CFP® Tax Planning Domain: High-Yield Topics You Must Know

Tax planning is consistently one of the highest-weighted domains on the CFP® exam, accounting for roughly 14–17% of questions depending on the exam year. The tested material spans individual income taxation, investment-related tax strategies, charitable planning vehicles, and Social Security benefit taxation. Candidates who lack fluency here leave significant points on the table.

Marginal vs. Effective Tax Rate

This distinction appears in calculations and in conceptual questions throughout the tax domain.

Marginal tax rate is the rate applied to the next dollar of taxable income — the rate at the top bracket the taxpayer occupies. It is the relevant rate for decisions at the margin: whether to do a Roth conversion, whether to take additional income, or whether a deduction provides more value than its face amount suggests.

Effective tax rate is total tax paid divided by total gross income (or adjusted gross income, depending on the context). It is a blended average rate and is always lower than the marginal rate for taxpayers with income in multiple brackets.

CFP® exam scenarios often require candidates to determine which rate is relevant to a planning decision. Use the marginal rate when analyzing the tax impact of an incremental change. Use the effective rate when discussing the overall tax burden.

Qualified Dividends vs. Ordinary Income

Qualified dividends are taxed at the preferential long-term capital gains rates (0%, 15%, or 20% depending on taxable income), rather than at ordinary income rates. To qualify, dividends must be paid by a U.S. corporation or qualifying foreign corporation, and the shareholder must meet the holding period requirement (more than 60 days during the 121-day period surrounding the ex-dividend date).

Ordinary dividends — those that do not meet these requirements — are taxed at the investor's marginal ordinary income rate. The exam tests whether a candidate can identify which tax treatment applies given specific holding period or source information.

Tax-Loss Harvesting

Tax-loss harvesting involves selling securities at a loss to offset capital gains recognized elsewhere in the portfolio. Key rules:

Short-term losses offset short-term gains first; long-term losses offset long-term gains first
Excess losses can offset the other type of gain
Up to $3,000 in net capital losses can offset ordinary income annually; excess losses carry forward indefinitely
The wash-sale rule (IRC §1091) disallows a loss if the taxpayer purchases a substantially identical security within 30 days before or after the sale

The wash-sale rule is one of the most tested tax-loss harvesting complications. Candidates must identify when it applies and what the consequence is — the disallowed loss is added to the basis of the replacement shares, deferring rather than eliminating the loss.

Net Investment Income Tax (NIIT)

The 3.8% Net Investment Income Tax applies to the lesser of (1) net investment income or (2) the amount by which modified adjusted gross income (MAGI) exceeds the applicable threshold ($200,000 for single filers, $250,000 for married filing jointly, not indexed for inflation).

Net investment income includes interest, dividends, capital gains, rents, royalties, and passive activity income. It does not include wages, active business income, or distributions from retirement accounts.

The NIIT is an additional layer — it does not replace the regular capital gains or ordinary income tax. High-income clients may face a 23.8% effective rate on long-term capital gains (20% + 3.8%) and a 40.8% rate on short-term gains and ordinary investment income (37% + 3.8%).

Charitable Planning Strategies

Four charitable vehicles appear with regularity on the CFP® exam:

Donor-Advised Funds (DAFs) allow donors to make an irrevocable contribution, take an immediate deduction, and recommend grants to qualified charities over time. The deduction is taken in the year of contribution — not when grants are made. Appreciated securities contributed to a DAF avoid capital gains tax on the appreciation.

Charitable Remainder Trusts (CRTs) pay an income stream to the donor (or named beneficiary) for life or a term of years, with the remainder passing to charity. The donor receives a partial charitable deduction in the year of contribution. CRTs are split-interest trusts — the IRS requires the remainder interest to have a present value of at least 10% of the initial contribution.

Charitable Lead Trusts (CLTs) work in reverse — the charity receives income for a period, and the remainder passes to heirs. CLTs are primarily an estate planning tool, reducing the value of the taxable estate by the present value of the charitable lead interest.

Qualified Charitable Distributions (QCDs) allow IRA owners age 70½ or older to transfer up to $105,000 per year (2024 indexed limit) directly from a traditional IRA to a qualified charity. QCDs satisfy RMD requirements and are excluded from gross income — making them more tax-efficient than taking the distribution and donating separately, particularly for taxpayers who take the standard deduction.

Up to 85% of Social Security benefits are includable in gross income depending on "combined income" (AGI + non-taxable interest + 50% of Social Security benefits). The thresholds are not indexed for inflation:

Below $25,000 (single) / $32,000 (MFJ): 0% of benefits included
$25,000–$34,000 (single) / $32,000–$44,000 (MFJ): up to 50% included
Above $34,000 (single) / $44,000 (MFJ): up to 85% included

These thresholds were set in 1984 and 1993 respectively and have not changed, meaning more retirees are subject to benefit taxation each year.

Roth Conversion Analysis and AMT

A Roth conversion involves transferring funds from a traditional IRA (or other pre-tax account) to a Roth IRA. The converted amount is included in gross income in the year of conversion. The key planning question is whether the client will be in a higher bracket in retirement than they are now.

The Alternative Minimum Tax (AMT) is a parallel tax system that disallows certain deductions and adds back certain preference items. AMT is most commonly triggered by large miscellaneous deductions, ISO stock option exercises, or high state and local tax deductions. The AMT exemption phases out at higher income levels. CFP® candidates should know which items are preference items and understand that a Roth conversion that pushes a client into AMT can negate the conversion's benefit.

Drill CFP® tax planning questions with detailed answer explanations at advisorexams.com/exams/cfp.