Tax Considerations

The whole unit on one sheet: individual income tax, entity taxation, and wealth transfer, condensed to the lines the exam rewards.

The One-Liners That Win Points

• Long-term (held more than 12 months): preferential rates 0%, 15%, or 20%. Short-term (12 months or less): ordinary income rates up to 37%.
• "More than 12 months" means a year and a day. Bought January 1, sold January 1 next year = short-term; sold January 2 = long-term.
• Net capital losses offset up to $3,000 of ordinary income per year; the rest carries forward indefinitely. No limit on offsetting capital gains.
• Wash sale rule: loss disallowed if a substantially identical security is bought within 30 days before or 30 days after the sale (a 61-day window). Applies to losses only, never gains.
• Wash-sale disallowed loss is generally added to the replacement security's basis (deferred, not lost), except if the replacement is bought in an IRA, where the loss is permanently disallowed with no basis adjustment.
• Qualified dividends are taxed at long-term capital gains rates (0%, 15%, 20%); ordinary (non-qualified) dividends are taxed at regular income rates.
• Qualified-dividend holding period: more than 60 days during the 121-day period beginning 60 days before the ex-dividend date, separate from the capital gains holding period.
• Gift = carryover basis (donor's basis transfers). Inheritance = stepped-up (or stepped-down) basis (fair market value at date of death), which generally eliminates unrealized gains on appreciated assets.
• Marginal rate applies to the last dollar; effective rate is total tax over total income (generally lower). A client "in the 32% bracket" does not pay 32% on all income.
• Alternative Minimum Tax (AMT): taxpayer pays the greater of regular tax or AMT; Incentive Stock Option (ISO) exercise spread is the most-tested preference item.
• C-corporation double taxation is its defining disadvantage; S-corporations and partnerships are passthrough (no entity-level federal income tax).
• Passthrough income is taxable to owners whether or not it is distributed (reported on Schedule K-1).
• Trusts hit the top 37% rate at taxable income over $16,000, so trustees distribute income to shift the burden to lower-bracket beneficiaries.
• Step-up in basis at death generally eliminates unrealized gains on appreciated assets; hold highly appreciated assets until death rather than gifting them.

Numbers to Lock In

Top Gotchas

• The $3,000 cap is on ordinary income only. There is no limit on using capital losses to offset capital gains.
• The wash-sale window runs both directions, and "substantially identical" includes the same security in an Individual Retirement Account (IRA) or a spouse's account; a different company in the same industry is generally fine. Buying the replacement inside an IRA makes the loss permanently disallowed, not just deferred.
• Qualified-dividend holding period is separate from the capital gains holding period. A stock held 45 days pays a non-qualified dividend even if later held long enough for long-term gain treatment on the sale.
• For gifted property sold at a loss (double basis rule): if fair market value at the gift was below the donor's basis, the recipient uses fair market value as basis for a loss.
• The 10% early-withdrawal penalty is in addition to ordinary income tax, not instead of it.
• Tax-exempt interest counts toward provisional income for Social Security; municipal bond interest can make Social Security benefits taxable.
• Private activity bond interest is an AMT preference item; not all municipal bond interest escapes AMT.
• The AMT exemption phaseout is $0.50 per $1, not $0.25: this is a rate change from prior law.
• Estate income tax and estate tax are different things. Income tax hits earnings the estate generates during administration; estate tax hits the value of assets transferred at death.
• Portability is not automatic. The surviving spouse must file the estate tax return (Form 706) to claim the deceased spouse's unused exemption, even if no tax is owed.
• The marital deduction requires U.S. citizenship of the surviving spouse; a non-citizen spouse does not qualify for the unlimited deduction.
• Step-up can be a step-down. If an asset declined in value, the heir's basis is the lower fair market value at death and the unrealized loss is permanently lost.

Individual Income Tax

• Capital gains basis: Gain or Loss = Sale Price minus Adjusted Basis. Basis adjusts for stock splits, reinvested dividends, return of capital, and improvements.
• Purchase basis = cost plus commissions. Gift = carryover (donor's basis). Inheritance = fair market value at death (stepped up) for capital property; traditional IRAs are an exception and stay taxable.
• Retirement distributions: Traditional Individual Retirement Accounts (IRAs) and traditional 401(k)s are pre-tax; distributions are taxed as ordinary income, except for any basis from non-deductible IRA contributions, which is not taxed again. Roth qualified distributions are tax-free with no lifetime RMDs.
• Government benefits: provisional income = Adjusted Gross Income (AGI) plus tax-exempt interest plus 50% of Social Security benefits. Medicare IRMAA surcharges use Modified Adjusted Gross Income (MAGI) from two years prior.

Corporations, Trusts, and Passthrough Entities

• C-corporation: flat 21% corporate rate, then shareholders pay again on dividends = double taxation.
• S-corporation: generally passthrough, up to 100 shareholders (generally U.S. individuals; certain trusts/estates may also qualify), one class of stock only. Partnership: passthrough, unlimited partners.
• Trusts and estates both file Form 1041 and use the same compressed brackets, reaching 37% on taxable income over $16,000.
• Grantor trust: taxed to the grantor. Simple trust: must distribute all income annually. Complex trust: may accumulate income, make charitable gifts, and distribute principal.

Estate and Gift Tax

• Gift annual exclusion (2026): $19,000 per recipient, per year; gift splitting by a married couple reaches $38,000, but gift splitting itself requires filing Form 709 (even if no tax is owed). Gifts within the exclusion made by a single donor need no gift tax return.
• Lifetime exemption (2026): $15 million per individual, unified with (shared pool for) the estate tax. Gifts above the annual exclusion reduce it dollar-for-dollar.
• Unlimited marital deduction (recipient must be a U.S. citizen spouse) and unlimited charitable deduction wipe out gift and estate tax on those transfers.
• Estate tax: $15 million exemption per individual, top rate 40%; portability lets a couple reach up to $30 million.
• Unified system: lifetime gifts and the estate draw from one exemption pool; the elevated exemption is now permanent, with a no-clawback rule protecting gifts made while it is in effect.

One-Breath Recap

Individuals pay preferential 0%, 15%, or 20% on long-term gains (held more than a year and a day) and qualified dividends, while short-term gains and ordinary dividends hit ordinary rates up to 37%. Net capital losses shave $3,000 of ordinary income a year with an indefinite carryforward; the wash sale rule disallows a loss when a substantially identical security is bought within 30 days on either side.

Gifts carry over the donor's basis but inherited capital property generally steps up to fair market value at death, erasing unrealized gains (inherited traditional IRAs are an exception and stay taxable), which is why appreciated assets are held until death rather than gifted.

Entities split by tax treatment: C-corporations face double taxation at the flat 21% rate, S-corporations and partnerships pass income through whether or not it is distributed, and trusts and estates hit the 37% rate on taxable income over $16,000.

Wealth transfer runs on one unified exemption of $15 million per individual (2026) with a $19,000 annual gift exclusion, a top estate rate of 40%, and portability that can reach $30 million for a married couple. Nail the holding periods, the basis rules, and the exemption figures, and this three-section unit answers itself.

Need more than the recap? This is a condensed summary. If it is not enough, read the full Tax Considerations unit for the complete lesson.