Tax Consulting Income Tax Knowledge 3 — Questions and Answers
Question 1: Which credit is refundable, meaning it can produce a refund larger than taxes paid?
- Child and Dependent Care Credit
- Earned Income Tax Credit (Correct answer)
- Lifetime Learning Credit
- Foreign Tax Credit
Correct answer: Earned Income Tax Credit
The Earned Income Tax Credit is fully refundable and can generate a refund exceeding tax liability.
Question 2: What is the difference between a tax deduction and a tax credit?
- No difference
- A deduction reduces taxable income; a credit reduces tax owed (Correct answer)
- A credit reduces taxable income; a deduction reduces tax owed
- Both reduce tax owed equally
Correct answer: A deduction reduces taxable income; a credit reduces tax owed
A deduction lowers the income subject to tax, while a credit directly reduces the tax liability dollar-for-dollar.
Question 3: Contributions to a traditional 401(k) reduce taxable income because they are made with what kind of dollars?
- After-tax dollars
- Pre-tax dollars (Correct answer)
- Tax-free dollars
- Borrowed dollars
Correct answer: Pre-tax dollars
Traditional 401(k) contributions are made pre-tax, lowering current taxable income.
Question 4: How long should taxpayers generally keep records supporting an item on a return?
- 1 year
- At least 3 years (Correct answer)
- 10 years
- Forever
Correct answer: At least 3 years
The IRS generally recommends keeping records for at least three years, matching the standard audit window.
Question 5: Which schedule is used to report itemized deductions on Form 1040?
- Schedule A (Correct answer)
- Schedule B
- Schedule C
- Schedule D
Correct answer: Schedule A
Schedule A is used to itemize deductions such as mortgage interest, state taxes, and charitable gifts.
Question 6: The deduction for state and local taxes (SALT) on Schedule A is capped at what amount for 2025?
- $5,000
- $10,000 (Correct answer)
- $15,000
- No cap
Correct answer: $10,000
The SALT deduction remains capped at $10,000 per return ($5,000 if married filing separately).
Question 7: Interest earned on which of the following is generally exempt from federal income tax?
- Corporate bonds
- Municipal bonds (Correct answer)
- Bank CDs
- Treasury notes
Correct answer: Municipal bonds
Interest on municipal bonds is generally exempt from federal income tax.
Tax Consulting Income Tax Knowledge 3
Which credit is refundable, meaning it can produce a refund larger than taxes paid?