For 2026, a married couple filing jointly has $600,000 of ordinary taxable income before applying the preferential long-term capital gain rate, plus a $50,000 net long-term capital gain from selling stock. The couple has no other investment income, and their modified adjusted gross income is $650,000. For 2026, the MFJ long-term capital gain brackets are 0% up to $98,900, 15% from $98,901 through $613,700, and 20% above $613,700. The 3.8% net investment income tax applies to the lesser of net investment income or the amount by which MAGI exceeds $250,000.
What is the total additional federal tax on the $50,000 long-term capital gain, including the NIIT? Answer: $11,215
Under IRC § 1(h), long-term capital gains are stacked on top of ordinary income. Because the couple's ordinary income already fills every bracket through $600,000, only the first $13,700 of the gain falls within the 15% capital gain bracket ($613,700 − $600,000), and the remaining $36,300 is taxed at 20%. The capital gain tax is $13,700 × 0.15 = $2,055 plus $36,300 × 0.20 = $7,260, or $9,315. Under IRC § 1411, the 3.8% NIIT applies to the full $50,000 gain because it is less than the MAGI excess over $250,000, producing $1,900. Total additional tax is $11,215. The $9,400 figure assumes the entire gain is in the 15% bracket but adds the NIIT. The $11,900 figure assumes the entire gain is in the 20% bracket and adds the NIIT. The $9,315 figure computes the correct capital gain tax but omits the NIIT.
- For tax year 2026, an investor in the 32% marginal federal income tax bracket is comparing a municipal bond that yields 3.4% with a corporate bond of comparable credit quality and maturity that yields 4.8%. Assume no state income tax applies. Which of the following statements is true?
Answer: The municipal bond's tax-equivalent yield is 5.0%, so the municipal bond provides the higher after-tax return.
Interest on municipal bonds is excluded from federal gross income under IRC § 103. The tax-equivalent yield converts a tax-exempt yield into the taxable yield that would produce the same after-tax return: 3.4% ÷ (1 − 0.32) = 5.0%. Because the corporate bond yields 4.8%, below the 5.0% tax-equivalent yield, the municipal bond provides the higher after-tax return. The 2.3% figure comes from multiplying 3.4% by (1 − 0.32); that formula computes the after-tax yield of a taxable bond, not the tax-equivalent yield of a tax-exempt one. The 10.6% figure comes from dividing 3.4% by the 32% tax rate instead of by the 68% after-tax retention percentage. The statement that the corporate bond is superior because 4.8% exceeds 3.4% compares nominal yields and ignores the tax exemption entirely.
- For tax year 2026, a single taxpayer has taxable income of $180,000, which includes a $40,000 long-term capital gain from stock held more than one year. The taxpayer's modified adjusted gross income is $240,000, and the capital gain is the taxpayer's only net investment income. For 2026, the long-term capital gains tax rates are 0% on taxable income up to $49,450, 15% on taxable income above $49,450 up to $545,500, and 20% above $545,500. The 3.8% net investment income tax applies to the lesser of net investment income or modified adjusted gross income above $200,000 for a single taxpayer. What is the total federal tax on the long-term capital gain, including the net investment income tax?
Answer: $7,520
Under IRC § 1(h), long-term capital gains are stacked on top of ordinary income. The taxpayer's $140,000 of ordinary income ($180,000 − $40,000) already consumes the entire 0% bracket, which ends at $49,450, so the full $40,000 gain is taxed at 15% because taxable income of $180,000 is below the $545,500 ceiling; the gain tax is 15% × $40,000 = $6,000. Under IRC § 1411, the 3.8% net investment income tax applies to the lesser of net investment income ($40,000) or the excess of modified adjusted gross income over the single threshold ($240,000 − $200,000 = $40,000), adding 3.8% × $40,000 = $1,520. The key is the sum, $7,520. The $1,520 answer applies the 0% rate to the gain itself while adding the NIIT, but the 0% bracket is filled first by ordinary income. The $6,000 answer omits the NIIT, and the $8,000 answer applies the 20% top rate despite taxable income being below $545,500.
In the 2026 tax year, a single client, age 45, with earned income of $95,000, is an active participant in her employer's 401(k) plan. Her modified adjusted gross income (MAGI) is $86,000. The 2026 Traditional IRA contribution limit is $7,500, and the deduction phase-out range for a single taxpayer covered by an employer retirement plan is $81,000 to $91,000 of MAGI.
What is the maximum Traditional IRA contribution the client may deduct on her 2026 federal income tax return? Answer: $3,750
IRC § 219(g). Because the client is an active participant in an employer retirement plan and her MAGI of $86,000 is $5,000 into the $10,000 phase-out range ($81,000–$91,000), 50% of the deduction is phased out. The maximum deductible contribution is $7,500 × 50% = $3,750; the remaining $3,750 becomes nondeductible basis. The $7,500 answer ignores the phase-out entirely. The $2,500 answer incorrectly subtracts the $5,000 MAGI excess directly from the contribution limit rather than applying the proportional phase-out. The $0 answer treats the phase-out as a cliff that eliminates the deduction at any MAGI above $81,000, when in fact the deduction is reduced proportionally across the full range.
In the 2026 tax year, a client in the 32% federal income tax bracket is subject to the 3.8% net investment income tax. The client is evaluating a municipal bond issued by the client's home state, which yields 3.5%, and a corporate bond of comparable credit quality and maturity that yields 5.25%.
What is the municipal bond's tax-equivalent yield? Answer: 5.45%
IRC § 103 and IRC § 1411. Interest on a home-state municipal bond is excluded from gross income and is not net investment income subject to the NIIT. The tax-equivalent yield is the taxable yield required to match the tax-exempt yield: 3.5% ÷ (1 − 0.32 − 0.038) = 3.5% ÷ 0.642 = 5.45%. The 5.15% answer divides by (1 − 0.32) only, omitting the NIIT from the denominator. The 4.95% answer computes the 5.15% tax-equivalent yield and then reduces it by the NIIT rate, misapplying the tax to the computed figure. The 3.37% answer applies the NIIT rate directly to the municipal bond's 3.5% yield, which is wrong because municipal interest is not subject to the NIIT.
At the start of 2025, a client bought 1,000 shares of a mutual fund for $10 per share. In January 2026, the fund paid a $400 dividend and a $600 capital gain distribution; both were automatically reinvested at $20 per share. In May 2027, the client sold all of her shares for $25 per share. The fund uses average cost basis for tax reporting.
What is the client's recognized capital gain on the sale? Answer: $15,250
Dividends and capital gain distributions are taxable when paid, but reinvesting them adds to the client's cost basis. The reinvested $1,000 bought $1,000 / $20 = 50 additional shares, so the client owns 1,050 shares with a total basis of $11,000. Sale proceeds are 1,050 × $25 = $26,250, so the gain is $15,250. The $16,250 figure counts all 1,050 shares in proceeds but keeps the basis at $10,000. The $14,000 figure adds the reinvested distributions to basis but counts proceeds on only the original 1,000 shares. The $15,000 figure uses 1,000 shares and a $10,000 basis, ignoring both effects.
On January 15, 2025, a client bought 400 shares of XYZ common stock for $25 per share and paid a $200 commission. Six months later, XYZ declared a 2-for-1 stock split. On December 10, 2026, the client sold 300 shares for $20 per share and paid a $150 commission. There were no other transactions in XYZ.
What amount and character of gain or loss must the client report on the 2026 sale? Answer: $2,025 long-term capital gain
Under IRC § 305(a), a stock split is not taxable, and under IRC § 307 the $10,200 cost basis ($10,000 purchase price plus the $200 purchase commission) is reallocated over the 800 shares, or $12.75 per share. The 300 sold shares have a basis of 300 × $12.75 = $3,825. The $150 selling commission reduces the amount realized, so net proceeds are $5,850. The gain is $5,850 − $3,825 = $2,025, and the holding period is long-term. The $2,175 figure uses gross proceeds and ignores the selling commission. The $2,100 figure uses net proceeds but omits the $200 purchase commission from basis. The $1,800 loss fails to reallocate basis for the split and uses the original $25.50 per-share basis.
- For tax year 2026, a taxpayer has a $10,000 long-term capital loss and a $2,000 short-term capital gain from sales of stock, with no other capital transactions. The annual limit on deducting net capital losses against ordinary income is $3,000. Which of the following statements is true?
Answer: The $2,000 gain is first offset by the loss; the taxpayer deducts $3,000 of the remaining loss against ordinary income and carries forward $5,000 as a long-term capital loss.
Under IRC § 1211(b), an individual may deduct net capital losses against ordinary income only up to $3,000 per year; under IRC § 1212(b), the excess is carried forward with its character intact. The $10,000 long-term loss must first offset the $2,000 short-term gain, leaving an $8,000 net loss whose character is long-term. Of that, $3,000 is deductible against ordinary income and the remaining $5,000 carries forward as a long-term capital loss. The statement that the carryforward is short-term is wrong because the character of the net loss is set by netting, and the loss that remains is long-term. The statement that the full $8,000 is deductible against ordinary income is wrong because the statutory limit is $3,000. The statement that the $2,000 gain is separately taxable is wrong because capital losses must absorb capital gains before any deduction against ordinary income is taken.
On July 15, 2025, a client purchased 200 shares of Delta Manufacturing common stock at $40 per share. On October 15, 2025, when the market price had fallen to $30 per share, the client sold all 200 shares. On October 30, 2025, the client repurchased 200 shares of Delta Manufacturing at $32 per share. The client sold all of these shares on September 15, 2026, at $38 per share.
For the 2026 tax year, which of the following correctly characterizes the client's gain or loss on the September 15, 2026, sale? Answer: An $800 long-term capital loss
IRC § 1091 and IRC § 1223(4). The October 15, 2025, sale at a $2,000 loss is disallowed as a wash sale because the client repurchased substantially identical shares within 30 days (October 30). The disallowed loss is added to the $6,400 cost of the replacement shares, producing an adjusted basis of $8,400 ($42 per share). The September 15, 2026, proceeds are 200 × $38 = $7,600, so the recognized loss is $800. Under § 1223(4), the original shares' holding period (July 15 to October 15, 2025, about 3 months) is added to the replacement shares' own holding period (October 30, 2025, to September 15, 2026, about 10.5 months). The October 15-30 gap does not count, but the tacked total of about 13.5 months still exceeds one year, so the loss is long-term. The $1,200 short-term gain answer ignores the basis adjustment and measures the holding period from the repurchase date. The $800 short-term loss answer adjusts the basis correctly but fails to tack the holding period. The $1,200 long-term gain answer ignores the basis adjustment while correctly applying the tacked holding period.
For the 2026 tax year, a single client has modified adjusted gross income (MAGI) of $230,000, which includes $15,000 of qualified dividends. The client's ordinary income is taxed at a marginal rate of 32%. The 2026 long-term capital gains rates for a single filer are 0% up to $49,450, 15% from $49,450 to $545,500, and 20% above $545,500. The 3.8% net investment income tax (NIIT) applies to the lesser of net investment income or the excess of MAGI over $200,000.
What is the total federal tax, including the net investment income tax, on the client's $15,000 of qualified dividends for 2026? Answer: $2,820
IRC § 1(h) and IRC § 1411. Qualified dividends are taxed at long-term capital gains rates, not the 32% ordinary income rate. The client's income places them in the 15% long-term capital gains bracket. The NIIT applies at 3.8% on the lesser of net investment income ($15,000) or the excess of MAGI over $200,000 ($30,000), so the base is $15,000. The total is 15% × $15,000 = $2,250 plus 3.8% × $15,000 = $570, for a total of $2,820. The $4,800 answer incorrectly applies the 32% ordinary rate to the qualified dividends. The $2,250 answer applies the correct capital gains rate but omits the NIIT. The $3,390 answer correctly treats the dividends at 15% but applies the NIIT to the full $30,000 MAGI excess instead of the $15,000 of net investment income.
A client, age 56, retired from her employer in January 2026, the year she turned 56. After separating from service, in February 2026 she received a $25,000 lump-sum distribution from her employer's 401(k) plan. In July 2026, she withdrew $10,000 from her traditional IRA to pay for a family member's wedding.
For the 2026 tax year, which statement correctly describes the client's exposure to the 10% early-withdrawal penalty? Answer: No penalty applies to the 401(k) distribution, and a $1,000 penalty applies to the IRA withdrawal.
IRC § 72(t). The 10% early-withdrawal penalty applies to most retirement distributions before age 59½ unless an exception applies. The 401(k) lump-sum distribution qualifies for the exception for separation from service during or after the calendar year in which the employee turns 55 (IRC § 72(t)(2)(A)(v)); because the client turned 56 in 2026, the 401(k) distribution is penalty-free. That exception applies only to qualified plans, not IRAs, and paying for a wedding is not a qualifying exception, so the $10,000 IRA withdrawal is subject to the 10% penalty: $10,000 × 10% = $1,000. The $2,500 penalty answer reverses the exception, applying it to the IRA and not the plan. The no-penalty answer applies the age-55 separation exception to the IRA, which the statute does not allow. The $3,500 answer applies the 10% penalty to both distributions, ignoring the plan exception.
- Under the federal income tax rules in effect for tax year 2026, which of the following statements regarding the wash sale rule is true?
Answer: A wash sale loss is disallowed when the taxpayer acquires a substantially identical security within 30 days before or after the sale; the disallowed loss is added to the basis of the replacement security, and the replacement's holding period includes that of the security sold.
Under IRC § 1091, a loss on the sale of stock or securities is disallowed when the taxpayer acquires substantially identical stock or securities within 30 days before or 30 days after the sale. The loss is not forfeited: it is added to the basis of the replacement security, and the replacement's holding period includes the holding period of the security sold, so the deferred loss is recognized when the replacement is ultimately sold. The statement that the rule applies only when the replacement is acquired within 30 days after the sale is wrong because the 30-day period runs both before and after the sale. The statement that the disallowed loss becomes a capital loss carryforward is wrong because the loss is capitalized into the replacement shares' basis rather than reported on the current return. The statement that the replacement's holding period begins on the purchase date is wrong because § 1091 tacks the holding period of the shares sold onto the replacement shares.
In 2026, a client received a gift of 100 shares of ABC stock from her father. The father's adjusted basis in the stock was $10,000, and the stock's fair market value on the date of the gift was $8,000. No gift tax was paid. The father had held the shares for more than one year before making the gift, and the client's holding period, including the father's, was more than one year before she sold all 100 shares later in 2026 for $9,500.
What amount and character of gain or loss must the client recognize on the sale? Answer: No gain or loss recognized
Under IRC § 1015, the basis of gifted property is the donor's adjusted basis for computing gain and the lower of the donor's adjusted basis or the fair market value at the date of the gift for computing loss. No gift tax was paid, so no gift-tax basis adjustment is made. Because the $9,500 sale price is between the $10,000 donor basis and the $8,000 gift-date FMV, the dual-basis rule produces neither a gain nor a loss. The $500 loss results from using the donor's basis to measure a loss, but the lower FMV must be used for a loss. The $1,500 gain results from using the gift-date FMV to measure a gain, but the donor's basis must be used for a gain. The $2,000 loss is the pre-gift decline in value; an unrealized loss in the donor's hands is not recognized by the donee when the sale price exceeds the gift-date FMV.
On January 15, 2025, an individual client bought 100 shares of XYZ common stock for $50 per share. On December 15, 2025, the client sold all 100 shares for $40 per share. On January 5, 2026, the client bought 100 shares of XYZ for $45 per share. The January 2026 purchase was within 30 days after the December 2025 loss sale. On November 15, 2026, the client sold all 100 shares for $60 per share. There were no other transactions in XYZ.
What amount and character of gain or loss must the client report on the 2026 federal income tax return as a result of the November 15, 2026 sale? Answer: $500 long-term capital gain
Under IRC § 1091, the December 2025 loss is disallowed because the client bought substantially identical stock within the 30-day wash-sale period after the sale. The $1,000 disallowed loss is added to the $4,500 cost of the replacement shares, giving a $55-per-share basis. The November 2026 proceeds are $6,000, so the gain is $6,000 − $5,500 = $500. Under IRC § 1223, the replacement shares' holding period includes the holding period of the original shares, and the combined holding period exceeds one year, so the gain is long-term. The $500 short-term gain applies the basis adjustment but ignores the tacked holding period. The $1,500 short-term gain uses the unadjusted $45 replacement cost and the actual short-term holding period. The $1,000 loss carryover treats the disallowed loss as a carryover rather than as an adjustment to the replacement shares' basis.
In 2026, a single client has $40,000 of ordinary taxable income before any capital loss deduction, a $6,000 short-term capital gain from a stock sale, and an $18,000 long-term capital loss carryover from 2025. For 2026, the maximum net capital loss a taxpayer may deduct against ordinary income is $3,000.
What amount of long-term capital loss carryover remains after the client applies the 2026 capital transactions? Answer: $9,000
Under IRC § 1212(b), a capital loss carryover is first applied against current-year capital gains, and then up to $3,000 of any remaining net capital loss may be deducted against ordinary income. The $18,000 carryover offsets the $6,000 short-term capital gain, leaving $12,000. After subtracting the $3,000 ordinary-income deduction, $9,000 of long-term loss carryover remains. The $12,000 figure omits the $3,000 ordinary deduction. The $15,000 figure ignores the $6,000 short-term capital gain and subtracts only the $3,000 ordinary deduction from the $18,000 carryover. The $18,000 figure ignores both the current-year gain and the ordinary deduction.
