Test Bank for Pearson's Federal Taxation 2026 Individuals, 39th Edition by Franklin, Richardson

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Pearson's Federal Taxation 2026: Individuals, 39e (Franklin)
Chapter I18: Taxes and Investment Planning
LO1: Investment Models

1) In the Current Model, investment earnings are taxed as they are earned.
Answer: TRUE
Explanation: In the Current Model, after-tax dollars are invested, and the earnings are taxed annually.
Page Ref.: I:18-2
Objective: 1

2) In the Deferred Model, both the initial investment dollars and the investment earnings are taxed at the
end of the investment period.
Answer: FALSE
Explanation: In the Deferred Model, after-tax dollars are invested, but earnings are not taxed until the
end of the investment period.
Page Ref.: I:18-2
Objective: 1

3) In the Exempt Model, the earnings are excluded from explicit taxation.
Answer: TRUE
Explanation: In the Exempt Model, the earnings are never taxed.
Page Ref.: I:18-2
Objective: 1

4) In the Pension Model, the initial investment is deductible or excludible from gross income, and
investment earnings are taxed currently.
Answer: FALSE
Explanation: The initial investment is deductible or excludible from gross income, and investment
earnings are taxed at the end of the investment period.
Page Ref.: I:18-2
Objective: 1

5) Savings accounts and money market funds are examples of investments taxed under the Current
Model.
Answer: TRUE
Explanation: Income is taxed annually under the Current Model.
Page Ref.: I:18-3 and I:18-4
Objective: 1

6) A single taxpayer earns a salary of $6,000. If he is taxed with a 10% flat rate, he has $5,400 of after-tax
dollars available to invest.
Answer: TRUE
Explanation: $6,000 (1.00 - .10) = $5,400.
Page Ref.: I:18-3; Example I:18-2
Objective: 1



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,7) A taxpayer in the 24% marginal tax bracket invests $1,000 of after-tax dollars at 10% interest before
taxes. At the end of year one, the taxpayer will have accumulated after-tax dollars of $1,076.
Answer: TRUE
Explanation: $1,000 + $1,000(.1)(1 - .24) = $1,076.
Page Ref.: I:18-4; Example I:18-3
Objective: 1

8) Investments conforming to the Current Model provide no deferral advantages because earnings are
taxed currently.
Answer: TRUE
Explanation: Under the Current Model, investment earnings are taxed each year.
Page Ref.: I:18-4
Objective: 1

9) The nondeductible traditional IRA is a classic example of the Pension Model.
Answer: FALSE
Explanation: It is an example of the Deferred Model. After-tax dollars are invested, but earnings are not
taxed until the IRA distributions are received.
Page Ref.: I:18-5
Objective: 1

10) In the Deferred Model, only after-tax dollars are invested.
Answer: TRUE
Explanation: Investment of after-tax dollars is a key characteristic of the Deferred Model.
Page Ref.: I:18-5
Objective: 1

11) The Deferred Model investment outperforms the Current Model investment if interest rates and tax
rates are constant over time because the interest on the Deferred Model investment grows tax free until
withdrawal.
Answer: TRUE
Explanation: Under the Deferred Model, investment earnings can compound without taxation so they
will outperform the Current Model where only after-tax investment earnings compound.
Page Ref.: I:18-7
Objective: 1

12) An investment in a growth stock which does not pay dividends is an example of the Exempt Model.
Answer: FALSE
Explanation: An investment in a growth stock is an example of the Deferred Model.
Page Ref.: I:18-8
Objective: 1




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,13) One of the characteristics of the Exempt Model is that earnings on the investment are exempt from
explicit taxation.
Answer: TRUE
Explanation: The key characteristics of the Exempt Model are that (1) after-tax dollars are invested and
(2) earnings are free of explicit taxation.
Page Ref.: I:18-10
Objective: 1

14) One characteristic of the Exempt Model is the fact that, like the Current and Deferred Models, only
after-tax dollars are invested.
Answer: TRUE
Explanation: After-tax dollars are invested under the Current, Deferred and Exempt Models.
Page Ref.: I:18-10
Objective: 1

15) One characteristic of the Pension Model is the fact that, like the Current and Deferred Models, only
after-tax dollars are invested.
Answer: FALSE
Explanation: Before-tax dollars are invested in the Pension Model.
Page Ref.: I:18-11
Objective: 1

16) The Roth IRA is an example of the Pension Model.
Answer: FALSE
Explanation: After-tax dollars are invested in the Roth and qualified distributions are excluded from tax
so a Roth IRA is an example of the Exempt Model.
Page Ref.: I:18-10 and I:18-11
Objective: 1

17) Examples of the Exempt Model include deductible IRAs, H.R. 10 (Keogh) plans, Sec. 401(k) plans, and
tax deferred annuities.
Answer: FALSE
Explanation: These are examples of the Pension Model because before-tax dollars are invested, earnings
are deferred, but full distributions are taxed at withdrawal.
Page Ref.: I:18-11
Objective: 1

18) Under the Pension Model, the entire accumulation, not just the earnings, is taxed at the end of the
investment horizon.
Answer: TRUE
Explanation: Under the Pension Model, before-tax dollars are invested and investment earnings are not
taxed until withdrawn.
Page Ref.: I:18-11
Objective: 1




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, 19) The Deferred Model offers two levels of tax deferral—the original contribution escapes current
taxation as do the earnings on the underlying investment.
Answer: FALSE
Explanation: This describes the Pension Model. In the Deferred Model, only taxes on investment
earnings are deferred.
Page Ref.: I:18-11
Objective: 1

20) Employer-sponsored qualified retirement plans and deductible IRAs fit the Pension Model.
Answer: TRUE
Explanation: In both employer-sponsored qualified retirement plans (other than the Roth 401(k) and
non-deductible IRAs), before-tax dollars are invested and investment earnings compound without
taxation. At withdrawal, the full distribution is taxed.
Page Ref.: I:18-11
Objective: 1

21) When given a choice between making a contribution to a Roth IRA or to a nondeductible traditional
IRA, the taxpayer should choose the Roth IRA.
Answer: TRUE
Explanation: After-tax contributions are made to both IRAs, but the earnings on the Roth IRA will be
exempt, whereas the earnings on the nondeductible traditional IRA are just deferred.
Page Ref.: I:18-13 and I:18-14
Objective: 1

22) The investment models discussed in the text include all of the following except for
A) the Deferred Model.
B) the Pension Model.
C) the Exempt Model.
D) the Equilibrium Model.
Answer: D
Explanation: The fourth model discussed is the Current Model.
Page Ref.: I:18-2
Objective: 1

23) In the Current Model
A) investment earnings are taxed currently.
B) the initial investment is taxable currently, and the investment earnings are taxed at the end of the
investment period.
C) investment earnings are exempt from explicit taxation.
D) the initial investment is deductible or excludible from gross income, and the entire accumulation is
taxed at the end of the investment period.
Answer: A
Explanation: Earnings are taxed currently in the Current Model.
Page Ref.: I:18-2
Objective: 1




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