Individual Tax Compliance and Planning
Individual tax compliance is a foundational topic on the TCP section of the CPA exam. While REG covers the basics of individual taxation, TCP goes deeper into compliance requirements and planning strategies that CPAs use in practice.
Filing Requirements and Status
Determining the correct filing status is the first step in tax compliance. The five filing statuses are:
- Single: Unmarried taxpayers not qualifying for another status.
- Married Filing Jointly (MFJ): Married couples combining income and deductions on one return. Generally produces the lowest combined tax.
- Married Filing Separately (MFS): Married couples filing separate returns. Limits certain deductions and credits but may be beneficial when one spouse has significant medical expenses or miscellaneous deductions.
- Head of Household (HOH): Unmarried taxpayers who maintain a household for a qualifying person. Provides a larger standard deduction and wider tax brackets than single status.
- Qualifying Surviving Spouse: Available for two years after spouse's death if taxpayer maintains a household for a dependent child. Uses MFJ tax brackets and standard deduction.
Income Exclusions and Adjustments
TCP tests advanced income exclusion and adjustment rules:
- Municipal bond interest (Section 103): Interest on state and local government bonds is excluded from federal income. However, private activity bond interest may be an AMT preference item.
- Life insurance proceeds (Section 101): Generally excluded from income when received by reason of the insured's death. Transfer-for-value rule applies exceptions.
- Employer-provided benefits: Health insurance premiums, group-term life up to $50,000, dependent care assistance up to $5,000, and educational assistance up to $5,250 are excludable.
- Foreign earned income exclusion (Section 911): Qualifying taxpayers living abroad can exclude up to $120,000 (indexed) of foreign earned income and claim a housing exclusion.
Advanced Tax Planning Strategies
Retirement Account Optimization
- Traditional IRA vs. Roth IRA: Traditional provides current deduction with taxable withdrawals. Roth provides no current deduction but tax-free qualified withdrawals. The choice depends on current vs. expected future tax rates.
- Roth conversion strategies: Converting traditional IRA to Roth in low-income years can minimize the tax cost of conversion.
- Required Minimum Distributions (RMDs): Begin at age 73 for traditional IRAs and employer plans. Failure to take RMDs results in a 25% penalty on the shortfall.
- Qualified Charitable Distributions (QCDs): Taxpayers age 70.5+ can distribute up to $100,000 from an IRA directly to charity, satisfying the RMD without increasing AGI.
Income Timing and Shifting
- Accelerating or deferring income: Cash-basis taxpayers can time receipt of income to shift between tax years. Year-end bonuses, billing timing, and installment sales are common tools.
- Bunching deductions: Concentrating itemized deductions into alternating years to exceed the standard deduction threshold, then taking the standard deduction in other years.
- Installment sales (Section 453): Spreading gain over the payment period to defer tax recognition. Each payment includes a proportionate share of gross profit.
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