Certified Financial Planner (CFP) Examination practice questions

Priya, aged 58, separated from service with her employer this year and took a lump-sum distribution of her entire 401(k) balance in one taxable year. The distribution included employer stock with a plan cost basis of $180,000 and a fair market value of $500,000 on the date of distribution. She transferred the stock in kind to a taxable brokerage account and elected net unrealised appreciation treatment, and she rolled the remaining plan assets directly to a traditional IRA. Eight months later she sold all of the employer stock for $560,000. How is the $380,000 of total gain recognised on that sale treated?

• A$320,000 is long-term capital gain and $60,000 is short-term capital gaincheck_circle Correct
• B$380,000 is long-term capital gain and no part of the gain is short-term
• C$320,000 is short-term capital gain and $60,000 is short-term capital gain
• D$320,000 is long-term capital gain and $60,000 is taxed as ordinary income

Why A is correct: The net unrealised appreciation of $500,000 minus $180,000, or $320,000, is long-term capital gain when the stock is sold irrespective of how long Priya held it after the distribution, while the further $60,000 of appreciation earned after the distribution takes its own holding period, which is eight months and therefore short-term.

Why B is wrong: This is tempting because the automatic long-term character of net unrealised appreciation is the memorable part of the rule, but that character attaches to the $320,000 measured at the distribution date, and appreciation arising after the distribution is governed by the ordinary holding period rules.

Why C is wrong: A candidate who applies the eight-month post-distribution holding period to the whole gain reaches this answer, but net unrealised appreciation is treated as long-term capital gain by statute, so the holding period after the distribution does not govern that portion.

Why D is wrong: This confuses the ordinary income element with the post-distribution growth, because the amount taxed as ordinary income under the election is the $180,000 plan cost basis reported in the year of the lump-sum distribution, not the appreciation that accrued in the taxable account afterwards.

Ravi, a CFP professional, is engaged by a new client for one narrow purpose: to review the client's existing disability income policy and advise whether to replace it. No financial planning engagement is agreed, and Ravi bills a flat hourly fee. One of the replacement policies he is considering pays his firm a materially higher commission than the others. Under the CFP Board Code of Ethics and Standards of Conduct, what standard of conduct governs the recommendation Ravi is about to make?

• ARavi owes a suitability obligation only, because the engagement is limited to a single insurance product and the client has declined financial planning.
• BRavi owes the fiduciary duty only from the point the client accepts the recommendation and the replacement policy is actually placed and paid for.
• CRavi owes the fiduciary duty at all times when providing Financial Advice, so the narrow engagement limits the subject matter he must consider but does not reduce the duty he owes on it.check_circle Correct
• DRavi owes the fiduciary duty only if the client later expands the engagement so that it requires integrated advice across several financial planning subject areas.

Why A is wrong: Tempting because insurance sales outside a planning engagement are often regulated on a suitability basis by state insurance law, but CFP Board sets its own higher bar for a CFP professional, and that bar does not drop to suitability for a narrow engagement.

Why B is wrong: Tempting because the commission is earned at placement, but the duty attaches when the advice is given, not when it is implemented. A recommendation the client rejects was still made under the fiduciary duty.

Why C is correct: Correct. The Code and Standards attach the fiduciary duty, comprising the duties of loyalty, care and following client instructions, to any Financial Advice, and a recommendation to replace an insurance policy is Financial Advice. Scope limits the breadth of the analysis, not the standard applied to it.

Why D is wrong: This confuses two separate tests. Whether the engagement requires integrated advice decides if the Practice Standards for the Financial Planning Process apply. The fiduciary duty applies to Financial Advice regardless of that answer.

A planner is reviewing a proposed transaction for a client. The client's cousin obtained a private letter ruling from the Internal Revenue Service two years ago approving an almost identical transaction, and the client now wants the planner to treat that ruling as settled law. A final Treasury regulation issued after the ruling reaches the opposite conclusion on the same point. How should the planner weigh these two authorities?

• AThe private letter ruling controls, because a ruling issued on identical facts binds the Service as to every taxpayer whose facts match those in the ruling.
• BThe Treasury regulation controls, because a private letter ruling binds the Service only as to the taxpayer who requested it and may not be cited as precedent by anyone else.check_circle Correct
• CThe two authorities rank equally, so the planner may adopt whichever position produces the lower tax provided the return is filed by its original due date.
• DNeither authority is binding until a court of original jurisdiction rules on the point, so the planner should advise the client to file the position and litigate it.

Why A is wrong: Tempting because a private letter ruling is genuine written guidance from the Service and does bind it, but that binding effect runs only to the taxpayer who requested the ruling and only on the facts submitted.

Why B is correct: Correct. A final Treasury regulation is an interpretation of the Internal Revenue Code with general application, while a private letter ruling answers one taxpayer's question and carries no precedential weight for a third party.

Why C is wrong: Tempting because both documents come from the same agency, but the sources of tax authority are ranked, and timely filing has no bearing on which authority governs a reporting position.

Why D is wrong: Tempting because litigation can settle a contested point, but a final Treasury regulation is authoritative from the moment it is issued, and advising a client into a dispute that the regulation already resolves against him is poor planning.