Tax Planning Fundamentals
Structure of taxation
Candidates must understand marginal versus effective tax rates, the difference between deductions (reduce taxable income) and credits (reduce tax owed directly), and above-the-line versus below-the-line treatment. A frequent trap is treating a credit as a deduction: a 1,000 credit reduces tax by 1,000, while a 1,000 deduction reduces tax by the marginal rate times 1,000.
Capital gains and basis
Know short-term versus long-term capital gains treatment, cost basis, and the effect of holding period on rate. Realized gains are taxed; unrealized gains are not. Losses can offset gains, with rules limiting how much net loss may offset ordinary income each year and allowing carryforward. Wash sale rules disallow a loss when a substantially identical security is repurchased within the statutory window.
Tax-advantaged accounts
Distinguish traditional (deductible contributions, taxable withdrawals) from Roth (after-tax contributions, generally tax-free qualified withdrawals). Understand that the benefit depends on the client's current versus expected future tax rate. Required minimum distributions apply to traditional accounts.
Worked example
A client in the 24% marginal bracket contributes 5,000 to a traditional account and deducts it, saving 1,200 in tax this year. If the client instead uses a Roth, the same 5,000 is taxed now, costing 1,200, but qualified withdrawals are tax-free. The decision hinges on whether the future rate exceeds 24%.
Planning levers
Timing of income and deductions, asset location (placing tax-inefficient assets in tax-deferred accounts), charitable strategies, and gifting all shift tax outcomes.