Key Tax Deductions & Credits for the CFP Exam

Above-the-line deductions, also known as adjustments to gross income (AGI), are subtracted from your gross income to arrive at your adjusted gross income. They are beneficial because you can take them regardless of whether you itemize or take the standard deduction. Common examples tested on the CFP exam include:

Retirement Contributions: Contributions to traditional IRAs are deductible, subject to income limitations if you (or your spouse) are covered by a retirement plan at work. Contributions to self-employment retirement plans, such as SEP IRAs and SIMPLE IRAs, are also deductible. Remember that Roth IRA contributions are not deductible.

Health Savings Account (HSA) Deduction: Contributions to an HSA are deductible, even if you are not itemizing. There are annual contribution limits, which are adjusted for inflation each year. Be aware of the catch-up contribution for those age 55 and older.

Student Loan Interest Deduction: You can deduct the amount of student loan interest you paid during the year, up to a maximum of $2,500. This deduction is phased out for taxpayers with higher incomes.

Itemized deductions are expenses that you can subtract from your adjusted gross income (AGI) if they exceed your standard deduction. You will choose to itemize if your total itemized deductions are greater than your standard deduction amount, which varies based on your filing status and is adjusted annually for inflation.

State and Local Taxes (SALT) Deduction: This deduction is capped at $10,000 per household ($5,000 if married filing separately). It includes state and local income taxes, property taxes, and either state and local sales taxes or income taxes (you can choose the higher amount).

Mortgage Interest Deduction: For mortgages taken out after December 15, 2017, you can deduct interest on mortgage debt up to $750,000 ($375,000 if married filing separately). Interest on home equity loans is deductible only if the loan proceeds were used to substantially improve the home.

Charitable Contributions: You can deduct contributions to qualified charities. Cash contributions are generally limited to 60% of AGI, while contributions of appreciated property are generally limited to 30% of AGI. Be aware of the substantiation requirements for charitable donations, especially for contributions of $250 or more.

Strategic charitable giving can provide significant tax benefits. Common strategies include:

Cash Contributions: Simple and straightforward, but remember the AGI limitations.

Appreciated Property: Donating appreciated assets (held for more than one year) allows you to deduct the fair market value while avoiding capital gains taxes. This is a powerful strategy, but be mindful of the 30% AGI limitation. Example: Donating stock with a cost basis of $1,000 and a fair market value of $5,000 allows a $5,000 deduction (subject to AGI limits) and avoids paying tax on the $4,000 gain.

Donor-Advised Funds (DAFs): DAFs allow you to make a large charitable contribution in one year (receiving an immediate tax deduction) and then distribute the funds to charities over time. This can be beneficial in years with high income or when you want to bunch charitable contributions.

Charitable Remainder Trusts (CRTs): CRTs provide income to the donor (or other beneficiaries) for a specified period, after which the remaining assets go to charity. This strategy can provide an immediate tax deduction, income stream, and potential estate tax benefits. There are two main types: Charitable Remainder Annuity Trusts (CRATs) and Charitable Remainder Unitrusts (CRUTs). CRUTs are more common due to their flexibility.

Two main education credits can help offset the costs of higher education:

American Opportunity Tax Credit (AOTC): This credit is for the first four years of undergraduate education. It's worth 100% of the first $2,000 in qualified education expenses and 25% of the next $2,000, for a maximum credit of $2,500 per student. 40% of the credit (up to $1,000) is refundable, meaning you can receive it even if you don't owe any taxes. The AOTC has income limitations and can only be claimed for students pursuing a degree or other credential.

Lifetime Learning Credit (LLC): This credit is for all years of education (undergraduate, graduate, and professional courses) and can be used to improve job skills. It's worth 20% of the first $10,000 in qualified education expenses, for a maximum credit of $2,000 per tax return. The LLC is nonrefundable and has income limitations.

Important note: You cannot claim both the AOTC and the LLC for the same student in the same tax year. The AOTC is generally more beneficial due to its higher value and refundability.

Child Tax Credit: This credit is for each qualifying child under age 17. The maximum credit amount is generally $2,000 per child, but this amount can vary depending on legislation. A portion of the child tax credit is refundable, subject to certain limitations. The credit is phased out for taxpayers with higher incomes.

Dependent Care Credit: This credit helps offset the costs of childcare expenses that allow you (and your spouse, if married) to work or look for work. The credit is a percentage of your expenses, up to a certain limit. The expenses must be for the care of a qualifying individual (a child under age 13 or a dependent incapable of self-care) and must be work-related. The amount of the credit depends on your adjusted gross income (AGI). The maximum amount of expenses that can be claimed is $3,000 for one qualifying individual and $6,000 for two or more qualifying individuals.

The Saver's Credit helps moderate- and low-income taxpayers save for retirement. It provides a credit for contributions to a traditional IRA, Roth IRA, 401(k), or other qualified retirement plan.

The maximum contribution that qualifies for the credit is $2,000 if single, married filing separately, or qualifying widow(er), and $4,000 if married filing jointly. The credit can be 50%, 20%, or 10% of your contribution, depending on your AGI. The lower your AGI, the higher the credit percentage. The Saver's Credit is nonrefundable.

This credit is often overlooked, so be sure to consider it when working with clients who meet the income requirements.

Several tax credits are available for making energy-efficient improvements to your home. These credits are designed to encourage taxpayers to invest in renewable energy and energy conservation.

The Residential Clean Energy Credit is for investments in renewable energy, such as solar electric panels, solar water heaters, and wind turbines. The credit is a percentage of the cost of new, qualified clean energy property. There are often limits to the amount of credit you can take.

The Energy Efficient Home Improvement Credit is for improvements to your home that increase its energy efficiency, such as insulation, energy-efficient windows, and energy-efficient doors. The credit is a percentage of the cost of qualified energy-efficient improvements. Like the Residential Clean Energy Credit, there are limits to the amount of credit you can take.

Many tax deductions and credits are subject to phase-out rules and income limitations. This means that the benefit of the deduction or credit is reduced or eliminated as your income increases. The CFP exam often tests your knowledge of these phase-out rules.

Be familiar with the AGI thresholds at which various deductions and credits begin to phase out. These thresholds vary based on filing status. For example, the Child Tax Credit, the American Opportunity Tax Credit, and the student loan interest deduction all have phase-out ranges based on modified AGI (MAGI).

Pay close attention to the details provided in exam questions, including the taxpayer's filing status and income, to determine whether a deduction or credit is subject to phase-out rules. If a phase-out applies, you'll need to calculate the reduced amount of the deduction or credit.

When tackling deduction and credit questions on the CFP exam, follow these steps:

1. Identify the Deduction or Credit: Carefully read the question to determine which deduction or credit is being tested.
2. Determine Eligibility: Assess whether the taxpayer meets the eligibility requirements for the deduction or credit. Consider factors like age, income, and qualifying expenses.
3. Calculate the Amount: Calculate the amount of the deduction or credit, taking into account any limitations or phase-out rules.
4. Consider Interaction with Other Items: Determine how the deduction or credit affects the taxpayer's overall tax liability, including AGI, taxable income, and tax credits.

Pay close attention to keywords in the question, such as "AGI," "itemized deductions," "refundable," and "nonrefundable." These keywords can provide clues about the correct answer.

Practice with sample questions to become familiar with the different types of deduction and credit scenarios that may be presented on the exam. A strong understanding of these concepts is crucial for success.