Mirch v. Commissioner

Tax LLM's 'Ballpark' Logs Sink Defense Against $99k Deficiency

Kevin and Marie Mirch, facing a challenge to a Notice of Federal Tax Lien (NFTL) regarding their 2006 tax liabilities, found their arguments unpersuasive before the Tax Court. Kevin Mirch, an attorney holding both a Tax LLM and a CPA license, argued that his wife qualified as a "real estate professional" under Section 469, and that the IRS had improperly assessed their taxes. However, the Court sustained the NFTL for approximately $99,000, rejecting the Mirchs' claims, finding their "ballpark" time logs for real estate activities implausible and dismissing their assertions of IRS misconduct as conspiracy theories. Ultimately, the Court upheld the IRS's determination, resulting in the denial of deductions and the sustaining of the NFTL.

The Facts: A Law Firm, Two Rentals, and a Missed Notice

Following the determination that the IRS could proceed with collection, the Tax Court delved into the specifics of the Mirchs' financial activities. Both Mr. and Mrs. Mirch are attorneys, and during 2006, they operated a law firm, Mirch & Mirch, in Reno, Nevada. Mr. Mirch held an LLM in taxation and was also a certified public accountant, while Mrs. Mirch worked part-time at the firm, managing its finances. In early April 2006, Mr. Mirch suffered a stroke, leading to a reduction in his working hours, with Mrs. Mirch subsequently increasing her hours to provide services to clients. Despite Mr. Mirch's health issues, the firm continued to file appellate briefs and motions throughout the latter half of 2006. The Court noted a lack of evidence establishing the precise number of hours Mrs. Mirch dedicated to the law firm's business. The Petitioners reported the law firm’s activities on Schedule C, Profit or Loss From Business, and only reported self-employment tax for Mr. Mirch.

In addition to their law firm, the Mirchs owned two rental properties during 2006: one on Hope Street in Providence, Rhode Island, and another in Reno, Nevada, next door to their residence. Importantly, they did not elect under Section 469 to treat these rental activities as a single unit. Section 469 generally disallows net losses from "passive activities" (like rental real estate), limiting them to offsetting passive income. The Hope Street property had been purchased in 2004 while their daughter attended Brown University and was rented to students, with their daughter residing there rent-free. During 2006, the Mirchs paid their daughter $500 per month to manage the Hope Street property, even after she graduated and no longer lived there. The Mirchs estimated that Mrs. Mirch performed 259 hours of service on the Hope Street property and Mr. Mirch performed 57 hours, totaling 316 hours. However, they only produced time logs for 2006, lacking records for 2005 and 2007, or for their daughter’s hours. The Reno property, a single-family home, was rented out as a short-term vacation rental, which, according to Temporary Treasury Regulation § 1.469-1T(e)(3)(ii)(A), is defined as an average rental period of less than 7 days. The property was rented approximately 23 times for a total of 93 days during 2006. The Mirchs advertised a cleaning fee of $80 to $100 per stay and rental invoices showed an $85 cleaning fee for most stays. They also hired cleaning and landscaping services. A log produced by the Mirchs estimated that Mrs. Mirch worked 944.5 service hours on the Reno property during 2006. They did not produce a log for 2005 or 2007. The 2006 log specified tasks performed by Mrs. Mirch, including a standardized 12 minutes to read and 12 minutes to send each email (totaling 7.4 hours); 7 hours to clean the property after each stay (totaling 168 hours); and 8 hours of site management and maintenance for each day the property was rented (totaling 744.5 hours). Site management included being "[o]n call for guests, repairs, supplies, Wi-Fi, cable, [and] snow removal.” They reported these rental activities on Schedule E, Supplemental Income and Loss, and Mrs. Mirch also filed a second Schedule C for a real estate investment activity, claiming a home office deduction without reporting any income.

The audit timeline revealed critical procedural issues. In September 2007, Revenue Agent (RA) Maureen Lytle was assigned to audit the Mirchs’ 2004 tax return, with the audit later expanded to include 2005–07. The Mirchs filed their 2006 return under extension on October 15, 2007, reporting tax of $115,660 but not paying the full amount. In 2008, the Mirchs moved from Reno, Nevada, to San Diego, California. In February 2009, during the audit, they filed Form 13683, Statement of Disputed Issues, for 2004–07, which the IRS treated as a written protest to the IRS Office of Appeals (Appeals). RA Lytle closed the audit on March 25, 2009, without preparing a revenue agent’s report (RAR). Around May 26, 2009, the protest was assigned to Appeals Officer (AO) Elizabeth Forrest in Las Vegas. The IRS issued a Notice of Deficiency on June 29, 2010, and mailed a separate copy to each petitioner by certified mail to their last known address on Moana Drive, San Diego. However, the U.S. Postal Service (USPS) attempted delivery in July 2010, but both copies were unclaimed and returned to the IRS. As a result, the Mirchs did not file a petition with the Tax Court within the 90-day period as required by Section 6213(a). Consequently, on December 20, 2010, the IRS assessed the 2006 deficiency of $99,862.

Arguments: 'Standardized' Time vs. Passive Loss Rules

Having unsuccessfully challenged the validity of the IRS's Notice of Deficiency, the core dispute centered on the underlying tax liability for 2006. The petitioners' primary argument rested on the claim that Mrs. Mirch qualified as a real estate professional under Section 469(c)(7), which defines the qualifications for relief from passive activity loss limitations. Under the general rule of Section 469, all rental activities are considered "per se passive," meaning losses can only offset passive income. However, if a taxpayer qualifies as a "real estate professional" and "materially participates" in their rental activities, those activities are treated as non-passive, allowing losses to offset ordinary income (e.g., wages). To qualify as a real estate professional, a taxpayer must satisfy two quantitative tests: (1) more than 50% of the personal services performed in all trades or businesses during the year must be performed in real property trades or businesses (RPTB) in which the taxpayer materially participates; and (2) the taxpayer must perform more than 750 hours of services during the year in RPTBs in which they materially participate. If Mrs. Mirch met these requirements, the petitioners argued that they were entitled to deduct the rental losses against their ordinary income and carry back a 2007 Net Operating Loss (NOL) to 2006 under Section 172, which allows taxpayers to use losses from one year to offset income in other years. They sought to carry back a 2007 NOL to $335,081.

The IRS countered that the rental losses were passive under Section 469, meaning the NOL was either absorbed elsewhere or was invalid in the first place. Critically, the IRS challenged the petitioners' substantiation of Mrs. Mirch's hours spent on real estate activities. The petitioners relied on a time log that used 'standardized' estimates, such as allocating 12 minutes per email and 7 hours for cleaning each unit, to reach the 750-hour threshold. The IRS argued that these 'ballpark' figures lacked the specificity and reliability necessary to meet the substantiation requirements for deducting rental losses.

Analysis: Why the Court Rejected the 'Guesstimate' Logs

The court's analysis centered on whether Mrs. Mirch qualified as a real estate professional under Section 469(c)(7)(B). Generally, Section 469 limits deductions for passive activity losses to the extent of the taxpayer’s passive income for the year. However, there is an exception if the taxpayer qualifies as a real estate professional. To qualify, Section 469(c)(7)(B) sets forth two tests: (1) more than 50% of the taxpayer's total service hours in all trades or businesses must be in real property trades or businesses in which they materially participate (the "50% test"), and (2) the taxpayer must spend at least 750 hours in those real property trades or businesses in which they materially participate (the "750-hour test").

The court focused on the 750-hour test, finding Mrs. Mirch's substantiation inadequate. Petitioners presented an undated log estimating that Mrs. Mirch performed 944.5 service hours on the Reno rental activity. However, the court found the log unreliable, noting that it relied on "standardized" time estimates. For example, the log allocated 12 minutes per email sent or received, totaling 7.4 hours for the year, and 7 hours for cleaning the property after each stay.

The court was unconvinced by the cleaning estimate, finding it unreasonable that Mrs. Mirch estimated 7 hours of cleaning “regardless of the length of stay, which ranged from 1 to 14 days.” The court also noted that the renters were charged a cleaning fee, which was inconsistent with Mrs. Mirch personally performing all the cleaning.

Because the court rejected the standardized estimates and found the log unreliable, it concluded that Mrs. Mirch failed to prove she met the 750-hour requirement. As a result, the rental losses were deemed passive. Because the losses were passive, they could not offset ordinary income. This had a cascading effect on the Mirches' tax liability. The disallowed passive losses increased their 2005 taxable income, which fully absorbed a 2007 net operating loss (NOL) carryback. Section 172 allows taxpayers to use NOLs from one year to offset income in other years. Because the 2007 NOL was fully absorbed in 2005, there was nothing left to carry back to 2006, further increasing their deficiency.

Procedural Analysis: Harmless Errors and Conspiracy Theories

The Mirches raised several procedural challenges to the IRS's assessment. They argued that the assessment was invalid because Form 4340, the Certificate of Assessments and Payments, listed the assessment as "AGREED" (Transaction Code 300 / Disposal Code 03). They contended this was incorrect because the assessment was actually a default following a Notice of Deficiency. Form 4340 is generally considered presumptive evidence that a tax assessment was validly made. The court noted that a Transaction Code (TC) 300 indicates an additional tax or deficiency assessment, while Disposal Code (DC) 03 often identifies an Automated Underreporter (AUR) selected case.

The Tax Court, however, was not convinced the presence of these codes invalidated the assessment. Citing Call v. Commissioner, T.C. Memo. 2005-289, a case with similar facts, the court held that even if Form 4340 contained an error, it amounted to a harmless labeling issue that did not prejudice the taxpayers. The Court in Call specifically found that such a labeling error "d[id] not affect the existence of valid, unsatisfied assessments." The Tax Court emphasized that the relevant Treasury regulations under Section 6203, which governs how the IRS makes an assessment, only require the record of assessment to include the taxpayer’s name, date of assessment, character of liability, taxable period, and amount assessed. The Court found all of this information was correctly stated on Form 4340. Because the Mirches had not shown any prejudice, the court declined to invalidate the assessment.

Finally, the court summarily dismissed the Mirches' broader claims of conspiracy, including allegations of fake envelopes and backdated liens, as baseless and unsupported by any credible evidence.

Impact: The High Bar for Pro Se Professionals

This case serves as a stark reminder that even tax professionals representing themselves are held to rigorous substantiation standards before the Tax Court. The court's rejection of the Mirches' "postevent ballpark guesstimates" for time logs underscores the importance of maintaining accurate and contemporaneous records to substantiate material participation under Section 469, which governs passive activity losses. To qualify as a real estate professional under Section 469(c)(7) and avoid the passive loss limitations, taxpayers must demonstrate, among other things, more than 750 hours of service in real property trades or businesses in which they materially participate. Vague recollections and "standardized" time allocations will not suffice. Furthermore, even clerical errors or omissions on IRS transcripts, such as Form 4340, do not automatically invalidate an assessment if the taxpayer fails to demonstrate prejudice. Taxpayers should ensure meticulous record-keeping and seek professional advice when navigating complex tax rules, as the court expects even pro se litigants with legal and accounting backgrounds to meet the same evidentiary burden as represented parties.