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.

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 $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.

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: Gas $3,500, Auto insurance $1,700, Interest on car loan $820, Auto club dues $325, Oil changes $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).

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. Miguels 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

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. Sofias 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.

The Arroyos have supported Raul Chavez (Sofias 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. Rauls 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.

One of the assets that Sofia inherited with the transfer of Rauls estate was his house. Upon the advice of the financial consultant who shares office space with Miguel, the Arroyos decided to convert Rauls 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:

House original cost $40,000, FMV 1/8/20 $220,000, Land original cost $10,000 FMV $50,000, Furniture and appliances original cost $21,000, FMV $14,000.

Rauls 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 didnt pay the December rent until January 1, 2021, because she was traveling internationally from Thanksgiving Day through New Years 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.

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 Miguels friend, the value of the corporations 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 PAIs preferred creditors would not be paid.

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.

One month before she died on April 14, 2010, Maria Chavez (Sofias 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 homeowners 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.

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.

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 Miguels 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.

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.

In addition to the receipts previously noted, the Arroyos received the following amounts during 2020:

Income tax refunds for tax year 2019: Federal $200, State $90. Interest income (reported on separate Forms 1099-INT) State of Michigan general-purpose bonds $1,400, General Electric corporate bonds $1,100. Certificate of deposit at Marquette National Bank $900, Certified dividends (Krist Energy reported on form 1099-DIV $1,200. Cash gifts from Miguals parents $24,000. Miguels net state lottery losses ($1,000 of winnings reported on Form W2-G, $2,300 of Losses) $1,300.

Payments made for 2020 expenditures not mentioned elsewhere are as follows:

Medical copayments $1,300, Dental $1,200. Sales taxes $1,120, Property taxes on personal residence $3,800, Interest on home mortgage $4,200, Charitable contributions to waters Edge Church $3,600.

The Arroyos medical insurance does not cover dental services. They pledge $1,200 per year to their church, The Waters Edge Church in Marquette, MI. In 2020, they paid the pledges for 2018 through 2020. During 2020, the Arroyos drove the Malibu 270 miles for medical purposes (e.g., trips to the hospital, doctor and dentist offices) and 320 miles delivering meals to the poor for Meals-on-Wheels, a qualified charity.

The Arroyos have two sons who live with them: Enrique and Jorge. Both are full-time students. Enrique is an accomplished singer and earned $4,200 during the year performing at special events (e.g., weddings, anniversaries, civic functions). Enrique deposits his earnings in a savings account and intends to use this for future college expenses. Jorge does not have a job. Sofias Form W2 reflects wages of $32,000. Appropriate amounts for Social Security and Medicare taxes were deducted. Income tax withholdings were $1,320 for Federal and $1,056 for state. The Arroyos made quarterly tax payments of $1,900 for Federal and $600 for state on each of the following dates: April 10, 2020; June 12, 2020; September 11, 2020; and December 28, 2020. The Arroyos do not hold any foreign financial accounts, nor do they have any dealings in virtual currencies. Relevant Social Security numbers are noted below. Miguel Arroyo 112-11-111 6/6/1978, Sofia Arroyo 123-45-1678 8/14/1979, Raul Chavez 123-45-4678 03/12/1940, Enrique Arroyo 123-45-8678 9/13/03, Jorge Arroyo 123-45-9678 7/20/05.

Requirements

Prepare an income tax return (with all appropriate forms and schedules) for the Arroyos for 2020 following these guidelines.

• Make necessary assumptions for info not given in the problem but needed to complete the return.
• The taxpayers are preparing their own return (i.e., no preparer is involved).
• The taxpayers have substantiation (e.g., records, receipts) to support all transactions for the year.
• If any refund is due, the Arroyos want a refund check mailed to them.
• The Arroyos had itemized deductions from AGI for 2019 of $26,700, of which $1,500 was for state and local income tax.
• The Arroyos do not want to contribute to the Presidential Election Campaign Fund.