AFC Tax Planning and Financial Literacy 4 — Questions and Answers
Question 1: A client receives a $5,000 distribution from a traditional IRA at age 45. In addition to income taxes, what additional penalty applies?
- 5% early withdrawal penalty
- 10% early withdrawal penalty (Correct answer)
- 15% early withdrawal penalty
- No penalty if used for any expense
Correct answer: 10% early withdrawal penalty
Early IRA distributions taken before age 59½ are subject to a 10% additional tax penalty on top of ordinary income taxes.
Question 2: Which filing status generally results in the lowest tax liability for a single parent with a dependent child?
- Single
- Married Filing Separately
- Head of Household (Correct answer)
- Qualifying Widow(er)
Correct answer: Head of Household
Head of Household status provides a larger standard deduction and more favorable tax brackets than Single filing status for single parents with qualifying dependents.
Question 3: What is the primary tax advantage of a Health Savings Account (HSA)?
- Contributions are taxed but withdrawals are tax-free
- Triple tax advantage: tax-deductible contributions, tax-free growth, and tax-free qualified withdrawals (Correct answer)
- Only withdrawals for medical expenses are tax-free
- Contributions reduce Social Security taxes only
Correct answer: Triple tax advantage: tax-deductible contributions, tax-free growth, and tax-free qualified withdrawals
HSAs offer a triple tax advantage — contributions are tax-deductible, funds grow tax-free, and qualified medical withdrawals are also tax-free.
Question 4: A client sells stock purchased for $10,000 that is now worth $16,000 after holding it for 14 months. How will the $6,000 gain be taxed?
- As ordinary income at the client's marginal rate
- At long-term capital gains rates (0%, 15%, or 20%) (Correct answer)
- At a flat 28% capital gains rate
- It is exempt from federal taxes since the holding period exceeded one year
Correct answer: At long-term capital gains rates (0%, 15%, or 20%)
Assets held longer than 12 months qualify for long-term capital gains rates, which are 0%, 15%, or 20% depending on taxable income.
Question 5: Which of the following expenses qualifies as a deductible student loan interest deduction?
- Interest on a home equity loan used to pay tuition
- Interest on a qualified student loan, subject to income phase-outs (Correct answer)
- Interest on a personal loan used to pay for books
- Interest on a loan from a family member for education
Correct answer: Interest on a qualified student loan, subject to income phase-outs
The student loan interest deduction applies to interest paid on qualified student loans, but phases out at higher income levels.
Question 6: What does the 'kiddie tax' rule primarily affect?
- Tax credits available to parents of young children
- Unearned income of children under age 19 (or 24 if full-time students) taxed at parental rates (Correct answer)
- Earned income of teenagers who work part-time jobs
- Child and Dependent Care Credit calculations
Correct answer: Unearned income of children under age 19 (or 24 if full-time students) taxed at parental rates
The kiddie tax taxes a child's unearned income (above a threshold) at the parent's marginal rate to prevent income-shifting strategies.
Question 7: A self-employed client earns $80,000 net profit. Which deduction can they claim without itemizing?
- 50% of self-employment tax paid (Correct answer)
- 100% of all business-related meals
- Home office deduction only if itemizing
- State income taxes in full
Correct answer: 50% of self-employment tax paid
Self-employed individuals may deduct 50% of self-employment taxes paid as an above-the-line deduction on their Form 1040.
AFC Tax Planning and Financial Literacy 4
A client receives a $5,000 distribution from a traditional IRA at age 45.
In addition to income taxes, what additional penalty applies?