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Individual compliance and planning

TCP Chapter 1 · Area I · Blueprint I.A

REG taught you how an individual return is built. TCP asks what an adviser does with it: which way to take equity pay, how to stay clear of the alternative minimum tax, when to move income and deductions between years, how to use FSAs and HSAs, whether to itemize or bunch, how much estimated tax to pay, which property to give to charity and how to keep the 3.8% and 0.9% Medicare taxes in check. Tessa, a partner at Westbrook Tax Partners, and Leo, her second-year associate, work through a year of planning for Mei and Daniel Chen, a tech executive and a teacher who file jointly. Figures are for tax year 2026.

In this chapter

  1. Equity compensation: NQSOs, ISOs and §83(b)
  2. The alternative minimum tax and how to manage it
  3. Imputed interest and foreign earned income
  4. The kiddie tax and the parents' election
  5. Timing income and deductions when rates or laws change
  6. Flexible spending accounts and health savings accounts
  7. Itemizing, the standard deduction and bunching
  8. Estimated tax payments
  9. Donating noncash property to charity
  10. Medicare taxes and the year-end projection

This chapter has 10 lessons, 50 practice MCQs with explanations and 20 simulations, plus flashcards and a recall sheet.

What this chapter covers

Chapter 1 is free to read in full. Here are its lessons.

Equity compensation: NQSOs, ISOs and §83(b)

Equity pay ties an employee's reward to the company's value. The tax law treats the main forms very differently, so an adviser's first question is always: which kind is it?

A nonqualified stock option (NQSO) produces wages equal to the spread (value less exercise price) when exercised; the employee's basis is the value at exercise. An incentive stock option (ISO) produces no regular income at grant or exercise, but the spread is an AMT adjustment in the year of exercise.

ISO shares sold more than 2 years after grant and 1 year after exercise give long-term capital gain on the whole growth. A sale earlier is a disqualifying disposition: the spread at exercise (or the actual gain, if less) becomes wages.

Restricted stock is taxed at vesting under §83, unless the employee elects under §83(b) within 30 days of the transfer to include its value now. Growth after an §83(b) election is capital gain; a later forfeiture gives no deduction for the amount included.

Example. A worker exercises NQSOs with a $12,000 spread. Her W-2 includes $12,000, subject to income tax withholding and FICA, and her basis in the shares rises to their value.

Step up. Mei exercises 1,000 ISOs at $20 when the stock trades at $50 and sells in a qualifying disposition (more than 2 years after grant and 1 year after exercise) at $65. Regular tax: $45,000 long-term capital gain ($65,000 - $20,000). AMT in the exercise year: a $30,000 positive adjustment.

Exam level. Mei also holds 2,000 restricted shares worth $5 each at grant, vesting in 3 years. With a §83(b) election filed within 30 days she reports $10,000 of wages now, nothing at vesting, and if the shares are worth $40 when she sells after vesting, a $70,000 long-term gain. Without the election she reports $80,000 of wages at vesting (2,000 x $40). The election trades a small amount of ordinary income now for capital gain treatment on the growth, but if she forfeits the shares, the $10,000 she reported is not deductible.

Watch out. Examiners include the ISO spread in regular taxable income at exercise. It is an AMT adjustment only, unless the shares are sold in a disqualifying disposition.

The alternative minimum tax and how to manage it

The AMT is a second tax computation with fewer deductions and two rates. A taxpayer pays the AMT only when the tentative minimum tax exceeds regular tax.

AMTI starts from taxable income and adds back items such as state and local taxes, the standard deduction (for non-itemizers), the ISO spread, private activity bond interest and differences in depreciation. The 2026 exemption is $140,200 joint ($90,100 unmarried), reduced by 50% of AMTI above $1,000,000 ($500,000 unmarried).

AMT caused by deferral items (ISOs, depreciation) creates a minimum tax credit that carries forward and offsets regular tax in later years when regular tax exceeds TMT. AMT from exclusion items (SALT, the standard deduction) creates no credit.

Planning means finding the AMT 'room' each year, the gap between regular tax and TMT, and using it with ISO exercises or other items.

Example. A single taxpayer with $150,000 of taxable income, no AMT adjustments and the standard deduction has AMTI of $166,100 ($150,000 + $16,100). After the $90,100 exemption, TMT is 26% x $76,000 = $19,760, well below regular tax.

Step up. AMTI = $400,000 + $40,000 + $150,000 = $590,000. Base = $590,000 - $140,200 = $449,800. TMT = $63,570 + 28% x $205,300 = $121,054. AMT = $121,054 - $81,196 = $39,858.

Exam level. How much ISO spread could Mei take with no AMT? Regular tax is $81,196, so the TMT must not exceed it: $63,570 covers the first $244,500 of base; the remaining $17,626 at 28% covers $62,950 more. Maximum base $307,450, so maximum AMTI $447,650. Since $440,000 is already there from income and the SALT add-back, she has only $7,650 of ISO room. The SALT add-back uses most of the room, a point clients rarely expect. The $39,858 of AMT from the full exercise becomes a minimum tax credit usable against regular tax in later years when regular tax exceeds TMT.

Watch out. Examiners give an AMT credit for AMT caused by state and local taxes. Only deferral items such as the ISO spread create a minimum tax credit.

Imputed interest and foreign earned income

Some income is real for tax even when no cash changes hands. Below-market loans and work abroad are two items the Blueprint names.

Under §7872, a loan at less than the applicable federal rate is treated as if the lender charged AFR interest and gave the forgone interest back. For a gift loan, that is a gift; for an employer loan, compensation; for a corporation-shareholder loan, a dividend (chapter 18 goes further).

Gift loans of $10,000 or less are ignored. Gift loans up to $100,000 impute interest only up to the borrower's net investment income, and not at all if that is $1,000 or less.

A U.S. citizen or resident working abroad may exclude up to $132,900 of foreign earned income for 2026 under §911, if her tax home is abroad and she is a bona fide resident or present abroad 330 days. Income not excluded is taxed at the higher rates that would apply if the excluded income were included.

Example. A parent lends a child $8,000 interest-free to buy a car. The loan is under $10,000 and not used for income-producing assets, so no interest is imputed.

Step up. Daniel's $150,000 gift loan, AFR 4% (given): forgone interest = 4% x $150,000 = $6,000. Daniel has $6,000 of interest income and is treated as giving his sister $6,000, within the annual exclusion; she has an interest payment she may deduct only if it qualifies, for example as home mortgage interest on a secured loan.

Exam level. If the loan were $90,000 and the sister's net investment income were $800, imputed interest would be $0: the loan is under $100,000 and her NII does not exceed $1,000. For Mei's London year with $180,000 of salary, the exclusion removes $132,900; the other $47,100 is taxed starting in the bracket where $180,000 of income would put it, not at 10%. Mei may instead claim the foreign tax credit on all of it if UK tax is higher; she cannot claim a credit for tax on excluded income.

Watch out. Examiners impute interest on a $90,000 gift loan when the borrower's investment income is under $1,000. Below $100,000 the imputed amount is limited to NII, and zero when NII is $1,000 or less.

The kiddie tax and the parents' election

The kiddie tax stops parents from shifting investment income to children in low brackets. The Blueprint asks you to calculate it.

A child's net unearned income, unearned income above $2,700 for 2026, is taxed at the parents' marginal rate on Form 8615. The first $1,350 is covered by the child's standard deduction and the next $1,350 is taxed at the child's own rate.

Parents may instead elect on Form 8814 to include a young child's interest and dividends in their own return, if the child's income is only interest and dividends and is less than $13,500. The election saves a return but raises the parents' AGI.

Earned income is never subject to the kiddie tax, and children with earned income above half their support at 18 or as students fall outside it.

Example. A 16-year-old with $2,500 of interest and no other income owes no kiddie tax: unearned income does not exceed $2,700.

Step up. The Chens' son Ethan, 15, has $9,000 of interest and nonqualified dividends and no earned income. Taxable income $9,000 - $1,350 = $7,650. Net unearned income $9,000 - $2,700 = $6,300 at the parents' 32% rate = $2,016; the other $1,350 at 10% = $135. Ethan's tax is $2,151.

Exam level. If the Chens elect on Form 8814 instead, they add $9,000 - $2,700 = $6,300 to their own income and pay 10% x $1,350 = $135 extra, for the same total tax. But their AGI rises by $6,300, which increases their NIIT by 3.8% x $6,300 = $239 (their MAGI is already over $250,000) and can cut AGI-based items. Filing Form 8615 for Ethan is the better choice here, and it keeps his income off their return.

Watch out. Examiners treat the Form 8814 election as always neutral. It can increase the parents' NIIT and reduce AGI-based benefits.

Timing income and deductions when rates or laws change

When a taxpayer knows rates will change, the year in which income and deductions land matters. The Blueprint asks you to consider the effect of changing rates and legislation on timing.

The basic rule: put income in the lower-rate year and deductions in the higher-rate year. Rate changes come from the taxpayer's own situation (a promotion, retirement, a business sale) or from legislation.

Cash-basis taxpayers control timing by when they receive and pay, subject to constructive receipt (income set aside and available is taxed now) and rules that deny deductions for prepayments beyond 12 months.

Legislation creates deadlines too. OBBBA made many rules permanent from 2026 but left the deductions for tips, overtime, car loan interest and seniors to end after 2028, and added a 0.5% floor on itemizers' charitable gifts from 2026.

Example. A retiree expects to drop from the 32% bracket to the 22% bracket next year. She defers a $15,000 IRA distribution to next year, saving 10% x $15,000 = $1,500.

Step up. Taking the $20,000 bonus in December at 24% instead of January at 35% saves (35% - 24%) x $20,000 = $2,200.

Exam level. The Chens also plan $10,000 of deductible expenses. Paid in December they save 24% x $10,000 = $2,400; paid in January, 35% x $10,000 = $3,500. Deferring saves $1,100 more, so the total benefit of moving both items is $3,300, before considering the time value of money. Constructive receipt limits the trick: Mei cannot defer a bonus that is already credited and available to her. A Roth conversion in the lower-rate year is another way to use the low bracket.

Watch out. Examiners let a taxpayer defer a bonus that was credited to her account and available in December. Constructive receipt taxes it when available.

Flexible spending accounts and health savings accounts

Tax-favored accounts let employees pay predictable medical and care costs with pre-tax dollars. The Blueprint asks you to identify the projected tax savings.

A health savings account requires coverage under a high-deductible health plan. Contributions are deductible (or excluded through payroll), growth is tax-free and withdrawals for medical costs are tax-free. Unused funds roll over indefinitely.

A flexible spending account is funded by salary reduction under a cafeteria plan. Health FSA amounts must generally be used within the year, with a limited carryover or grace period. The dependent care FSA limit is $7,500 from 2026 under OBBBA.

Through payroll, both save income tax and the employee's 7.65% FICA. The same expenses cannot also produce a credit or itemized deduction.

Example. A single employee with self-only HDHP coverage contributes $4,400 to her HSA through payroll at a 29.65% combined rate (22% + 7.65%), saving $1,305.

Step up. Rafael, 56, family HDHP, combined marginal rate 31.65% (24% income tax + 7.65% FICA). He contributes $8,750 + $1,000 = $9,750 to his HSA through payroll: saving 31.65% x $9,750 = $3,086.

Exam level. He also sets aside $7,500 in the dependent care FSA for day care: saving 31.65% x $7,500 = $2,374. The dependent care credit cannot be claimed on the same expenses, and at his income the credit rate (20% under the IRS table) would save only 20% x $6,000 = $1,200 for his two children, so the FSA wins. If he contributed to the HSA outside payroll, he would deduct it for AGI but lose the FICA saving: 24% x $9,750 = $2,340 instead of $3,086.

Watch out. Examiners let a taxpayer claim the dependent care credit on expenses already paid from a dependent care FSA, or let an HSA be funded without HDHP coverage. Neither is allowed.

Itemizing, the standard deduction and bunching

Taxpayers deduct the larger of the standard deduction or itemized deductions each year. When the two are close, the standard deduction is wasted in some years.

Bunching moves deductible payments that the taxpayer controls, such as charitable gifts and sometimes property taxes or elective medical costs, into alternate years, so one year is well above the standard deduction and the other uses it.

A donor-advised fund makes bunching easy for charity: the deduction comes when the fund is funded; grants to charities can follow over several years.

From 2026, OBBBA added a 0.5%-of-AGI floor for itemizers' charitable gifts, a $1,000/$2,000 deduction for non-itemizers' cash gifts to public charities, and a cap so that itemized deductions save at most 35% for taxpayers in the 37% bracket.

Example. A single taxpayer has $15,000 of itemized deductions every year, below the $16,100 standard deduction. By bunching two years of $6,000 gifts into one year, she itemizes $21,000 in that year and takes the standard deduction in the other.

Step up. Bunching adds $73,200 - $66,000 = $7,200 of deductions over two years. At 24%, that saves $1,728.

Exam level. Bunching works best when itemized deductions hover near the standard deduction. With a donor-advised fund, the Chens deduct the $16,000 in year 1 when they fund it, even though the fund grants $8,000 to charities in each year. Since 2026 the 0.5% floor applies each year an itemizer gives, so bunching also saves a second floor: in the usual plan the floor costs $1,000 a year, $2,000 over two years; bunched, $1,000 once. Non-itemizers instead get a deduction of up to $2,000 (joint) for cash gifts to public charities in the standard deduction year, but not for gifts to donor-advised funds.

Watch out. Examiners allow the non-itemizer charitable deduction for a gift to a donor-advised fund. It applies only to cash gifts to qualifying public charities, not DAFs or private foundations.

Estimated tax payments

The tax system is pay-as-you-go. Taxpayers with income not covered by withholding make quarterly estimates, and the penalty is interest-like, charged on each late installment.

No penalty applies if the tax shown, less withholding and credits, is under $1,000. Otherwise payments must reach the required annual payment: the lesser of 90% of this year's tax or 100% of last year's tax (110% if last year's AGI exceeded $150,000).

Withholding is treated as paid evenly throughout the year, whenever it was actually withheld, unless the taxpayer elects actual dates. Estimates count on the dates paid.

When income arrives late in the year, the annualized income installment method lets early installments be based on income earned to date, computed on Form 2210 Schedule AI.

Example. A taxpayer whose 2025 AGI was $120,000 and tax $18,000 expects $30,000 of tax for 2026. Her required annual payment is the lesser of $27,000 or $18,000: $18,000, or $4,500 a quarter.

Step up. Chens: 2025 tax $40,000, 2025 AGI $210,000; 2026 tax projected $60,000. Required annual payment = lesser of 90% x $60,000 = $54,000 or 110% x $40,000 = $44,000. Daniel's withholding is $20,000, so estimates must cover $24,000: $6,000 a quarter.

Exam level. They forgot the April and June payments. Two fixes: pay larger September and January installments (penalty still runs on the missed ones), or have Mei raise her withholding by $12,000 in December. Withholding is treated as paid evenly through the year (unless they elect otherwise), so it covers the earlier quarters and removes the penalty. If Mei's stock sale had been in November instead, the annualized income method would let the early installments be based on the lower income actually earned by those dates.

Watch out. Examiners use 100% of last year's tax for a high-income taxpayer, or treat December withholding as paid in December. Over $150,000 of prior-year AGI means 110%, and withholding counts evenly through the year.

Donating noncash property to charity

Charitable gifts of property can save more tax than gifts of cash, but only if the right property is chosen. The Blueprint asks you to calculate the savings and identify the best property.

Long-term capital gain property (held over one year) given to a public charity is deducted at fair value, limited to 30% of AGI, and the built-in gain is never taxed.

Ordinary income property, including short-term capital assets and inventory, is deducted at basis. Tangible personal property the charity does not use in its exempt purpose is also limited to basis.

Loss property should be sold and the cash donated: the donor deducts the cash and keeps the capital loss. Excess contributions carry forward 5 years.

Example. A donor gives a painting worth $30,000 (basis $8,000, held 10 years) to a hospital that will sell it. Because the use is unrelated, the deduction is limited to $8,000.

Step up. Donating shares A saves income tax on the $50,000 deduction at 35% = $17,500, plus the tax she would have paid on the $40,000 gain if she sold first: 15% + 3.8% NIIT = 18.8% x $40,000 = $7,520. Total benefit $25,020.

Exam level. Donating shares B gives only a $40,000 deduction ($14,000 of tax saved), because short-term property is deducted at basis. Donating shares C gives a $50,000 deduction but wastes a $20,000 capital loss; selling C and giving cash keeps the $50,000 deduction and a $20,000 loss that offsets other gains. The 30% limit for appreciated stock is 30% x $400,000 = $120,000, so the full $50,000 is deductible this year. For gifts of property over $5,000 other than publicly traded stock, a qualified appraisal and Form 8283 Section B are required.

Watch out. Examiners deduct short-term stock at fair value, or let a donor deduct the loss on donated loss property. Short-term property is limited to basis, and the loss on donated property is never deducted.

Medicare taxes and the year-end projection

Two Medicare taxes reach high-income households: the 3.8% net investment income tax and the 0.9% additional Medicare tax on wages and self-employment income. Their thresholds ($200,000 single, $250,000 joint) are not indexed.

NIIT applies to the lesser of net investment income or MAGI over the threshold. Planning reduces NII (tax-exempt bonds, loss harvesting, giving appreciated property, installment sales, becoming nonpassive in a business) or MAGI (retirement contributions, timing).

The additional Medicare tax is withheld only on an employee's wages over $200,000 from one employer, whatever the filing status. Two-earner couples often owe more with the return.

A year-end projection reviews these with the AMT room, estimated payments and charitable plans, and lists options before December 31, which is the Blueprint's analysis task.

Example. A single taxpayer has $180,000 of wages and $40,000 of dividends. MAGI $220,000 exceeds $200,000 by $20,000, so NIIT is 3.8% x $20,000 = $760.

Step up. Additional Medicare: 0.9% x ($350,000 - $250,000) = $900; Mei's employer withheld 0.9% x $60,000 = $540, so $360 is due with the return. NIIT: 3.8% x $60,000 = $2,280.

Exam level. Year-end options: selling stock with $20,000 of losses cuts NII to $40,000 and NIIT by $760; moving $200,000 of taxable bonds paying 5% into municipal bonds removes $10,000 of NII (saving $380 of NIIT plus regular tax at 35%, $3,500, less the lower muni yield); giving appreciated shares to charity avoids the NIIT on that gain. Wages bear the additional Medicare tax whatever they do, so the only fix there is adjusting withholding. A rental owner could avoid NIIT on rents by qualifying as a real estate professional who materially participates (chapter 2).

Watch out. Examiners assume the employer withheld the full additional Medicare tax for a couple, or include wages in net investment income. Employers withhold only above $200,000 per employee, and wages are never NII.

Chapter 2: Passive activity and at-risk limits