CTP Tax Preparation & Filing 3 — Questions and Answers
Question 1: A married couple files jointly with $180,000 AGI. Which deduction phase-out is most likely to affect them?
- Student loan interest deduction (Correct answer)
- Standard deduction
- Charitable contribution deduction
- Mortgage interest deduction
Correct answer: Student loan interest deduction
The student loan interest deduction phases out for married filing jointly taxpayers with MAGI above $145,000 (2023), making it unavailable at $180,000 AGI.
Question 2: What is the 'kiddie tax' and who does it primarily affect?
- A tax on children who earn wages from employment
- A tax that applies children's unearned income above a threshold to the parent's tax rate (Correct answer)
- An additional tax on child tax credits claimed by high-income earners
- A penalty for failing to claim dependents correctly
Correct answer: A tax that applies children's unearned income above a threshold to the parent's tax rate
The kiddie tax taxes a child's net unearned income above the threshold (e.g., $2,500 in 2023) at the parent's marginal tax rate to prevent income-shifting strategies.
Question 3: A taxpayer received $5,000 from a lawsuit settlement for personal physical injury. How is this treated for tax purposes?
- Fully taxable as ordinary income
- Partially taxable — only the punitive portion
- Excluded from gross income entirely (Correct answer)
- Taxed at the capital gains rate
Correct answer: Excluded from gross income entirely
Compensatory damages received for personal physical injuries or physical sickness are excluded from gross income under IRC Section 104.
Question 4: When must a taxpayer include a Schedule B with their Form 1040?
- When ordinary dividends exceed $100
- When taxable interest or ordinary dividends exceed $1,500 (Correct answer)
- When they receive any foreign interest income
- When they receive any bank interest whatsoever
Correct answer: When taxable interest or ordinary dividends exceed $1,500
Schedule B is required when the taxpayer has more than $1,500 in taxable interest income or ordinary dividends, or has certain foreign accounts or trusts.
Question 5: What is the difference between a tax credit and a tax deduction?
- A credit reduces taxable income; a deduction reduces tax owed dollar-for-dollar
- A deduction reduces taxable income; a credit reduces tax owed dollar-for-dollar (Correct answer)
- Both reduce taxable income but at different rates
- Credits apply only to corporate taxes; deductions apply only to individuals
Correct answer: A deduction reduces taxable income; a credit reduces tax owed dollar-for-dollar
A deduction lowers taxable income (saving taxes at the marginal rate), while a tax credit directly reduces the tax owed dollar-for-dollar, making credits generally more valuable.
Question 6: A sole proprietor reports business income and expenses on which schedule?
- Schedule C (Correct answer)
- Schedule E
- Schedule F
- Schedule K-1
Correct answer: Schedule C
Schedule C (Profit or Loss from Business) is used by sole proprietors to report business income and deductible expenses, with net profit flowing to Form 1040.
Question 7: Which of the following correctly describes the 'wash sale' rule?
- A rule requiring taxpayers to wash (clean) their investment records annually
- A rule that disallows a loss deduction when a substantially identical security is purchased within 30 days before or after the sale (Correct answer)
- A rule that taxes gains on securities held less than 30 days as ordinary income
- A rule requiring brokers to report all securities transactions to the IRS
Correct answer: A rule that disallows a loss deduction when a substantially identical security is purchased within 30 days before or after the sale
The wash sale rule (IRC §1091) disallows a capital loss deduction if you buy a substantially identical security within 30 days before or after the sale that generated the loss.
CTP Tax Preparation & Filing 3
A married couple files jointly with $180,000 AGI.
Which deduction phase-out is most likely to affect them?