Couple Hit with Negligence Penalty on "Too Good to Be True" Investment Arrangement

(Parker Tax Publishing April 2025)

The Tax Court held that Code Sec. 469 precluded a couple from claiming investment tax credits under Code Sec. 48 with respect to a purported solar farm investment where the only activity engaged in by the husband was the signing documents. The court also concluded that because the investments were part of a tax avoidance scheme that provided the couple with an arrangement that was "too good to be true," the couple was liable for accuracy-related penalties on their underpayment of taxes. Strieby v. Comm'r, T.C. Memo. 2025-28.

Background

Solar Farm, LLC (Solar Farm) is an Arizona limited liability company treated as a partnership for federal income tax purposes. In 2016, Kelly Strieby and Charles Kirkland, the manager of Solar Farm, signed a Membership Agreement and a Membership Funding Agreement (collectively, 2016 Agreements) with respect to a purported 2015 investment in Solar Farm by Strieby. Such membership interests purportedly entitled members to investment tax credits in the exact amount of their tax liability.

When Strieby and his wife filed their joint 2015 Form 1040, they attached Form 3800, General Business Credit, and Form 3468, Investment Credit, on which they claimed investment tax credits under Code Sec. 38 and energy tax credits under Code Sec. 48 of $28,043 relating to the Solar Farm investment. The credits were the exact amount of the couple's 2015 income tax liability. A similar transaction followed with respect to the Striebys' 2016 tax return, where they claimed investment tax credits of $31,763, which was the exact amount of their 2016 income tax liability. The Striebys paid a portion of their refunds to Solar Farm. Subsequently, the Striebys filed amended returns for earlier years also claiming investment tax credits relating to Solar Farm.

The IRS audited the Striebys' 2015 and 2016 tax returns and assessed tax deficiencies and penalties because, it said, Solar Farm was part of a tax avoidance scheme to generate false investment tax credits. According to the IRS, taxpayers like Strieby who invested in Solar Farm were engaged in a passive activity and were thus precluded by Code Sec. 469 from claiming the credits because they did not have any taxable income from passive activities in the years at issue and did not materially participate in the trade or business of Solar Farm other than by receiving Schedules K-1 and claiming the resulting tax benefits. The IRS also assessed accuracy-related penalties under Code Sec. 6662(a) because it found that the Striebys' tax underpayments were due to negligence.

The Striebys countered that (1) Code Sec. 469 did not apply with respect to the credits under Code Sec. 48; (2) they had sufficient bases in their interests in Solar Farm to permit the credits claimed; and (3) Rev. Rul. 2010-16 supported their position because it concluded that Code Sec. 469 did not apply to the Code Sec. 45D new markets credit in certain circumstances and the Code Sec. 48 credit was not "intrinsically different" from Code Sec. 45D.

Code Sec. 38 allows a general business credit against a taxpayer's income tax for the tax year and that credit includes the amount of the investment tax credit determined under Code Sec. 46. The investment tax credit in turn includes the amount of the energy tax credit under Code Sec. 48, which is a percentage of the basis of each energy property placed in service during the tax year. Property placed in service by a taxpayer during the tax year includes the taxpayer's share of the basis (or cost) of property placed in service by a partnership in the tax year of such partnership ending with or within the taxpayer's tax year. However, under Code Sec. 469(a), if the taxpayer is an individual, no passive activity credit is allowed.

A passive activity is any activity that involves the conduct of a trade or business and in which the taxpayer does not materially participate. Under Code Sec. 469(h)(1), a taxpayer materially participates in an activity only when he or she is involved on a regular, continuous, and substantial basis. The measurement of participation focuses on work done by an individual who owns an interest in the activity and Reg. Sec. 1.469-5T generally requires satisfaction of one of seven tests for an individual to be treated as materially participating in an activity for the tax year.

Analysis

The Tax Court sided with the IRS and held that the Striebys were liable for the taxes and penalties assessed by the IRS. The court rejected the Striebys' argument that the passive activity loss rules did not apply and cited its decision in Olsen v. Comm'r, T.C. Memo. 2021-41, aff'd, 2022 PTC 335 (10th Cir. 2022). In that case, the Tax Court held that the energy tax credit determined under Code Sec. 48 and included in the investment tax credit amount under Code Sec. 46, and thus the general business credit in Code Sec. 38, is allowable only under Code Sec. 38. The court found that because Code Sec. 38 is in subpart D of part IV of subchapter A of the Code, the Code Sec. 48 energy credit is a credit allowable under that subpart, and, accordingly, potentially, a passive activity credit.

Since the Striebys acknowledged that their only activity with respect to Solar Farm was signing documents and making contribution payments, the court concluded that they could not be considered to have materially participated in Solar Farm's business and thus were not eligible for the investment tax credit. Further, the court found that because the Striebys had no income from passive activities and thus no regular tax liability allocable to passive activities, the Code Sec. 48 credits claimed on the Striebys' tax returns were passive activity credits and were not allowed under Code Sec. 469.

With respect to the Striebys' reliance on Rev. Rul. 2010-16, the court said that reliance was misplaced as the focus of that ruling was driven by the particular provisions of Code Sec. 45D, which determines a credit for a taxpayer's qualified equity investment in a qualified community development entity (CDE). According to the Tax Court, because the Code Sec. 45D credit relates to an investment in a CDE, an entity which might itself be engaged in a trade or business, Rev. Rul. 2010-16 indicates that the trade or business of the CDE is irrelevant and the inquiry under Code Sec. 469 relates to whether the taxpayer investing in the CDE does so in connection with a trade or business.

With respect to the negligence penalty, the court cited Reg. Sec. 1.6662-3(b)(1)(ii) in finding that negligence is strongly indicated if a taxpayer fails to make a reasonable attempt to ascertain the correctness of a credit on a return that would seem to a reasonable and prudent person to be "too good to be true." The Striebys, the court noted, purported to acquire membership interests in Solar Farm for each year well after the year closed. Further, the court noted, those membership interests purportedly entitled them, effort free, to investment credits in the exact amount of their tax liability. A reasonable and prudent person, the court concluded, should have found this arrangement "too good to be true" and made a reasonable attempt to ascertain the correctness of the credits.

For a discussion of the general business credit, see Parker Tax ¶104,100. For a discussion of the passive activity credits, see Parker Tax ¶247,180. For a discussion of the accuracy-related penalty on underpayments of tax, see Parker Tax ¶262,120.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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