FiCEP Taxes and Insurance 2 — Questions and Answers
Question 1: What is the difference between a tax deduction and a tax credit?
- They are the same thing
- A deduction reduces taxable income; a credit directly reduces the amount of tax owed (Correct answer)
- A credit reduces taxable income
- Neither affects the final tax bill
Correct answer: A deduction reduces taxable income; a credit directly reduces the amount of tax owed
Tax deductions reduce income subject to tax, while credits directly reduce the tax bill dollar-for-dollar.
A $1,000 deduction for someone in the 22% bracket saves $220. A $1,000 credit saves $1,000 regardless of bracket. Credits can be refundable or non-refundable.
Question 2: A client earns $40,000 and does not itemize. What common tax credit might they be eligible for?
- Mortgage interest deduction
- Earned Income Tax Credit (Correct answer)
- Charitable deduction for large donations
- Business expense deduction
Correct answer: Earned Income Tax Credit
The EITC is available to lower and moderate-income workers regardless of itemizing, and it is refundable.
The EITC is one of the most significant anti-poverty tools in the tax code. The IRS estimates 20% of eligible workers do not claim it. Counselors should screen all low-to-moderate income clients for eligibility.
Question 3: What is the purpose of Form W-4 and when should it be updated?
- It is a tax return filed annually
- It tells the employer how much tax to withhold, and should be updated after major life changes (Correct answer)
- It is only needed when starting a new job
- It determines Social Security benefits
Correct answer: It tells the employer how much tax to withhold, and should be updated after major life changes
Form W-4 guides employer tax withholding and should be updated after marriage, divorce, birth of child, or significant income changes.
Under-withholding results in a tax bill and possibly penalties. Over-withholding gives the government an interest-free loan. Life events warranting updates include marriage, divorce, children, home purchase, and salary changes.
Question 4: Which type of insurance is most critical for a single-income family with young children?
- Dental insurance
- Life insurance on the primary earner (Correct answer)
- Extended warranty coverage
- Pet insurance
Correct answer: Life insurance on the primary earner
Life insurance on the primary earner is critical for protecting family financial security.
Term life insurance is typically most cost-effective, providing coverage until children are independent. Coverage should be 10-12 times annual income, or calculated to cover mortgage, education, income replacement, and debts.
Question 5: What is the standard deduction for 2024 and when should a taxpayer itemize?
- There is no standard deduction
- $14,600 for single filers; itemize when deductible expenses exceed this amount (Correct answer)
- $5,000 for all filers; always itemize
- $14,600 for all; never itemize
Correct answer: $14,600 for single filers; itemize when deductible expenses exceed this amount
The 2024 standard deduction is $14,600 for single filers. Itemize only when total deductible expenses exceed the standard deduction.
Since the Tax Cuts and Jobs Act roughly doubled the standard deduction, approximately 90% of taxpayers now take it. Itemizable expenses include mortgage interest, state/local taxes up to $10,000, charitable contributions, and medical expenses exceeding 7.5% of AGI.
Question 6: What is a health savings account and what triple tax advantage does it offer?
- A savings account with no tax benefits
- An account with tax-deductible contributions, tax-free growth, and tax-free withdrawals for medical expenses (Correct answer)
- A government health insurance program
- A checking account only for pharmacies
Correct answer: An account with tax-deductible contributions, tax-free growth, and tax-free withdrawals for medical expenses
HSAs offer a unique triple tax advantage: deductible contributions, tax-free growth, and tax-free medical withdrawals.
HSAs require a High Deductible Health Plan. Unlike FSAs, funds roll over indefinitely and are portable. After age 65, funds can be withdrawn for any purpose with only income tax, making HSAs also a retirement savings tool.
FiCEP Taxes and Insurance 2
What is the difference between a tax deduction and a tax credit?