Question

Izzy ran into a cash shortfall and had to cash in a certificate of deposit early. She incurred a $50 penalty for early withdrawal. How should Izzy treat the penalty for tax purposes?

A) Izzy can deduct the $50 as an investment expense from AGI (if she is able to itemize deductions).
B) Izzy can NOT deduct the $50 penalty because penalties are against public policy.
C) Izzy can deduct the $50 as a "for" AGI deduction.
D) Izzy can deduct the $50 from any interest income reported for tax purposes.

Answer 1

Izzy can deduct the $50 penalty from any interest income for tax purposes, allowing her to lower her reported gross income and potentially her tax liability.

Step-by-step explanation:

Izzy can treat the $50 penalty for early withdrawal of her certificate of deposit as a deduction from gross income for tax purposes. Specifically, under IRS rules, a penalty for early withdrawal of savings is deductible from gross income. This kind of deduction is known as an adjustment to income, or more commonly, an "above-the-line" deduction, and can be taken regardless of whether the taxpayer itemizes deductions.

Therefore, the correct treatment for Izzy's situation is:

• Option D: Izzy can deduct the $50 penalty from any interest income reported for tax purposes.

This means that the penalty reduces the amount of interest income that Izzy has to include in her gross income, thereby potentially lowering her taxable income and tax liability.