Individual taxation is one of the highest-weighted topics on the REG section of the CPA exam, and for good reason. The tax rules that apply to individuals form the foundation of the entire Internal Revenue Code, and nearly every other area of tax law, from partnerships to corporations, connects back to individual taxation at some point. If you can master the core concepts of individual tax, you will have a solid base for understanding the rest of the REG section.
This study guide covers the essential individual tax topics tested on the CPA exam, including filing status, gross income inclusions and exclusions, above-the-line and below-the-line deductions, tax credits, and the alternative minimum tax. Use this as a roadmap for your REG preparation.
Filing Status
Filing status determines the tax rate schedule, the standard deduction amount, and eligibility for certain credits and deductions. The five filing statuses are:
- Single - Unmarried individuals who do not qualify for another status.
- Married Filing Jointly (MFJ) - Married couples who elect to file a combined return. Generally produces the lowest tax liability for married couples.
- Married Filing Separately (MFS) - Married couples who elect to file separate returns. This status often results in a higher combined tax and limits certain deductions and credits.
- Head of Household (HOH) - Unmarried individuals who maintain a household for a qualifying person. Provides a more favorable tax rate and higher standard deduction than single status.
- Qualifying Surviving Spouse - Available for two years following the year of a spouse's death if the taxpayer maintains a household for a dependent child.
Exam tip: Head of household is a frequently tested status. To qualify, the taxpayer must be unmarried at the end of the year, pay more than half the cost of maintaining a home, and have a qualifying person live in the home for more than half the year. Parents are an exception and do not need to live with the taxpayer.
Gross Income: What Is Included
Gross income includes all income from whatever source derived, unless specifically excluded by the Code. Common inclusions tested on the exam include:
- Wages, salaries, tips, and bonuses
- Interest income (taxable and tax-exempt must be distinguished)
- Dividend income (qualified dividends receive preferential rates)
- Business income (Schedule C)
- Capital gains
- Rental income
- Alimony received (for divorce agreements executed before 2019)
- Unemployment compensation
- Social Security benefits (may be partially taxable based on income thresholds)
- Gambling winnings
- Cancellation of debt income (with important exceptions)
- Prizes and awards
Gross Income: Common Exclusions
Certain items are specifically excluded from gross income. The exam tests your ability to distinguish inclusions from exclusions:
- Gifts and inheritances (excluded from the recipient's income)
- Life insurance proceeds (generally excluded)
- Municipal bond interest (tax-exempt at the federal level)
- Qualified scholarships (for tuition and required fees)
- Workers' compensation benefits
- Child support payments received
- Employer-provided health insurance premiums
- Foreign earned income exclusion (up to the annual threshold for qualifying taxpayers)
- Gain on sale of a principal residence (up to $250,000 single / $500,000 MFJ if ownership and use tests are met)
Exam tip: The distinction between alimony and child support is a classic exam topic. Alimony under pre-2019 agreements is included in the recipient's income and deductible by the payer. Child support is neither income to the recipient nor deductible by the payer. For agreements executed after December 31, 2018, alimony is not deductible by the payer and not included in the recipient's income.
Above-the-Line Deductions (Adjustments to Income)
Above-the-line deductions reduce gross income to arrive at adjusted gross income (AGI). These deductions are available regardless of whether the taxpayer itemizes. Key above-the-line deductions include:
- Educator expenses (up to $300)
- Health savings account (HSA) contributions
- Self-employment tax deduction (50% of self-employment tax)
- Self-employed health insurance premiums
- Penalty on early withdrawal of savings
- Alimony paid (pre-2019 agreements only)
- Traditional IRA contributions (subject to income limitations if the taxpayer or spouse is covered by an employer plan)
- Student loan interest deduction (up to $2,500, subject to income phaseouts)
- Qualified business income deduction (Section 199A) for certain pass-through income
Itemized Deductions vs. Standard Deduction
After calculating AGI, the taxpayer chooses between taking the standard deduction or itemizing deductions. The taxpayer should choose whichever is greater. The major categories of itemized deductions are:
Medical and Dental Expenses
Deductible to the extent they exceed 7.5% of AGI. Only unreimbursed expenses qualify.
State and Local Taxes (SALT)
Includes state and local income taxes (or sales taxes), property taxes, and sometimes foreign taxes. The total SALT deduction is capped at $10,000 ($5,000 for MFS).
Interest Expenses
Qualified residence interest on mortgage debt up to $750,000 ($375,000 MFS) is deductible. Investment interest is deductible up to net investment income.
Charitable Contributions
Cash contributions to public charities are generally deductible up to 60% of AGI. Capital gain property is generally limited to 30% of AGI. Different percentage limitations apply to private foundations.
Casualty and Theft Losses
After the Tax Cuts and Jobs Act, personal casualty losses are deductible only if attributable to a federally declared disaster. The loss must exceed $100 per event and the total must exceed 10% of AGI.
Tax Credits
Tax credits reduce tax liability dollar for dollar, making them more valuable than deductions. Key credits tested on the exam:
- Child Tax Credit - Up to $2,000 per qualifying child under age 17, with a refundable component.
- Child and Dependent Care Credit - Based on qualifying expenses for the care of a qualifying individual to allow the taxpayer to work.
- Earned Income Tax Credit (EITC) - A refundable credit for low-to-moderate income workers. The amount depends on filing status, number of qualifying children, and earned income.
- American Opportunity Tax Credit (AOTC) - Up to $2,500 per eligible student for the first four years of higher education. 40% is refundable.
- Lifetime Learning Credit - Up to $2,000 per return for qualified tuition and related expenses. Not refundable.
- Adoption Credit - For qualified adoption expenses.
- Saver's Credit - For contributions to qualified retirement plans by eligible low-income taxpayers.
Exam tip: Know the difference between refundable and nonrefundable credits. A refundable credit can reduce tax liability below zero, resulting in a refund. A nonrefundable credit can only reduce tax liability to zero.
Alternative Minimum Tax (AMT)
The AMT is a parallel tax system designed to ensure that high-income taxpayers pay at least a minimum amount of tax. The AMT calculation starts with taxable income, adds back certain tax preference items and adjustments, and then applies the AMT rates (26% and 28%) after subtracting the AMT exemption amount.
Common AMT adjustments and preferences include:
- State and local tax deduction (added back)
- Tax-exempt interest on private activity bonds (added back)
- Incentive stock option (ISO) exercise spread (adjustment)
- Excess depreciation (MACRS vs. ADS differences)
The AMT is less commonly triggered after the Tax Cuts and Jobs Act increased the exemption amounts, but it remains a testable topic. Know the concept and the major preference items.
Exam Focus Areas
Based on the REG blueprint, individual taxation questions tend to focus on the following areas:
- Determining filing status and dependency
- Calculating gross income with inclusions and exclusions
- Identifying above-the-line deductions
- Applying itemized deduction limitations
- Distinguishing refundable from nonrefundable credits
- Basic AMT concepts and preference items
- Capital gains and losses (covered in more detail in the property transactions article)
The REG section tests both knowledge and application. You need to know the rules, but you also need to apply them to realistic scenarios. Think CPA provides REG practice questions organized by topic, allowing you to focus your study time on individual tax until you are confident in each subtopic before moving on.