Income Tax Planning
Income Tax Planning
This domain tests individual federal income tax planning: marginal and effective rates, deductions versus credits, basis, capital gains, timing, and estimated taxes.
Core rules and concepts
- Marginal rate applies to the next dollar; effective rate is total tax divided by taxable income or gross income.
- Above-the-line deductions reduce gross income; itemized deductions reduce taxable income only if they exceed the standard deduction.
- A deduction saves tax at the marginal rate; a credit reduces tax dollar-for-dollar.
- Capital assets: realized gain = amount realized − adjusted basis; holding period determines short-term vs long-term treatment.
- Wash-sale rule disallows a loss if substantially identical securities are bought within 30 days before or after.
- Estimated tax safe harbors generally require paying 90% of current-year tax or 100% of prior-year tax (110% for higher AGI).
- QBI deduction, AMT, and phaseouts can change the value of a strategy.
Worked example
A client in the 24% marginal bracket can choose a $10,000 deduction or a $7,500 credit. The deduction saves $10,000 × 24% = $2,400. The credit saves $7,500. The credit is worth $5,100 more, assuming no phaseout or alternative minimum tax interaction. The adviser must verify eligibility and whether the credit is refundable or nonrefundable.
Traps
- Comparing a deduction and credit without adjusting for the marginal rate.
- Ignoring phaseouts, state tax, and AMT.
- Missing the wash-sale window.
- Using the wrong basis after dividends, gifts, or inheritance.