Miguel and Sofia Arroyo are married and live at 13071 Sterling Drive, Marquette, MI 49866. Miguel is a self-employed insurance claims adjuster (business activity code 524290), and Sofia is the dietitian for the local school district. They choose to file a joint tax return each year.
Problem 1: Miguel and Sofia Arroyo are married and live at 13071 Sterling Drive, Marquette, MI 49866. Miguel is a self-employed insurance claims adjuster (business activity code 524290), and Sofia is the dietitian for the local school district. They choose to file a joint tax return each year. 1. Miguel represents several national casualty insurance companies on a contract basis. He operates this business on the cash basis. He is paid a retainer and receives additional compensation if the claims he processes for the year exceed a specified number. During 2020, Miguel received $84,800 in payment for services rendered as reported on Forms 1099-MISC issued by several payor insurance companies. As an independent contractor, he is responsible for whatever expenses he incurs. Miguel works out of an office near his home. The office is located at 1202 Moose Road. He shares Suite 326 with a financial consultant, and operating expenses are divided equally between them. The suite has a common waiting room with a receptionist furnished and paid by the landlord. Miguel paid his one-half share of the 2020 expenses as detailed below. Office rent $11,600 Utilities (includes telephone and fax) 4,300 Replacement of waiting room furniture on April 22 3,600 Renters’ insurance (covers personal liability, casualty, theft) 1,400 Office expense (supplies, postage) 740 Toshiba copier (purchased new on February 7) 300 Waiting room coffee service (catered) 280 Waiting room magazine subscriptions 90 For his own business use, Miguel purchased a $2,100 laptop computer on June 17 and a $1,200 Nikon camera on February 5. Except for his vehicle (see item 2 below), Miguel uses the § 179 write-off option whenever possible. Miguel has no expenditures for which he is required to file Form 1099s. 2. On January 2, 2020, Miguel paid $31,000 (including sales tax) to purchase a gently used Toyota Camry that he uses 92% of the time for business. No trade-in was involved in this purchase, and he did not claim any § 179 expensing. Miguel uses the actual operating cost method to compute his tax deduction. He elects to use the 200% declining-balance MACRS depreciation method with a half-year convention. His expenses relating to the Camry for 2020 are as follows: Gasoline $3,500 Auto insurance 1,700 Interest on car loan 820 Auto club dues 325 Oil changes and lubrication 210 License and registration 190 In connection with his business use of the Camry, Miguel paid $510 for tolls and $350 in fines for traffic violations. In 2020, Miguel drove the Camry 14,352 miles for business and 1,248 miles for personal use (which includes his daily, roundtrip commute to work). 3. Miguel handles most claim applications locally, but on occasion he must travel out of town. Expenses in connection with these business trips during 2020 were $930 for lodging and $1,140 for meals. He also paid $610 for business dinners he had with several visiting executives of insurance companies with whom he does business. Miguel’s other business-related expenses for 2020 are listed below. Contribution to H.R. 10 (Keogh) retirement plan $8,000 Premiums on medical insurance covering self and family (spouse and children) 4,600 Premiums on disability insurance policy (pays for loss of income in the event Miguel is disabled and cannot work) 2,400 State and local occupation fee 450 Birthday gift for receptionist ($25 box of Godiva chocolates plus $3 for gift wrap) 28 4. Sofia earns $32,000 working as a registered dietitian for the Marquette Public School District. The job she holds as manager of the school lunch program is not classified as full time. Consequently, she is not eligible to participate in the teacher retirement or health insurance programs. Sofia’s expenses for 2020 are summarized as follows: Contribution to traditional IRA $6,000 Job hunting expense 720 Continuing education program 350 Membership dues to the National Association of Dietitians 120 Subscription to Nutrition Today 90 To work full time and earn a larger salary, Sofia applied for a position as chief dietitian for a chain of nursing homes. According to the director of the recruiting service she hired, the position has not yet been filled, and Sofia is one of the leading candidates. The continuing education program was sponsored by the National Association of Dietitians and consisted of a one-day seminar on special diets for seniors. Sofia drove the family Chevrolet Malibu 930 miles on job-related use and 5,200 miles in commuting to work, out of a total of 8,670 miles driven for the year. The Arroyos purchased the car on July 11, 2018, for $23,400. 5. The Arroyos have supported Raul Chavez (Sofia’s widowed father) for several years, appropriately claiming him as a dependent for tax purposes. On December 27, 2019, Raul suffered a massive stroke. The doctors did everything they could, but Raul died in the intensive care unit of Riverwood Hospital on January 8, 2020. In January and February of 2020, the Arroyos paid the following bills on behalf of Raul: medical expenses of $11,800 not covered by Medicare ($6,000 incurred in 2019 and $5,800 in 2020) and funeral expenses of $15,300. Raul’s health insurance was limited to his Medicare coverage because the Arroyos’ medical insurance (see item 3 above) only covered Miguel, Sofia, and their sons. In his will, Raul named Sofia the executor and sole heir of his estate. 6. One of the assets that Sofia inherited with the transfer of Raul’s estate was his house. Upon the advice of the financial consultant who shares office space with Miguel, the Arroyos decided to convert Raul’s home into a furnished rental house. After several minor repairs (e.g., touching up the paint on the interior walls, replacing various window screens, pressure washing the brick exterior, etc.), the property was advertised for rent in the classified section of the local newspaper on March 1, 2020. The repairs cost $720, and the newspaper ad was $360. Based on reconstructed records and appraisal estimates, information about the property is as follows: Original Cost FMV, Jan. 8, 2020 House $40,000 $220,000 Land 10,000 50,000 Furniture and appliances 21,000 14,000 7. Raul’s former residence was rented almost immediately, with occupancy commencing April 1, 2020, under the following terms: one-year lease, $2,400 per month due the first day of the month, first and last months’ rent in advance, $2,000 damage deposit, lawn care included but not utilities. The tenant complied with all terms except that she didn’t pay the December rent until January 1, 2021, because she was traveling internationally from Thanksgiving Day through New Year’s Eve. Expenses in connection with the property were as follows: property taxes, $2,600; repairs, $320; lawn maintenance, $540; insurance, $1,800; and street paving assessment, $2,100. The property is located at 12120 Lake Road, Harvey, MI 49855. 8. In early December 2019, a friend advised Miguel to buy stock in Pioneer Aviation Inc. (PAI). At that time, PAI was in serious financial straits and was headed toward bankruptcy. Nevertheless, according to Miguel’s friend, the value of the corporation’s underlying assets was such that the shareholders were bound to recover considerably more than the current market price of $0.50 per share. Excited at the chance for a “sure” profit, on December 15, 2019, Miguel purchased 20,000 shares for $10,000. In September 2020, the trustee in bankruptcy announced that the stock was worthless and that even some of PAI’s preferred creditors would not be paid. 9. On June 14, 2020, the Arroyos sold 500 shares of Garnet Corporation stock for $17,500 ($35 per share). They owned 1,200 shares, acquired as follows: 500 shares on November 5, 2019, for $25 per share and 700 shares on April 5, 2020, for $30 per share. The Arroyos did not instruct their broker as to which shares to sell, so Form 1099-B for this sale reported a $12,500 basis for these shares. 10. One month before she died on April 14, 2010, Maria Chavez (Sofia’s mother) gave Sofia a coin collection. Based on careful records that Maria kept, the collection had a cost basis of $9,000 and a fair market value of $18,000 at the time Maria passed away. On February 12, 2020, the Arroyo residence was burglarized, and the coin collection was stolen. The Arroyos filed a claim with the carrier of their homeowner’s insurance policy for $24,000 (the current value of the collection). Unfortunately, they were only able to collect $10,000, which was the maximum payout allowed for valuables (e.g., jewelry, antiques) without a special rider attached to the insurance policy. 11. In her will, Maria Chavez (see item 10) left Sofia a vacant lot on Wright Street. Maria had paid $15,000 for the property, and it had a value of $19,000 when she died. Maria had purchased the lot because it was adjacent to Northern Michigan University property and she expected the school to eventually expand the campus. By 2020, it has become clear that the university did not have the funds to expand the campus. Consequently, on July 1, 2020, Sofia sold the lot for $19,000. Not included in this price are unpaid property taxes (and interest on the unpaid taxes) of $700 on the lot, which the purchaser assumed and later paid. Sofia received a Form 1099-B as documentation for this transaction which did not report the basis of this property. 12. Every year around Christmas, Miguel receives cards from various car repair facilities and car dealerships that express thanks for his business referrals during the year. Many of these cards include cash. Miguel has no arrangement, contractual or otherwise, that requires any compensation for the referrals he makes. Concerned about the legality of such “gifts,” Miguel consulted an attorney about the matter a few years ago. Without passing judgment on the status of the payors, the attorney found that Miguel’s acceptance of the payments does not violate state or local law. Miguel sincerely believes that the payments he receives have no effect on the referrals he makes. During December 2020, Miguel received cards containing $7,200. One additional card containing $900 was delayed in the mail, and Miguel did not receive it until January 4, 2021. 13. During a sunny weekend in June, the Arroyos held a garage sale to dispose of unwanted furniture, appliances, books, bicycles, clothes, and one boat (including trailer). Proceeds from the sale totaled $9,200. The estimated basis of the items sold is $25,500. All sold assets had been used by the Arroyos for personal purposes. 14. In addition to the receipts previously noted, the Arroyos received the