Tax Law Blog

IRS has made a habit of challenging whether a member of a limited liability company that is treated as a partnership for tax purposes is materially participating in the activities of the partnership.

A recent Tax Court case (Strieby v. Commissioner) considers whether the passive activity credit limitation rules of Code Section 469 may prevent taxpayers from claiming energy credits allocated to them by virtue of their membership interests in a partnership.[1]

Facts Presented.

In Strieby, taxpayers invested in a solar farm but their only involvement consisted merely of completing the paperwork, making a capital contribution after receiving refunds from the IRS, receiving Schedules K-1 from the solar farm showing their allocation of tax credits, and then claiming the credits on their own Forms 1040. The plea agreement indicated that the manager was sentenced to nine years in prison and required to pay IRS about $52 million in restitution. The court admitted the disputed plea agreement and press release in the federal income tax case as probative in determining whether a trade or business existed and that there was ‘minimal to nonexistent potential for unfair prejudice.

The Taxpayers argued that Section 469 was inapplicable to tax credits under Section 48 because, among other arguments, the definition of passive activity credit specifically cites credits that are allowable under Subpart B and Subpart D. Since Section 48 does not appear in either Subpart B or Subpart D, but Subpart E (containing rules for calculating investment credit under Section 46 and elsewhere), credits under Section 48 are not subject to the limitations under Section 469.

Background.

Tax Credits. Taxpayers can generally claim certain ‘general business credits, including current year business credits. Section 38. These include investment credits under Section 46, which include energy credits described in Section 48. The amount of energy credit is equal to a percentage of the basis of each energy property that is placed in service during a year. Property placed in service includes the taxpayer’s share of the property that he holds (indirectly) through a partnership.

Passive Activity Credits. Passive activity credits include credits that are allowable under Subpart B of Subchapter A of the Internal Revenue Code (which are various credits found in Sections 27 through 30D) or under Subpart D of Subchapter A of the Internal Revenue Code (which are business-related credits located in Sections 38 through 45AA). Section 469 restricts the use of passive activity credits to satisfy federal income tax liabilities. Sec. 469(a)(1)(B); Sec. 469(d)(2). Disproving passive activity involves proving a double negative – i.e., the taxpayer does not not “materially participate.” A taxpayer must show that he is involved in the conduct or operations of the activity on a regular, continuous, and substantial basis and meet one of seven tests.

Tax Court’s Analysis

The energy credit under Section 48 is part of the investment credit under Section 46, which is a part of the general business credit under Section 38. The amount determined under Section 48 (under Section 46, and thus under Section 38), is allowable only under Section 38. Because Section 38 is in Subpart D, the Section 48 energy credit is a credit allowable under Subpart D and potentially a passive activity credit. See, e.g., Olsen v. Commissioner, T.C. Memo 2021-41, aff’d 52 F.4th 889 (10th Cir. 2022) (passive activity credit means the excess of all general business credits from passive activities over regular tax liability for the taxable year allocable to all passive activities).

Passive Activity/Material Participation.

For purposes of Section 46, property placed in service includes a taxpayer’s share of the basis/cost of the property held through a partnership, allowing a partner to meet the placed in service requirement via indirect ownership. But to be energy property, it must be depreciable or amortizable property; i.e., either used in a trade or business or held for producing income. The plea agreement involving the manager of the solar farm indicated that the entities in the transaction did not claim that they were in the business of buying, installing, and leasing solar equipment. The credits would therefore be passive activity credits unless the Taxpayers materially participated. They did not since all they did was sign documents, pay contributions, and claim credits.

Activities of a taxpayer include those conducted through partnerships, but a taxpayer materially participates only when he is involved on a regular, continuous, and substantial basis, and meets one of the seven tests under the regulations. Treas. Reg. 1.469-4(a); Section 469(h)(1); Treas. Reg. 1.469-5T. Here they did not because their activities involved purely executory/administrative and investment activities such as signing documents, contributing capital, and claiming tax credits.

In addition, Revenue Ruling 2010-16 which Taxpayers cited, indicating that new market credits under Section 45D may not be subject to passive activity credit limitations, is not binding authority and is distinguishable because the credits under Section 45D and Section 48 are different. Unlike Section 48, whether the new markets tax credit under 45D is disallowed under 469 does not depend on the taxpayer’s interest or extent of participation in the business entity’s trade or business.

Penalties.

Negligence penalties were proper because: (i) Taxpayers acquired membership interests in the solar farm well after the relevant tax years closed; (ii) tax outcome too good to be true; (iii) no attempt to independently verify whether their position was proper; (iv) contrary to statute and relevant authority; (v) Taxpayers did not rely on (or even review) professional advice or information returns – they claimed 2015 credits without ever receiving K-1s and claimed 2016 credits before getting a K-1. The court added that even if the Taxpayers had relied on an information return to determine the credit amount, it would have provided no support for the position regarding Section 469.

Conclusion.

Tax credits are a tempting incentive. Because the landscape changes often, their application is often misunderstood by taxpayers and abused by promoters. IRS is not shy about challenging material participation in partnership activities, especially in evolving or controversial areas like investment tax credits involving green and renewable projects.

As Strieby demonstrates, it is essential to understand both the technical requirements for any prospective tax credit as well as the interplay between the eligibility rules and other provisions of the Code that will govern their application. Ensure your investment structures and tax credit strategies can withstand IRS scrutiny. Contact our team to review your partnership activities and confirm compliance with Section 469 and related credit rules:

• Nick Stock...616.726.2255...nstock@fosterswift.com
• Mike Zahrt...616.726.2223...mzahrt@fosterswift.com

[1] Strieby v. Commissioner, T.C. Memo 2025-28.