Intuit Academy Tax Practice Exam

Which type of income is subject to a preferential tax rate capped at 20%?

1. Long-term capital gains

2. Short-term capital gains

3. Ordinary income

4. Qualified dividends

The correct answer is: Long-term capital gains

Long-term capital gains are subject to a preferential tax rate, which is capped at 20%. This tax treatment is designed to encourage long-term investment by rewarding individuals who hold their investments for more than one year before selling them. The key distinction here is that long-term capital gains benefit from lower tax rates compared to ordinary income or short-term capital gains. While ordinary income, which includes wages and salaries, is taxed at the individual’s regular tax brackets that can go as high as 37%, short-term capital gains are taxed at the same rate as ordinary income since they pertain to assets held for one year or less. Qualified dividends also have favorable tax rates but typically fall under a different set of rules, where they can be taxed at 0%, 15%, or 20%, depending on the taxpayer's income level. However, for the specific context of the $20% cap, the focus is primarily on long-term capital gains, which confirms why this answer is appropriate.