CPA TCP Individuals and personal financial planning: practice questions with answers

Question 1

On February 10, 2025, Bryce Halloran's employer granted him incentive stock options (ISOs) on 2,500 shares at $12 a share. He exercised them on January 5, 2026, when the stock traded at $30, and sold all 2,500 shares on September 15, 2026, for $26 a share. What does Bryce report for 2026 on the sale?

1. A No ordinary income; short-term capital gain $35,000
2. B Ordinary income $45,000; short-term capital loss $10,000
3. C Long-term capital gain $35,000; no ordinary income
4. D Ordinary income $35,000; no capital gain or loss

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Answer: D. Holding periods for ISO treatment: more than 2 years from grant (Feb. 10, 2025) and more than 1 year from exercise (Jan. 5, 2026). A sale on September 15, 2026, fails both, so it is a disqualifying disposition (IRC §421(b), §422(a)).

Spread at exercise = 2,500 x ($30 - $12) = $45,000

Gain realized on the sale = 2,500 x ($26 - $12) = $35,000

Because the sale would produce a loss measured from the $30 value, ordinary income is limited to the gain realized (§422(c)(2)): $35,000 ordinary income, and no capital gain or loss.

Because the shares were exercised and sold in the same year, there is no AMT adjustment for 2026.

Question 2

Which of the following does NOT require an adjustment or preference in computing 2026 alternative minimum taxable income?

1. A The standard deduction claimed by a taxpayer who does not itemize
2. B State income taxes deducted as an itemized deduction
3. C The bargain element of ISOs exercised in March 2026 when the shares were sold in October 2026
4. D Percentage depletion in excess of the adjusted basis of a mineral property

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Answer: C. The ISO bargain element is an AMT adjustment only if the shares are held beyond the end of the year of exercise. A same-year sale is a disqualifying disposition that gives ordinary income for regular tax, and the AMT result is the same, so no adjustment is made (IRC §56(b)(3)).

The others all increase AMTI: the standard deduction and state and local taxes are disallowed (§56(b)(1)(A), (E)), and percentage depletion over basis is a preference (§57(a)(1)).

Question 3

On January 1, 2026, Mercer Instruments lent its engineer Stellan Brooks $200,000, interest-free and payable on demand, as part of his compensation package. He used the money to buy a sailboat for personal use. The loan was outstanding all year, and the 2026 blended annual rate is 4.0% (use simple interest). What is the effect of the loan on each party's 2026 taxable income?

1. A Mercer: increase of $8,000; Stellan: increase of $8,000
2. B Mercer: no net change; Stellan: no net change
3. C Mercer: no net change; Stellan: increase of $8,000
4. D Mercer: increase of $8,000; Stellan: no change

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Answer: C. A compensation-related below-market demand loan (IRC §7872(c)(1)(B)) is recast as if Mercer paid Stellan the forgone interest as wages and Stellan paid it back as interest.

Forgone interest = $200,000 x 4.0% = $8,000

Mercer: interest income $8,000 and compensation deduction $8,000: net $0.

Stellan: wage income $8,000; the deemed $8,000 interest payment is personal interest (§163(h)) because the loan bought a personal sailboat, so it is not deductible: taxable income rises by $8,000.

Question 4

Cosima Marchetti owns 25% of an S corporation that runs a trade or business in which she does not materially participate. Her share of the 2026 ordinary loss is $70,000, and she has no other items from it. At the end of 2026 (before the loss) her stock and debt basis together are $60,000 and her amount at risk is $45,000. She has no passive income. How is the $70,000 loss treated for 2026?

1. A Suspended: basis $0, at-risk $25,000, passive $45,000; allowed $0
2. B Suspended: basis $10,000, at-risk $15,000, passive $20,000; allowed $25,000
3. C Suspended: basis $10,000, at-risk $0, passive $60,000; allowed $0
4. D Suspended: basis $10,000, at-risk $15,000, passive $45,000; allowed $0

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Answer: D. Losses pass through four limits in order: basis (IRC §1366(d)), at-risk (§465), passive activity (§469), then excess business loss (§461(l)).

1. Basis: $70,000 - $60,000 = $10,000 suspended at the basis level.
2. At-risk: $60,000 - $45,000 = $15,000 suspended under §465.
3. Passive: the remaining $45,000 is a passive loss; with no passive income it is suspended.
4. Allowed: $0, so the excess business loss limit is not reached.

Each suspended amount carries forward and is tested again at its own level and every later level.

Question 5

On July 1, 2026, Ambrose Kilgannon gave his daughter Tessa his entire interest in a rental duplex, a passive activity. His adjusted basis was $70,000, the fair market value was $110,000, and $25,000 of passive losses from the duplex were suspended. Which statement describes the tax result of the gift?

1. A Neither deducts the $25,000; Tessa's basis for gain is $95,000
2. B Neither deducts the $25,000; Tessa's basis is $110,000
3. C Tessa carries forward the $25,000 loss; her basis is $70,000
4. D Ambrose deducts $25,000 in 2026; Tessa's basis is $70,000

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Answer: A. On a gift of a passive activity, the donor's suspended losses are added to the basis of the interest immediately before the gift and are never deductible (IRC §469(j)(6)).

Tessa's basis for gain = carryover basis $70,000 + suspended losses $25,000 = $95,000. The FMV of $110,000 is higher than this, so the special loss-basis rule for gifts does not come into play.

Planning: an owner with large suspended losses usually gets more value from a taxable sale to an unrelated buyer than from a gift.

Question 6

Which of the following transfers made in 2026 is a gift for federal gift tax purposes?

1. A A $40,000 contribution to a political organization described in §527 to support a candidate
2. B Paying $24,000 of rent for an adult son, age 31, who is employed and self-supporting
3. C A written, irrevocable refusal of an inheritance made within nine months, before accepting any benefit
4. D Paying for the food, clothing and housing of a 14-year-old daughter

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Answer: B. A gift requires a transfer for less than full consideration that is not otherwise excluded.

- Rent for a self-supporting adult child is not a support obligation, so it is a gift (IRC §2511); it may be covered by the annual exclusion.
- Transfers to political organizations are not subject to gift tax (§2501(a)(4)).
- A qualified disclaimer (§2518: written, within 9 months, no benefits accepted, passes without direction) is not a transfer by the disclaimant.
- Payments meeting a parent's legal support obligation for a minor child are not gifts.