CFP - Tax Planning (14% of the exam) - Section E.42

Tax implications of special circumstances

Divorce (alimony, property settlements, dependency), death of a taxpayer, disability, foreign income and accounts, stock options and equity compensation, passive activity and at-risk rules, and the tax effect of each on a client's return and plan.

Internal Revenue Code Section 469Incentive stock options

Practice question for this objective

Free sampleTax Planningmedium

A client reported 240,000 dollars of gross income on a federal income tax return that he filed on its original due date. A later review shows that he left out 70,000 dollars of consulting receipts through an honest bookkeeping error rather than fraud. Assume the assessment period extends to six years where a taxpayer omits gross income exceeding 25 per cent of the gross income stated on the return. How long does the Internal Revenue Service have to assess the additional tax?

ASix years from filing, because the omitted 70,000 dollars exceeds 25 per cent of the 240,000 dollars of gross income stated on the return, which is 60,000 dollars. Correct
BThree years from filing, because the ordinary assessment period is displaced only where the Service can show that the return was fraudulent or that no return was filed at all.
CThree years from filing, because the omitted 70,000 dollars is less than 25 per cent of his 310,000 dollars of corrected gross income once the consulting receipts are added back.
DUnlimited, because a return that leaves out a substantial amount of gross income is treated as though no return had been filed for the purposes of assessing the tax.

Apply the substantial omission test against gross income stated on the return, not corrected gross income, to fix the assessment period. The ordinary period for assessing federal income tax is three years from the later of the due date or the filing date. It extends to six years when the taxpayer omits gross income exceeding 25 per cent of the gross income stated on the return. Here the stated figure is 240,000 dollars, so the threshold is 60,000 dollars, and the omitted 70,000 dollars exceeds it. The common error is to divide the omission by corrected gross income of 310,000 dollars, which gives about 22.6 per cent and wrongly suggests the three year period. Intent is irrelevant to this test, and only a fraudulent return or an unfiled return leaves the period open without limit.

Why A is correct: Correct. The threshold is 25 per cent of the gross income reported on the return, so 60,000 dollars, and an omission of 70,000 dollars clears it and extends the period to six years.

Why B is wrong: Tempting because fraud and non filing do lift the period entirely, but the six year rule for a substantial omission of gross income turns on the size of the omission and requires no bad intent.

Why C is wrong: Tempting because 70,000 dollars is indeed about 22.6 per cent of 310,000 dollars, but the test compares the omission with the gross income stated on the return as filed, not with the corrected figure.

Why D is wrong: Tempting because an unfiled return does leave the period open indefinitely, but a filed return containing an omission is still a return, and only fraud or a genuine failure to file removes the time limit.

See more CFP practice questions, answers explained.

Exam traps in Tax Planning

Answers that look right on this material and are not. Each one is a distractor from a different question in the CFP bank for this domain.

The brokerage account, by 96,000 dollars after tax, because the transfer resets her basis in the shares to 400,000 dollars.
Why it is wrong: A full basis adjustment to date of transfer value belongs to property acquired from a decedent, and to community property at the first death in a community property state. A transfer incident to divorce carries the transferor's basis across untouched.
12,000 dollars
Why it is wrong: This deducts only the nonrecourse share and suspends the rest, which reverses the position. The nonrecourse amount is the piece he is not at risk for, so it is the amount removed from the limit rather than the amount allowed.
The Individual Retirement Account is divided by a qualified domestic relations order and the 401(k) by a transfer incident to divorce under the decree, so both splits are free of tax to Marcus and Elena may draw immediately on either share without the 10 per cent additional tax
Why it is wrong: The two instruments are named correctly and both really do produce a tax free split, so this reads well to a candidate who has learned the terms without the plan types, but the mechanisms are attached to the wrong accounts and the penalty relief is stated far too widely.

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