High 5 Fridays 2017 March Exam Session 2 Handout January 20, 2017 Michael Long, CFP, CLU, ChFC

Transcription

1 High 5 Fidays 2017 Mach Exam Session 2 Handout Januay 20, 2017 Michael Long, CFP, CLU, ChFC michael.long@kaplan.com A ecoding of today s session will be posted in the High 5 webinas folde on the Dashboad Have you ead the Standads of Pofessional Conduct at least once this week?

2 2 3 BOOK Investment Planning 1 2 CFP_Book 3.indb 1 3/16/2016 3:12:47 PM

3 NPV and IRR is coveed on pages in Book 1; the example hee is fom Couse 101 NPV equals the diffeence between the initial cash outflow (investment) and the pesent value of discounted cash inflows NPV: "Need Positive Value" The I/YR input is the client's equied ate of etun Note in the IRR calculation we ae solving fo the etun, we do not input I/YR If NPV > 0; IRR > equied ate of etun If NPV = 0; IRR = equied ate of etun If NPV < 0; IRR < equied ate of etun IRR is the discount ate that makes the PV of the cash inflows equal to the initial cash outflows such that the NPV is zeo Note - NPV and IRR use uneven cash flows input. Uneven cash flows can also be used fo education funding and etiement calculations.

4 Povided Fomulas These fomulas ae available to exam candidates when taking the CFP Cetification Examination: g D V = 1 = p f m f p p β α g P D = 1 p f p p T β = j i ij ij COV σ σ ρ = y y c y c t y y y D t = ) ( ) ( ) ( ij j i j j i i p COV W W W W = σ σ σ = y y D P P 1 2 m im i COV σ β = m i im σ σ ρ = σ A RP RB IR = n n t t = = 1 ) 2 ( σ 1 1 ) 2 ( = = n n t t S i f m f i β ) ( = V

5 Povided Fomulas (cont.) S p = p σ p f Page 2 of 2

6 4 Appendix 185 Definitions of vaiables and symbols used in CFP Boad fomula page: V = Intinsic Value of Stock as used in Constant Gowth Dividend Discount Model D 1 = Next Yea s Dividend payable by Stock in Constant Gowth Dividend Discount Model g = Requied Rate of Retun in Constant Gowth Dividend Discount Model; also used to mean Expected Rate of Retun in Expected Retun Fom of Dividend Discount Model = Gowth Rate of Dividends in Constant Gowth Dividend Discount Model P = Puchase Pice of Tageted Stock using Expected Retun Fom of Dividend Discount Model COV ij o COV im = Covaiance between Two Sample Assets ( ij ) o Covaiance between One Sample Asset and Maket o Maket Index ( im ) ρ ij o ρ im = Coelation Coefficient between Two Sample Assets ( ij ) o Coelation Coefficient between One Sample Index and Maket o Maket Index ( im ) σ i = Standad Deviation of Fist Sample Asset σ j = Standad Deviation of Second Sample Asset σ p = Standad Deviation of a Potfolio W i = Weighting Pecentage of Fist Sample Asset in Standad Deviation of a Potfolio Fomula W j = Weighting Pecentage of Second Sample Asset in Standad Deviation of a Potfolio Fomula 2 = Numbe of Sample Assets in Standad Deviation of a Potfolio Fomula m = Maket Rate of Retun in Capital Asset Picing Model β i = Beta Coefficient of Sample Stock o Asset in Capital Asset Picing Model p = Potfolio Rate of Retun in Capital Maket Line Theoy, Shape Ratio, Jensen s Alpha, and Teyno Ratio S p = Shape Ratio α p = Jensen s Alpha β p = Beta Coefficient of Sample Potfolio in Jensen s Alpha and Teyno Ratio T p = Teyno Ratio D = Macaulay Duation ΔP = Change in Bond Pice given a espective change in maket inteest ates (Δy) σ m = Standad Deviation of Maket o Maket Line σ = Population Standad Deviation of a Single Asset Σ = Geek Sigma meaning multiple numbe (n) of actual etuns = Aveage o Mean etun among multiple numbe of actual etuns (in standad deviation fomulas) s = Sample Standad Deviation of Single Asset y t c i f = Yield to Matuity = Tem to Matuity = Coupon Rate = Requied Rate of Retun in Capital Asset Picing Model = Risk-Fee Rate of Retun in Capital Asset Picing Model, Capital Maket Line Theoy, Shape Ratio, Jensen s Alpha, and Teyno Ratio EAR = Effective Annual Retun TEY = Taxable Equivalent Yield t = Tax Rate (as a decimal) in TEY Calculation AM = Aithmetic Mean CFP_Book 3.indb /16/2016 3:13:07 PM

7 5 186 Kaplan Financial Education Review fo the CFP Cetification Examination a 1 R N = Rate of Retun fo a Given Peiod = Rate of Retun fo Peiod N N = Numbe of Peiods R = Inteest Rate fo Peiod E( 1 1 ) = Expected Inteest Rate fo Peiod 2 E( N 1 ) = Expected Inteest Rate fo Given Peiod HPR = Holding Peiod Retun CFP_Book 3.indb /16/2016 3:13:07 PM

8 6 92 Kaplan Financial Education Review fo the CFP Cetification Examination EXHIBIT 19: The Efficient Fontie Efficient Fontie Expected etun E() D A B C Risk (σ) a. Evey potfolio esiding on the efficient fontie has eithe a highe ate of etun fo equal isk o lowe isk fo an equal ate of etun than anothe potfolio below o undeneath the fontie. In the pevious gaphic, Potfolios A and B ae both equally efficient and dominate Potfolio C because: 1.) Potfolio A has an equal expected ate of etun as Potfolio C, but with a significantly lowe level of assumed isk 2.) Potfolio B has an equal level of assumed isk as Potfolio C, but with a significantly highe expected ate of etun. Theefoe, Potfolio C is inefficient; it is attainable but not optimal. 3.) Potfolio D is unattainable because it esides above the efficient fontie b. Indiffeence cuves (I 1, I 2, and I 3 ) that cuve upwad ae used to measue the iskewad tade-offs that investos ae willing to make 1.) The indiffeence cuve will coss the efficient fontie in two locations, unless it is tangent to the efficient fontie 2.) Each investo has an infinite numbe of indiffeence cuves 3.) Using indiffeence cuves in conjunction with the efficient fontie allows investos to choose the best potfolio fo the given level of isk. The potfolio that lies at the tangent of the indiffeence cuve and the efficient fontie is the optimum potfolio fo the investo. CFP_Book 3.indb /16/2016 3:12:56 PM

9 7 Book 3: Investment Planning 93 EXHIBIT 20: Choosing the Optimal Potfolio Expected Retun E() A B I C I I Efficient Fontie Risk (σ) c. The efficient fontie consists of potfolios with the highest expected etun fo a given level of isk 1.) Thee ules fo choosing efficient assets: a.) Fo any two isky assets with the same expected etun, choose the one with the lowe isk b.) c.) Fo any two assets with the same isk, choose the one with the highe expected etun Choose any asset that has a highe expected etun and lowe isk 2.) Potfolios may exist below the efficient fontie 3.) Potfolios may not exist above the efficient fontie a.) The efficient fontie consists of the most efficient potfolios (potfolios of assets with the highest expected etun fo a given level of isk) b.) Any potfolio above the efficient fontie is unattainable 4.) The x-axis epesents the level of isk that is measued by the standad deviation (σ) of the potfolio 5.) The y-axis measues the expected etun [E()] fom the potfolio D. CAPITAL ASSET PRICING MODEL 1. The capital asset picing model (CAPM), developed lagely by William F. Shape, elied and expanded on the concepts developed by Hay Makowitz i = f ( m f ) β i i = expected etun fo a stock m = maket ate of etun f = isk-fee ate of etun β i = beta, measues systematic isk of a paticula stock CFP_Book 3.indb /16/2016 3:12:56 PM

10 8 Book 3: Investment Planning 97 EXAMPLE Howie, a secuities analyst, has used the concept of multiple egession to detemine the sensitivity of a cetain stock to vaious factos. He has found that the following factos ae the most indicative of his stock s etuns: Facto Facto Beta Facto Risk Pemium Inflation 1.1 5% Unemployment 0.8 7% Industial poduction 0.5 6% If the ate on 90-day T-bills is 2%, then the expected etun fo this stock equals 16.1%: i = a 0 b 1 F 1 b 2 F 2 b 3 F 3 i = (0.05) 0.8(0.07) 0.5(0.06) i = = 16.1% F. THE EFFICIENT MARKET HYPOTHESIS (EMH) 1. This theoy suggests that investos ae unable to outpefom the maket on a consistent basis without accepting additional isk a. The maket s efficiency in valuing secuities is extemely quick and accuate; theefoe, investos ae not able to find undevalued stocks on a consistent basis b. The basic assumption of this theoy is that cuent stock pices eflect all available infomation fo a company and that the pices apidly adjust to eflect any new infomation 2. Day-to-day pice changes follow a andom walk patten a. This patten occus because futue events cannot be pedicted fom past infomation; cuent stock pices fully eflect all known infomation b. Theefoe, pice changes ae unpedictable and andom. If pices move in a andom fashion, any tading ules o techniques will be useless. c. New infomation must be unexpected, othewise it would be eflected in the cuent stock pice. Theefoe, if new infomation is unexpected and andom, changes in the stock pice will also be andom. 3. The EMH has thee distinct foms a. The weak fom 1.) Holds that cuent stock pices have aleady incopoated all histoical maket data, such as pices, tading volume, and published financial infomation 2.) Technical analysis is founded on the concept of analyzing past secuity pices and levels of tading volume in an attempt to pedict demand and, theefoe, futue pices. The EMH and technical analysis ae in diect contadiction. 3.) Fundamental analysis and inside infomation may poduce above-maket etuns unde the weak fom CFP_Book 3.indb /16/2016 3:12:57 PM

11 9 98 Kaplan Financial Education Review fo the CFP Cetification Examination b. The semistong fom 1.) The cuent stock pice not only eflects all past histoical pice data but also data fom analyzing financial statements, industy, o cuent economic outlook 2.) Stock pices will adjust quickly to eflect any new infomation (including maket, economic, social, political, and global) 3.) This fom suggests that many analysts follow the same stock and that any new infomation will be quickly incopoated into the cuent pice. Thus, even fundamental analysis is not likely to yield above-maket etuns. 4.) Inside infomation may poduce supeio etuns c. The stong fom 1.) Holds that stock pices eflect all public infomation and most pivate (inside) infomation. Theefoe, even tades using inside infomation ae unlikely to consistently outpefom the maket. 2.) Technical analysis, fundamental analysis, and inside infomation will not allow investos to achieve consistently supeio pefomance unde the stong fom EXHIBIT 22: The Thee Foms of the EMH Fom Weak Type of Infomation Reflected in Pice Technical Analysis Semistong Technical and Fundamental Analysis Stong Technical and Fundamental Analysis and Inside Infomation d. Empiical evidence 1.) Numeous studies have been conducted to detemine the validity, if any, of the thee foms of the efficient maket hypothesis. These studies have poduced evidence suppoting all thee foms of maket efficiency. 2.) Exceptions to efficient makets ae called anomalies 4. Anomalies ae unexpected esults assuming the EMH is tue fo all makets. Following ae vaious anomalies that contadict the efficient maket hypothesis: a. The pice-to-eanings atio (P/E) effect suggests that highe etuns ae attainable with potfolios consisting of secuities with low P/E atios 1.) Reseach and evidence may suppot the validity of this anomaly 2.) Consideing the evidence, it seems fims that geneally tade at low pice-toeanings multiples have highe etuns than othe fims CFP_Book 3.indb /16/2016 3:12:57 PM

12 Kaplan Financial Education Review fo the CFP Cetification Examination VI. BOND AND STOCK VALUATION CONCEPTS CFP Boad Pincipal Knowledge Topic E.38. A. BOND VALUATION 1. Basis point a. A basis point epesents one hundedth of one pecent (0.01% o ) b. Fo example, a bond s yield falling fom 3.35% to 3.22% is a decline of 13 basis points 2. Basic concepts a. Cuent yield (CY) 1.) Measues a bond s yield based on its annual inteest payments and cuent maket pice 2.) CY = annual inteest payment cuent maket pice 3.) As a bond s pice inceases, its cuent yield declines 4.) As a bond s pice deceases, its cuent yield inceases b. Yield to matuity (YTM) the intenal ate of etun (IRR) fo cash flows associated with the bond, including the puchase pice, coupon payments, and matuity value 1.) The geneal valuation model may be used to solve fo a bond s YTM (y). In this case, the investo would have been povided with the bond s pesent value (PV), cash flows (PMT), numbe of peiods (t), and matuity value (FV). NOTE: Fo calculation puposes, the vaiable t is equivalent to N and the vaiable y is equivalent to I/YR on a financial calculato such as the HP10BII/HP10BII. PV = CF 1 CF 2... CF t (1y) 1 (1y) 2 (1y) t PV = pesent value of the secuity CF = cash flow fo a paticula peiod y = discount ate pe peiod yield to matuity t = numbe of cash flows to be evaluated CFP_Book 3.indb /16/2016 3:12:57 PM

13 11 Book 3: Investment Planning 107 EXAMPLE A thee-yea junk bond has an annual coupon ate of 8% (paid semiannually). If the yield fo this type of bond inceases to a 10% annual coupon ate, what should the bond with a coupon ate of 8% sell fo in the seconday maket? PV = PV = CF 1 CF 2 CF 3 CF 4 CF 5 CF 6 (1y) 1 (1y) 2 (1y) 3 (1y) 4 (1y) 5 (1y) ,040 (1.05) 1 (1.05) 2 (1.05) 3 (1.05) 4 (1.05) 5 (1.05) 6 PV = PV = , o $ The YTM in this example is 10% (5% semiannually). In geneal, the YTM is the annualized inteest ate that the bond eans ove the tem of the bond. An easie method is to use a financial calculato. FV = 1,000 PMT = 40 i = 5 n = 6 Solve fo PV = , o $ EXAMPLE A thee-yea bond with a coupon of 6% paid annually is selling fo $750. What is the bond s YTM? PV = 750 = CF 1 CF 2 CF 3 (1y) 1 (1y) 2 (1y) ,060 (1y) 1 (1y) 2 (1y) 3 NOTE: This equation may be easily solved using a financial calculato. PV = (750) n = 3 PMT = 60 FV = 1,000 Solve fo y (i on you financial calculato) YTM = , o % 2.) Bonds of simila isk and tem stuctue will have equal YTMs 3.) Bonds iskie than othes with the same tem stuctue will have highe yields to matuity CFP_Book 3.indb /16/2016 3:12:57 PM

14 Kaplan Financial Education Review fo the CFP Cetification Examination 4.) When the maket ate of inteest (maket yield) fo the same tem and isk is highe than a bond s coupon ate, the bond will be piced at a discount (below pa) 5.) If the maket ate of inteest (maket yield) is below the coupon ate, the bond will be piced at a pemium (above pa) 6.) Assumptions of YTM a.) A majo assumption when calculating the YTM is that all inteest payments ae einvested at the calculated YTM. Theefoe, if the calculated YTM is 6%, any inteest payments geneated fom the bond ae assumed to be einvested at 6%. b.) If the inteest payments ae not einvested at the YTM ate, the ealized o actual etun will be diffeent fom the calculated o expected etun o YTM c. Yield to call (YTC) NOTE: If the coupon payments fom the bond ae einvested at a ate less than the calculated YTM, then the actual yield will be lowe than the YTM. If the coupon payments ae einvested at a ate highe than the calculated YTM, then the actual yield will be geate than the calculated YTM. 1.) Bonds will often be issued with a call featue pemitting the issue to pay off the debt obligation at a pedetemined call pice and time a.) This featue is a benefit to the issue because it pemits the issue to efinance the outstanding debt in the event that inteest ates decline b.) This featue causes the equied yield to incease fo investos because the investment time hoizon is no longe cetain 2.) The YTC should be calculated to detemine how the call featue will affect the bond s etun EXAMPLE Davis Company issues a 25-yea bond paying a 6% semiannual coupon selling at pa ($1,000). If Davis Company has the option to call the bonds in five yeas fo 105% ($1,050) of pa value, what is the bond s yield to call? FV = 1,050 PV = (1,000) PMT = 30 n = 10 Solve fo i YTC = 6.86% ( x 2) NOTE: In this example, the YTM would equal 6%, indicating the bond is cuently selling at pa. d. Bond pices and inteest ates 1.) Bond pices move invesely with changes in inteest ates. If inteest ates incease, bond pices decease. This occus because the bond is yielding a lowe CFP_Book 3.indb /16/2016 3:12:58 PM

15 13 Book 3: Investment Planning 109 ate than is cuently available in the maket. Investos ae unwilling to puchase the lowe yielding bond fo the same pice as a cuent, highe yielding bond. Thus, the pice of the lowe yielding bond will decline accodingly. 2.) Similaly, bond pices will incease if inteest ates decline. This occus because the bond is yielding a highe ate than is cuently available in the maket. Theefoe, investos ae willing to pay a pemium fo this highe yielding bond because the maket is offeing lowe yields. e. Tem and pice volatility 1.) The tem of the bond will affect the degee to which the pice of the bond fluctuates 2.) Bonds with longe tems ae subject to moe pice volatility with changing inteest ates than bonds with shote tems. A 30-yea Teasuy bond will be moe pice volatile than a five-yea Teasuy note. f. Coupon ate and pice volatility 1.) The pice volatility of a bond with espect to inteest ate changes is also a function of the bond s coupon ate 2.) Bonds with highe coupon ates ae moe stable when inteest ates change than bonds with lowe coupon ates. A zeo-coupon bond will have a tendency to be moe pice volatile than a bond with a 4% coupon. g. Evaluating bonds with egad to inteest ate isk equies consideation of both tem and coupon ate of the bond. Bonds with low coupon ates and long matuities will be the most pice sensitive to inteest ate changes. These bonds will have much highe pice fluctuations than bonds of shote matuities and lage coupon ates. Theefoe, the most volatile bond will be a long-tem zeo-coupon bond. 3. Yield cuve a. A yield cuve is a gaph of inteest ate yields fo bonds anging fom 31 days to 30 yeas. 1.) Typically, yield cuves eflect ates offeed by Teasuy instuments fo vaious matuities. 2.) Yield cuves have a tendency to slope upwad and outwad, denoting that as the matuity of bonds inceases, the coesponding inteest ate yields incease (nomal yield cuve, see following exhibit). EXHIBIT 24: Positively Sloped Yield Cuve (Nomal) Yield (%) Yeas 30 3.) Occasionally, yield cuves may be flat (denoting no diffeence in the yield elative to the matuity) o inveted (denoting that cuent shot-tem boowing costs ae highe than long-tem boowing costs). CFP_Book 3.indb /16/2016 3:12:58 PM

16 14 Investment Planning Example: Davis Company issues a 25-yea bond paying a 5% coupon paid semiannually and selling at pa ($1,000). If Davis Co. has the option to call the bonds in five yeas fo 105% ($1,050) of pa, what is the yield to call? FV PV = = 1,050 (1,000) PMT = 25 (50 2) n = 10 (5 2) Solve fo i YTC = % ( ) Compaison oftoytm, Coupon Rate, and Cuent Yield of a Bond Cuent Yield, Yield Matuity, and Yield to Call CY YTM YTC CY = Cuent yield YTM = Yield to matuity YTC = Yield to call Pemium Pa Discount Coupon This is fom the Live Review mateial, showing the elationship between the coupon ate, CY, YTM, and YTC, depending on whethe the bond is selling at pa, at a pemium, o at a discount Bond questions often test the calculations, but may test the conceptual aspects without equiing a calculation 4. Yield cuves. a. Yield cuves typically epesent U.S. Teasuy instuments fo vaious matuities. b. Yield cuves have a tendency to slope upwad denoting that as the matuity of bonds inceases, the coesponding inteest ate yields incease (nomal yield cuve). c. Occasionally yield cuves may be flat (denoting no diffeence in the yield elative to the matuity) o inveted (denoting that cuent shot-tem boowing costs ae highe than long-tem boowing costs) Kaplan, Inc. Page _LiveReview_InClass_Guide.indb 119 3/23/2016 8:32:53 PM

17 Book 4: Tax Planning CFP_Book_4.indb /21/2016 8:59:19 AM

18 16 The tax tables and limits below ae povided to individuals taking the July 2016 CFP Cetification Examination. Exam Window Tax Rates, Tables, & Law Tested July Novembe Mach INCOME TAX RATES 2016 SINGLE Taxable Income But Not % on of the amount Ove Ove Pay Excess ove $0 -- $9,275 $0 10% $ 0 9, , ,275 37, ,150 5, ,650 91, ,150 18, , , ,350 46, , , , , , , , ,050 16

19 MARRIED FILING JOINTLY Taxable Income But Not % on of the amount Ove Ove Pay Excess ove $0 -- $18,550 $0 10% $ 0 18, ,300 1, ,550 75, ,900 10, , , ,450 29, , , ,350 51, , , , , , , , , MARRIED FILING SEPARATELY Taxable Income But Not % on of the amount Ove Ove Pay Excess ove $0 -- $9,275 $0 10% $ 0 9, , ,275 37, ,950 5, ,650 75, ,725 14, , , ,675 25, , , ,475 55, , , , ,475 17

20 HEAD OF HOUSEHOLD Taxable Income But Not % on of the amount Ove Ove Pay Excess ove $0 -- $13,250 $0 10% $ 0 13, ,400 1, ,250 50, ,150 6, , , ,800 26, , , ,350 49, , , , , , , , , NET INVESTMENT INCOME TAX The net investment income tax is applied at a ate of 3.8%. Individuals Applied to the lesse of: the net investment income, o the excess of modified adjusted goss income ove the following theshold amounts: $250,000 fo maied filing jointly o qualifying widow(e) with dependent child $125,000 fo maied filing sepaately $200,000 in all othe cases Estates & Tusts Applied to the lesse of: the undistibuted net investment income, o the excess of: the adjusted goss income ove $12,400 18

21 2016 ADDITIONAL MEDICARE TAX The additional Medicae tax is applied at a ate of 0.9%. 19 Filing Status Theshold Amount Maied filing jointly $250,000 Maied filing sepaately $125,000 Single, Head of household, o Qualifying widow(e) $200, LONG-TERM CAPITAL GAINS RATES Taxpayes in the 10% o 15% odinay income tax backet 0% Maximum Long-Tem Capital Gain Tax Rate Taxpayes in the 25%, 28%, 33%, o 35% odinay income tax backet 15% Taxpayes in the 39.6% odinay income tax backet 20% IRC Section 1250 depeciation ecaptue 25% Collectibles 28% 19

22 CORPORATE INCOME TAX RATES Taxable Income But Not % on of the amount Ove Ove Pay Excess ove $0 -- $50, % $ 0 50, ,000 7, ,000 75, ,000 13, , , ,000 22, , , ,000, , ,000 10,000, ,000,000 3,400, ,000,000 15,000, ,333,333 5,150, ,000,000 18,333, ESTATES AND NON-GRANTOR TRUSTS INCOME TAX RATES Taxable Income But Not % on of the amount Ove Ove Pay Excess ove $0 -- $2, % $ 0 2, , ,550 5, ,050 1, ,950 9, ,400 2, ,050 12, , ,400 20

23 STANDARD DEDUCTIONS AND PERSONAL EXEMPTION Standad Deduction*: Single $ 6,300 Maied filing jointly/ Qualifying widow 12,600 Maied filing sepaately 6,300 Head of household 9,300 Dependent 1,050 ** *inceased by $1,250 fo a maied taxpaye age 65 o olde o blind ($2,500 if both 65 and blind); by $1,550 fo a single taxpaye age 65 o olde o blind ($3,100 if both 65 and blind) **o $350 plus eaned income, if geate Pesonal Exemption: $4,050 21

24 22 Fa less to memoize now!! 2016 RETIREMENT PLAN CONTRIBUTION LIMITS AND PHASE-OUTS Elective defeals 401(k), 403(b), 457, and SARSEPS emembe to aggegate defeals except 457 Catch - up contibution Defined contibution limit Defined benefit limit $18,000 $6,000 this is the annual additions limit $53,000 this is the max annual pension benefit payout $210,000 SIMPLE plan elective defeal limit $12,500 SIMPLE catch-up contibution Maximum includible compensation Highly compensated employee Look-back to 2014 $3,000 note this is the maximum compensation consideed in a QP fomula ($210,000 is the max DB) Look-back to 2015 $265,000 $115,000 $120,000 Key employee (top-heavy plan) >$170,000 SEP paticipation limit $600 IRA o Roth IRA contibution limit $5,500 combined limit IRA o Roth IRA catch-up $1,000 IRA deduction phase-out fo active paticipants note tad IRA phaseout is fo deduction, not contibution Single $61,000-$71,000 possible fo patial phaseout Maied filing jointly Maied filing sepaately $98,000-$118,000 $0-$10,000 excess > theshold total theshold ange Spousal IRA Roth IRA phase-out $184,000-$194,000 note Roth IRA phaseout is fo contibution Single $117,000-$132,000 Maied filing jointly $184,000-$194,000 22

25 ESTATE AND GIFT TAX RATES AND EXEMPTIONS Applicable cedit fo gift/estate taxes $2,125,800 Applicable exclusion amount $5,450,000 Max Estate/Gift Tax Rate 40% Max Geneation-Skipping Tansfe Tax (GSTT) Rate 40% Annual gift tax exclusion $14, SOCIAL SECURITY WAGE BASE AND EARNINGS LIMITS Wage base $118,500 Eanings limitations: Below Full Retiement Age $15,720 Pesons eaching Full Retiement Age $41, SOCIAL SECURITY FULL RETIREMENT AGES Yea of Bith Social Secuity Social Secuity Full Retiement Age Yea of Bith Full Retiement Age and 8 months and 2 months and 10 months and 4 months 1960 and late 67 23

26 HEALTH SAVINGS ACCOUNT LIMITS High Deductible Health Plan Minimum Deductible Amounts Single $1,300 Family $2,600 Maximum Out-of-Pocket Limits Single $6,550 Family $13,100 Contibution Maximums Single $3,350 Family $6,750 Catch-Up Contibutions (age 55 o olde) $1,000 24

27 ALTERNATIVE MINIMUM TAX (AMT) EXEMPTIONS AND PHASE-OUTS Filing Status Exemption AMTI Phase-Out Single $53,900 $119,700 Maied filing jointly $83,800 $159,700 Maied filing sepaately $41,900 $79,850 Tusts and estates $23,900 $79, AMT RATES AMTI up to $186,300 26% AMTI ove $186,300 28% 2016 CHILD TAX CREDIT Modified AGI Beginning Phase-Out Range fo Child Tax Cedit Maied Filing Jointly $110,000 Single/Head of Household $75,000 Maied Filing Sepaately $55,000 Phase-out complete when MAGI exceeds applicable theshold by $20,000/child 25

28 EDUCATION PHASE-OUTS EE bonds fo education - exclusion phase-out Single $77,550 - $92,550 Maied filing jointly $116,300 - $146,300 Covedell Education Savings Account- contibution phase-out Single $95,000 - $110,000 Maied filing jointly $190,000 - $220,000 Lifetime Leaning Cedit - AGI phase-out Single $55,000 - $65,000 Maied filing jointly $111,000 - $131,000 Ameican Oppotunity Tax cedit - AGI phase-out Single $80,000 - $90,000 Maied filing jointly $160,000 - $180,000 Education loan inteest deduction - AGI phase-out Single $65,000 - $80,000 Maied filing jointly $130,000 - $160,000 26

29 Kaplan Financial Education Review fo the CFP Cetification Examination XVII. ALTERNATIVE MINIMUM TAX (AMT) CFP Boad Pincipal Knowledge Topic F.46. A. GENERAL 1. This tax is a backup to the fedeal income tax to ensue that no taxpaye with substantial economic income can avoid significant tax liability by using deductions and exclusions 2. Applies to all taxpayes (individuals, tusts, estates, and copoations) a. Small copoations with aveage goss eceipts ove a thee-tax-yea peiod not exceeding $7.5 million ae exempt b. Amount is educed to $5 million fo the fist thee-tax-yea peiod of existence B. INDIVIDUAL ALTERNATIVE MINIMUM TAX 1. This tax paallels the egula fedeal income tax in many ways but uses adjustments and pefeences to account fo the diffeences. Fo example, both allow depeciation deductions, but the amount used in the calculation will be diffeent. 2. A taxpaye may have to pay the AMT in 2016 if taxable income fo egula tax puposes, combined with any adjustments and pefeence items, exceeds (in 2016): a. $53,900 if the filing status is that of a single taxpaye b. $41,900 fo a filing status of maied filing sepaately (MFS) c. $83,800 fo a maied taxpaye filing jointly (MFJ) d. $23,900 fo estates and tusts e. Exemption amounts begin to be phased out in 2016 on a one-fo-fou basis when 1.) a single taxpaye s AGI exceeds $119,700, 2.) a MFJ taxpaye s AGI exceeds $159,700, 3.) a MFS taxpaye s AGI exceeds $79,850, and 4.) estates and tusts with income exceeding $79,850. f. Taxpayes (MFJ, SS, single, estates, and tusts) with AMTI of $186,300 o less have a tax ate of 26% and a ate of 28% fo AMTI in excess of the theshold g. Taxpayes filing as MFS with AMTI of $93,150 o less have a tax ate of 26% and a ate of 28% fo AMTI in excess of the theshold 3. Calculating altenative minimum taxable income (AMTI): Regula taxable income Positive AMT adjustments Negative AMT adjustments Tax pefeences = AMTI CFP_Book_4.indb /21/2016 9:00:56 AM

30 28 Book 4: Tax Planning Then, to calculate altenative minimum tax (AMT): AMTI AMT exemption = Minimum tax base AMT ate = Tentative AMT Regula income tax on taxable income = AMT 5. Adjustments listed a. Adjustments made to taxable income in the fomula can be eithe positive o negative 1.) A positive adjustment is made when the deduction o exemption allowed fo egula income tax puposes exceeds the deduction o exemption allowed fo AMT puposes. Income is theefoe added to the calculation. 2.) A negative adjustment is made when the deduction allowed fo AMT puposes exceeds that fo egula income tax puposes. Income is theefoe subtacted fom the calculation. EXHIBIT 24: Altenative Minimum Tax Adjustment Regula Tax AMT Positive/ Negative Pesonal and dependency exemptions Allowed Disallowed Positive Standad deduction Allowed Disallowed Positive Itemized deduction medical Allowed in excess of 10% of Allowed in excess of Positive 2 AGI (7.5% if 65 o olde) 10% of AGI Itemized deduction taxes (state income taxes and Allowed Disallowed Positive popety taxes) Miscellaneous itemized deductions Allowed >2% of AGI Disallowed Positive Diffeence between qualified-esidence inteest and Allowed Disallowed Positive home equity loan inteest 1 Investment inteest expense as limited fo AMT Allowed Disallowed Positive puposes (elated to qualified-esidence inteest and pivate-activity-bond inteest) Execise of incentive stock options Not taxed Bagain element Positive (spead) is an addback Tax benefit ule fo state income tax efund Included in income Not included in income Negative Depeciation of post-1986 popety MACRS allowed ADS allowed Both 3 Completed contact method Small businesses can use the completed contact method Small businesses must use the pecentage-ofcompletion method Passive activity losses Both 3 Adjusted gain/loss Both 3 1 Home equity loan inteest that is not used fo home impovements is not consideed qualified esidence inteest fo the puposes of AMT. 2 The impact of a highe theshold, 10%, is an add-back of 2.5% (10% 7.5%) (if 65 o olde) of the taxpaye s AGI fo puposes of calculating AMTI. 3 Both means the adjustment could be positive o negative depending on cicumstances. Both 3 CFP_Book_4.indb /21/2016 9:00:57 AM

31 Kaplan Financial Education Review fo the CFP Cetification Examination 6. Tax pefeences ae always positive (incease taxable income) a. The AMT is designed to take back all o pat of the tax benefits available when calculating egula income tax, and includes the following: 1.) Pecentage depletion in excess of basis 2.) Tax-exempt inteest on cetain pivate activity bonds (e.g., bonds used to fund spots stadiums) 3.) A potion of the exclusion of gain on sale of cetain small business stock (Section 1202) a.) Fo Section 1202 qualified small business stock acquied afte 9/27/10, 100% of the gain on the sale of this stock is excluded fom altenative minimum taxable income 4.) Acceleated depeciation in excess of staight-line depeciation on cetain popety placed in sevice befoe Exclusion items vesus defeal items: a. The following AMT adjustments/pefeence items ae consideed exclusion items: 1.) Standad deduction 2.) Itemized deduction 3.) Pesonal exemption 4.) A potion of the exclusion of gain fom qualified small business stock (Section 1202) acquied befoe 9/28/ ) Tax-exempt inteest teated as a tax pefeence fo AMT 6.) Pecentage depletion teated as a tax pefeence fo AMT b. Any adjustment/pefeence item that is not an exclusion item is a defeal item and includes the following: 1.) Acceleated depeciation 2.) ISO bagain element 8. The exemption is phased out acoss the boad at a ate of $.25 fo each dolla ove the theshold amount. CFP_Book_4.indb /21/2016 9:00:57 AM

32 30 84 Kaplan Financial Education Review fo the CFP Cetification Examination IX. PASSIVE ACTIVITY AND AT-RISK RULES CFP Boad Pincipal Knowledge Topic F.49. A. TAX SHELTER INVESTMENTS 1. Typically, tax shelte investments defeed o eliminated taxes fo the investo. Befoe Congess cubed tax shelte abuse, these sheltes allowed pape losses in excess of the amount of capital the investo povided because of the high expenses (depeciation, inteest, development, and so foth) and low evenues in the ealy yeas of a poject. 2. Two majo changes in the IRC have significantly educed the availability of tax sheltes a. At-isk ules b. Passive activity loss ules limits 3. At-isk ules ae applied befoe the passive activity loss ules limits B. AT-RISK RULES 1. The maximum deductible loss fo an activity is limited to the amount that the investo has at isk at the end of the cuent tax yea (i.e., the potential economic loss) 2. The amount at isk is the total of the cash and popety invested and the debt fo which the investo is pesonally liable (typically efeed to as ecouse debt). The amount is adjusted annually on the basis of the taxpaye s shae of taxable pofit o deductible loss fom the investment. a. Nonecouse debt is a liability fo which the patne has no isk of economic loss if the liability is not satisfied by the patneship (fo example, a motgage o loan secued solely by a lien on an asset owned by the patneship) b. Fo ecouse debt, a limited patne cannot be allocated ecouse liabilities in excess of that limited patne s capital contibution and futue contibution obligations unless thee is an ageement with the patneship to the contay c. Total amount each patne has at isk is adjusted annually (like basis) by the taxpaye-investo s shae of pofit o loss fom the activity 3. If a loss is disallowed because of at-isk ules, the loss can be caied fowad and taken in the fist yea the at-isk amount becomes a positive amount (enough to absob the loss) 4. Geneally, when a passive activity inteest is disposed of in a taxable tansaction, any net passive loss fist must be applied against income o gain fom any othe passive activities of the taxpaye a. Any loss in excess of the netting against passive income o gain is then eclassified as nonpassive and may be used to offset odinay (nonpassive) income such as wages and inteest income b. If it is a elated paty tansaction, the loss may only be claimed when the elated paty disposes of the activity with an unelated peson. Abandonment is consideed a fully taxable tansaction. CFP_Book_4.indb /21/2016 9:00:43 AM

33 31 Book 4: Tax Planning EXAMPLE (Suspended unde the at-isk ules) In Yea 1, Bob invested $50,000 fo a 20% inteest in a patneship in which he was a mateial paticipant duing the yea. The patneship incued a loss, and Bob s shae was $75,000. Bob has only $50,000 of capital at isk, so he cannot deduct moe than $50,000 against his othe income. Bob s nondeductible loss of $25,000 can be caied ove and used when the at-isk povisions allow. If Bob has taxable income of $45,000 fom the patneship in Yea 2 and no othe tansactions that affect his at-isk amount, he can use all of the $25,000 loss caied ove fom Yea 1. In this case, he would only ecognize $20,000 of taxable income fom the patneship in Yea 2. C. PASSIVE ACTIVITY LOSS RULES LIMITS 1. Passive activity loss ules passive losses may only be deducted against passive income a. Investos ae pohibited fom deducting passive losses against eithe active income (wages, salaies, and othe employee compensation) o potfolio income (dividends, inteest, and capital gains) b. Because active and potfolio income likely constitutes the majoity, if not all, of an investo s income in any one yea, the passive loss estictions have effectively cutailed all tax-shelte investment activity conducted in the limited patneship fom 2. Apply to the following a. Individuals b. Estates c. Tusts d. Closely held C copoations e. Pesonal sevice copoations (PSCs) 3. Passive activity loss ules divide all income into active, passive, and potfolio 4. Limit the deduction fo passive losses to the amount of passive income (with exceptions fo eal estate activities) a. The limits ae applied to closely held copoations to pevent an individual o business fom incopoating solely to take advantage of passive losses b. Closely held copoations may offset passive losses against active income but not potfolio income c. The limits ae applied to pesonal sevice copoations (PSCs) to pevent pofessionals fom foming a PSC and using it to acquie investments that poduce passive losses to deduct against active copoate pofits d. A PSC is a copoation whee the pimay economic activity is the pefomance of pesonal sevices by the ownes of the copoation CFP_Book_4.indb /21/2016 9:00:43 AM

34 32 88 Kaplan Financial Education Review fo the CFP Cetification Examination 5.) The popety is customaily made available duing business hous fo nonexclusive use by customes (e.g., golf couse) 6.) The popety is used in a nonental activity conducted by a patneship, S copoation, o joint ventue whee the owne has an inteest F. SPECIAL RULES FOR PUBLICLY TRADED PARTNERSHIPS 1. The patneship is taded on an established secuities maket o is eadily tadable on a seconday maket 2. Sometimes efeed to as MLPs, o maste limited patneships 3. Losses fom a publicly taded patneship a. Can only be used to offset income fom that same publicly taded patneship 4. Losses fom a publicly taded patneship (PTP o MLP) that ae disallowed can be caied fowad and allowed as a deduction in a yea when the same publicly taded patneship has net income o is disposed of EXAMPLE (Losses fom publicly taded patneships) Dana puchased an inteest in a nonpublicly taded patneship that had income in the cuent yea of $15,000. She also puchased an inteest in a maste limited patneship with $20,000 of losses. Losses fom a publicly taded patneship cannot offset income fom any othe limited patneship. So, the income of $15,000 fom the nonpublicly taded limited patneship will be fully taxable to Dana this yea, and the $20,000 loss will be disallowed (suspended) this yea (and caied fowad). G. EXCEPTION FOR REAL ESTATE ACTIVITIES 1. Real estate tade o business a. Losses ae not consideed passive fo cetain eal estate pofessionals, povided that: 1.) eal estate is geate than 50% of thei pesonal sevices in all tades o businesses fo the yea; and 2.) the taxpaye pefoms geate than 750 hous of sevice in eal popety tades o business in which the taxpaye mateially paticipates b. Real estate pofessionals who meet the paticipation test listed peviously will teat losses fom eal estate ental activities as nonpassive and can offset those losses against active and potfolio income 2. Real estate ental activities fo non-eal estate pofessionals a. Individuals can deduct up to $25,000 of ental eal estate losses against active and potfolio income b. Two tests must be met to qualify fo this exception: 1.) Active paticipation in the activity (makes management decisions in a bona fide sense, an easie hudle to clea than mateial paticipation) 2.) Owneship of 10% o moe (in value) of all inteests in the activity duing the taxable yea CFP_Book_4.indb /21/2016 9:00:43 AM

35 33 Book 4: Tax Planning c. The $25,000 offset allowance is educed by 50% of AGI in excess of $100,000 (complete phaseout at $150,000 AGI) fo single files and those maied and filing jointly. Theefoe, thee is a loss of $1 fo evey $2 of AGI geate than $100,000. The loss is deducted fom the $25,000 maximum available. d. Maied taxpayes who have lived apat the entie yea and file as MFS have a phaseout theshold beginning at $50,000 and an applicable loss allowance of $12,500. If the MFS taxpayes have lived togethe at any time duing the tax yea, the loss allowance is not allowed. e. Note: Two steps ae equied fo this calculation. 1.) Step 1: Detemine the maximum allowable loss (based on AGI) 2.) Step 2: Limit this calculated loss by the actual ental eal estate losses incued 3.) AGI is calculated by disegading the following: a.) Taxable Social Secuity and aiload etiement benefits b.) c.) d.) e.) f.) The exclusion fo qualified U.S. savings bonds used fo qualified highe education expenses The exclusion fo employe adoption assistance The exclusion fo passive activity income and losses on Fom 8582, losses fom publicly taded patneships, and ental eal estate losses fo eal estate pofessionals Deductions attibuted to domestic poduction activities, contibutions to IRAs and pension plans, and the employe shae of self-employment taxes paid Deductions attibuted to inteest on student loans and highe education expenses CFP_Book_4.indb /21/2016 9:00:43 AM

36 Questions? High 5 Fidays 2017 Mach Exam Session 2 Handout Januay 20, 2017 Michael Long, CFP, CLU, ChFC michael.long@kaplan.com A ecoding of today s session will be posted in the High 5 webinas folde on the Dashboad Have you ead the Standads of Pofessional Conduct at least once this week?