PFS Tax Planning

Question 1

Which of the following is considered a tax-deferred retirement account?

Accepted Answer

Traditional IRA

Answer

A Traditional IRA is a tax-deferred retirement account, meaning contributions may be tax-deductible in the year they are made, and investment earnings grow tax-free until retirement. Taxes are only paid when withdrawals are made in retirement. In contrast, a Roth IRA offers tax-free withdrawals in retirement, while a Health Savings Account has specific medical expense usage rules, and a Brokerage Account is typically taxable annually.

Question 2

What type of income is typically subject to self-employment tax?

Accepted Answer

Net self-employment income

Answer

Self-employment tax, which funds Social Security and Medicare for self-employed individuals, is specifically calculated on an individual's net earnings from self-employment. This amount is derived from gross income earned through a trade or business, minus allowable business expenses. Interest income, dividend income, and wages (from an employer) are subject to different tax rules and are not included in this calculation.

Question 3

Which deduction can be claimed without itemizing deductions on a federal tax return?

Accepted Answer

Standard deduction

Answer

The standard deduction is a fixed dollar amount that taxpayers can subtract from their adjusted gross income (AGI) to reduce their taxable income, without having to list out specific expenses. Taxpayers choose between taking the standard deduction or itemizing deductions (such as mortgage interest or charitable contributions), opting for whichever provides the greater tax benefit. It is a pre-set amount available to most taxpayers.

Question 4

Which tax strategy helps reduce taxable income by deferring it to a later year?

Accepted Answer

Tax deferral

Answer

Tax deferral is a strategy that allows income or capital gains to grow without being taxed until a future date, typically when the funds are withdrawn. This is common in retirement accounts like Traditional IRAs or 401(k)s, where contributions and earnings are not taxed until retirement. By delaying taxation, investors can benefit from compounding growth on the full amount, potentially reducing their overall tax burden if they are in a lower tax bracket in retirement.

Question 5

Capital gains are typically taxed lower when assets are held for how long?

Accepted Answer

Over 1 year

Answer

Capital gains are classified as either short-term or long-term based on how long an asset is held before being sold. Assets held for "over 1 year" (more than 365 days) qualify for long-term capital gains tax rates, which are generally lower than ordinary income tax rates. Assets held for one year or less are considered short-term and are taxed at an individual's ordinary income tax rate, which is typically higher.

(PFS) Personal Financial Specialist Practice Test

(PFS) Personal Financial Specialist Practice Test

PFS Tax Planning