Individual Income Tax

REG loves to test this as an inclusion-vs.-exclusion sorting drill: you’re handed a list and asked the total includible, with wrong answers built from items that feel taxable. The “tell” is a §61 item disguised next to a statutory exclusion. Memorize the high-yield exclusions the exam hides: gifts and inheritances (§102), life-insurance proceeds paid by reason of death (§101), interest on most state/local (municipal) bonds (§103, but not nonqualified private-activity or arbitrage bonds), return of capital, and §104 damages for personal physical injury or sickness. Classic traps: punitive damages and non-physical emotional-distress awards are taxable; prizes, awards, gambling winnings, and forgiven debt (COD income) are generally includible; and unemployment compensation is fully taxable.

Don’t confuse the layers. Subtracting above-the-line items yields AGI; only then do standard or itemized deductions reach taxable income. Students wrongly net deductions into the gross figure or treat a credit (which cuts tax dollar-for-dollar, not income) as a subtraction here. Hook: “from whatever source derived” means taxable unless Congress says otherwise — when unsure, include it.

REG loves to bury AGI inside a multi-step calculation: the tell is a question that hands you gross income, a pile of adjustments (educator expenses, HSA contributions, the deductible half of SE tax, student-loan interest, traditional IRA), and then a phaseout or floor that secretly depends on AGI. The hinge is sequencing — you must reach AGI before applying the 7.5%-of-AGI medical floor or the AGI-based charitable ceilings (generally 60% cash / 30% appreciated property). Watch for MAGI: the student-loan-interest deduction and IRA phaseouts add back certain exclusions, so MAGI ≠ AGI, and the exam plants a distractor where you stop at plain AGI. (Note: investment-interest expense is capped by net investment income, not AGI — don’t be lured into an AGI percentage there.)

The classic trap is mixing categories: above-the-line adjustments (which produce AGI) are not the same as the itemized/standard deductions that come after AGI, and neither is a credit that cuts tax dollar-for-dollar. Hook: adjustments are “above the line,” AGI is the line, deductions live below it.

REG loves to test the sequencing of deductions, not just the totals. Expect a fact pattern listing several outlays and asking which lower AGI versus which sit “below the line.” The “tell” is that above-the-line deductions (educator expenses, HSA contributions, the deductible half of SE tax, student-loan interest) hit before AGI on Schedule 1, so they help everyone and shrink the AGI used in later phaseouts; itemized deductions land after AGI on Schedule A and only help if they exceed it. For 2025 that standard figure is $15,750 single / $31,500 MFJ (the 2025 OBBBA bumped it above the originally indexed $15,000 / $30,000 some banks still print).

The classic trap is treating a deduction like a credit: a deduction saves only your marginal rate times the amount, while a credit cuts tax dollar-for-dollar. Watch the AGI floors — medical expenses deductible only above 7.5% of AGI — and note the old 2%-floor miscellaneous deductions are now permanently repealed (TCJA suspended them through 2025; OBBBA made that permanent). Hook: above-the-line “adjustments” adjust AGI; itemized deductions only fight the standard deduction.

REG MCQs almost always hinge on refundable vs. nonrefundable: a nonrefundable credit can only zero out the tax, so the “tell” is a credit larger than the liability, and the answer caps the benefit at the tax and asks where the excess goes. Memorize the refundable short list—earned income credit, additional child tax credit (the refundable slice of the CTC), the American Opportunity credit (40% refundable, up to $1,000), and the premium tax credit—because everything else (foreign tax, lifetime learning, child/dependent care, general business credit) is nonrefundable. Watch the general business credit (GBC): under §39 it carries back 1 year, forward 20, and §38(c) limits it to net income tax minus the greater of tentative minimum tax or 25% of net regular tax liability above $25,000.

The classic trap is the examTip’s flip side—students treat a $1,000 credit and a $1,000 deduction as equal, but a deduction only saves tax at your marginal rate (e.g., $220 at 22%). Don’t confuse credits with the above-the-line deductions that build AGI or the standard/itemized choice below it; those shrink the base, while credits attack the computed tax at the very bottom of the return.

REG tests this as a build-the-1040 calculation: the tell is a fact pattern that forces the right ordering, because above-the-line (for-AGI) deductions lower AGI before AGI-based phaseouts and floors apply. Watch the standard vs. itemized choice, the 7.5%-of-AGI medical floor, the SALT cap (raised to $40,000 for 2025–2029 under the One Big Beautiful Bill Act, phasing down above ~$500k income and reverting to $10,000 in 2030 — some older banks still say a flat $10,000), and refundable vs. nonrefundable credits (only refundable ones, like the EITC or the refundable Child Tax Credit portion, can drive a refund below zero). The hinge is usually sequence and phaseout, not the headline number.

The classic trap is confusing this with gross income, the broad starting pool before exclusions and deductions; individual taxation is the full liability computation that follows. Don’t blur it with corporate taxation: a C corp pays a flat 21% entity rate with no standard deduction or filing status, then double taxes dividends. Memory hook: AGI is the gate every later limitation passes through.

REG loves a multi-step computation that hands you raw figures and forces you to assemble them in the right order: gross income minus above-the-line (for-AGI) deductions = AGI, then AGI minus the greater of the standard or itemized deductions, minus the QBI deduction = taxable income. (“Above-the-line,” “for-AGI,” and “adjustments to income” all name the same set.) The “tell” is a question giving you wages, interest, IRA contributions, and itemized data together; the answer hinges on slotting each item above or below the AGI line, because placement controls AGI-driven floors and phaseouts.

The classic trap is stopping one line too early or too late: candidates confuse AGI (a subtotal, before the standard/itemized choice and QBI) with taxable income, or subtract tax credits here. Remember that credits attack the tax, not the base — they come after rates are applied, never reducing taxable income itself. The QBI deduction — a 20% pass-through deduction OBBBA made permanent (it had been scheduled to expire after 2025) — is also frequently missed because it reduces taxable income yet is not an itemized deduction. Hook: G-A-T (Gross → AGI → Taxable) walks you down the return in order.

REG tests this as a build-up calculation: start with regular taxable income, add back preferences and adjustments (the classic tells are ISO bargain element on exercise, private-activity bond interest, and depreciation/percentage-depletion timing) to reach AMTI, subtract the AMT exemption (which phases out 50 cents per dollar of AMTI above the threshold from 2026, up from the 25-cent rate through 2025 that older banks still cite), then apply the 26%/28% rates to get tentative minimum tax. The number the answer hinges on is tentative minimum tax minus regular tax — only a positive difference is the AMT you actually add.

The classic trap is treating add-backs as permanent: timing/deferral items (ISOs, depreciation) create a basis difference and a minimum tax credit carried forward against future regular tax, while exclusion items (private-activity bond interest, the standard deduction) never reverse. Don’t confuse the standard deduction, an AMT add-back, with credits — and remember the higher exemptions are now permanent, so individual AMT rarely bites, while the reinstated corporate AMT (CAMT) hits billion-dollar firms.

REG questions almost always make you compute the required annual payment to dodge the §6654 underpayment penalty, which is the lesser of 90% of the current year’s tax or 100% of the prior year’s tax (the prior-year safe harbor jumps to 110% when prior-year AGI exceeds $150,000, or $75,000 if married filing separately). The “tell” is a high-income taxpayer with a spiking current-year liability: the answer hinges on the prior-year safe harbor because it caps exposure regardless of how large this year’s bill grows. Watch the $1,000 de minimis threshold (no penalty if the balance due after withholding and refundable credits is under $1,000) and remember withholding is treated as paid evenly across all four quarters (unless the taxpayer proves the actual dates), while estimates count when actually paid.

The classic trap is confusing the tax base with the payment mechanism: taxable income (after deductions) drives the amount of tax, while estimates govern the timing of paying it. Another trap—tax credits reduce the liability used in the 90%/100% calculation, so a generous credit can shrink or eliminate the required payment. Hook: “90 now or 100/110 then.”