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Free Questions › CPA › Tax Compliance and Planning
Free CPA Tax Compliance and Planning Practice Questions & Answers
400 exam-style Tax Compliance and Planning questions. Pick your answer, hit Check answer, and see the worked solution — free to start, no signup.
100% free · No login to startQuestion 31
The PORTABILITY election allows a surviving spouse to:
Select an option first.
Correct answer: C — Use the DECEASED spouse's UNUSED estate tax EXCLUSION — but it must be ELECTED on a timely-filed estate tax return
Explanation: PORTABILITY (the DSUE amount) lets a surviving spouse inherit the deceased spouse's UNUSED exclusion. Crucially, it must be AFFIRMATIVELY ELECTED on a TIMELY-FILED Form 706 — even if no estate tax is otherwise due. Failing to file wastes the exclusion, and it is a common and expensive omission.
Question 32
A CREDIT SHELTER (bypass) trust is used to:
Select an option first.
Correct answer: B — Use the FIRST spouse's exclusion, keeping the assets AND their future appreciation OUT of the survivor's estate
Explanation: A CREDIT SHELTER TRUST funds the first spouse's exclusion at their death. The assets — AND all their FUTURE APPRECIATION — are then OUT of the survivor's estate. Portability preserves the exclusion AMOUNT, but a bypass trust also captures the GROWTH. The trade-off: assets in the trust get NO second step-up.
Question 33
The disadvantage of a credit shelter trust versus portability is:
Select an option first.
Correct answer: C — NO SECOND STEP-UP in basis at the survivor's death for the trust assets
Explanation: Assets in a BYPASS TRUST are OUT of the survivor's estate — which means NO SECOND STEP-UP at the survivor's death. With today's high exclusions, many families now PREFER PORTABILITY, keeping assets in the survivor's estate specifically TO GET the second step-up. The right answer depends on whether estate tax or capital gains tax is the greater threat.
Question 34
A LIFE INSURANCE policy owned by the insured is:
Select an option first.
Correct answer: A — INCLUDED in the gross estate — which is why an ILIT (irrevocable life insurance trust) is used
Explanation: If the insured holds any INCIDENTS OF OWNERSHIP, the death benefit is INCLUDED in the gross estate. An IRREVOCABLE LIFE INSURANCE TRUST (ILIT) owns the policy instead, keeping the proceeds OUT of the estate — while the death benefit remains INCOME tax-free.
Question 35
A CRUMMEY POWER converts a gift to a trust into:
Select an option first.
Correct answer: B — A PRESENT interest — qualifying it for the annual exclusion
Explanation: The annual exclusion requires a PRESENT INTEREST. A gift to a trust normally creates a FUTURE interest and gets NO exclusion. A CRUMMEY POWER gives the beneficiary a temporary right of WITHDRAWAL — converting it into a present interest. It is the standard mechanism for funding an ILIT with exclusion gifts.
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Question 36
Social Security benefits are taxable up to:
Select an option first.
Correct answer: B — 85%, depending on PROVISIONAL INCOME
Explanation: Up to 85% of benefits may be taxable, based on PROVISIONAL INCOME (AGI + tax-exempt interest + half the benefits). Note that MUNICIPAL BOND interest, though excluded from gross income, IS counted — so tax-exempt bonds can indirectly INCREASE the tax on Social Security.
Question 37
Delaying Social Security from 62 to 70 increases the benefit by roughly:
Select an option first.
Correct answer: C — 76-77% — about 8% per year of delayed retirement credits after full retirement age
Explanation: Claiming at 70 rather than 62 increases the monthly benefit by roughly 76-77%. It is effectively an inflation-indexed annuity purchase at a rate no commercial insurer can match. Delay favours those with LONGEVITY, other income sources, and a higher-earning spouse (whose benefit determines the survivor benefit).
Question 38
MEDICARE IRMAA surcharges are based on:
Select an option first.
Correct answer: D — MAGI from TWO YEARS PRIOR — so a one-off income spike raises premiums two years later
Explanation: IRMAA (income-related monthly adjustment amount) uses MAGI from TWO YEARS PRIOR. A large Roth conversion, a business sale, or a big capital gain therefore raises Medicare premiums TWO YEARS LATER — a hidden cost of income-acceleration strategies that is routinely overlooked. IRMAA is also a CLIFF, not a phase-in.
Question 39
IRMAA is a CLIFF, meaning:
Select an option first.
Correct answer: D — ONE DOLLAR over a threshold triggers the ENTIRE surcharge for the year
Explanation: IRMAA operates as a CLIFF: exceeding a threshold by ONE DOLLAR imposes the FULL surcharge tier. This creates enormous effective marginal rates at the thresholds — and makes precise income management (of Roth conversions, capital gains, RMDs) genuinely valuable for retirees.
Question 40
A taxpayer expecting to be in a LOWER bracket in retirement should generally prefer:
Select an option first.
Correct answer: C — A TRADITIONAL (pre-tax) 401(k) — deduct at a high rate now, withdraw at a low rate later
Explanation: Deduct at the HIGH rate, withdraw at the LOW rate. If today's marginal rate exceeds the expected retirement rate, TRADITIONAL wins. If retirement rates will be HIGHER (or rates rise by law), ROTH wins. In practice many advise diversifying across both, since future rates are unknowable.
Question 41
TAX DIVERSIFICATION means holding assets in:
Select an option first.
Correct answer: C — TAXABLE, TAX-DEFERRED and TAX-FREE accounts — providing flexibility to manage the bracket in retirement
Explanation: TAX DIVERSIFICATION spreads assets across TAXABLE, TAX-DEFERRED (traditional) and TAX-FREE (Roth) accounts. In retirement, this allows the taxpayer to CHOOSE which account to draw from each year — filling low brackets from the traditional account and topping up tax-free from the Roth, managing IRMAA and Social Security thresholds precisely.
Question 42
ASSET LOCATION (as distinct from allocation) means:
Select an option first.
Correct answer: A — Placing TAX-INEFFICIENT assets in TAX-DEFERRED accounts and TAX-EFFICIENT ones in taxable accounts
Explanation: ASSET LOCATION: put TAX-INEFFICIENT assets (bonds, REITs, high-turnover funds generating ordinary income) inside TAX-DEFERRED accounts; put TAX-EFFICIENT assets (index funds, individual stocks held long-term, municipal bonds) in TAXABLE accounts, where they benefit from LTCG rates and the step-up at death.
Question 43
Holding a MUNICIPAL BOND inside an IRA is:
Select an option first.
Correct answer: B — WASTEFUL — you forfeit the tax exemption (IRA withdrawals are taxable anyway) and accept a lower yield for nothing
Explanation: Municipal bonds pay a LOWER yield precisely because their interest is tax-EXEMPT. Inside an IRA, ALL withdrawals are taxed as ordinary income regardless — so you accept the lower yield and get NO exemption. It is a pure loss, and a classic asset-location error.
Question 44
Placing HIGH-GROWTH assets in a ROTH is attractive because:
Select an option first.
Correct answer: C — ALL the growth is TAX-FREE — and the Roth has no RMDs, so it can compound the longest
Explanation: A ROTH's growth is entirely TAX-FREE and faces NO lifetime RMDs — so it should hold the assets with the HIGHEST EXPECTED GROWTH and the LONGEST horizon. Putting a stable bond fund in a Roth wastes its greatest advantage.
Question 45
The STEPPED-UP BASIS at death argues for holding appreciated assets in:
Select an option first.
Correct answer: A — A TAXABLE account — retirement accounts get NO step-up
Explanation: Assets in a TAXABLE account receive the §1014 STEP-UP at death, permanently erasing the gain. Assets in a TRADITIONAL IRA get NO step-up — every dollar is taxed as ordinary income to the heir. This is a powerful argument for holding appreciated equities in taxable accounts and drawing down the IRA first (or converting it).
Question 46
An INHERITED traditional IRA (non-spouse, post-SECURE Act) must generally be emptied within:
Select an option first.
Correct answer: D — 10 YEARS
Explanation: The SECURE Act eliminated the 'stretch IRA' for most non-spouse beneficiaries. The account must generally be emptied within TEN YEARS — compressing decades of deferral into a single decade, often during the heir's PEAK EARNING YEARS. This substantially increased the value of ROTH conversions during the owner's lifetime.
Question 47
The 10-year rule for inherited IRAs made ROTH CONVERSIONS more attractive because:
Select an option first.
Correct answer: D — The heir would otherwise face 10 years of TAXABLE distributions during their PEAK earning years — a Roth passes TAX-FREE
Explanation: An inherited TRADITIONAL IRA forces the heir to take taxable distributions within 10 YEARS — likely during their highest-earning decade, at their highest rate. An inherited ROTH still empties in 10 years, but TAX-FREE. Converting during the owner's (possibly lower-rate) lifetime can therefore be a substantial family-level win.
Question 48
A SPOUSE inheriting an IRA may:
Select an option first.
Correct answer: B — TREAT IT AS THEIR OWN — rolling it into their own IRA and deferring RMDs to their own required beginning date
Explanation: A SURVIVING SPOUSE has options unavailable to others: treat the IRA as THEIR OWN (rolling it in, deferring RMDs to their own age), or remain a beneficiary. The 10-year rule applies to most NON-spouse beneficiaries; the spouse is an ELIGIBLE DESIGNATED BENEFICIARY with far greater flexibility.
Question 49
An NUA (net unrealised appreciation) election on employer stock in a 401(k) allows:
Select an option first.
Correct answer: A — The APPRECIATION to be taxed at LTCG rates rather than ordinary rates, when distributed in kind
Explanation: NET UNREALISED APPRECIATION: distribute employer stock IN KIND from the 401(k), pay ORDINARY tax only on the COST BASIS, and the APPRECIATION is taxed at LTCG rates when eventually sold. For long-held, highly-appreciated employer stock, the saving can be enormous — and rolling it into an IRA instead FORFEITS the election permanently.
Question 50
Rolling employer stock into an IRA instead of taking the NUA election:
Select an option first.
Correct answer: A — PERMANENTLY FORFEITS the NUA opportunity — all future distributions become ordinary income
Explanation: Once employer stock is rolled into an IRA, the NUA election is GONE FOREVER — the appreciation that could have been taxed at 15-20% will instead be taxed at ordinary rates (up to 37%) on withdrawal. It is an irreversible, and expensive, default choice.
Question 51
A taxpayer in the 24% bracket expects to be in the 32% bracket next year. They should:
Select an option first.
Correct answer: B — ACCELERATE income into this year and DEFER deductions to next year
Explanation: When rates are RISING, INVERT the default. ACCELERATE income into the low-rate year (24%), and DEFER deductions into the high-rate year (32%), where each dollar of deduction is worth more. The standard 'defer income, accelerate deductions' advice assumes CONSTANT or FALLING rates.
Question 52
A taxpayer with a large NOL and no other income should consider:
Select an option first.
Correct answer: A — A ROTH CONVERSION — the NOL absorbs the conversion income, making it effectively TAX-FREE
Explanation: An NOL year is the PERFECT Roth conversion window: the conversion income is ABSORBED by the NOL, so the conversion can be nearly TAX-FREE — converting a deferred-tax asset into a PERMANENTLY tax-free one. Wasting an NOL year is a genuine missed opportunity.
Question 53
A taxpayer harvesting losses should be careful NOT to:
Select an option first.
Correct answer: C — Repurchase a SUBSTANTIALLY IDENTICAL security within 30 days — including in an IRA or by a SPOUSE
Explanation: The WASH SALE rule looks through to a SPOUSE'S purchases and to purchases in the taxpayer's own IRA. Buying a SIMILAR but NOT SUBSTANTIALLY IDENTICAL fund (a different index tracking a similar market) maintains exposure without triggering the rule — that is the standard technique.
Question 54
GAIN harvesting (deliberately realising gains) makes sense when the taxpayer is in the:
Select an option first.
Correct answer: B — 0% LTCG bracket — realising gains tax-free and RESETTING basis higher
Explanation: In the 0% LTCG bracket, a taxpayer can realise long-term gains at NO TAX and immediately repurchase (there is no wash sale rule for GAINS) — RESETTING the basis higher for free. This is genuinely valuable in a low-income gap year, and it is the mirror image of loss harvesting.
Question 55
The WASH SALE rule does NOT apply to:
Select an option first.
Correct answer: C — GAINS — a taxpayer may sell at a gain and repurchase immediately
Explanation: The WASH SALE rule applies ONLY to LOSSES. A taxpayer may sell at a GAIN and repurchase the identical security the same day, resetting basis higher. This asymmetry is what makes GAIN HARVESTING in the 0% bracket possible.
Question 56
A taxpayer with highly appreciated, concentrated stock wanting DIVERSIFICATION without immediate tax should consider:
Select an option first.
Correct answer: A — A CHARITABLE REMAINDER TRUST — the trust sells tax-free, diversifies, and pays the donor an income stream
Explanation: The concentrated low-basis position is a classic problem. A CRT lets the TRUST sell TAX-FREE, diversify fully, and pay the donor an INCOME STREAM — with a partial charitable deduction now. The trade-off: the remainder goes to charity, so it works only for someone with charitable intent.
Question 57
An EXCHANGE FUND allows a concentrated holder to:
Select an option first.
Correct answer: D — SWAP the concentrated position for a diversified portfolio WITHOUT triggering gain — but with a multi-year lock-up
Explanation: An EXCHANGE FUND pools concentrated positions from many investors, giving each a share of the DIVERSIFIED pool without a taxable exchange. The cost: a LONG LOCK-UP (typically 7 years), high fees, and a carryover basis — the gain is DEFERRED, not eliminated (though it may be erased by the step-up at death).
Question 58
A taxpayer facing a LARGE one-time gain (a business sale) should consider its effect on:
Select an option first.
Correct answer: A — IRMAA (two years later), NIIT, the QBI phase-out, and the loss of other AGI-based benefits
Explanation: A large one-time gain CASCADES: it may trigger the 3.8% NIIT, push the taxpayer through the QBI phase-out, raise MEDICARE IRMAA premiums TWO YEARS LATER, and eliminate AGI-sensitive deductions. The true marginal cost of the gain far exceeds the headline 20% LTCG rate.
Question 59
An INSTALLMENT SALE of a business spreads the gain, which helps by:
Select an option first.
Correct answer: D — Keeping the taxpayer in LOWER brackets each year, and reducing NIIT and IRMAA exposure
Explanation: An INSTALLMENT SALE spreads the gain across years, keeping the taxpayer in LOWER brackets and below the NIIT and IRMAA thresholds. The risks: the buyer may DEFAULT; RATES may RISE; and DEPRECIATION RECAPTURE is still triggered in full in the year of sale.
Question 60
The risk of an instalment sale when rates are expected to RISE is:
Select an option first.
Correct answer: C — Future payments are taxed at HIGHER rates — an ELECTION OUT of instalment treatment (recognising all gain now) may be better
Explanation: If rates will RISE, spreading the gain into future high-rate years is COUNTERPRODUCTIVE. A taxpayer may ELECT OUT of instalment treatment and recognise the ENTIRE gain in the year of sale at today's lower rate. The election-out is affirmative and irrevocable.
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