Part 1 — Individuals

Part 1 · Lesson 1 of 6

Preliminary Work with Taxpayer Data: The Intake Interview That Wins 14 Questions

Before a single number goes on a return, a preparer gathers facts: last year's return, IDs, residency status, filing requirements, and every side obligation like FBAR or a gift return. This domain is worth 14 scored questions on Part 1 of the SEE, and it rewards people who know the 2025 thresholds cold. Remember: the exam window (July 2026 - February 2027) tests the law as of December 31, 2025, so the One, Big, Beautiful Bill Act changes for 2025 are fair game.

Start With Last Year's Return and the Client's Basic Facts

Every engagement starts the same way: pull the prior-year return. You use it three ways. First, for comparison — a W-2 that appeared last year but not this year is a question to ask, not a fact to ignore. Second, for accuracy — names, SSNs, and bank info carry forward. Third, for carryovers — capital loss carryovers, charitable contribution carryovers, net operating losses, and passive losses all ride from one year to the next. Miss a carryover and the client overpays.

Next, nail down personal data:

• Date of birth. Age drives real money: the extra standard deduction at 65, the child tax credit age cutoff, and the kiddie tax age rules.
• Marital status on December 31. Filing status is fixed by the last day of the year. Married on December 31 means married for the whole year.
• Dependents. Get each dependent's SSN, birth date, months in the home, and who paid support.
• Identity Protection PIN (IP PIN). A six-digit number the IRS issues to stop identity thieves. A new one is generated every year. An e-filed return with a missing or wrong IP PIN gets rejected.

Also ask about prior IRS correspondence. A CP2000 notice, an audit letter, or an IP PIN letter changes how you prepare this year's return.

Who Must File — and When

For most people, the filing requirement kicks in when gross income reaches the standard deduction for their status. For tax year 2025 (post-OBBBA): single $15,750, married filing jointly $31,500, head of household $23,625. Add $1,600 for each spouse 65 or older ($2,000 if unmarried and not a surviving spouse) — age raises the filing threshold, but blindness does not; blindness only raises the standard deduction by the same amounts. But memorize the oddball: married filing separately must file at just $5 of gross income.

Some people must file even below those numbers:

• $400 or more of net self-employment earnings — this triggers self-employment tax (15.3% for 2025).
• Advance premium tax credit (APTC) was paid for Marketplace health coverage — the taxpayer must file and attach Form 8962, using the Form 1095-A the Marketplace sends, to reconcile the advance against the real credit based on household income and family size.
• A dependent with unearned income over $1,350 or earned income over $15,750 (2025).

Deadlines: 2025 returns are due April 15, 2026. Form 4868 gives an automatic extension to October 15. Taxpayers living outside the U.S. get an automatic two-month extension to June 15. The rule the exam loves: an extension to file is never an extension to pay — interest runs from April 15 no matter what.

Resident or Nonresident? Citizens, Green Cards, and Counting Days

U.S. citizens and resident aliens are taxed on worldwide income — every source, every country. Nonresident aliens are generally taxed only on U.S.-source income and file Form 1040-NR.

A foreign national becomes a resident alien one of two ways:

• Green card test — a lawful permanent resident at any time during the year.
• Substantial presence test — at least 31 days in the U.S. this year, and 183 weighted days over three years: all of this year's days, plus 1/3 of last year's, plus 1/6 of the year before.

Try it: 120 days in the U.S. in each of 2025, 2024, and 2023 gives 120 + 40 + 20 = 180 days. That is under 183, so the person is a nonresident for 2025. The exam loves this exact math.

People who need a tax ID but cannot get an SSN use an ITIN — a nine-digit number requested on Form W-7. Two facts matter: an ITIN does not qualify anyone for the earned income tax credit, and ITINs can expire and need renewal before filing.

Money Outside the U.S. — and the Other Returns Clients Forget

Because worldwide income is taxable, foreign wages, interest, and rents all belong on the return. Foreign accounts and assets also trigger separate reports — two different tests:

• FBAR (FinCEN Form 114). Required when the aggregate value of foreign financial accounts tops $10,000 at any time during the year. It is filed electronically with FinCEN, not the IRS, due April 15 with an automatic extension to October 15.
• Form 8938. Attached to the 1040. For 2025, U.S.-resident thresholds are $50,000 on the last day of the year or $75,000 anytime (single/MFS), doubled to $100,000 / $150,000 for joint filers. Taxpayers living abroad get much higher thresholds ($200,000/$300,000 single; $400,000/$600,000 MFJ).

A client can owe both filings — meeting one test never excuses the other.

Screen for other required returns too. A gift of more than $19,000 to any one person in 2025 means the giver files a gift tax return (Form 709) — usually no tax is due because of the $13,990,000 lifetime exclusion (2025), but the return is still required. Household employees can require Schedule H employment tax filings. And taxpayers in presidentially declared disaster areas may get postponed deadlines, while an injured spouse (refund grabbed for the other spouse's debt) can file Form 8379 to recover their share.

Kids, Dependents, and the Kiddie Tax

Dependency has two doors. A qualifying child must meet relationship, age (under 19, or under 24 if a full-time student), residency (more than half the year with the taxpayer), and support tests (the child cannot provide more than half of their own support). A qualifying relative is the fallback for others, with a gross income limit and a support test. Dependents unlock credits: the child tax credit of up to $2,200 per qualifying child for 2025 (raised from $2,000 by OBBBA), with up to $1,700 refundable, plus the $500 credit for other dependents, child and dependent care credit, and education credits.

A dependent's own standard deduction is limited: the greater of $1,350 or earned income plus $450 (capped at the regular standard deduction, 2025).

The kiddie tax stops parents from parking investments in a child's name. For 2025, a child's unearned income above $2,700 is taxed at the parents' rate, computed on Form 8615. It applies to children under 18, most 18-year-olds, and full-time students under 24 who do not support themselves with earned income. Alternatively, if the child's income was only interest and dividends under $13,500 (2025), the parents may elect Form 8814 to report it on their own return. Key point: the kiddie tax touches unearned income only — a teenager's wages are always taxed at the teen's own rate.

Sources: www.irs.gov/forms-pubs/how-to-update-withholding-to-account- · www.irs.gov/taxtopics/tc551 · www.irs.gov/publications/p501 · www.irs.gov/filing/individuals/when-to-file · www.irs.gov/individuals/international-taxpayers/us-citizens- · www.irs.gov/individuals/international-taxpayers/substantial-

Part 1 · Lesson 2 of 6

Income and Assets: What Gets Taxed, When, and How Much

This is one of the two biggest domains on SEE Part 1 — 17 scored questions, tied with Deductions and Credits for the most. It covers what counts as income, how retirement money is taxed, and how to figure gain or loss when property is sold. Master the handful of core rules here and you bank points on a fifth of the exam.

Almost Everything Is Income

The tax law starts from a simple idea: all income is taxable unless a specific rule says it is not. Wages and salaries (Form W-2), interest (Form 1099-INT), and dividends (Form 1099-DIV) are the everyday examples. Qualified dividends get the lower capital gain rates; ordinary dividends are taxed like wages.

Constructive receipt decides when income is taxed. A cash-basis taxpayer has income the moment money is made available without restriction — not when it is deposited. A paycheck handed to you on December 30, 2025 is 2025 income even if you cash it in January. A related idea is the constructive dividend: when a corporation pays a shareholder's personal expenses, that benefit is treated as a dividend even though nobody called it one.

Watch these other income items:

• Gambling: every dollar of winnings is income (Schedule 1). Losses are deductible for 2025 only if you itemize, and never more than the winnings you reported.
• Canceled debt (Form 1099-C): forgiven debt is usually income. Big exceptions: debt canceled in bankruptcy, and cancellation while insolvent (excluded up to the amount your debts exceeded your assets right before the cancellation).
• Barter: you have income equal to the fair market value of what you received.
• Hobby income: taxable; hobby expenses are not deductible.
• Scholarships: tax-free for a degree candidate's tuition, required fees, and books — but amounts for room and board are taxable.
• Alimony: for divorce agreements executed after 2018, it is not income to the recipient and not deductible by the payer.

Retirement Money: In, Out, and the Penalty Box

Think of a traditional IRA as "deduct now, pay tax later" and a Roth IRA as "pay tax now, qualified withdrawals tax-free later." For 2025, the IRA contribution limit is $7,000 plus a $1,000 catch-up at age 50, and the 401(k) elective deferral limit is $23,500.

If someone makes nondeductible traditional IRA contributions, they must file Form 8606. Those after-tax dollars are basis, so each later distribution is partly tax-free under a pro-rata rule. Rollovers must finish within 60 days; a direct trustee-to-trustee transfer avoids that clock. Converting traditional money to a Roth is allowed anytime — but the converted amount is taxable that year.

Key age rules:

• Before 59½: taxable early distributions carry a 10% additional tax. Exceptions include death, total and permanent disability, substantially equal periodic payments, medical expenses above 7.5% of AGI, and separating from your employer at age 55 or later (employer plans only — not IRAs).
• Age 73: required minimum distributions (RMDs) begin. The first one can wait until April 1 of the following year. A missed RMD triggers a 25% excise tax, cut to 10% if corrected within two years. Roth IRAs have no RMDs during the owner's life.
• Inherited accounts: most non-spouse beneficiaries must empty the account by the end of the 10th year after death. Eligible designated beneficiaries — a spouse, minor child of the owner, disabled or chronically ill person, or someone not more than 10 years younger — may stretch payouts over life expectancy.

Social Security can be up to 50% taxable when income plus half of benefits passes the base amount ($25,000 single, $32,000 joint), and up to 85% taxable past $34,000/$44,000. Married filing separately while living with your spouse has a base amount of zero.

Selling Property: Basis, Gains, and Your Home

Gain or loss is simply what you got minus your basis. Basis depends on how you acquired the asset:

• Purchased: basis is cost. After a stock split, spread the same basis over more shares.
• Gift: you take the donor's basis (carryover) for figuring gain. For figuring a loss, use the lower of the donor's basis or the fair market value on the gift date. Sell between those two numbers and there is no gain or loss at all.
• Inherited: basis is the fair market value at the date of death (the "step-up"), and the holding period is automatically long-term.

Held more than one year means long-term, taxed at 0%, 15%, or 20% (for 2025, the 0% rate runs up to $48,350 of taxable income single, $96,700 joint). One year or less is short-term, taxed at ordinary rates. Netting works like this: short-term items net together, long-term items net together, then the two results net against each other. A net capital loss deducts against other income only up to $3,000 per year ($1,500 married filing separately); the rest carries forward. Virtual currency is property, so spending or trading it is a taxable disposition using these same rules.

The Section 121 home sale exclusion lets a taxpayer exclude up to $250,000 of gain ($500,000 on a joint return) on the sale of a main home, if they owned and used it as their residence for at least 2 of the 5 years before the sale. Gain above the cap is a long-term capital gain.

Side Hustles, K-1s, and Adjustments to Income

Self-employment income arrives on Form 1099-NEC (nonemployee compensation), 1099-MISC (rents, royalties, prizes), or 1099-K (payment apps and marketplaces — for 2025 the law restored the threshold to more than $20,000 AND more than 200 transactions). Memorize this: income is taxable even if no form ever shows up. If a 1099 is wrong, the taxpayer reports the correct amount and asks the issuer for a corrected form.

Self-employment tax is 15.3% — 12.4% Social Security (on net earnings up to $176,100 for 2025) plus 2.9% Medicare. It applies once net self-employment earnings reach $400, and half of it is deductible as an adjustment to income.

Pass-through income from a partnership or S corporation arrives on Schedule K-1 and is taxed to the owner whether or not any cash was distributed. Losses are deductible only up to the owner's basis. Qualified business income may support the QBI deduction of up to 20%.

Common above-the-line adjustments for 2025: half of SE tax, self-employed health insurance, HSA contributions ($4,300 self-only / $8,550 family, plus $1,000 at age 55), student loan interest up to $2,500, and IRA contributions.

Installment sales (e.g., related parties, original cost, date of acquisition, possible recalculations and recharacterization)

An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. The installment method is the default: you report gain as you collect the money, not all at once.

The math has three pieces. Selling price is cash plus the fair market value of any property received plus any buyer-assumed liabilities, excluding interest. Gross profit is selling price minus adjusted basis and selling expenses. Contract price is generally selling price reduced by liabilities the buyer assumes, but only down to basis; a liability that exceeds basis is added back. Then:

• Gross profit percentage = gross profit / contract price.
• Each year, taxable gain = principal received that year x gross profit percentage.
• Interest is reported separately as ordinary income. If the contract states no adequate interest, part of each payment is recharacterized as unstated interest using the applicable federal rate.

Report it on Form 6252 in the year of sale and every later year a payment is received. The character of the gain (capital or ordinary, short-term or long-term) is set by the property and by the holding period at the date of sale, not by the year the cash arrives.

Now the exceptions. The installment method cannot be used for a sale at a loss, for inventory or dealer sales, or for stock and securities traded on an established market. Depreciation recapture under sections 1245 and 1250 must be reported as ordinary income in the year of sale, even if no cash was received; only the remaining gain goes on the installment method, and the recaptured amount is added to basis for the computation.

You may elect out and report all gain in the year of sale, on Form 4797 or Schedule D with Form 8949. The election is made by the due date of the return, including extensions, and revoking it requires IRS consent.

Related parties: if a related person resells the property within 2 years of the first sale while payments are still owed, the original seller must accelerate gain as if the second sale's proceeds had been received. Marketable securities have no 2-year cutoff. There is an exception if neither disposition had tax avoidance as a principal purpose. And a sale of depreciable property to a related person generally cannot use the installment method at all: all payments are treated as received in the year of sale.

Other income (e.g., scholarships, barter income, hobby income, alimony, non-taxable combat pay, unearned income, taxable recoveries, NOL, illegal income)

Illegal income is taxable income. Section 61 defines gross income as income from whatever source derived. There is no exception for money earned illegally. Income from drug dealing, bribes, kickbacks, gambling that violates state law, embezzlement, and stolen property all belong on the return.

The rule for stolen or embezzled funds is that the thief has gross income in the year of the taking, because the thief has complete dominion over the money even though there is an obligation to return it. If the funds are repaid in a later year, the taxpayer looks to a deduction or a claim-of-right adjustment in the year of repayment. Repayment does not erase the original year's income.

Where it goes on the return depends on the activity. If the illegal activity is a trade or business carried on regularly, it is reported on Schedule C and is subject to self-employment tax. One-off items such as a bribe or a kickback go on Schedule 1 as other income. Amounts a taxpayer takes as an employee, such as embezzled payroll funds, are still reportable even though no Form W-2 or Form 1099 will ever be issued.

Deductions are where the exception lives. Ordinary and necessary expenses of an illegal business are generally deductible under the normal rules, but section 280E denies any deduction or credit for a business that consists of trafficking in controlled substances that are prohibited by federal law. Cost of goods sold is not a deduction, so it still reduces gross receipts even for a 280E business. Separately, section 162(c) denies deductions for bribes, kickbacks, and illegal payments, and section 162(f) denies deductions for fines and penalties paid to a government for violating a law.

The same "income from whatever source" idea runs through the other items in this group. A scholarship is excluded only for a degree candidate's tuition and required fees, books, and supplies; amounts for room, board, or services performed are taxable. Barter income equals the fair market value of goods or services received. Hobby income is fully reportable, but hobby expenses are not deductible while miscellaneous itemized deductions are suspended. Enlisted members' combat pay is excluded from gross income, with a cap for officers, though it may be elected into earned income for the earned income credit. A recovery, such as a refunded state tax or reimbursed expense, is income only to the extent the earlier deduction produced a tax benefit.

Two practitioner points. The Fifth Amendment does not excuse a taxpayer from filing a return or from reporting the amount of income, although it may protect against having to identify the illegal source on the return itself. And a preparer who knows income was omitted cannot sign the return; Circular 230 section 10.21 requires the practitioner to advise the client of the noncompliance and its consequences.

Loans from qualified plans

A loan from a qualified employer plan such as a 401(k) is not a distribution if it stays inside the section 72(p) rules. Break one of those rules and the loan becomes a deemed distribution: taxable income, plus the 10% additional tax on early distributions if no exception applies. Note that plans are permitted to offer loans but are never required to; IRAs may never make loans at all, and a loan from an IRA is a prohibited transaction that disqualifies the entire account.

The dollar limit. The maximum loan is the lesser of $50,000 or 50% of the participant's vested account balance. If 50% of the vested balance is under $10,000, the plan may permit a loan of up to $10,000. The $50,000 ceiling is reduced by the participant's highest outstanding loan balance from the plan during the prior 12 months, so paying a loan down right before borrowing again does not restore full capacity.

The repayment terms. The loan must be repaid within 5 years, in substantially level payments made at least quarterly, under an enforceable written agreement. The only exception to the 5-year term is a loan used to buy the participant's principal residence, which may run longer under the plan's terms. Buying a vacation home or a rental does not qualify.

What failure looks like. If the loan exceeds the limits at the outset, the excess is a deemed distribution immediately. If the terms are fine but the participant stops paying, the plan may allow a cure period, and after that the outstanding balance is a deemed distribution reported on Form 1099-R with code L. A deemed distribution is not eligible for rollover, and the participant must still repay the plan; those later repayments become basis so they are not taxed again.

Distinguish this from a plan loan offset, which happens when the account is actually reduced by the unpaid loan, usually on termination of employment or plan termination. An offset is an eligible rollover distribution. If it is a qualified plan loan offset arising from separation from service or plan termination, the participant has until the due date of that year's return, including extensions, to roll the amount over.

Investor versus trader

Almost everyone who buys and sells securities is an investor. An investor holds securities for dividends, interest, or long-term appreciation. Sales go on Form 8949 and Schedule D as capital gains and losses, the $3,000 net capital loss limit applies, wash sale rules apply, and investment expenses are not deductible because miscellaneous itemized deductions subject to the 2% floor are suspended. Investment interest expense is still deductible on Schedule A, limited to net investment income.

A trader in securities is in a trade or business. There is no bright-line test; the courts and the IRS look at three things: the taxpayer must seek to profit from daily market swings rather than from dividends, interest, or long-term appreciation; the activity must be substantial; and it must be carried on with continuity and regularity. Sporadic trading, however large the dollars, is not a trade or business.

Trader status changes the expense side, not the gain side. A trader deducts trading expenses such as data feeds, software, and a home office on Schedule C. But absent an election, the securities are still capital assets: gains and losses still go on Form 8949 and Schedule D, wash sale rules still apply, and the $3,000 capital loss limit still applies. A trader's trading gains are not subject to self-employment tax, so Schedule C typically shows only expenses and a loss.

The section 475(f) mark-to-market election is what changes the gain side. A qualifying trader who elects marks all securities held at year end to fair market value, treating them as sold on the last business day of the year. Gains and losses become ordinary and are reported on Form 4797. That means no $3,000 capital loss limit and no wash sale rules, but also no long-term capital gain rates.

The timing is unforgiving. An existing taxpayer must file the election statement by the unextended due date of the return for the year before the year the election takes effect, attached to that return or to a timely extension request. A new taxpayer places the statement in its books and records within 2 months and 15 days after the first day of the election year. The taxpayer then files Form 3115 to change the accounting method. Late elections generally are not allowed, and revoking within five years requires non-automatic consent.

Converted property: basis for depreciation when personal-use property becomes business or rental use

When a taxpayer moves personal-use property into business or rental service, the property does not get a fresh start at cost. It gets a special basis rule, and depreciation begins on the date of conversion.

The depreciable basis rule. On the conversion date, compare two numbers: the property's adjusted basis (usually original cost plus improvements, minus any prior allowable depreciation) and its fair market value. The basis used for depreciation is the lower of the two. That is why a house bought years ago and converted after prices fell may be depreciated on a much smaller number than the owner paid.

Why the rule exists. Personal losses are not deductible. If the taxpayer could depreciate a value higher than the market value on the day of conversion, the taxpayer would slowly deduct the personal-use decline in value that the law never allowed.

Land is separate. When a residence is converted to rental, only the building portion is depreciable. The taxpayer must allocate the lower-of amount between land and improvements, usually using property tax assessment ratios or an appraisal.

Basis for gain and loss is not the same number. Converted property carries a split basis when it is later sold:

• Gain basis starts from the adjusted basis at conversion, reduced by depreciation allowed or allowable.
• Loss basis starts from the lower-of number (basis or fair market value at conversion), also reduced by depreciation allowed or allowable.

Because the two numbers can differ, a sale price landing between them produces no gain and no loss.

Depreciation starts on the placed-in-service date, which is the day the property is ready and available for its business or rental use, not the day cash first arrives. Residential rental real property uses the straight-line method over its recovery period under MACRS with a mid-month convention.

Watch the reverse case too. Converting business property back to personal use stops depreciation but does not by itself trigger gain, though it can trigger recapture of a prior section 179 deduction or excess depreciation when business use drops below the required level.

Roth conversions and recharacterization (Form 8606)

Form 8606 is the conversion's paper trail. When a taxpayer converts a traditional, SEP, or SIMPLE IRA to a Roth IRA, the taxable amount is figured and reported in Part II of Form 8606. If the taxpayer has any basis from nondeductible contributions, Part I applies the pro-rata rule first: the nontaxable share of the conversion is basis divided by the total value of all traditional, SEP, and SIMPLE IRAs the taxpayer owns, valued at year end plus distributions and conversions. A taxpayer cannot cherry-pick the after-tax dollars out of one account.

Recharacterization is gone for conversions. A conversion to a Roth IRA can no longer be undone. Under IRC 408A(d)(6)(B)(iii), a Roth conversion is irrevocable, so there is no do-over if the account value drops after the conversion. What survives is recharacterization of a regular annual contribution: a taxpayer may still treat a contribution made to one type of IRA as if made to the other, if it is done by the due date of the return including extensions.

No 10% additional tax applies to the conversion itself, but converted amounts carry their own five-year clock for that additional tax when withdrawn early.

Inherited retirement accounts: the SECURE Act 10-year payout rule and eligible designated beneficiaries

The default is the 10-year rule. For an account owner who dies after 2019, a designated beneficiary who is not an eligible designated beneficiary must empty the inherited IRA or defined contribution plan account by December 31 of the tenth calendar year following the year of death. The old stretch over the beneficiary's life expectancy is gone for these beneficiaries. If the owner had already begun required minimum distributions, the beneficiary must also take annual distributions during years one through nine and still empty the account by the end of year ten.

Eligible designated beneficiaries (EDBs) may still stretch distributions over life expectancy. The five categories are:

• the surviving spouse,
• a minor child of the account owner (under the final regulations the stretch ends when the child reaches age 21, then the 10-year rule starts),
• a disabled individual,
• a chronically ill individual, and
• an individual not more than 10 years younger than the account owner.

No designated beneficiary at all — an estate, or most nonqualifying trusts — falls outside these rules and uses the pre-SECURE default rules instead. A surviving spouse alone may also elect to treat the IRA as the spouse's own.

Nonbusiness bad debts as short-term capital loss, total-worthlessness requirement

A nonbusiness bad debt is always a short-term capital loss. Under IRC 166(d), when a debt not connected with the taxpayer's trade or business becomes worthless, the loss is treated as a short-term capital loss no matter how long the debt was outstanding. That matters because it lands on Schedule D, offsets capital gains first, and is subject to the annual limit on net capital loss against ordinary income, with the excess carried forward.

Total worthlessness only. A business bad debt may be deducted as it becomes partially worthless. A nonbusiness bad debt may not. It must be completely worthless before any deduction is allowed, and the deduction is taken in the year worthlessness occurs.

There must be a real debt. The taxpayer must show a bona fide debtor-creditor relationship with a genuine expectation of repayment, and must have basis in the debt, meaning money actually lent or an amount previously included in income. A cash-basis taxpayer therefore has no bad debt deduction for unpaid fees never taken into income. Money given to a relative with no expectation of repayment is a gift, not a debt.

Report the loss on Form 8949 and Schedule D with a statement describing the debt, the debtor, the efforts to collect, and why it became worthless.

Excess IRA contributions: the 6% excise tax and Form 5329 correction

What makes a contribution excess. An IRA contribution is excess when it exceeds the taxpayer's contribution limit for the year, or exceeds the taxpayer's taxable compensation, or is a Roth contribution made above the applicable income phase-out.

The 6% excise tax. IRC 4973 imposes a 6% excise tax on the excess amount, and it applies every year the excess stays in the account, not just the year of the mistake. It is reported on Form 5329, filed with the taxpayer's Form 1040, or by itself if no return is otherwise required.

Two ways to fix it.

• Timely withdrawal. Remove the excess contribution plus the net income attributable to it by the due date of the return, including extensions. Done this way, the 6% tax does not apply. The earnings withdrawn are taxable in the year the contribution was made. The SECURE 2.0 Act removed the 10% additional tax that used to apply to those earnings when the excess is corrected this way.
• Absorb it later. Leave the money in and apply the excess against a future year's unused contribution limit. This stops the tax going forward, but 6% is owed for each earlier year the excess remained.

Withdrawing an excess after the deadline means the 6% applies for that year, and the withdrawal itself is taxed under the normal distribution rules.

Personal property (equipment) rental reported on Schedule 1

Not all rental income goes on Schedule E. Schedule E is for rental real estate and royalties. When a taxpayer rents out personal property — equipment, tools, vehicles, a boat, a trailer — and the activity is not a trade or business, the income is reported on Schedule 1 (Form 1040) as other income, and the related expenses are deducted on Schedule 1 as an adjustment to income, not on Schedule A.

The three-way test. Ask what the taxpayer is renting and how regularly:

• Real estate rental, taxpayer is not a dealer: Schedule E.
• Personal property rented as a regular, continuous trade or business: Schedule C, and the net profit is subject to self-employment tax.
• Personal property rented for profit but not as a trade or business: Schedule 1, income as other income and expenses as an adjustment.

The expense deduction is capped. The Schedule 1 adjustment for expenses from the rental of personal property cannot exceed the rental income reported. The activity cannot generate a loss that shelters other income.

If the property is not rented for profit at all, the hobby rules of IRC 183 apply: the income is still reported, and the expenses are not currently deductible.

Theft losses and condemnations

Theft losses. A theft is the taking of money or property with criminal intent under the law of the state where it occurred. The loss is deductible in the year the taxpayer discovers the theft, not the year it happened. If there is a reasonable prospect of recovery through insurance or a claim, the taxpayer waits until the claim is settled to fix the deductible amount. Simply misplacing property is not a theft.

For a personal-use theft loss, current law allows a deduction only if the loss is attributable to a federally declared disaster, which a theft essentially never is. Theft losses of business or income-producing property remain deductible and are not subject to the personal casualty floors. A Ponzi-type investment theft loss is treated under its own safe harbor as an ordinary theft loss of income-producing property.

Condemnations. A condemnation, or a sale under threat or imminence of condemnation, is treated as an involuntary conversion, not a casualty. The taxpayer compares the net condemnation award to the adjusted basis of the property. Gain may be deferred under IRC 1033 if the taxpayer buys qualified replacement property within the replacement period, and gain is recognized only to the extent the award exceeds the cost of the replacement. The replacement period for condemned real property held for business or investment is longer than the ordinary period. Severance damages paid for the retained portion of the land reduce that land's basis rather than producing income.

Like-kind exchanges (IRC 1031)

A like-kind exchange under IRC 1031 lets a taxpayer trade one property for another and postpone the gain instead of paying tax on it now. The gain is not forgiven, only deferred: it follows the new property through its basis.

What qualifies today. After the Tax Cuts and Jobs Act, only real property held for productive use in a trade or business or for investment qualifies. Personal property no longer qualifies at all: equipment, machinery, vehicles, artwork, livestock, franchise rights and other intangibles are out. Both the property given up and the property received must be real property, and both must be held for business or investment use. A personal residence or a vacation home held only for personal enjoyment never qualifies.

Statutory exclusions. Even real property fails if it is inventory or stock in trade held primarily for sale, such as a dealer's lots. Also excluded by statute are stocks, bonds, notes, other securities, certificates of trust, and partnership interests. Real property in the United States is not like kind to real property outside the United States.

The two deadlines. In a deferred exchange the taxpayer must identify replacement property in writing within 45 days after transferring the relinquished property, and must receive the replacement property within 180 days after that transfer, or by the due date of the return including extensions if that date is earlier. The two periods run at the same time from the same transfer date, so the 45-day period is part of the 180 days, not added to it. Neither period can be extended for convenience, although the IRS may postpone them for a federally declared disaster. Because the taxpayer may not touch the sale proceeds, a qualified intermediary normally holds the money and buys the replacement property.

Boot. Boot is anything received that is not like-kind real property: cash, other property, or net relief from liabilities when the debt given up exceeds the debt taken on. Gain is recognized to the extent of the lesser of realized gain or boot received. A loss is never recognized in a 1031 exchange, even if boot is received.

Basis. The replacement property takes a substituted basis: basis of the property given up, plus gain recognized and any cash paid, minus boot received. The exchange is reported on Form 8824.

Sources: test-takers.psigov.us/api/content/bulletin/12238 · www.irs.gov/taxtopics/tc701 · www.irs.gov/taxtopics/tc409 · www.irs.gov/faqs/social-security-income · www.irs.gov/publications/p915 · www.irs.gov/taxtopics/tc558

Part 1 · Lesson 3 of 6

Part 1 — Deductions and Credits: Schedule A, QBI, and the Major Individual Credits

This domain carries 17 scored questions — one of the heaviest in Part 1. It tests whether you know which expenses go on Schedule A (and their floors and caps), how the QBI deduction works, and the eligibility and dollar rules for the big credits: child tax credit, EITC, education, adoption, and dependent care. The 2025 law year matters here because the One, Big, Beautiful Bill Act changed several numbers the exam loves to test, including the SALT cap and the child tax credit.

Itemize or Take the Standard Deduction? Medical, Taxes, and Interest

A taxpayer takes the larger of the standard deduction or total itemized deductions. For 2025 (post-OBBBA), the standard deduction is $15,750 single or MFS, $31,500 MFJ, and $23,625 head of household. Taxpayers 65 or older or blind add $1,600 per condition ($2,000 if unmarried and not a surviving spouse), and OBBBA added a separate $6,000 senior deduction for age 65+ (2025-2028, with income phase-outs). Itemizing only pays when Schedule A beats these numbers.

Medical, dental, vision, and long-term care. Only unreimbursed expenses above 7.5% of AGI count. Example: AGI $50,000, medical bills $6,000. The floor is $3,750, so the deduction is $2,250. Qualifying costs include insurance and qualified long-term care premiums, prescriptions, glasses, hearing aids, and medical travel at 21 cents per mile (2025) plus tolls and parking.

Taxes (SALT). Big 2025 change: OBBBA raised the state and local tax cap from $10,000 to $40,000 ($20,000 MFS). It covers state and local income (or sales) taxes, real estate taxes, and personal property taxes combined. The cap phases down once MAGI passes $500,000 ($250,000 MFS), but never below $10,000 ($5,000 MFS).

Interest. Home mortgage interest is deductible on up to $750,000 ($375,000 MFS) of acquisition debt for loans taken out after December 15, 2017. Points are generally deducted over the life of the loan, though points on a loan to buy or build the main home can often be deducted in full in the year paid. Investment interest is deductible only up to net investment income; how borrowed money is actually used (the tracing rules) decides which category interest falls into.

Charitable Gifts and Casualty Losses: Limits and Paperwork

Charitable contributions go to qualified organizations only — never to individuals, political groups, or foreign charities (with limited treaty exceptions). Cash gifts to public charities are deductible up to 60% of AGI; long-term appreciated property to public charities is generally limited to 30% of AGI; excess carries over to future years. Driving for a charity counts at 14 cents per mile (statutory, not indexed). The value of your donated time is never deductible.

The exam loves the documentation ladder:

• Any cash gift: bank record or receipt.
• $250 or more (any single gift): a contemporaneous written acknowledgment from the charity stating whether goods or services were received.
• Noncash over $500: attach Form 8283.
• Noncash over $5,000: a qualified appraisal is also required.

Nonbusiness casualty and theft losses are deductible only if attributable to a federally declared disaster. The loss is the smaller of adjusted basis or the drop in fair market value, minus any insurance reimbursement. Then subtract $100 per event, and finally 10% of AGI from the yearly total. (Qualified disaster losses use a $500-per-event reduction with no 10% floor.) A stolen laptop with no disaster attached is simply not deductible.

Form 1040-NR note: nonresident aliens generally cannot take the standard deduction, and their itemized deductions are limited — mainly state and local income taxes, gifts to U.S. charities, and qualifying casualty losses.

The QBI Deduction: 20% Off Qualified Business Income

The qualified business income (QBI) deduction under section 199A lets owners of sole proprietorships, partnerships, and S corporations deduct up to 20% of QBI, plus 20% of qualified REIT dividends and publicly traded partnership income. OBBBA made it permanent. Three things trainees must lock in:

• It is not an itemized deduction — a taxpayer can claim it and the standard deduction.
• It cannot exceed 20% of taxable income minus net capital gain.
• Above certain taxable income thresholds, wage-and-property limits kick in, and specified service trades or businesses (health, law, accounting, consulting, financial services, and similar) can lose the deduction entirely.

QBI excludes W-2 wages earned as an employee, capital gains, and reasonable compensation paid to an S corporation owner. Example: a plumber with $80,000 of QBI and enough taxable income may deduct up to $16,000.

Family Credits: Child Tax Credit, Dependent Care, and EITC

Child tax credit (CTC). For 2025, OBBBA raised the CTC to $2,200 per qualifying child — under age 17 at year-end, a dependent with a valid SSN, who lived with the taxpayer over half the year and did not provide over half of their own support. It phases out above $200,000 ($400,000 MFJ). The refundable piece, the additional child tax credit (ACTC), is up to $1,700 per child and requires at least $2,500 of earned income. Dependents who miss the CTC rules (a 17-year-old, a parent, a child with an ITIN) may qualify for the $500 credit for other dependents — nonrefundable.

Child and dependent care credit. A nonrefundable credit for work-related care of a child under 13 or a spouse/dependent incapable of self-care. Expenses are capped at $3,000 for one qualifying person, $6,000 for two or more, cannot exceed the lower-earning spouse's earned income, and the credit is a percentage of those expenses based on AGI. Both spouses generally must work (full-time students get deemed income).

Earned income tax credit (EITC) — fully refundable. For 2025 the maximum runs from $649 (no children) to $8,046 (three or more), and investment income must be $11,950 or less. Paid preparers must complete the Form 8867 due-diligence checklist. If a claim is denied for anything other than a math error, the next claim needs Form 8862; reckless or intentional disregard brings a 2-year ban, fraud a 10-year ban.

Education, Adoption, and the Other Big Credits

Education credits. The American opportunity tax credit (AOTC) is up to $2,500 per student: 100% of the first $2,000 of qualified expenses plus 25% of the next $2,000. It covers only the first 4 years of postsecondary education, requires at least half-time enrollment, is 40% refundable (up to $1,000), and is lost if the student has a felony drug conviction. The lifetime learning credit (LLC) is up to $2,000 per return (20% of the first $10,000 of expenses), works for any year of study including graduate school and job-skills courses, and is nonrefundable. Both phase out with MAGI between $80,000-$90,000 ($160,000-$180,000 MFJ), and you cannot claim both for the same student in the same year.

Adoption credit. For 2025, up to $17,280 of qualified expenses per child, phasing out at MAGI of $259,190-$299,190. New under OBBBA: up to $5,000 is refundable starting in 2025; the nonrefundable remainder carries forward up to 5 years. For a special-needs adoption, the taxpayer may claim the full credit even with no actual expenses.

Rounding out the list: the foreign tax credit offsets U.S. tax dollar-for-dollar for income tax paid to other countries (Form 1116, unless small enough for the exemption). The premium tax credit is refundable and must be reconciled on Form 8962 if advance payments were made. The saver's credit is 50%, 20%, or 10% of up to $2,000 ($4,000 MFJ) of retirement contributions — but not for dependents, full-time students, or anyone under 18. The energy efficient home improvement credit (30%, generally up to $1,200 per year, $2,000 for heat pumps) is available for property placed in service in 2025 — its final year.

Other adjustments to income (e.g., student loan interest, alimony, moving expenses for active military, write-in adjustments)

The moving expense deduction is suspended for nearly everyone. One exception survives: a member of the Armed Forces on active duty who moves because of a military order to a permanent change of station. No civilian move qualifies, no matter the distance or the job change, and the old 50-mile distance test and 39-week time test simply do not apply to the military exception. The move must be ordered; a voluntary relocation does not count.

A permanent change of station means moving from home to the first active duty post, moving between permanent duty stations, or moving from the last post to home or to a nearer point in the United States. That last move must generally happen within one year of ending active duty, or within the period allowed under the Joint Travel Regulations. A spouse or dependent moving to or from that station may also claim the expenses, including cases where the member is imprisoned, dies, or deserts.

What is deductible is limited to reasonable unreimbursed costs of two things:

• Moving household goods and personal effects, including packing, crating, hauling, in-transit insurance, and storage. Storage counts only for the 30 consecutive days after the goods leave the former home and before delivery to the new one.
• Travel, including lodging, for the member and household members on the way to the new home. Use actual car expenses, or the standard mileage rate for moving, which is 21 cents per mile for 2025, plus parking and tolls.

What is not deductible: meals on the trip, side trips for sightseeing, lavish lodging, house-hunting trips, temporary living expenses, and the cost of buying or selling a home. Anything the government moved or stored for free, and anything covered by an excluded allowance such as a dislocation allowance, move-in housing allowance, or temporary lodging allowance, is also out.

Compute the deduction on Form 3903 and carry it to Schedule 1 (Form 1040) as an adjustment to income, so it is available whether or not the taxpayer itemizes. If reimbursements or allowances exceed the actual expenses, the excess is taxable wages reported on Form W-2.

Other adjustments sit on the same Schedule 1. Student loan interest is deductible for interest actually paid on a qualified education loan, subject to an annual dollar cap and an income phase-out, and only if the taxpayer is legally obligated on the loan and does not file separately. Alimony is deductible by the payer and taxable to the recipient only under a divorce or separation instrument executed on or before December 31, 2018 and not later modified to adopt the current rules; for later instruments alimony is neither deductible nor includible. Write-in adjustments cover items with no printed line, such as jury duty pay turned over to an employer or certain repayments, entered with the correct code on Schedule 1.

Sources: www.irs.gov/taxtopics/tc502 · www.irs.gov/instructions/i1040sca · www.irs.gov/publications/p526 · www.irs.gov/charities-non-profits/charitable-organizations/c · www.irs.gov/taxtopics/tc515 · www.irs.gov/newsroom/qualified-business-income-deduction

Part 1 · Lesson 4 of 6

Part 1 — Taxation: Self-Employment Tax, the Extra Medicare Taxes, the Nanny Tax, AMT, and Other Taxes

This lesson covers the "other taxes" that get added to a Form 1040 after regular income tax: self-employment tax, the 0.9% Additional Medicare Tax, the 3.8% net investment income tax, household employment tax, AMT, and a handful of special situations like clergy pay and income in respect of a decedent. The real exam draws 15 scored questions from this domain, and most of them are quick computations or threshold checks. If you memorize a few rates and thresholds and know which form each tax rides on, these become some of the easiest points on Part 1.

Self-Employment Tax: The 15.3% You Pay Yourself

A W-2 employee splits Social Security and Medicare tax with the employer. A self-employed person pays both halves. That is self-employment (SE) tax, and it applies once net earnings from self-employment reach $400 (a statutory amount, not indexed).

The math has two steps. First, multiply net profit by 92.35% to get net earnings from self-employment. Second, multiply that by 15.3% (12.4% Social Security + 2.9% Medicare). For 2025, the 12.4% Social Security piece stops at $176,100 of combined wages and SE earnings; the 2.9% Medicare piece never stops.

Example: Net Schedule C profit of $10,000. Step 1: $10,000 × 92.35% = $9,235. Step 2: $9,235 × 15.3% = about $1,413. The taxpayer also deducts one-half of SE tax as an adjustment to income on the return. All of this runs through Schedule SE.

Clergy are a special SE-tax story. Ministers are usually employees for income tax, but their ministerial earnings are covered under the SE tax system, not FICA withholding. A housing allowance is excluded from income tax (to the extent used to provide a home) but is included in SE earnings. A minister with a religious objection to public insurance can apply for an SE-tax exemption on Form 4361. One more oddball: church employees of organizations exempt from FICA owe SE tax once paid more than $108.28.

Two Extra Taxes on Higher Incomes: 0.9% and 3.8%

Two surtaxes share the same thresholds: $200,000 single or head of household, $250,000 married filing jointly, and $125,000 married filing separately. Neither threshold is indexed for inflation.

• Additional Medicare Tax — 0.9% on earned income. It applies to wages and SE income above the threshold for your filing status. An employer must start withholding it once that employer's wages to you pass $200,000 — regardless of your filing status, and with no employer match. The true-up happens on Form 8959 with your return.
• Net investment income tax (NIIT) — 3.8% on investment income. It applies to the lesser of net investment income or the amount your MAGI exceeds the threshold. Investment income means interest, dividends, capital gains, rents, royalties, and non-qualified annuities. Wages, SE income, and Social Security benefits are not investment income. It is figured on Form 8960.

Example: A single filer has MAGI of $250,000, including $30,000 of net investment income. MAGI over the threshold is $50,000. NIIT = 3.8% × the lesser amount ($30,000) = $1,140.

Household Employees, Excess Social Security, and Uncollected Tax

A worker in your home is a household employee if you control both what work is done and how — think nanny, housekeeper, or caregiver. For 2025, paying a household employee $2,800 or more in cash wages triggers Social Security and Medicare tax on all the wages: 6.2% + 1.45% (7.65%) for each of the employer and employee shares. Paying $1,000 or more in any calendar quarter triggers federal unemployment (FUTA) tax. The employer reports it all on Schedule H, filed with their own Form 1040.

Excess Social Security withholding. Each employer must withhold up to the wage base, so a person with two jobs can have too much withheld. The 2025 maximum is $10,918.20 (6.2% × the $176,100 wage base). If two or more employers combined went over, the excess is claimed as a credit on the income tax return. If one employer withheld too much, the credit is not allowed — the employer should refund it, and if it will not, the employee files Form 843.

Uncollected Social Security and Medicare tax still gets paid on the return: unreported tip income uses Form 4137, and wages from an employer that wrongly treated the worker as a contractor use Form 8919.

Pay-As-You-Go: Underpayment Penalties and Interest

Income tax is pay-as-you-go. Money must come in during the year through withholding or quarterly estimated payments. Fall short and the IRS charges an underpayment penalty that works like interest — figured quarter by quarter on Form 2210 for the time each shortfall stayed unpaid.

There is no penalty if any one of these safe harbors is met:

• The balance due after withholding and refundable credits is less than $1,000; or
• Payments during the year were at least 90% of the current year's tax; or
• Payments were at least 100% of the prior year's tax — but 110% if prior-year AGI was more than $150,000 ($75,000 if married filing separately for the current year).

One practical wrinkle the exam tests: withholding is treated as paid evenly through the year, no matter when it actually happened, while estimated payments count only when paid. So extra withholding late in the year can cure an early-year shortfall; a December estimated payment cannot.

AMT, the Prior-Year AMT Credit, and the Grab Bag

The alternative minimum tax is a parallel calculation with fewer deductions and its own exemption. You compute regular tax and tentative minimum tax on Form 6251 and effectively pay the higher one. For 2025 the AMT exemption is $88,100 for unmarried filers ($68,500 married filing separately) and $137,000 for joint filers, phasing out once AMT income passes $626,350 and $1,252,700 respectively.

AMT caused by timing (deferral) items — the classic is exercising incentive stock options — can generate a credit for prior-year minimum tax (Form 8801) that offsets regular tax in a later year when regular tax exceeds tentative minimum tax.

• Income in respect of a decedent (IRD): income the decedent earned but had not received at death (final paycheck, accrued interest). The recipient — estate or beneficiary — reports it, it keeps the same character it had for the decedent, and it gets no basis step-up. The recipient may deduct the estate tax attributable to the IRD.
• First-time homebuyer credit repayment: the 2008 credit was an interest-free loan repaid at 1/15 per year from 2010 through 2024. If the home stops being the main home while a balance remains, the rest is generally due at once, reported on Form 5405.
• Military: pay for service in a combat zone can be excluded from income tax, and filing deadlines are automatically extended for those serving there.

Sources: www.irs.gov/taxtopics/tc554 · www.irs.gov/instructions/i1040sse · www.irs.gov/taxtopics/tc560 · www.irs.gov/businesses/small-businesses-self-employed/questi · www.irs.gov/individuals/net-investment-income-tax · www.irs.gov/newsroom/questions-and-answers-on-the-net-invest

Part 1 · Lesson 5 of 6

Advising the Individual Taxpayer: Property, Planning, and Filing Decisions

This lesson covers Part 1's advising domain: helping clients plan around property sales, gifts and inheritances, retirement and education accounts, divorce, estimated taxes, and refund claims. It is worth 11 scored questions on the exam, and most of them test whether you know a handful of bright-line rules — holding periods, basis rules, safe-harbor percentages, and deadlines. Learn the rules here and the questions become simple lookups.

Selling What You Own: Homes, Stock, and Collectibles

When a client sells property, your first question is: how long did they hold it? Held more than one year, the gain is long-term and gets favored rates of 0%, 15%, or 20%. Held one year or less, it is short-term and taxed at ordinary rates. For 2025, the 0% rate applies up to $48,350 of taxable income for single filers and $96,700 for joint filers.

Two special rules show up constantly:

• Home sales. A taxpayer can exclude up to $250,000 of gain on a main home ($500,000 on a joint return) if they owned the home and used it as their main home for at least 2 of the last 5 years. Example: a couple bought a home for $300,000 and sells for $700,000. The $400,000 gain is fully excluded — no tax, and nothing to report unless they receive a Form 1099-S (a fully excluded sale must still be reported if a 1099-S arrives).
• Collectibles. Long-term gain on coins, art, and similar items is taxed at a maximum 28% rate — worse than regular capital gain rates.

If losses beat gains, the client deducts up to $3,000 of the excess per year ($1,500 married filing separately) and carries the rest forward with no time limit.

Gifts vs. Inheritances: Basis Is the Whole Game

The exam loves this contrast because the answers are opposites:

• Gifts take carryover basis. The person receiving the gift generally steps into the giver's basis. Dad bought stock for $10,000; he gives it to you when it is worth $50,000; you sell at $50,000 — you have a $40,000 gain.
• Inheritances take stepped-up basis. Inherited property's basis is generally its fair market value at the date of death. Inherit that same stock at $50,000 and sell at $50,000 — zero gain.

Neither gifts nor inheritances are income to the person who receives them. Any gift tax falls on the giver, and it rarely applies: for 2025 a person can give $19,000 per recipient with no gift tax return required, and the estate tax basic exclusion is $13,990,000 for deaths in 2025. Life insurance proceeds paid because of the insured's death are also generally not taxable income to the beneficiary. So a planning tip you can state confidently: holding appreciated property until death erases the built-in gain for heirs, while gifting it hands the gain to the recipient.

Retirement and Education Planning

Know the 2025 contribution numbers cold: IRA limit $7,000 plus a $1,000 catch-up at age 50; 401(k) elective deferrals $23,500 plus a $7,500 catch-up at 50 (a higher $11,250 catch-up applies at ages 60-63).

On the way out of retirement accounts:

• RMDs begin at age 73. The first required minimum distribution can be delayed until April 1 of the following year — but that means two RMDs land in one year. Missing an RMD triggers a 25% excise tax on the shortfall, reduced to 10% if corrected within two years.
• Qualified charitable distributions (QCDs). An IRA owner who is at least 70½ can have the trustee pay up to $108,000 (2025) directly to charity. The amount is excluded from income and can count toward the RMD — often better than a deduction, especially for clients who do not itemize.

For education: the Lifetime Learning Credit is 20% of up to $10,000 of qualified expenses — a maximum of $2,000 per return, not per student. It is nonrefundable and phases out between $80,000 and $90,000 of MAGI ($160,000-$180,000 joint). 529 plans grow tax-free, and withdrawals for qualified education expenses are tax-free too.

Marriage, Divorce, and Filing Status

Married filing jointly usually produces the lowest tax and the biggest standard deduction ($31,500 for 2025) — but both spouses take on joint and several liability: the IRS can collect the entire tax from either spouse. Married filing separately ($15,750 standard deduction for 2025) walls off each spouse's liability but costs many credits and cuts the capital loss limit to $1,500. Head of household ($23,625 for 2025) requires being unmarried (or considered unmarried) and paying more than half the cost of a home for a qualifying person.

Divorce rules turn on one date. For agreements executed after December 31, 2018, alimony is not deductible by the payer and not income to the recipient. Older agreements keep the old rules unless modified to adopt the new treatment. Property settlements between divorcing spouses are generally not taxable events.

Finally, keep the two spouse-relief forms straight:

• Injured spouse (Form 8379): your share of a joint refund was taken for your spouse's separate debt — past-due child support, their old taxes, defaulted student loans.
• Innocent spouse (Form 8857): you seek relief from joint liability caused by your spouse's understated tax.

Estimated Tax, Carryovers, and Fixing Past Returns

Income tax is pay-as-you-go. A client generally avoids the underpayment penalty if they owe less than $1,000 after withholding and refundable credits, or if their payments equal the smaller of 90% of the current year's tax or 100% of the prior year's tax. If prior-year AGI was over $150,000 ($75,000 married filing separately), the prior-year target rises to 110%. Mid-year planning tip: extra withholding is treated as paid evenly through the year, so a late-year withholding boost can cure an early-year shortfall in a way a late estimated payment cannot.

Several items reach across tax years: capital losses carry forward indefinitely, net operating losses generally carry forward (no carryback for most taxpayers), Form 8801 claims the credit for prior-year minimum tax, and a negative QBI amount carries to the next year and reduces future QBI.

To fix a past return, file Form 1040-X. A refund claim must be filed by the later of 3 years from when the return was filed or 2 years from when the tax was paid. And remember: every return is signed under penalty of perjury — the signer declares it true, correct, and complete.

Sources: www.irs.gov/taxtopics/tc701 · www.irs.gov/taxtopics/tc409 · www.irs.gov/taxtopics/tc306 · www.irs.gov/instructions/i2210 · www.irs.gov/publications/p970 · www.irs.gov/instructions/i8863

Part 1 · Lesson 6 of 6

Specialized Returns for Individuals: Estate Tax, Gift Tax, and International Reporting

This lesson covers the three "specialty" return families the SEE tests in Part 1: the estate tax return (Form 706) and the estate income tax return (Form 1041), the gift tax return (Form 709), and the international information reports (FBAR, Form 8938, and friends). It is worth 11 scored questions, and most of them are memory questions: who files, by when, at what dollar threshold, and what the penalty is. Learn the numbers and due dates here and these become some of the easiest points on the exam.

The Estate Tax: Gross Estate, Taxable Estate, and Form 706

When a person dies, the tax law first adds up everything they owned. That total, at fair market value on the date of death, is the gross estate. It includes cash, homes, investments, and business interests. It also includes three items students often miss:

• IRAs and retirement plans. The account balance goes into the gross estate, even though it passes by beneficiary form and skips probate.
• Life insurance. Proceeds are income-tax-free to the person who receives them. But they are counted in the gross estate if the decedent owned the policy or held incidents of ownership (the right to change the beneficiary, cancel, or borrow against it), or if the proceeds are payable to the estate.
• Jointly held property. If the joint owners were spouses, only 50% of the value is included. If the joint owner was not a spouse, 100% is included unless the survivor can prove they paid part of the cost.

Next come the subtractions: debts, funeral and administration costs, the unlimited marital deduction for property passing to a U.S. citizen spouse, and gifts to charity. What is left is the taxable estate.

Very few estates pay tax, because the unified credit shelters the first $13,990,000 (the 2025 basic exclusion amount) of combined lifetime gifts and the estate. The credit amount itself is $5,541,800 for 2025, which is the tax on exactly $13,990,000.

Form 706 is required when the gross estate plus the decedent's adjusted taxable gifts exceeds $13,990,000 (2025 deaths). It is due 9 months after the date of death. Form 4768 gives an automatic 6-month extension to file (paying is a separate request).

Portability and the Estate's Income Tax Return (Form 1041)

Portability lets a surviving spouse pick up whatever part of the exclusion the first spouse to die did not use. This leftover is called the DSUE (deceased spousal unused exclusion). Example: a husband dies in 2025 with a $4 million estate that all passes to his wife. The marital deduction wipes out any tax, so he used none of his $13,990,000 exclusion. If portability is elected, his wife can later shelter her own $13,990,000 plus his unused amount.

The catch the exam loves: portability is not automatic. The executor must file Form 706 and make the election, even though the estate is too small to owe tax. If the only reason for filing is portability, Rev. Proc. 2022-32 allows the return to be filed as late as the fifth anniversary of death. One more wrinkle: the DSUE covers estate and gift tax only — the GST exemption is never portable.

Do not confuse Form 706 with Form 1041, the estate's income tax return. After death, the estate itself may keep earning money — interest, dividends, rent. The fiduciary must file Form 1041 for a domestic estate that has:

• Gross income of $600 or more for the tax year, or
• Any beneficiary who is a nonresident alien, no matter how small the income.

A calendar-year estate files by April 15 of the next year. Unlike most trusts, an estate may choose a fiscal year; then the return is due the 15th day of the 4th month after the year ends.

Gift Tax: The Annual Exclusion, Gift Splitting, and Form 709

The gift tax and the estate tax share the same $13,990,000 lifetime shelter — that is why the credit is called unified. Taxable gifts made during life use it up, and whatever remains covers the estate at death.

Most gifts never touch it, thanks to the annual exclusion: $19,000 per person, per year (2025). Give $19,000 each to ten grandchildren and nothing is taxable and no return is needed. The exclusion only works for gifts of a present interest — the person must be able to use the gift now.

Some gifts are unlimited and never taxable, no matter the size:

• Tuition or medical bills paid directly to the school or provider (never to the person),
• Gifts to a U.S. citizen spouse (a non-citizen spouse instead gets a special annual exclusion of $190,000 for 2025),
• Gifts to charity and to political organizations.

Gift splitting lets a married couple treat a gift by one spouse as made half by each, doubling the exclusion to $38,000 per recipient (2025). Both spouses must consent, and splitting itself requires filing Form 709. Form 709 is due April 15 of the year after the gift. Key idea: filing Form 709 rarely means writing a check. A $30,000 gift just reports an $11,000 taxable gift that nibbles at the lifetime exclusion.

The generation-skipping transfer (GST) tax is an extra flat tax at the top rate (40%) on transfers that skip a generation — say, grandparent straight to grandchild. Each person has a GST exemption equal to the basic exclusion amount, $13,990,000 for 2025, allocated on Form 709. Remember: unused GST exemption does not port to a spouse.

International Reporting: FBAR vs. Form 8938, and the Big-Penalty Forms

Two overlapping reports catch foreign money, and the exam constantly tests their differences.

• FBAR (FinCEN Form 114). Required when the total value of all foreign financial accounts exceeds $10,000 at any time during the year — add the accounts together. It is filed electronically with FinCEN, not with the tax return. Due April 15, with an automatic extension to October 15 — no form needed.
• Form 8938 (specified foreign financial assets). Attached to the income tax return. Much higher thresholds for taxpayers living in the U.S.: unmarried, more than $50,000 on the last day of the year or $75,000 at any time; married filing jointly, $100,000 / $150,000. Living abroad, the thresholds jump to $200,000/$300,000 (unmarried) and $400,000/$600,000 (MFJ). It covers more than accounts — foreign stock and partnership interests held directly count too.

Meeting both tests means filing both forms — one never replaces the other.

Penalties are where the exam gets specific:

• FBAR: non-willful violations draw a civil penalty of up to $10,000 per violation (a base amount adjusted yearly for inflation). Willful violations can cost the greater of $100,000 (inflation-adjusted) or 50% of the account balance, plus possible criminal charges.
• Form 8938: $10,000 for failure to file, plus $10,000 per 30 days after IRS notice (max $50,000 more), plus a 40% accuracy penalty on understatements tied to undisclosed foreign assets. Not filing keeps the statute of limitations open for the return until 3 years after the form is filed; omitting more than $5,000 of foreign-asset income stretches the assessment window to 6 years.
• Form 3520: a U.S. person who receives more than $100,000 in gifts or bequests from a nonresident alien or foreign estate in a year must report it. The penalty is 5% per month, up to 25% of the gift.
• Form 5471 (U.S. officers, directors, and shareholders of certain foreign corporations): $10,000 per corporation per year, plus $10,000 per 30 days after the 90-day notice window, capped at $50,000 extra. Form 8865 applies parallel rules to foreign partnerships.

Itemized deductions on Form 1040-NR

A nonresident alien filing Form 1040-NR does not use the same Schedule A a resident uses. Nonresidents complete Schedule A (Form 1040-NR), which is a much shorter list, and in most cases a nonresident cannot claim the standard deduction at all.

The general rule. Under IRC 63(c)(6), a nonresident alien is not allowed the standard deduction. So a nonresident either itemizes the limited categories allowed or effectively deducts nothing.

What is allowed. The deductions a nonresident may itemize are generally limited to:

• State and local income taxes paid on income effectively connected with a U.S. trade or business, subject to the same overall cap on state and local taxes that applies to individuals. Note this category is income taxes, not the broader taxes a resident may deduct.
• Charitable contributions to qualifying U.S. organizations.
• Casualty and theft losses of property located in the United States, and only to the extent allowable under the federally declared disaster rules.
• Other itemized deductions that survive current law. Gambling losses are the classic example, but a nonresident may offset gambling winnings with losses only where the activity is effectively connected income or a treaty (notably the U.S.-Canada treaty) allows it; otherwise U.S. gambling winnings of a nonresident are taxed gross with no offset.

What is not allowed. Mortgage interest on a personal residence, medical expenses, and general real property or sales taxes on personal property are not deductible on Schedule A (Form 1040-NR).

The connection requirement. Itemized deductions offset only income that is effectively connected with a U.S. trade or business. Fixed, determinable, annual, or periodical (FDAP) income taxed at a flat statutory or treaty rate is taxed on a gross basis with no deductions at all.

The main exception. A student or business apprentice who qualifies under the U.S.-India income tax treaty may claim the standard deduction. That is the classic exam fact pattern. Separately, a nonresident who makes a valid election to be treated as a resident, or who files jointly with a U.S. citizen or resident spouse, is taxed as a resident and follows the ordinary rules instead.

Foreign pension income and treaty benefits

Start with the worldwide income rule. A U.S. citizen or resident is taxed on income from all sources, so a pension paid by a foreign employer or a foreign government is reportable on the U.S. return even if it is exempt in the country paying it and even if no Form 1099-R is issued.

A treaty can change that. Most U.S. income tax treaties have a pensions article that assigns taxing rights, often giving the country of residence the primary right to tax a private pension while reserving government service pensions to the paying country. Treaty terms vary, so the specific treaty article controls. A taxpayer taking a treaty position that reduces or eliminates U.S. tax generally discloses it on Form 8833 under IRC 6114, unless a regulatory exception applies.

The saving clause. Nearly every U.S. treaty contains a saving clause letting the United States tax its own citizens and residents as if the treaty had not entered into force. Unless the pension article is listed as an exception to the saving clause, a U.S. citizen usually cannot use the treaty to escape U.S. tax on the pension.

Double tax relief. Foreign tax actually paid on the pension may support a foreign tax credit on Form 1116. Separately, a foreign retirement account may trigger FBAR (FinCEN Form 114) and Form 8938 reporting.

International information-return penalties (Forms 3520, 5471, willful FBAR)

These penalties attach to the form, not to the tax. A taxpayer can owe zero tax and still face large penalties for failing to file an international information return on time and complete.

Form 3520 reports certain transactions with foreign trusts and the receipt of large gifts or bequests from foreign persons. For a reportable transfer to, ownership of, or distribution from a foreign trust, IRC 6677 sets the penalty as a percentage of the gross reportable amount, with additional amounts if the failure continues after IRS notice. For an unreported large foreign gift, IRC 6039F imposes a monthly percentage penalty on the gift, subject to a cap. Reasonable cause, not willful neglect, is a defense. A related form, Form 3520-A, is the foreign trust's own annual information return and is due earlier in the year than Form 3520.

Form 5471 reports a U.S. person's interest in a foreign corporation. IRC 6038(b) imposes a flat per-form, per-year penalty with continuation penalties after IRS notice, plus a reduction of the taxpayer's foreign tax credit under IRC 6038(c) if the failure persists.

FBAR (FinCEN Form 114) is filed under the Bank Secrecy Act, not the Internal Revenue Code. A willful failure carries a far larger penalty than a non-willful one, computed as the greater of a statutory dollar amount or a percentage of the account balance, and willful cases can also be referred criminally. Willfulness includes reckless disregard, not only intentional violation. The Supreme Court held in Bittner that the non-willful FBAR penalty applies per report, not per account; that per-report limit does not extend to willful violations.

Foreign pensions and retirement income

Start with the default rule. A U.S. citizen or resident alien is taxed on worldwide income. A distribution from a pension set up under the laws of another country is still gross income on the U.S. return unless a specific rule says otherwise. Where the money sits, what currency it is in, and whether it was ever reported to the IRS before do not change that.

Foreign plans are usually not qualified plans. The favorable U.S. rules for retirement plans, such as deferral on employer contributions and on inside buildup, generally apply only to plans meeting IRC 401(a) and related sections. A foreign employer's plan rarely does. Two consequences follow. First, employer contributions and earnings inside a foreign plan may be currently taxable to the U.S. person, even though nothing has been distributed. Second, the participant may have basis in the plan from amounts already taxed, so a later distribution is not necessarily fully taxable. Track that basis, or the same dollars get taxed twice.

Treaties can change the answer, but never automatically. Many U.S. income tax treaties contain a pensions article. Depending on the specific treaty and the taxpayer's facts, it may make the pension taxable only in the country of residence, exempt certain government-service pensions, re-source the income so a foreign tax credit can be claimed, or allow deferral that mirrors the source country's treatment. Relief applies only if the taxpayer meets that article's conditions, identifies it, and claims it. When a taxpayer takes a treaty-based return position that overrides or modifies U.S. tax law, Form 8833, Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b), is generally required, subject to the exceptions in the regulations. Social security style benefits paid by a foreign government are also governed by the applicable treaty, and the outcome varies by country.

Double tax relief. If the source country also taxes the pension, the taxpayer may claim a foreign tax credit on Form 1116 for qualified foreign income taxes paid or accrued. The credit is limited by the ratio of foreign source taxable income in the relevant category to total taxable income, so income category and sourcing matter. Amounts a treaty makes exempt from foreign tax are generally not creditable, because a payment is creditable only if it is compulsory and the taxpayer exhausts practical remedies to reduce it. A taxpayer may instead deduct foreign income taxes, but not both in the same year.

Reporting is separate from taxation. A foreign pension often triggers information filings that stand on their own. FinCEN Form 114 (FBAR) reports foreign financial accounts and is filed with FinCEN, not with the tax return. Form 8938 reports specified foreign financial assets and is filed with Form 1040. Foreign trust rules can also pull in Forms 3520 and 3520-A for some arrangements. These obligations apply whether or not any tax is owed, and their penalties are separate from tax penalties. A taxpayer whose pension is exempt by treaty may still have to file every one of them.

Sources: www.irs.gov/businesses/small-businesses-self-employed/estate · www.irs.gov/instructions/i706 · www.irs.gov/instructions/i709 · www.irs.gov/businesses/small-businesses-self-employed/freque · www.irs.gov/newsroom/irs-releases-tax-inflation-adjustments- · www.irs.gov/businesses/small-businesses-self-employed/whats-