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Unformatted text preview: Chapter 11 - Investments Chapter 11 Investments SOLUTIONS MANUAL Discussion Questions 1. [LO 1] Describe how interest income and dividend income are taxed. What are the similarities and differences in their tax treatment? Because they are cash method taxpayers, individual investors typically are taxed on interest and dividends when they receive them. However, interest income is taxed using ordinary rates while qualified dividends are taxed at lower capital gains rates. 2. [LO 1] What is the underlying policy rationale for the current tax rules applicable to interest income and dividend income? Interest and dividends are typically taxed annually when received because taxpayers have the wherewithal to pay the tax at that time. Interest income is taxed at ordinary rates because it is viewed as a less risky type of income compared to other more risky forms of income such as the expected appreciation in capital assets. Qualified dividends are taxed at capital gains rates to mitigate the effect of double taxation on corporate earnings. 3. [LO 1] Compare and contrast the tax treatment of interest from a Treasury bond and qualified dividends from corporate stock. Both the interest from Treasury bonds and dividends are taxed by cash method taxpayers in the year they are received. However, interest is taxed using ordinary rates while qualified dividends are taxed at lower capital gains rates. An additional difference between these types of income relates to their state income tax treatment. The interest from Treasury bonds is exempt from state income taxes while dividends are subject to state income taxes. 4. [LO 1] How are Treasury notes and Treasury bonds treated for federal and state income tax purposes? Generally, interest from Treasury bonds and notes is taxed annually as it is received at ordinary rates for federal income tax purposes. However, interest from Treasury bonds and notes is exempt from state income taxes. Treasury bonds and Treasury notes are issued at maturity value, at a discount, or at a premium, depending on prevailing interest rates. Treasury bonds and Treasury notes pay a stated rate of interest semiannually. When Treasury bonds and notes are either issued or subsequently purchased at either a premium or discount, special rules apply. Specifically, taxpayers may elect to amortize the premium to reduce the amount of interest currently reported. To the extent taxpayers amortize the premium, they reduce the tax basis in the related bond or note. If a portion of the premium is 11-1 Chapter 11 - Investments unamortized (either because the election to amortize the premium was not made or because the bond is sold prior to maturity), the unamortized premium remains part of the tax basis of the bond or note and affects the amount of capital gain or loss taxpayers recognize when the bond or note is sold or when it matures....
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This document was uploaded on 07/29/2011.
- Summer '11