NASAA Series 65 — All Questions

What holding requirement must an investor meet for dividends on common stock to be taxed as qualified dividends?

• a.Hold the stock for more than one year as of the date the dividend is paid
• b.Hold the stock more than 60 days during the 121-day period beginning 60 days before the ex-dividend date✓
• c.Hold the stock at least 30 days before and 30 days after the ex-dividend date
• d.Hold the stock more than 60 days during the 91-day period beginning 45 days before the ex-dividend date

Qualified dividends receive long-term capital gain rates only if the holding period is met: more than 60 days within the 121-day window that starts 60 days before the ex-dividend date. A one-year hold is the long-term gain test for a sale, not for dividends. The 30-day window is the wash sale period, which is a different rule.IRC 1(h)(11), 246(c); IRS Pub. 550

An investor buys a bond with a $1,000 face amount for $985 in the secondary market, exactly eight full years before it matures, and holds it to maturity. How is the $15 of market discount treated?

• a.It is ordinary interest income, because market discount on a bond is always ordinary
• b.It is tax exempt, because discount at purchase is a return of capital
• c.It is treated as zero, because it is less than one-fourth of 1% of $1,000 times eight full years, or $20, so the $15 is capital gain✓
• d.It is ordinary income that must be accrued each year, because the bond was bought below par and market discount is treated as interest as it accrues

Market discount is the difference between the redemption price and the purchase price. It is normally ordinary income when realized, but it is treated as zero if it is below the de minimis amount: 0.25% of the redemption price times the full years left to maturity. Here that is $1,000 × 0.0025 × 8 = $20. The $15 is below $20, so it is not ordinary market discount, and the gain is taxed as capital gain.IRC 1278(a)(2)(C); IRS Pub. 550

A client paid $9,000 of margin interest on money borrowed to buy taxable investments and has $6,000 of net investment income this year. What can she deduct as investment interest expense this year?

• a.$6,000, and the remaining $3,000 is permanently lost
• b.$9,000, because margin interest is deductible in full on investment property
• c.$6,000, with the remaining $3,000 carried forward to the next year✓
• d.$3,000, which is the excess of interest over investment income

Investment interest is deductible only up to net investment income. She can deduct $6,000 and carry the unused $3,000 forward indefinitely, which is why the lost-forever answer is wrong. The $3,000 is the amount carried, not the amount deducted.IRC 163(d); IRS Pub. 550

A 45-year-old professional takes one graduate evening course to improve his job skills. He has already completed postsecondary education. Which federal education credit may he be able to claim?

• a.The Lifetime Learning Credit, worth up to $2,000 per return, because it has no degree requirement or limit on years✓
• b.The Lifetime Learning Credit, worth up to $2,500 per course, because it is available per class
• c.The American Opportunity Credit, worth up to $2,500 per student, because it covers any year of study including graduate courses
• d.The American Opportunity Credit, because graduate students qualify for it in their first year

The Lifetime Learning Credit is available for courses to acquire or improve job skills, with no degree requirement, no limit on the number of years, and a maximum of $2,000 per return. The American Opportunity Credit is limited to the first four years of postsecondary education for a student pursuing a degree or credential, so graduate study does not qualify. The credit is figured per return, not per course.IRC 25A; IRS Pub. 970

In a defined contribution plan that is top-heavy for the plan year, what minimum employer contribution must generally be made for each non-key employee?

• a.2% of compensation for each year of service, up to 20%, which is the minimum for defined benefit plans
• b.5% of compensation, but only for non-key employees who make elective deferrals
• c.3% of compensation in every case, even if key employees receive a lower rate
• d.3% of compensation, or a lower percentage equal to the highest rate given to any key employee✓

A top-heavy plan must give non-key employees a minimum contribution of 3% of compensation. If the highest contribution rate for any key employee is below 3%, the non-key minimum is reduced to that rate. The 3% is therefore a ceiling in that case, not an absolute floor.IRC 416(c)(2)

A married couple, both under age 50, file jointly in 2026. The husband has $60,000 of compensation and the wife has none. The 2026 IRA limit is $7,500 per person. What is the most that can be contributed to IRAs for the two of them?

• a.$30,000, since each spouse may contribute $7,500 to a traditional IRA and also to a Roth IRA
• b.$7,500, since only the spouse who earned the income can contribute
• c.$15,000 total, $7,500 to each spouse's IRA, since their combined compensation is sufficient✓
• d.$60,000, since the limit is 100% of the earner's compensation

A spousal IRA lets a working spouse's compensation support a contribution for a nonworking spouse on a joint return. Each spouse may contribute up to $7,500, but the total cannot exceed their combined taxable compensation, which is $60,000. The limit is a combined limit across a person's traditional and Roth IRAs, so doubling for both types is wrong.IRC 219(c); IRS Pub. 590-A

A retired client gives his daughter stock with a $20,000 cost basis and a $100,000 market value as a gift, and she sells it for $100,000 soon after. His brother held identical stock (cost $20,000, value $100,000 at his death) and leaves it to his own daughter at death, and she sells it for $100,000. What gain does each daughter report?

• a.$80,000 for each, because both received the stock from a relative
• b.$80,000 for the daughter who received the gift, and $0 for the daughter who inherited it✓
• c.$0 for the daughter who received the gift, and $80,000 for the daughter who inherited it
• d.$0 for each, because transfers between family members carry no gain

A donee generally takes the donor's basis for gain, so the gift recipient has $20,000 of basis and an $80,000 gain. Inherited property generally takes a basis equal to its fair market value at the date of death, so the heir has $100,000 of basis and no gain. This is why appreciated assets are often held until death instead of given away.IRC 1014(a), 1015(a)

For 2026, what is the minimum annual deductible a health plan must have to be an HSA-qualifying HDHP with self-only coverage?

• a.$2,200
• b.$1,700✓
• c.$3,400
• d.$8,500

For 2026 an HDHP must have an annual deductible of at least $1,700 for self-only coverage and $3,400 for family coverage. The $3,400 amount is the family minimum, $8,500 is the self-only out-of-pocket cap, and $2,200 is an unrelated HRA figure.IRC 223(c)(2); Rev. Proc. 2025-19

A widow who dies in 2026 leaves a taxable estate of $12.5 million. During life she made $3 million of taxable gifts that used her exclusion in earlier years. Using a $15 million exclusion and the 40% top rate, what is the approximate federal estate tax, ignoring credits other than the unified credit?

• a.$0, because the $12.5 million estate is under the $15 million exclusion
• b.$1,200,000, which is 40% of the $3 million of prior taxable gifts
• c.$1,000,000, which is 40% of the $2.5 million by which the estate falls short of the exclusion
• d.$200,000, which is 40% of the $500,000 by which her estate plus prior taxable gifts exceeds $15 million✓

The estate tax base adds adjusted taxable gifts to the taxable estate: $12.5 million plus $3 million is $15.5 million. The unified credit shelters the first $15 million, so $500,000 is taxed at the top rate of 40%, or $200,000. The exclusion is a single lifetime amount shared by gifts and the estate, so looking at the estate alone is wrong.IRC 2001(b), 2010(c)(3); Rev. Proc. 2025-32 sec. 4.14

A U.S.-citizen client gives $200,000 cash to his spouse, who is not a U.S. citizen, in 2026. The annual exclusion for gifts to a noncitizen spouse is $194,000, and the regular annual exclusion is $19,000. What is the taxable gift?

• a.$0, because gifts between spouses always qualify for the unlimited marital deduction
• b.$6,000, because the unlimited marital deduction does not apply to a noncitizen spouse✓
• c.$200,000, because gifts to a noncitizen are never excludable
• d.$181,000, because only the regular $19,000 annual exclusion applies

The unlimited marital deduction is denied for gifts to a noncitizen spouse, but a larger annual exclusion ($194,000 for 2026) is allowed instead. The taxable gift is $200,000 less $194,000, or $6,000. The regular $19,000 exclusion is replaced by the higher one, not stacked on top of it.IRC 2523(i); Rev. Proc. 2025-32 sec. 4.42

Under the SEC's interpretation of an investment adviser's fiduciary duty, how should an adviser handle a known conflict of interest in a way that satisfies its duty of loyalty?

• a.Make full and fair disclosure that is specific enough for the client to give informed consent, and avoid saying it "may" have the conflict when it does✓
• b.Disclose the conflict in general terms in Form ADV once, because the client is deemed to consent by continuing the relationship after receiving the brochure
• c.Tell the client only that it "may" have conflicts, since that wording is sufficient if the conflict actually exists and the client signs the advisory agreement
• d.Eliminate every conflict, because an adviser may never have a conflict with a client

The adviser must either eliminate the conflict or disclose it fully and fairly so the client can give informed consent. Saying an adviser "may" have a conflict when it actually has one is inadequate. Conflicts are permitted when disclosed and consented to, so a flat ban is wrong, and consent cannot be inferred merely from the client staying.Advisers Act sec. 206; Release IA-5248 (2019)

An advisory agreement with a retail client says the client waives all of the adviser's fiduciary duties under federal law. How does the SEC's interpretation treat this provision?

• a.The waiver is valid if the adviser also gives the client a copy of Form CRS
• b.The waiver is valid for a client who is financially sophisticated, but not for a retail client
• c.The federal fiduciary duty may not be waived, though the agreement can shape how it applies to the agreed scope of services✓
• d.The waiver is valid, because the client signed it after reading the agreement

The SEC states that an adviser's federal fiduciary duty may not be waived, even by an institutional or sophisticated client, though the scope of services the adviser agrees to provide can shape how the duty applies. A signature, a client's sophistication, or additional disclosures do not create a valid waiver. Waiver language of this sort can also itself be misleading to a client.Advisers Act sec. 206, 215; Release IA-5248 (2019)

Under the SEC's interpretation of the adviser's duty to seek best execution, what is the determinative factor when an adviser with discretion selects a broker-dealer for client trades?

• a.The lowest commission rate offered by any broker-dealer, in every case
• b.Whether the transaction represents the best qualitative execution, not simply the lowest possible commission✓
• c.Whether the broker-dealer is affiliated with the adviser, since affiliates are always preferred
• d.Whether the broker-dealer provides research, since soft-dollar benefits must always be maximized

The duty of best execution requires the adviser to seek execution under which the client's total cost or proceeds is the most favorable under the circumstances. The determinative factor is the best qualitative execution, not the lowest commission. Affiliation and research do not by themselves answer the question, and conflicts such as those need their own disclosure.Advisers Act sec. 206; Release IA-5248 (2019)

An adviser is choosing between two comparable funds for a retail client's account. One has a lower expense ratio, and the other costs more but is the one the adviser reasonably believes best fits the client's needs. Under the SEC's interpretation, what is required?

• a.The adviser may recommend the costlier fund if it has a reasonable belief that doing so is in the client's best interest, treating cost as one factor among others✓
• b.The adviser may recommend the costlier fund only if the client signs a waiver of the duty of care and the adviser discloses the cost difference in writing
• c.The adviser must recommend the lowest-cost fund, because cost is the only factor that matters
• d.The adviser must recommend the fund with the highest expected return regardless of cost

The SEC says an adviser need not simply recommend the lowest-cost or least remunerative product, because cost is one of many factors in whether advice is in the client's best interest. What the adviser needs is a reasonable belief that the advice serves the client given the client's objectives. It must also disclose any conflict, such as higher compensation. Waiving the duty of care is not an option.Advisers Act sec. 206; Release IA-5248 (2019)

Absent exemptive relief, section 12(d)(1)(A) of the Investment Company Act restricts a registered fund from owning more than what share of another registered fund's total outstanding voting stock?

• a.5%
• b.25%
• c.10%
• d.3%✓

Section 12(d)(1)(A)(i) bars an acquiring fund and its controlled companies from owning more than 3% of another investment company's voting stock. The 5% and 10% figures appear in the same provision but measure the size of the holding against the acquiring fund's own assets (5% for one acquired fund, 10% for all investment companies together), not against the acquired fund's voting stock.15 U.S.C. 80a-12(d)(1)(A)

Under the same fund-of-funds limits, an acquiring fund with $200 million in assets may not hold securities of any single other registered fund worth more than what, absent exemptive relief or an exception?

• a.$20 million, which is 10% of the acquiring fund's total assets
• b.$6 million, which is 3% of the acquiring fund's total assets
• c.$50 million, which is 25% of the acquiring fund's total assets
• d.$10 million, which is 5% of the acquiring fund's total assets✓

Section 12(d)(1)(A)(ii) bars an acquiring fund from holding securities of one acquired fund worth more than 5% of the acquiring fund's total assets, which is $10 million here. The 10% limit applies to all investment companies in aggregate, and the 3% limit measures the acquired fund's voting stock rather than the acquirer's assets.15 U.S.C. 80a-12(d)(1)(A)(ii)-(iii)

A private fund's securities are beneficially owned by 90 persons, and it makes no public offering. It will not be treated as an investment company if it relies on which provision of the Investment Company Act?

• a.Section 3(c)(1), which excepts an issuer with not more than 100 beneficial owners and no public offering✓
• b.Section 3(c)(7), which excepts any issuer whose owners are all accredited investors
• c.Section 3(c)(7), which excepts an issuer with not more than 250 beneficial owners and requires each owner to be an accredited investor
• d.Section 3(c)(1), which excepts an issuer with not more than 35 accredited owners

Section 3(c)(1) excepts an issuer whose outstanding securities are beneficially owned by not more than 100 persons (250 for a qualifying venture capital fund) and that is not making a public offering. Section 3(c)(7) has no head-count ceiling but requires every owner to be a qualified purchaser. Being an accredited investor is a Regulation D concept and is not the test under either exception.15 U.S.C. 80a-3(c)(1), (c)(7)

For a natural person, what is the main threshold for being a qualified purchaser under the Investment Company Act, such as for a fund relying on section 3(c)(7)?

• a.Owning at least $5 million in investments✓
• b.Owning at least $25 million in investments
• c.Having at least $200,000 in annual income in each of the last two years
• d.Having at least $1 million in net worth, excluding the primary residence

A natural person is generally a qualified purchaser if he or she owns not less than $5,000,000 in investments as defined by the SEC. The $1 million net worth and $200,000 income standards are accredited investor tests under Regulation D, and they are much lower than the qualified purchaser test. Larger sums apply to institutions, not individuals.15 U.S.C. 80a-2(a)(51)

Under the Investment Company Act's definition of a diversified company, at least what percentage of a fund's total assets must be in cash, government securities, other investment companies, and other securities with each issuer limited as stated?

• a.75%, with each issuer limited to 10% of the fund's assets and 5% of the issuer's voting securities
• b.50%, with each issuer limited to 10% of the fund's assets and 5% of the issuer's voting securities
• c.75%, with each issuer limited to 5% of the fund's assets and 10% of the issuer's voting securities✓
• d.90%, with each issuer limited to 5% of the fund's assets and 25% of the issuer's voting securities

A diversified company must have at least 75% of its total assets in cash, government securities, other investment companies and other securities, with the other securities limited for any issuer to no more than 5% of the fund's total assets and no more than 10% of the issuer's outstanding voting securities. The remaining 25% is unrestricted. Reversing the 5% and 10% figures gives a different rule.15 U.S.C. 80a-5(b)(1)

A registered closed-end fund (not a business development company) wants to issue bonds to leverage its portfolio. What asset coverage must it have immediately after the issuance?

• a.At least 200% for the debt
• b.At least 100% for the debt
• c.At least 150% for the debt
• d.At least 300% for the debt✓

Section 18(a)(1) requires a registered closed-end fund issuing a debt senior security to have asset coverage of at least 300% immediately after the issue. The 200% figure is the corresponding requirement for preferred stock under 18(a)(2). Lower coverage ratios do not apply to an ordinary closed-end fund.15 U.S.C. 80a-18(a)(1)

What may a registered open-end fund do about borrowing under the senior securities rule in section 18(f) of the Investment Company Act?

• a.Borrow from banks only, provided asset coverage is at least 150%
• b.Issue preferred stock, provided asset coverage is at least 200%
• c.Borrow from any lender, provided asset coverage is at least 300%
• d.Borrow from banks only, provided asset coverage is at least 300% immediately after each borrowing✓

An open-end company generally may not issue senior securities, but it may borrow from a bank if there is asset coverage of at least 300% for all of its borrowings. Borrowing from nonbank lenders or issuing preferred stock is not permitted by this exception; the 200% preferred stock figure is the closed-end standard.15 U.S.C. 80a-18(f)(1)

A mutual fund's investment advisory contract has been in effect for three years after its initial approval. Under section 15 of the Investment Company Act, how may it continue beyond the initial period of two years?

• a.Automatically, as long as no shareholder objects in writing
• b.Only if the adviser files an updated Form ADV with the SEC and the fund's chief compliance officer certifies the continuance in writing each year
• c.Only if continuance is specifically approved at least annually by the board or by a majority of the outstanding voting securities✓
• d.Only if shareholders approve it every three years by a majority of those voting at a meeting, and the board takes no separate vote

An advisory contract may continue for more than two years from execution only so long as continuance is specifically approved at least annually by the board of directors or by a majority of the outstanding voting securities. Silence from shareholders is not approval. Filing a Form ADV is an adviser registration matter and does not renew the fund contract.15 U.S.C. 80a-15(a)(2)

A mutual fund has a board of 10 directors. What is the greatest number who may be interested persons of the fund under section 10(a) of the Investment Company Act?

• a.6, because no more than 60% of the board may be interested persons✓
• b.3, because no more than 25% of the board may be interested persons
• c.5, because no more than half of the board may be interested persons
• d.4, because at least 60% of the board must be interested persons

Section 10(a) says that no registered investment company may have a board of directors more than 60% of whose members are interested persons. With 10 directors, six may be interested and at least four must be independent. (The Act and SEC rules impose stricter independence requirements on funds that rely on certain exemptive rules, but this is the statutory floor.)15 U.S.C. 80a-10(a)

A mutual fund calculates its NAV as of 4:00 p.m. Eastern time. An investor's order to buy shares is received by the fund's authorized dealer at 4:30 p.m. on a Tuesday. At which price will the order be executed?

• a.The average of Tuesday's and Wednesday's NAVs
• b.The price at which the fund's shares first trade on Wednesday morning
• c.The NAV next computed after the order is received, which is calculated as of 4:00 p.m. on Wednesday✓
• d.Tuesday's 4:00 p.m. NAV, because the order was placed on Tuesday

Rule 22c-1 requires forward pricing: orders to purchase or redeem are executed at the NAV next computed after receipt. An order that arrives after the 4:00 p.m. calculation gets the following business day's NAV. Using the earlier NAV would let investors profit from known after-hours news, and mutual funds are not priced by intraday trading.17 CFR 270.22c-1(a)

Under the SEC's ETF rule (Rule 6c-11), what must an exchange-traded fund make available on its website each business day?

• a.Only the previous quarter's holdings, which are updated four times a year
• b.The adviser's performance for the year to date compared to its prospectus benchmark
• c.The names of its authorized participants and the fees each paid
• d.The prior day's NAV per share, the market closing price, and the premium or discount of the market price to NAV✓

Rule 6c-11 requires an ETF to disclose daily on its website its prior business day's NAV per share, the market closing price or midpoint of the bid-ask spread, and the premium or discount, as well as portfolio holdings each business day. The rule is about transparency so investors can see how closely the market price tracks NAV.17 CFR 270.6c-11(c)

A non-affiliate holds restricted securities acquired directly from an issuer that has been subject to Exchange Act reporting for at least 90 days. What minimum holding period must elapse before she can resell them under Rule 144?

• a.Two years
• b.Three months
• c.Six months✓
• d.One year

For restricted securities of an issuer that has been reporting for at least 90 days, Rule 144 requires a minimum six-month holding period. If the issuer is not a reporting company, the period is one year. Affiliate sales have additional conditions such as volume limits.17 CFR 230.144(d)(1)

An affiliate of an NYSE-listed issuer plans a Rule 144 sale. The class has 5,000,000 shares outstanding and its average weekly trading volume over the preceding four calendar weeks was 70,000 shares. She has made no other sales in three months. What is the largest number of shares she may sell in the three-month period?

• a.50,000 shares, because the limit is always 1% of the shares outstanding
• b.280,000 shares, because the four weeks of volume are added together
• c.120,000 shares, because the two measures are added together
• d.70,000 shares, because the average weekly volume exceeds 1% of the shares outstanding✓

An affiliate selling under Rule 144 is limited in any three-month period to the greatest of 1% of the class outstanding or the average weekly reported trading volume over the four calendar weeks before the notice of sale. One percent is 50,000 shares; average weekly volume is 70,000. The greatest of the two governs, so the limit is 70,000. The measures are alternatives and are not added.17 CFR 230.144(e)(1)

In 12 months, what is the maximum an issuer can raise under Regulation A in a Tier 2 offering?

• a.$20 million
• b.$75 million✓
• c.$10 million
• d.$150 million

Regulation A Tier 2 permits offerings of up to $75 million in a 12-month period, with at most $22.5 million offered by affiliate selling securityholders. Tier 1 is limited to $20 million. The $10 million figure is the ceiling for Rule 504 offerings.17 CFR 230.251(a)

Which issuer is ineligible to use the Rule 504 exemption for limited offerings of up to $10 million?

• a.A company that has sold securities under Rule 504 in another state
• b.A company subject to Exchange Act Section 13 or 15(d) reporting requirements✓
• c.A newly formed company with no operating history
• d.A company organized as a limited liability company

Rule 504 is not available to an issuer that is subject to Exchange Act reporting requirements, an investment company, or a blank check company. A start-up, an LLC, or a prior Rule 504 issuer remains eligible if the other conditions are met. The ceiling is $10 million in any 12-month period.17 CFR 230.504(a)

An issuer wants to advertise a private offering broadly on its website without registering the sale. Which exemption allows general solicitation?

• a.Rule 506(b), provided no more than 35 non-accredited purchasers invest
• b.Rule 506(c), provided no more than 35 non-accredited purchasers invest
• c.Rule 506(c), provided all purchasers are accredited investors and the issuer takes reasonable steps to verify their status✓
• d.Rule 506(b), provided the issuer files a notice with each state

Rule 506(c) permits general solicitation but requires that every purchaser be an accredited investor and that the issuer take reasonable steps to verify that status. Rule 506(b) prohibits general solicitation, though it allows up to 35 non-accredited purchasers who meet sophistication requirements. A state notice filing does not lift the ban on solicitation.17 CFR 230.506(b)(1), (c)

An issuer relies on Rule 147A for an intrastate offering. Which statement about who may be offered and who may buy is correct?

• a.Sales may be made to out-of-state residents if they are accredited investors
• b.Offers may be made only to residents of the state, but sales may be made to anyone
• c.Offers may be made to out-of-state residents, but sales may be made only to residents of the issuer's state✓
• d.Offers and sales may be made only to residents of the issuer's state

Rule 147A, unlike Rule 147, allows offers to persons located anywhere (for example, over the internet), but all sales must be to residents of the issuer's state, and the issuer must be doing business in that state under the rule's tests such as deriving 80% of its revenues there. Accredited status does not create an exception to the residency requirement for sales.17 CFR 230.147A

To qualify as a real estate investment trust, which condition must the entity meet?

• a.It must hold only unleveraged properties
• b.It must distribute 100% of its taxable income to avoid tax
• c.It must have at least 500 shareholders on an exchange
• d.Its beneficial ownership must be held by 100 or more persons✓

A REIT must have beneficial ownership held by 100 or more persons and may not be closely held. It must also pass income and asset tests and distribute at least 90% of its taxable income to avoid corporate-level tax, with no requirement to be unleveraged. A fixed 500 shareholder minimum is not part of the rule.IRC 856(a)(5), (a)(6)

What is the distribution requirement for a REIT, as a percentage of its real estate investment trust taxable income (excluding net capital gain), to be taxed as a REIT?

• a.75%
• b.95%
• c.90%✓
• d.100%

A REIT must pay dividends equal to at least 90% of its REIT taxable income (determined without the dividends-paid deduction and excluding net capital gain) to obtain pass-through tax treatment. The 75% number is the share of gross income that must come from real estate sources. A trust that distributes less than 100% pays corporate tax only on the retained part.IRC 857(a)(1)

A publicly traded partnership will not be taxed as a corporation under section 7704 if it meets which gross income test?

• a.At least 75% of its gross income comes from rents on real property
• b.At least 50% of its gross income is distributed to limited partners in cash
• c.At least 90% of its gross income is qualifying income, such as interest, dividends, and real property rents✓
• d.No more than 10% of its gross income comes from operating a business

A publicly traded partnership keeps pass-through treatment if 90% or more of its gross income is qualifying income, which includes interest, dividends, certain real property rents and income from mineral or natural resource activities. The 75% real estate test belongs to REITs.IRC 7704(c)(2)

A single taxpayer who actively participates in a rental property has $40,000 of passive rental losses and adjusted gross income of $120,000 (before the passive loss). Under the passive loss rules, how much of the loss may offset non-passive income this year?

• a.$0, because passive losses may never offset non-passive income
• b.$25,000, because the full allowance applies to anyone who actively participates
• c.$15,000, because the $25,000 allowance is cut by 50% of the amount over $100,000✓
• d.$20,000, because the allowance is cut by the full excess over $100,000

Section 469(i) allows up to $25,000 of passive rental losses to offset other income for active participants, reduced by 50% of AGI above $100,000. Here that is $25,000 − (50% × $20,000) = $15,000. The allowance disappears at $150,000. The remaining $25,000 of loss is suspended and carried forward.IRC 469(i)

A life insurance contract fails the 7-pay test of section 7702A. What is the tax consequence for policy loans taken from the contract?

• a.It remains an ordinary policy, so loans are taxed only after the policy's basis has been recovered first in all cases, with no additional tax of any kind
• b.It is no longer life insurance, so the death benefit is taxable to the beneficiary
• c.It is a modified endowment contract, but loans are never taxable because loans are not income and the policy is still ordinary life insurance for tax purposes
• d.It is a modified endowment contract, so loans are treated as distributions, taxed income first, and may be subject to a 10% additional tax✓

A contract that fails the 7-pay test is a modified endowment contract (MEC). Loans and withdrawals from a MEC are taxed as income first (up to the gain in the contract), and a 10% additional tax applies to amounts included in income before age 59½ unless an exception applies. The death benefit usually stays income tax free. For an ordinary policy, amounts are generally basis first.IRC 7702A(a)-(b), 72(e)(10), 72(v)

Which exchange does NOT qualify as a tax-free exchange under section 1035?

• a.A life insurance contract for another life insurance contract
• b.An annuity contract for a life insurance contract✓
• c.A life insurance contract for an annuity contract
• d.An annuity contract for another annuity contract

Section 1035 allows life insurance to be exchanged for life insurance, endowment, or annuity contracts, and an annuity to be exchanged for another annuity, but it does not allow an annuity to be exchanged for a life insurance contract. Such an exchange would be a taxable surrender of the annuity.IRC 1035(a)

A 50-year-old owns a nonqualified deferred annuity worth $100,000 in which her investment (basis) is $60,000. She withdraws $30,000 before annuitizing. What are the tax results?

• a.None is taxable, because withdrawals first return her $60,000 of basis
• b.All $30,000 is taxable as income first, plus a 10% additional tax of $3,000✓
• c.$12,000 is taxable, because the withdrawal is split pro rata between basis and earnings
• d.All $30,000 is taxable but no additional tax applies, because it is a withdrawal from an annuity

Withdrawals from a nonqualified deferred annuity before the annuity starting date are taxed on a last-in, first-out basis: earnings come out first. Her gain is $40,000, so the entire $30,000 is taxable. Because she is under 59½, a 10% additional tax applies to the taxable portion, or $3,000, unless an exception applies. The pro rata method applies to annuity payouts, not to lump withdrawals.IRC 72(e)(2)(B), 72(e)(3), 72(q)

An employee exercises an incentive stock option on February 1, 2025, having been granted it on January 15, 2024. She sells the shares on January 20, 2026. How is the sale classified?

• a.A qualifying disposition, because she sold more than two years after the grant
• b.A qualifying disposition, because she sold more than 12 months after the exercise window opened
• c.A disqualifying disposition, because she sold less than one year after exercise✓
• d.A disqualifying disposition, because she sold less than two years after exercise

To get ISO treatment, the employee must not dispose of the shares within two years from the grant date or within one year after the transfer on exercise. She met the two-year-from-grant test (January 15, 2026 had passed), but the sale on January 20, 2026 came before February 1, 2026, so she failed the one-year-from-exercise test. The disposition is disqualifying and the spread is generally ordinary income.IRC 422(a)(1)

How are gains and losses on regulated futures contracts and other section 1256 contracts treated at tax time?

• a.60% as long-term and 40% as short-term, regardless of how long the position was held, and they are marked to market at year-end✓
• b.Long-term if held more than one year and short-term otherwise, with no year-end marking to market, as for stock held in a brokerage account
• c.40% as long-term and 60% as short-term, regardless of how long the position was held or whether the contract was closed out before year-end
• d.100% short-term, because futures positions are always short-term trades

Section 1256 contracts are marked to market at year-end, and gain or loss is treated as 60% long-term and 40% short-term, whatever the actual holding period. The reversed split would produce less favorable treatment than the law gives. The usual one-year holding period test does not apply.IRC 1256(a), (a)(3)

Two spouses hold a joint account with no other accounts at one FDIC-insured bank, and the balance is $600,000. Assuming equal ownership interests, how much is insured and how much is uninsured?

• a.$500,000 insured and $100,000 uninsured, because each co-owner's interest is insured up to $250,000✓
• b.$500,000 insured and $100,000 uninsured, because the limit is $500,000 per bank
• c.$250,000 insured and $350,000 uninsured, because one account has a single limit
• d.$600,000 insured, because spouses are covered by an unlimited limit

FDIC deposit insurance covers $250,000 per depositor, per ownership category, per bank. Each co-owner's share of a joint account is insured up to $250,000 separately, so two equal owners are covered to $500,000 and $100,000 is exposed. There is no unlimited coverage for spouses, and the account is not limited to one $250,000 amount.12 CFR 330.9; FDIC deposit insurance

A brokerage fails and is liquidated by SIPC. A customer has $200,000 of securities and $260,000 of cash in one account. What is the most SIPC can restore to her?

• a.$250,000, because SIPC covers only the cash limit
• b.$460,000, because the total is under the $500,000 limit
• c.$500,000, because SIPC always pays the full limit
• d.$450,000, because the $250,000 cash sub-limit leaves $10,000 of cash uncovered✓

SIPC protection is up to $500,000 per customer, which includes up to $250,000 for cash. Her total of $460,000 is under $500,000, but only $250,000 of the $260,000 cash qualifies, so she can recover $200,000 plus $250,000, or $450,000. SIPC does not cover market losses.15 U.S.C. 78fff-3; SIPC

What is required for a mutual fund to adopt a Rule 12b-1 distribution plan with respect to board review?

• a.Shareholders must re-approve it each year at the annual meeting, and the board reviews expenditures annually instead of quarterly, with no disinterested director vote
• b.The adviser alone must approve it, and the board is informed once the plan has been in effect for a year, with no director vote required
• c.Directors who are not interested persons must approve it, and the board must review a written report of expenditures at least quarterly✓
• d.The SEC must approve each plan and expenditure report before the fund can pay any fee

A 12b-1 plan requires approval by the board, including a majority of the directors who are not interested persons, and the board must review a written report of amounts spent and their purposes at least quarterly. The plan must be terminable at any time by vote of a majority of the disinterested directors. The SEC does not preapprove expenditures.17 CFR 270.12b-1(b)-(e)

A diversified mutual fund wants to reclassify itself as a nondiversified fund. What does the Investment Company Act require?

• a.A vote of a majority of its outstanding voting securities✓
• b.Only a vote of the fund's board of directors
• c.A vote of the board including a majority of the independent directors, with notice to shareholders after the change
• d.Nothing, if the fund notifies shareholders in its next annual report

Section 13(a) prohibits a registered investment company from changing its subclassification from diversified to nondiversified (or other listed fundamental policies) unless authorized by a vote of a majority of its outstanding voting securities. Board approval alone or after-the-fact notice is not enough.15 U.S.C. 80a-13(a)(1)

A bond has a modified duration of 6.0. If its yield rises by 50 basis points, what is the approximate percentage change in price?

• a.A decrease of about 0.3%
• b.A decrease of about 12.0%
• c.A decrease of about 3.0%✓
• d.An increase of about 3.0%

Modified duration estimates the percentage price change per 1 percentage point change in yield, with an inverse relationship. A 0.50 point rise times 6.0 gives roughly a 3.0% price decline. Reading 50 basis points as 5 points would yield a far larger move, and a rising yield cannot raise the price.

Fund A returned 12% with a standard deviation of 15%. Fund B returned 10% with a standard deviation of 10%. The risk-free rate is 3%. Which statement is correct?

• a.The two funds have the same Sharpe ratio, because both beat the risk-free rate
• b.Fund A has the higher Sharpe ratio, because its raw return of 12% is higher than 10%
• c.Fund A has the higher Sharpe ratio, because its excess return of 9% exceeds Fund B's 7%
• d.Fund B has the higher Sharpe ratio, 0.70 versus 0.60 for Fund A✓

The Sharpe ratio is excess return divided by standard deviation. Fund A is (12 − 3) / 15 = 0.60 and Fund B is (10 − 3) / 10 = 0.70. Fund B earned more excess return per unit of total risk even though its raw return is lower. Ranking by raw return ignores risk.

A project costs $1,000 today and returns $400, $500, and $600 at the end of years 1 through 3. Using a 10% discount rate, what is the project's NPV, and should it be accepted?

• a.About $228, so accept it because NPV is positive✓
• b.About $500, so accept it because the total inflows exceed the cost
• c.About $228, so reject it because the payback period is longer than two years
• d.About $-228 negative, so reject it because discounting turns the NPV negative

NPV discounts each cash flow: 400/1.1 + 500/1.1² + 600/1.1³ = 1227.65, less the $1,000 cost, is about 227.65. A positive NPV means the project earns more than the 10% required return, so the decision rule says accept. Adding undiscounted inflows ignores the time value of money, and payback length is not the NPV rule.

A portfolio earned a 7.0% nominal return in a year when inflation was 3.0%. What is the real return, computed exactly rather than by simple subtraction?

• a.4.00%
• b.10.00%
• c.3.88%✓
• d.4.12%

The exact real return is (1 + nominal) / (1 + inflation) − 1 = 1.07 / 1.03 − 1 = 3.88%. Simple subtraction gives 4.00%, which is only an approximation. Dividing the 4-point difference by (1 − inflation) gives 4.12%, and adding the two rates, 10.00%, is not a real return at all.

A three-year, 5% annual-pay bond with a $1,000 par value is priced to yield 6%. About what is its price?

• a.$1,150.00
• b.$973.27✓
• c.$1,000.00
• d.$1,027.75

Discount the three $50 coupons and the $1,000 principal at 6%: the present value is about $973.27. A bond whose coupon rate is below its market yield sells at a discount to par. The $1,027.75 figure is the price if the yield were 4%, so it is a premium price and fails the direction test, and $1,150 simply adds the three coupons to par.

A 10-year bond with a 7% coupon trades at 108 and is callable in three years at 102. Which of its yield measures is the lowest?

• a.Current yield, because it is computed on the premium price rather than on par
• b.Nominal yield, because the coupon is always the lowest measure for a bond selling at a premium
• c.Yield to call, because a premium bond is more likely to be called and the investor loses the premium sooner✓
• d.Yield to maturity, because a longer horizon always lowers the yield

For a bond selling at a premium, the price will be pulled down toward par or the call price, and the sooner that happens the greater the capital loss per year. The yield to the earliest call is therefore generally the lowest measure, and investors quote the yield to worst. For these terms the measures rank 7.0% nominal, about 6.5% current, about 5.9% to maturity, and about 4.7% to the call, so the nominal yield is actually the highest.