A client inherits stock, gifts other shares to a grandchild, and asks why her muni interest never shows up as taxable. Three different rules, three different cost bases, and one rep who has to disclose every fee before the trade prints.
Before you recommend anything, the customer must understand what they are buying. You disclose the product's characteristics (how it works), its risks, the services wrapped around it, and its expenses. The prospectus is the primary delivery vehicle. It states objectives, strategies, fees, and risks in a standardized order.
The statement of additional information sits behind the prospectus. The SAI carries deeper detail: the fund's full financials, officer and director information, and tax specifics. You are not required to deliver the SAI automatically, but you must provide it free on request.
KEY: The prospectus is delivered with or before the sale. The SAI is available free on request. Never tell a customer the SAI costs money.
Some disclosures attach to the trade itself, not the product brochure. You must disclose the material aspects of the investment: anything a reasonable investor would want before committing.
Common mistakes
- Using date-of-gift value as the recipient's basis. A gift carries over the donor's basis, not the value when gifted. Stock worth $50,000 but bought at $30,000 gives the recipient a $30,000 basis.
- Applying step-up to a gift. The stepped-up basis is for inherited securities only. Gifts get carryover basis and the donor's holding period.
- Mixing the two exclusions. The $19,000 annual exclusion is per recipient per year; the $15 million lifetime exclusion is one shared gift-and-estate bucket. They are not the same number.
Bottom line
- Disclose a product's characteristics, risks, services, and expenses before recommending; the statement of additional information (SAI) is free on request and expands the prospectus
- Control relationships and material events must be disclosed in writing before the transaction completes
- Systematic risk (market, interest-rate, inflation) is undiversifiable; nonsystematic risk (company, industry) shrinks with diversification; call and reinvestment risk both bite when rates fall; timing risk is acting at the wrong moment
- Return of capital is not taxed now and lowers cost basis; municipal interest is federally tax-exempt
Exam shortcut
Gift carries, inheritance steps. Gift equals donor's carryover basis and holding period; inheritance equals stepped-up fair market value at death and automatic long-term treatment. Two gift numbers, two jobs. $19,000 is the annual per-recipient exclusion; $15 million is the single unified lifetime gift-and-estate bucket. Subtract the annual exclusion first, then draw down the lifetime amount. No-load means 12b-1 of 0.25% or less.
The full lesson (about 2,553 words, 17 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- C9
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