We rounded up some CFP® practice questions on tax planning to help you test your knowledge. Give them a try!
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
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 1st $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
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.
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.
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:
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:
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:
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.
Correct answer: A. $10,850
Instructor insight:
Here are the above-the-line deductions available to Jon and Olivia:
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.
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:
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:
| Short-term | Long-term |
| FIB = ($20,000) | BIF = +$11,000 |
| BFI = +$3,000 | Painting = +$8,000 |
| IFB = ($7,000) |
Step 2: Separate the long-term gains and losses further into 28%, 25%, and 0/15/20 baskets:
| Short-term | Long-term | ||
| Ordinary Income | 28% | 25% | 0/15/20 |
| FIB = ($20,000) | Painting = +$8,000 | $0 | BIF = +$11,000 |
| BFI = +$3,000 | IFB = ($7,000) | ||
Step 3: Net capital gains and losses in each basket:
| Short-term | Long-term | ||
| Ordinary Income | 28% | 25% | 0/15/20 |
| ($17,000) | $8,000 | $0 | $4,000 |
| STCL | LTCG | LTCG | |
Step 4: Net capital gains and losses in each basket:
| ($17,000) | STCL |
| $8,000 | LTCG (28%) |
| ($9,000) | |
| $4,000 | LTCG (0/15/20) |
| ($5,000) | STCL |
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)?
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.
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?
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.
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?
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.
Your client has a $2,000 tax liability and a $3,000 refundable tax credit. How much of a tax refund will they receive?
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.
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?
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:
| Breakdown of $15,000 Distribution | Tax Amount |
| $1,300 (child's standard deduction) | $0 |
| $1,300 x 10% (child's tax rate) | $130.00 |
| $12,400 x parent's highest marginal rate | $4,588.00 |
| Total | $4,718.00 |
The BIF Review includes the materials, resources, and support you need to pass the CFP® Exam. Try it free for 30 days to see how we've helped thousands of students earn their marks.