividend are not the base.Mutual fund yield

An investor bought 100 fund shares at $10 and later 300 shares at $14, and sells 100 shares at $15. Using the average cost method, the gain is:

• a.$200, because the basis is $13 per share✓
• b.$300, because the basis is $12
• c.$100, because the basis is $14 per share
• d.$500, because the basis is $10 per share

The average cost is ($1,000 + $4,200) / 400 = $13 per share, so the 100 shares sold have a $1,300 basis and the gain is $1,500 - $1,300 = $200. Using the first shares gives $500, using the latest purchase price gives $100, and averaging the two prices ($12) ignores the share counts.Cost basis methods for mutual funds

A donor buys stock for $20,000 and gives it to a child when it is worth $15,000. The child later sells it for $12,000. What is the child's loss?

• a.$8,000, because the basis for a loss is the donor's $20,000 cost
• b.$5,000, because the loss is the $5,000 decline between the cost and the gift
• c.$3,000, because the basis for a loss is the $15,000 value at the gift✓
• d.$0, because the sale price is below both bases, so no loss is recognized

When the value at the gift is below the donor's cost, the recipient uses the donor's cost as basis for a gain and the lower value for a loss. The child sold below $15,000, so the loss is $15,000 - $12,000 = $3,000.Gifted securities; IRC Section 1015

An annuitant invested $60,000 in a fixed annuity with an expected return of $100,000. Each annual payment is $10,000. How much of each payment is excluded from income?

• a.$4,000, because the exclusion ratio is 40%
• b.$6,000, because the exclusion ratio is 60%✓
• c.$0, because annuity payments are all taxable
• d.$10,000 until cost is back, then none

The exclusion ratio is the investment in the contract divided by the expected return: $60,000 / $100,000 = 60%, so $6,000 of each payment is a tax-free return of cost and $4,000 is taxable. Once the investment is recovered, the full payment is taxable.Annuity taxation; exclusion ratio