CFP® Exam Tax Planning Practice Questions

We rounded up some CFP® practice questions on tax planning to help you test your knowledge. Give them a try! 

Gift and Estate Tax Compliance and Calculation

This question was originally a part of BIF's Special Webinar series which was created to help students affected by the July 2020 CFP^® Exam postponement to September 2020.

Identify the Unified Credit Amount in 2020

1. $15,000
2. $157,000
3. $4,577,800
4. $11,580,000

Correct answer: C. $4,577,800

Instructor insight:

The Unified Credit Amount offsets taxes on an estate valued at $11,580,000 at death.

Assuming that there is an estate in which the total lifetime gifts and estate value at death equaled $11,580,000, the Unified Credit Amount can be calculated as follows:

$345,800 on 1^st $1,000,000 (per the 2020 Gift and Estate Tax Tables)

$10,580,000 x 0.40 = $4,232,000

$345,800 + $4,232,000 = $4,577,800

Gift and Estate Tax Compliance and Tax Calculation #2

This question was a part of BIF's Special Webinar series which was created to help students affected by the July 2020 CFP® Exam postponement to September 2020. 

A mother's basis in stock is $400,000 and she gifts the stock to her daughter when it is worth $360,000. Eight months later, the daughter sells the stock for $380,000. Identify the correct tax treatment of the daughter’s sale.

1. $20,000 long-term capital gain
2. $40,000 short-term capital gain
3. $20,000 long-term capital loss
4. No capital gain or loss

Correct answer: D. No capital gain or loss

Instructor insight:

Since the FMV of the initial gift is lower than the original basis AND the sale price falls between the mother's original basis ($400,000) and the FMV on the date of the gift ($360,000), the daughter recognizes no capital gain or loss on the sale.

CFP® Exam insight:

When a gift is transferred at a loss, the ensuing sale price will serve as a cue to identify the correct basis for calculation of capital gains or capital losses. Work toward understanding the three potential paths to tax treatment with a gifted loss property that is eventually sold.

Alternative Minimum Tax (AMT)

This question was originally a part of BIF's Special Webinar series which was created to help students affected by the July 2020 CFP^® Exam postponement to September 2020.

Identify the strategy that a financial planner can implement if a taxpayer is subject to AMT in the current tax year:

1. Accelerate income into the AMT year
2. Defer tax deductions until a regular tax year

1. I only
2. II only
3. Both I and II
4. Neither I nor II

Correct answer: C. Both I and II

Instructor insight:

Optimal strategy would be to accelerate income into the AMT year and defer tax deductions to a regular tax year until the AMT liability equals the regular liability.

CFP® Exam insight:

Understand the Alternative Minimum Tax (AMT) basics.

The AMT system requires taxpayers to follow these steps:

1. Adjust regular taxable income by adjustments and preferences.
2. Subtract an exemption amount to arrive at the AMT base.
3. Multiply the AMT base by the special AMT rates to compute the AMT.
4. Pay the greater of the regular income tax or the AMT.
   
   

Tax Reduction/Management Techniques

This question was originally a part of BIF's Special Webinar series which was created to help students affected by the July 2020 CFP^® Exam postponement to September 2020.

In 2020, Jon and Olivia had the following transactions:

• Olivia, a full-time 5^th grade teacher, incurred $500 of unreimbursed expenses on supplies for her classroom.
• Jon, age 60, maximized available contributions to his family HSA.
• Jon and Olivia contributed $7,000 to their Traditional IRA. Both are active participants.
• Olivia paid $3,000 of educational loan interest from Subsidized and Unsubsidized Federal Stafford Loans.
• Jon made alimony payments to his ex-wife, Nina, ($500/month) according to terms of a separation agreement established in 2019.

Jon and Olivia filed MFJ and had an AGI of $137,000.

Identify the total above-the-line deductions taken by Jon and Olivia in 2020.

1. $10,850
2. $21,100
3. $16,350
4. $18,350

Correct answer: A. $10,850

Instructor insight:

Here are the above-the-line deductions available to Jon and Olivia:

• $250 for unreimbursed expenses on school supplies.
• $8,100 for contributions to the family HSA ($7,100 + $1,000 over 55 catch-up).
• $0 for Traditional IRA contributions. $137,000 AGI exceeds allowable range ($104,000-$124,000).
• $2,500 of educational loan interest.
• $0 for alimony payments since the separation agreement was established in 2019. Alimony payments are not deductible for post-2019 separation agreements.

CFP® Exam insight:

Remember that deductions and exemptions reduce taxable income and credits offer a dollar-for-dollar reduction of tax liability. In other words, a $2,000 deduction for a taxpayer in the 22% marginal tax bracket reduces taxes by $440, while a $2,000 credit directly offsets $2,000 of tax liability.

Tax Consequences of Property Transactions

This question was originally a part of BIF's Special Webinar series which was created to help students affected by the July 2020 CFP^® Exam postponement to September 2020.

In 2020, Dominique sold the following capital assets:

• BIF stock, held for 7 years. $11,000 gain.
• A rare oil painting, owned for 20 years, for an $8,000 gain.
• IFB stock, held for 3+ years. $7,000 loss.
• FIB stock, held for 11 months. $20,000 loss.
• BFI stock, held for 3 months. $3,000 gain.

Compute Dominique’s net capital gain or loss and identify the character (long-term or short-term).

Correct answer: $5,000 STCL

Instructor insight:

Step 1: Separate short-term from long-term:

Step 2: Separate the long-term gains and losses further into 28%, 25%, and 0/15/20 baskets:

Step 3: Net capital gains and losses in each basket:

Step 4: Net capital gains and losses in each basket:

Income Tax Fundamentals and Calculations

This question is a part of BIF's Special Webinar series which was created to help students affected by the July 2020 CFP® Exam postponement to September 2020.

Taxable income is determined by deducting which of the following from Adjusted Gross Income (AGI)?

1. Standard Deduction
2. Itemized Deductions
3. Exclusions
4. The greater of the Standard Deduction or Itemized Deductions

Correct answer: D. The greater of the Standard Deduction or Itemized Deductions.

Instructor insight:

The Individual Tax Formula is as follows:

1) Gross Income

      minus

2) Exclusions & Pretax items

      minus

3) Adjustments to Income

      equals

4) ADJUSTED GROSS INCOME (AGI)

      minus

5) Standard Deduction or Itemized Deductions

      equals

6) Taxable Income

      minus

7) Credits

      plus

8) Other Liabilities

      equals

9) Refund or Liability

CFP® Exam insight:

Implement a ‘deductive’ approach in your tax planning studies by starting at the high-level (e.g. the Individual Tax Formula) and begin to incorporate more detail and nuance as you progress. This will help you to frame concepts within the broader architecture of the tax flow. Ultimately, this approach will lead you to a more comprehensive understanding of taxes in personal financial planning.

Tax Treatment of Social Security Benefits

Renee, a single taxpayer, retired at age 62 and is receiving Social Security retirement benefits and she continues to work part-time. She also receives municipal bond interest and qualified dividends to supplement her income. Which of the following statements is not correct regarding the calculation of Renee’s provisional income to determine how much, if any, of her Social Security benefits will be subject to income tax?

1. Part-time earned income is included in provisional income.
2. 100% of her Social Security benefit is included in provisional income.
3. Municipal bond interest is included in provisional income.
4. Qualified dividends are included in provisional income.

Correct answer: B. 100% of her Social Security benefit is included in provisional income.

Instructor insight:

50% (not 100%) of the Social Security benefit is included in provisional income. A worker’s MAGI plus 50% of the Social Security retirement benefit is the provisional income. For this calculation, MAGI consists of the worker’s AGI, plus any tax-exempt interest, interest on bonds used to finance higher education, amounts excluded under an employer’s adoption assistance program, and any foreign earned income exclusion.

Taxation of Rental Property Income

Rudy rents his beachfront home out to his frat brothers every spring for 14 days. He charges them $4,000 to cover damages. What is Rudy’s tax consequences?

1. Rudy can write off the repairs against his income
2. Rudy does not have to report income
3. The repairs are deductible but Rudy cannot show a loss
4. In addition to deducting repairs Rudy can deduct an allocated portion of real estate taxes, depreciation and other expenses.

Correct answer: B. Rudy does not have to report income.

Instructor insight:

Vacation rentals homes are classified into one of three categories for tax purposes: 1. primarily personal use, 2. primarily rental use, and 3. mixed use.

If a rental property is rented less than 15 days per year, the property is classified as primarily personal use and the owner does not need to declare the rental income. Expenses associated with the rental activity are not deductible, except for mortgage interest, property taxes, and casualty losses.

Refundable Tax Credits

Your client has a $2,000 tax liability and a $3,000 refundable tax credit. How much of a tax refund will they receive?

1. $0
2. $1,000
3. $2,000
4. $3,000

Correct answer: B. $1,000

Instructor insight:

A tax credit reduces your tax liability dollar for dollar, while a tax deduction only reduces your taxable income. This means a tax credit is much more valuable than a tax deduction of the same amount.

For example, a $1,000 tax credit directly reduces a person's tax bill by $1,000. The most a $1,000 tax deduction can reduce a person's tax bill is by $370 and this requires that the person is in the 37% tax bracket ($1,000 x 37% = $370). If the person is in a lower tax bracket the reduction will be even less.

The best part about refundable tax credits is that they can refund you above and beyond your tax liability. This enables individuals to receive a tax refund even if they did not overpay their taxes.

If instead the client had a nonrefundable tax credit of $3,000 the answer would be A. $0. This is because nonrefundable tax credits can only offset your tax liability. They do not refund you the excess credit amount above your tax liability.

Refundable tax credits are quite rare. Most credits are nonrefundable.

Kiddie Tax Calculation

At only thirteen years old, Melissa Moore is a promising figure skater with dreams of Olympic competition. When she was born, her parents established a section 2503(c) Minor's Trust on her behalf. Melissa's parents are in the 37% marginal federal income tax bracket. In 2024, $15,000 of income from the trust was distributed to cover private figure skating coaching sessions. Assume that Melissa has no other sources of income. How will the distribution of trust income be taxed?

1. This distribution of unearned income from a trust for a minor's current enjoyment will be taxed under "kiddie tax" rules. The tax that applies to the $15,000 distribution will be $130.
2. This distribution of unearned income from a trust for a minor's current enjoyment will be taxed under "kiddie tax" rules. The tax that applies to the $15,000 distribution will be $4,718.
3. The income will be taxed entirely at the fiduciary tax rates applicable to trusts. The tax that applies to the $15,000 distribution will be $3,771.
4. This distribution of unearned income from a trust for a minor's current enjoyment will be taxed at the parent's highest marginal rate. The tax that applies to the $15,000 distribution will be $4,846.

Correct answer:

B. This distribution of unearned income from a trust for a minor's current enjoyment will be taxed under "kiddie tax" rules. The tax that applies to the $15,000 distribution will be $4,718.

Instructor insight:

Income distributed from a Section 2503(c) Minor's Trust is taxed under "kiddie tax" rules as follows:

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