AFC Tax Planning and Financial Literacy 5 — Questions and Answers
Question 1: Under the American Opportunity Tax Credit (AOTC), what is the maximum credit amount per eligible student per year?
- $1,000
- $2,000
- $2,500 (Correct answer)
- $4,000
Correct answer: $2,500
The AOTC provides up to $2,500 per eligible student per year for the first four years of post-secondary education.
Question 2: Which of the following best describes 'tax loss harvesting'?
- Deferring income to a later tax year to lower current taxes
- Selling losing investments to offset capital gains and reduce tax liability (Correct answer)
- Maximizing deductions by bunching them in alternate years
- Converting a traditional IRA to a Roth IRA in a low-income year
Correct answer: Selling losing investments to offset capital gains and reduce tax liability
Tax loss harvesting involves strategically selling investments at a loss to offset capital gains and up to $3,000 of ordinary income annually.
Question 3: A married couple files jointly and has $250,000 in net investment income and $300,000 MAGI. Which additional tax applies to their investment income?
- Additional Medicare Tax of 0.9%
- Net Investment Income Tax of 3.8% (Correct answer)
- Alternative Minimum Tax surcharge of 2%
- No additional tax since they are under the $400,000 threshold
Correct answer: Net Investment Income Tax of 3.8%
The 3.8% Net Investment Income Tax (NIIT) applies to the lesser of net investment income or MAGI exceeding $250,000 for married filing jointly.
Question 4: What is the primary benefit of a Qualified Opportunity Zone (QOZ) investment for tax planning?
- Immediate deduction of the invested amount
- Deferral and potential reduction of capital gains, with tax-free growth if held 10+ years (Correct answer)
- Avoidance of estate taxes on the investment
- Exemption from state and local income taxes
Correct answer: Deferral and potential reduction of capital gains, with tax-free growth if held 10+ years
QOZ investments allow capital gains deferral, a step-up in basis after 5-7 years, and complete exclusion of QOZ appreciation if held for at least 10 years.
Question 5: A client contributes $6,000 to a traditional IRA but their income exceeds the deductibility phase-out range. What is this type of contribution called?
- Roth IRA contribution
- Nondeductible IRA contribution (Correct answer)
- Catch-up contribution
- Rollover contribution
Correct answer: Nondeductible IRA contribution
When IRA contributions cannot be deducted due to income limits, they are called nondeductible contributions, which still grow tax-deferred and create basis tracked on Form 8606.
Question 6: Which strategy involves converting a traditional IRA to a Roth IRA to pay taxes now and achieve tax-free growth in retirement?
- Roth conversion (Correct answer)
- Backdoor contribution
- Direct rollover
- Qualified rollover distribution
Correct answer: Roth conversion
A Roth conversion moves funds from a traditional IRA to a Roth IRA, triggering ordinary income tax now in exchange for tax-free qualified withdrawals later.
Question 7: What is the 'wash sale' rule and how does it affect tax planning?
- Prohibits selling securities at a gain within 30 days of purchase
- Disallows a loss deduction if substantially identical securities are repurchased within 30 days before or after the sale (Correct answer)
- Requires investors to hold bonds until maturity for capital gain treatment
- Limits the number of loss-harvesting transactions to three per year
Correct answer: Disallows a loss deduction if substantially identical securities are repurchased within 30 days before or after the sale
The wash sale rule disallows a capital loss if the same or substantially identical security is purchased within 30 days before or after the sale.
AFC Tax Planning and Financial Literacy 5
Under the American Opportunity Tax Credit (AOTC), what is the maximum credit amount per eligible student per year?