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CPWA Test Prep > Tax Planning > Flashcards

Tax Planning Flashcards

1
Q

What is the Marginal Tax Rate?

A

The tax rate applied to the next dollar of income earned or deduction. Important for decision-making on incremental income.

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2
Q

Explain Effective Tax Rate.

A

The average tax rate paid on total income, calculated by dividing total taxes by total income.

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3
Q

What is Alternative Minimum Tax (AMT)?

A

A parallel tax system ensuring high-income taxpayers pay a minimum tax, adjusting taxable income for preferences and exclusions.

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4
Q

Describe Tax Bracket Stacking.

A

A strategy to allocate income across years or taxpayers, maximizing lower tax brackets to reduce the overall tax burden.

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5
Q

What are the 2024 AMT exemption amounts for married filing jointly?

A

$133,300, with a phase-out beginning at $1,218,700.

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6
Q

What is Distributable Net Income (DNI) in trusts?

A

Limits a trust’s deduction for beneficiary distributions and determines the taxable income passed to beneficiaries.

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7
Q

How are Incentive Stock Options (ISOs) taxed?

A

Not taxed at grant or exercise if held for two years from grant and one year from exercise. Gains taxed as long-term capital gains if held.

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8
Q

Explain the Qualified Business Income (QBI) Deduction.

A

A 20% deduction on qualified income for pass-through entities, subject to business type and income limits.

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9
Q

What is the Kiddie Tax?

A

Applies parents’ tax rate to a child’s unearned income above $2,600, limiting tax savings from income-shifting to children.

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10
Q

What is Net Investment Income Tax (NIIT)?

A

A 3.8% tax on the lesser of net investment income or MAGI above $250,000 (MFJ) or $200,000 (Single).

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11
Q

Describe a §1031 Like-Kind Exchange.

A

Allows tax deferral on gains from real property exchanges for similar properties, deferring taxes on gains without loss recognition.

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12
Q

What is a Wash Sale?

A

Disallows loss deduction if substantially identical securities are repurchased within 30 days before or after the sale.

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13
Q

Define a Crummey Trust.

A

A trust allowing annual gifts to qualify for the gift tax exclusion by granting beneficiaries a temporary withdrawal right.

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14
Q

What are above-the-line deductions?

A

Deductions taken before calculating AGI, including student loan interest, IRA contributions, and self-employed health insurance.

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15
Q

Explain the Kiddie Tax exemption threshold.

A

The first $2,600 of a child’s unearned income is tax-free; income above this may be taxed at the parent’s rate.

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16
Q

Describe capital gain tax rates for 2024.

A

0% up to $94,050 (MFJ), 15% for $94,051 to $583,750 (MFJ), and 20% over $583,750 (MFJ).

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17
Q

What is a Charitable Remainder Trust (CRT)?

A

A trust providing income to beneficiaries for a term with the remainder going to charity, allowing an immediate charitable deduction.

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18
Q

Define “basis” in partnership interest.

A

Basis starts with the partner’s contributions, adjusted for income, distributions, and allocated debt, affecting gain or loss on sale.

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19
Q

Describe Qualified Dividend Income.

A

Qualified dividends, from U.S. or qualified foreign companies held for a minimum period, are taxed at long-term capital gains rates.

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20
Q

What is Phantom Income in Partnerships?

A

Income allocated to a partner that is taxable even if not distributed, requiring the partner to pay tax on allocated income.

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21
Q

Explain capital gain tax treatment for collectibles.

A

Gains on collectibles are taxed at a maximum rate of 28%, different from the general long-term capital gains rates.

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22
Q

What are Passive Loss Limitations?

A

Limits deductions for passive losses to the amount of passive income, with unused losses carried forward until passive income is available.

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23
Q

Define Step-Transaction Doctrine.

A

Prevents tax avoidance through structured transactions without a business purpose by treating multiple steps as one for tax purposes.

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24
Q

Explain mortgage interest deduction limits.

A

Deductible on up to $750,000 of acquisition debt for primary and secondary homes; HELOC interest deductible if used to improve the home.

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25
Q

What is the Economic Substance Doctrine?

A

Requires transactions to have economic substance beyond tax benefits to qualify for deductions.

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26
Q

How is mortgage insurance treated for tax purposes?

A

Deductible as mortgage interest if acquired under allowable dates and phased out for higher incomes.

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27
Q

Describe Adjusted Gross Income (AGI).

A

Income after ‘above-the-line’ deductions, used to calculate further tax and eligibility for certain credits and deductions.

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28
Q

What is a Flow-Through Entity?

A

A business structure like partnerships and S-corporations where income, credits, and deductions pass through to owners’ personal tax returns.

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29
Q

Explain the Self-Employment Tax.

A

Applies a combined rate of 12.4% for Social Security and 2.9% for Medicare on net earnings from self-employment, with limits on the SS portion.

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30
Q

Define Realized vs. Recognized Gains.

A

Realized gains are calculated upon sale, but only recognized gains are taxable if they trigger a taxable event.

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31
Q

What are the limitations for charitable contributions of appreciated assets?

A

Contributions of appreciated assets held over a year are deductible at FMV, subject to AGI limits, with excess deductions carried forward.

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32
Q

How does AMT apply to ISOs?

A

The spread between FMV at exercise and exercise price for ISOs is an AMT preference item, added to AMTI for AMT calculation.

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33
Q

What are Deductible Investment Interest Expense Rules?

A

Deductible only up to the amount of net investment income, with disallowed amounts carried forward to future years.

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34
Q

Explain Passive Activity and Income.

A

Income from business activities where the taxpayer does not materially participate, often including rental activities, offset only by passive losses.

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35
Q

Define Safe Harbor for Estimated Tax Payments.

A

Safe harbor rules prevent penalties if payments equal 100% of last year’s tax (110% for high income) or 90% of the current year’s tax.

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36
Q

What is Substantial Economic Effect in Partnerships?

A

Allocations must reflect the economic arrangement among partners and have a real economic impact beyond tax effects.

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37
Q

Describe Net Operating Loss (NOL) Carryforwards.

A

NOLs can offset future taxable income, with restrictions on how much can be used each year to reduce taxes.

38
Q

What is the 20% QBI Deduction?

A

A deduction for pass-through income from qualified businesses, with income limits and certain exclusions for specified service trades.

39
Q

What is a Like-Kind Exchange (IRC §1031)?

A

A deferral of gain on exchanges of real property held for investment or business for similar properties, deferring taxes on gains.

40
Q

Define ‘Basis’ in Tax Context.

A

Represents the owner’s original investment in an asset, adjusted for income, expenses, and withdrawals, affecting taxable gain on sale.

41
Q

Explain AMT adjustments for ISOs.

A

AMT requires adding the spread between exercise price and FMV as an AMT preference item, increasing AMTI.

42
Q

What is the Tax Impact of Charitable Deductions?

A

Charitable deductions reduce taxable income, with limits based on AGI and the type of property donated.

43
Q

What is a Qualified Personal Residence Trust (QPRT)?

A

A trust where the grantor retains use of a residence for a term, after which the home passes to beneficiaries, reducing gift tax value.

44
Q

Define Adjusted Gross Income (AGI).

A

Total income minus above-the-line deductions. AGI determines eligibility for various credits and tax benefits.

45
Q

Describe the purpose of a Grantor Retained Annuity Trust (GRAT).

A

Allows the grantor to retain annuity payments while transferring future appreciation to beneficiaries, minimizing gift tax.

46
Q

What is the Substance-Over-Form Doctrine?

A

IRS doctrine stating that the tax treatment of a transaction is based on its economic substance rather than its formal structure.

47
Q

Explain the concept of Phantom Income in Partnerships.

A

Income allocated to a partner that is taxable, even if not distributed, requiring the partner to pay tax on their share of the income.

48
Q

What is a Qualified Terminable Interest Property (QTIP) Trust?

A

A trust providing income to a surviving spouse, with the remainder passing to other beneficiaries upon their death, often used in estate planning.

49
Q

How are charitable contributions of appreciated stock treated?

A

Contributions of appreciated stock held over a year are deductible at fair market value, subject to AGI limits, with excess carried forward.

50
Q

Define the Net Investment Income Tax (NIIT) threshold.

A

NIIT applies to individuals with MAGI over $250,000 for MFJ or $200,000 for singles, taxing the lesser of net investment income or MAGI excess.

51
Q

What is the Kiddie Tax for 2024?

A

Unearned income over $2,600 for a child under 19 or 24 (if a student) is taxed at the parent’s rate to prevent income-shifting for tax reduction.

52
Q

Explain the Uniform Transfers to Minors Act (UTMA).

A

Allows assets to be held in a custodial account for a minor, with transfers made tax-free, often used for educational or savings purposes.

53
Q

Describe Distributable Net Income (DNI) for trusts.

A

DNI determines the maximum taxable amount distributed to beneficiaries and limits the trust’s deduction for those distributions.

54
Q

How does AMT affect incentive stock options (ISOs)?

A

The spread between exercise price and FMV of ISOs is an AMT preference item, increasing alternative minimum taxable income (AMTI).

55
Q

What is an intentionally defective grantor trust (IDGT)?

A

A trust where the grantor pays income tax on trust income, allowing assets to grow outside the grantor’s estate for estate tax purposes.

56
Q

Define tax basis in a partnership.

A

Reflects the partner’s share of contributions, income, and allocated debt, adjusted for withdrawals and expenses, impacting gain or loss.

57
Q

What is the annual exclusion for gifts?

A

The amount that can be gifted tax-free per recipient each year, set at $17,000 for 2024, without affecting the lifetime exemption.

58
Q

Explain above-the-line deductions vs. below-the-line deductions.

A

Above-the-line deductions reduce AGI, while below-the-line deductions (itemized) apply after AGI to determine taxable income.

59
Q

What is the purpose of a 529 plan?

A

A tax-advantaged savings plan for education expenses, where contributions grow tax-free and withdrawals are tax-free if used for qualified expenses.

60
Q

Describe ‘qualified dividends.’

A

Dividends meeting certain holding period requirements from U.S. or qualified foreign corporations, taxed at favorable long-term capital gains rates.

61
Q

What is the benefit of a Health Savings Account (HSA)?

A

Contributions are tax-deductible, grow tax-free, and withdrawals are tax-free for qualified medical expenses, with no ‘use it or lose it’ policy.

62
Q

Explain carryover basis in estate planning.

A

A method where gifted assets retain the donor’s cost basis, potentially resulting in capital gains tax for the recipient upon sale.

63
Q

Define a Qualified Charitable Distribution (QCD).

A

A tax-free transfer from an IRA directly to a charity for individuals 70½ or older, up to $100,000 annually, reducing taxable income.

64
Q

What is a section 2503(b) trust?

A

A trust providing for annual mandatory income distributions to a minor, qualifying for the annual gift tax exclusion.

65
Q

How is AMT calculated for individuals?

A

Calculated by adding preference items and AMT adjustments to regular income, then applying AMT rates and subtracting the AMT exemption.

66
Q

What is a step-up in basis?

A

The adjustment of an inherited asset’s cost basis to its FMV at the decedent’s death, minimizing capital gains upon sale.

67
Q

Explain the passive loss limitation rules.

A

Limits passive losses to the amount of passive income; unused losses are carried forward until passive income or sale of the activity.

68
Q

Describe the “at-risk” rules.

A

Limits a taxpayer’s deductible losses to the amount invested in an activity, including certain types of qualified nonrecourse debt.

69
Q

Define ‘effective tax rate.’

A

The average tax rate calculated by dividing total tax by total income, reflecting the overall tax burden on income.

70
Q

Explain what constitutes a “material participant” in a business.

A

An individual who meets IRS-defined criteria of active involvement in a business, allowing them to offset active income with business losses.

71
Q

What is a Section 2503(c) minor’s trust?

A

A trust providing income for a minor, with remaining assets passing to them at age 21, allowing for annual gift tax exclusions.

72
Q

Define adjusted gross income (AGI).

A

Total income minus above-the-line deductions, serving as a threshold for eligibility for certain credits and deductions.

73
Q

Describe an irrevocable life insurance trust (ILIT).

A

A trust holding life insurance policies to keep proceeds out of the insured’s estate, providing tax-free benefits to beneficiaries.

74
Q

What is a bypass trust?

A

A trust using the estate tax exemption of the first spouse to die, preserving assets for beneficiaries while minimizing estate taxes.

75
Q

Define Qualified Domestic Trust (QDOT).

A

A trust allowing non-citizen spouses to qualify for the marital deduction, deferring estate tax on assets passed to them.

76
Q

What is depreciation recapture?

A

The portion of a gain on a sale taxed as ordinary income to the extent of previously claimed depreciation deductions.

77
Q

Explain the Uniform Gift to Minors Act (UGMA).

A

Allows minors to own assets in a custodial account until reaching the age of majority, with tax benefits for growth in the account.

78
Q

What are capital gain tax rates for short-term vs. long-term?

A

Short-term gains are taxed at ordinary income rates; long-term gains are taxed at reduced rates (0%, 15%, or 20%) based on income.

79
Q

Define installment sale.

A

A sale allowing the seller to receive payments over time, reporting gains as they are received to spread out tax liability.

80
Q

What is a Net Operating Loss (NOL)?

A

A financial loss that can be used to offset taxable income in future years, reducing tax liability.

81
Q

What is a Net Operating Loss (NOL)?

A

A business loss that can offset future taxable income, with limitations on how much can be applied each year to reduce taxes.

82
Q

Explain the carryforward rules for capital losses.

A

Capital losses exceeding capital gains can offset up to $3,000 of ordinary income each year, with remaining losses carried forward.

83
Q

Describe a charitable lead trust (CLT).

A

A trust providing income to a charity for a term, with remaining assets passing to non-charitable beneficiaries, often used for tax benefits.

84
Q

What is the purpose of a Family Limited Partnership (FLP)?

A

A partnership for estate planning that allows parents to transfer business assets to family members while retaining control.

85
Q

Define a stretch IRA.

A

A strategy allowing beneficiaries to withdraw required minimum distributions over their lifetime, maximizing tax-deferred growth.

86
Q

What are required minimum distributions (RMDs)?

A

Mandatory withdrawals from retirement accounts starting at age 72, based on life expectancy and account balance.

87
Q

Explain the charitable deduction AGI limits.

A

Charitable cash contributions to public charities are limited to 60% of AGI, with a 5-year carryforward for excess amounts.

88
Q

What is a disregarded entity?

A

A single-member LLC or other entity ignored for tax purposes, with income reported on the owner’s individual tax return.

89
Q

Describe the Qualified Small Business Stock (QSBS) exclusion.

A

Allows gains from the sale of qualified small business stock held for five years to be excluded from income, up to specific limits.

90
Q

What is the AMT rate for individuals?

A

26% on AMTI up to $232,600 and 28% on amounts over $232,600.

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