Federal and State Taxation, AMT, Cost Basis – Series 7 Exam

🧾 Federal and State Taxation, AMT, Cost Basis – Series 7 Exam

The Series 7 exam includes multiple questions on taxation rules, especially as they apply to investments. Topics like federal and state tax treatment, the alternative minimum tax (AMT), and cost basis calculations are important for understanding suitability, reporting, and tax efficiency — all of which impact client recommendations.

Here’s a breakdown of what you need to know for this section of the exam.

🇺🇸 Federal and State Taxation

📌 Federal Tax Concepts:

• Interest on corporate bonds: Fully taxable (federal & state)
• Interest on U.S. Treasury securities: Taxable at federal level, exempt from state/local tax
• Interest on municipal bonds:
  • In-state munis: Often exempt from both federal and state tax
  • Out-of-state munis: Exempt from federal, but taxable at state level

💡 Capital Gains:

• Short-term (held ≤ 1 year): Taxed at ordinary income tax rates
• Long-term (held > 1 year): Taxed at a lower capital gains rate (0%, 15%, or 20%)

📄 Dividends:

• Qualified dividends (U.S. corps): Taxed at the long-term capital gains rate
• Non-qualified dividends: Taxed at ordinary income rates

⚖️ Alternative Minimum Tax (AMT)

The AMT is a parallel tax system meant to ensure high-income earners pay a minimum tax, even if they qualify for many deductions.

📌 Relevance to Investments:

• Private Activity Municipal Bonds: Interest is tax-exempt under regular tax rules,
  but included in AMT calculation
• Candidates must recognize when a municipal bond is subject to AMT, which affects suitability for high-net-worth clients

📈 Cost Basis

The cost basis determines capital gains or losses upon the sale of a security.

Key Cost Basis Rules:

• Default method: FIFO (First In, First Out) unless another is specified
• Average cost basis: Allowed for mutual funds (if client elects)
• Specific share identification: Permitted if client designates specific shares being sold

Adjustments to Cost Basis:

• Stock splits and dividends: Adjust the per-share basis, not total investment value
• Inherited securities: Cost basis is stepped up to market value at date of death
• Gifted securities: Basis depends on donor’s basis and FMV at time of gift

🧠 Series 7 Exam Tips

• Know what types of income are taxable and where they’re taxed (federal vs. state)
• Understand how AMT applies to private activity bonds
• Be able to calculate cost basis and capital gain/loss on various securities
• Remember the rules for dividends, mutual funds, and inherited assets

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For complete coverage of tax rules, AMT scenarios, and cost basis calculations with practice questions and mock exams:

👉 Visit finra-exam-mastery.com — your trusted resource for Series 7 exam prep and success.