Intuit Academy Tax Practice Exam

Can Taxpayer A and B reduce their adjusted gross income because of a $50 penalty paid for an early withdrawal of a certificate of deposit?

1. Yes, they can reduce their AGI

2. No, penalties cannot reduce AGI

3. Yes, but only for first-time withdrawals

4. No, unless claimed as a business expense

The correct answer is: Yes, they can reduce their AGI

In the context of tax regulations, taxpayers can indeed reduce their adjusted gross income (AGI) by considering certain penalties incurred during the tax year. Specifically, the penalty for early withdrawal of savings, such as a certificate of deposit, is considered an eligible adjustment that can lower AGI. This means that when Taxpayer A and B pay a $50 penalty for an early withdrawal, they can treat this penalty as an adjustment to their income. While penalties are often seen as expenses that simply detract from savings, tax laws allow the deduction of certain penalties, including those incurred from early withdrawal of deposits, directly from gross income. This adjustment reflects the understanding that such penalties can impact a taxpayer's overall financial situation, thereby influencing their taxable income calculations. In contrast, other options contain limitations or inaccuracies regarding the nature of penalties and their classification in tax reporting. For instance, penalties do not hinge on the status of withdrawals being first-time or on their categorization as business expenses. Therefore, the assertion that Taxpayer A and B can reduce their AGI by the amount of the penalty aligns with tax regulations that support this kind of adjustment for penalties incurred.