In the case of Olsen v. Commissioner, CA10, CIR No. 26469-14 & No. 21247-16,[1] the Tenth Circuit Court of Appeals affirmed a Tax Court decision denying various tax benefits to the taxpayers related to the purchase of solar lenses.  The panel agreed with the Tax Court that the taxpayers had no profit motive in the supposed business for which the lenses were purchased, rather using benefits from depreciation and tax credits on those lenses to obtain a tax benefit in excess of the cash they had paid to the promoter.

The Facts

The Court described the arrangement the Olsens entered into as follows:

Mr. Olsen bought the lenses in 2009, 2011, 2012, 2013, and 2014, through a program created by Mr. Neldon Johnson. Under the program, Mr. Johnson would use the lenses in a new system to generate electricity by heating a liquid to generate steam and drive a turbine.

Mr. Johnson never finished the system. He did build nineteen test towers by 2006. Nine years later, though, he had completed the lenses on only one tower and hadn't decided whether those lenses would heat water, oil, or molten salt.

Mr. Johnson funded the program through investors like Mr. Olsen. The investors bought lenses from Mr. Johnson's companies (at first International Automated Systems, Inc. and later RaPower3, LLC) and leased the lenses to another of Mr. Johnson's companies (LTB).

Under the leases, LTB promised to place the lenses in service and to operate them. Once the system began producing revenue, LTB would pay Mr. Olsen's company (PFO Solar, LLC) $150 per lens per year.

Based on this arrangement, Mr. Olsen's company made a down payment of 30% of the lens price. The rest of the price would be due in installments starting five years after the system started producing revenue. But the system never generated any revenue.[2]

Although Mr. Olsen had only paid 30% of the claimed purchase price of the lenses and never would have to pay more unless the lenses produced electricity (which they never had and were unlikely to do in the future), he still claimed depreciation on the entire claimed purchase price and used that purchase price to claim solar energy credits:

From 2009 to 2014, the Olsens annually claimed depreciation deductions and solar energy credits. The depreciation deduction recognizes that business property declines in value through wear and tear, obsolescence, or exhaustion. I.R.C. § 167(c)(1). To compensate for a decline in value, the taxpayer can deduct losses from the amount of taxable income. I.R.C. § 167(a). A solar energy credit also exists, allowing a credit equaling 30% of the basis for qualifying equipment that “uses solar energy to generate electricity.” I.R.C. § 48(a)(3)(A).

From 2009 to 2014, the Olsens reported wages of $140,000 to $183,000. To offset these wages, the Olsens claimed depreciation deductions and solar energy credits based on the full price of the lenses, rather than the 30% that Mr. Olsen's company had paid….

These claims allowed the Olsens to pay little or no federal income taxes. So the Olsens came out ahead even though they had never obtained any money from the leases.[3]

In fact, the overall net tax reduction from the depreciation deduction and the dollar value of the solar tax credits allowed Mr. Olsen to net more in tax savings than he was likely ever going to have to pay for the devices even though he had not received, nor likely ever would receive, a dollar of revenue on his leases.

IRS Challenge

The IRS’s view is that a “business” which makes money entirely from tax savings represents a business without a true profit motive—that is, tax savings cannot represent the entire business purpose of the operation.  In this case the IRS decided to act on that belief and disallowed the Olsens’ claimed tax benefits from this operation:

The IRS issued notices of deficiency, disallowing the deductions and solar energy credits that the Olsens had claimed from 2010 to 2014. The Olsens challenged the deficiency notices. For this challenge, the Olsens needed to show a right to the deductions and credits. T.C. R. 142(a). The tax court found the showing insufficient, and the Olsens appeal.[4]

The IRS argued for denying both the depreciation deductions and the credits:

• The IRS argued that without a profit motive, there is no trade or business under the IRC and, without a trade or business, no deduction for depreciation would be allowed on the purchased lenses and

• As the lenses did not qualify for a depreciation deduction, they could not obtain the tax credit at §48 since it required the taxpayers must have a right to claim a deduction for depreciation or amortization of the item to claim these credits.

Thus, the key question became whether the taxpayers had a profit motive, since if the Court agreed that no such motive existed and that meant there was no trade or business, both the depreciation deduction and tax credits would be lost.

Profit Motive

The Tax Court and the panel looked at two different sets of factors in determining if a profit motive existed in this case:

We have used two sets of factors to assess the taxpayer’s intent:

1. the nine nonexclusive factors listed in Treasury Regulation § 1.183-2(b), Cannon, 949 F.2d at 350, and

2. five signs that the taxpayer lacks a profit motive, Nickeson, 962 F.2d at 977.

But “each case is unique,” and neither set of factors is exclusive; so the tax court must consider “all of the unique circumstances of a case.” Id.[5]

The nine factor test proved to be a bit of a disaster for the taxpayer, as the panel found that the first eight factors all went against the taxpayer and the ninth factor was simply not relevant in this case.[6]

More interesting, though, was the panel’s analysis of the second set of factors—the five signs that the taxpayer lacks a profit motive which looks specifically at this sort of marketed tax transaction.

The opinion outlines the five factors from the Nickeson case as follows:

• The marketing materials focus on expected tax benefits,

• The taxpayer buys the item for a grossly inflated price without negotiating,

• The taxpayer doesn’t ask the seller about potential profitability,

• The taxpayer lacks control over activities, and

• The taxpayer uses nonrecourse debt. Nickeson v. Comm’r, 962 F.2d 973, 977 (10th Cir. 1992).[7]

The panel found that three of these issues clearly indicated that Mr. Olsen lacked a profit motive:

1. The marketing materials focused on projected tax benefits.

2. Mr. Olsen paid a grossly inflated purchase price for the lenses without negotiating.

3. Mr. Olsen lacked control over the business.[8]

Marketing Materials Focused Primarily on Tax Benefits

Marketing materials that spend an inordinate amount of time focusing on tax benefits implies that there may be no realistic other reason to take part in the transaction.  In this case the panel did find a suspiciously large amount of the marketing talked about the claimed tax benefits:

First, the marketing for the lenses focused on projected tax benefits. See Appellants’ App’x vol. 9, at 2206. For example, the promotional materials said:

“Your objective in purchasing your [solar-energy lens] systems is to zero out your taxes.”

“Buy our solar units with your tax money instead of giving it away to the IRS.”

Id. at 2178, 2180.[9]

The interactions directed at Mr. Olsen via email also emphasized primarily these tax benefits, at times giving cringe-worthy statements (such as buying solar units based primarily on zeroing out income taxes without any mention of making money from leasing those units out, the purported business being operated):

And an early email pitched Mr. Olsen on the tax benefits while saying little about the possibility of a profit:

Liz said you may be interested in our new solar tax credit program. I would like to set up a time where we could talk about it in more detail but I will give you the basics of the program now.

1. Decide how much you owe in taxes (personally or business)

2. Buy our solar units with your tax money rather than give it away to the IRS.

3. Give the IRS forms #3468, #3800, #4562 and Schedule C instead of money.

4. Receive nearly double your investment from the IRS in tax benefits.

5. Get income off of your equipment for $35 [sic] years.

Also, for each unit bought, our company will give $30,000 to a not-for-profit organization of your choice in your name if you would like to set this up too.

Appellants’ App’x vol. 3, at 703.[10]

The panel found this marketing to indicate a lack of a profit motive:

This marketing weighed against a profit motive. See Nickeson, 962 F.2d at 977 (stating that “marketing on the basis of projected tax benefits” is a “common component[ ]” of transactions lacking a profit motive).[11]

Paying an Inflated Purchase Price Without Negotiations

The second key problem revolved around the fact that Mr. Olsen did not bargain for a more reasonable purchase price even though it was fairly clear that it was highly unlikely the revenue from his leases would provide anything like a reasonable return on his investment—or even just return his investment.

Mr. Olsen conceded that he’d not negotiated the purchase price, and the record contains no evidence about the market value of the lenses. The promoters told Mr. Olsen the purchase price for each lens: $30,000 in 2009 and $3,500 from 2011 to 2014. After paying for the lenses, Mr. Olsen had to lease them to a Johnson entity. That lease would be free unless the system produced revenue. See p. 3, above. And if the system were to produce revenue, the Johnson entity would pay Mr. Olsen’s company only $150 per year. See id. At that rate, it’d take over 23 years for Mr. Olsen to break even. And there was no evidence suggesting that the lenses would even last that long.[12]

Again, the panel found this lack of negotiation indicated that Mr. Olsen did not truly care if this project produced any profit, only that he would be paid back solely by the tax benefits:

Despite the one-sided nature of the transaction, Mr. Olsen did not even try to negotiate the purchase price. The willingness to forgo any negotiation suggests the lack of a profit motive. See Nickeson, 962 F.2d at 977 (stating that “grossly inflated purchase price[s] set without bargaining” are common components of transactions lacking profit motives).[13]

Mr. Olsen Lacked Control Over the Project

Finally, the panel found that the evidence clearly indicated Mr. Olsen had no control over these lenses he had supposedly purchased:

…[A]fter buying lenses for two years, Mr. Olsen admitted that he did not fully understand the project, explaining “that people ask[ed] [him] what it [was] specifically that they [would] be purchasing and [he didn’t] know.” Appellants’ App’x vol. 9, at 2186. Given his lack of understanding, he apparently lacked any control over the operations.[14]

Noting that Mr. Olsen didn’t even know which lenses were his, the Court found that this lack of control also indicated a clear lack of a profit motive:

Mr. Olsen not only lacked an understanding, but never took possession of the lenses that he had bought and couldn’t identify which ones were his. Given his inability to identify his own lenses, the tax court could reasonably find a lack of control over the business, which would weigh against a profit motive. See Nickeson, 962 F.2d at 977 (stating that a “taxpayer[’s] lack of control over activities” is a common component of transactions lacking a profit motive).[15]

Tax Benefits By Themselves Cannot Be Sufficient to Establish a Profit Motive

The taxpayers argued that, regardless of the fact that they had miserably failed the nine factor test and had issues on three of the more general tests for a profit motive, they could still show a profit motive if the tax benefits of the transaction by themselves were enough to repay their investments.  Not unexpectedly, the IRS argues for the opposite, claiming one needs a profit motive before tax benefits are taken into account.

The Olsens argue that a profit motive can exist when a taxpayer intends to make a profit after taxes even if the tax benefits were essential to profitability. The government takes a different approach, distinguishing between motives to profit and save in taxes. See Simon v. Comm’r, 830 F.2d 499, 500 (3d Cir. 1987) (“’[P]rofit’ means economic profit, independent of tax savings.”); Thomas v. Comm’r, 792 F.2d 1256, 1258 (4th Cir. 1986) (same); Holmes v. Comm’r, 184 F.3d 536, 543 (6th Cir. 1999) (same); Wolf v. Comm’r, 4 F.3d 709, 713 (9th Cir. 1993) (same). The tax court could reasonably reject a profit motive under either approach by doubting profitability even after the payment of taxes.[16]

The taxpayers look to rely upon a case from the Ninth Circuit Court of Appeals.  The opinion notes:

The Olsens rely on Sacks v. Commissioner, 69 F.3d 982 (9th Cir. 1995), where the Ninth Circuit held that a taxpayer's investment wasn't a sham even though the activity had become profitable only because of a solar energy credit. Id. at 991.7 There the Ninth Circuit recognized that

Congress sometimes used tax incentives to change investor behavior and

when Congress did intend for tax incentives to change investor behavior, a profit motive might exist even if the tax benefit had been essential to profitability.

Id. at 991-92.[17]

However, the panel distinguished Mr. Olsen’s case from the Sacks case, noting that the taxpayer in Sacks did not rely entirely on tax benefits for all returns on the project:

But there the Ninth Circuit said that a profit motive cannot arise solely from a desire for a tax benefit: the court must ask “whether the taxpayer [had] intended to do anything other than acquire tax deductions.” Id. at 987. So taxpayers might have a profit motive if they intend for a tax credit to turn an activity that’s otherwise unprofitable into a profitable venture. But it’s not enough if the taxpayer’s primary intent is to save in taxes.[18]

Thus, the panel concludes:

The Olsens have not shown an expectation for the solar leasing business to become profitable even with the tax benefits. To the contrary, the tax court found that Mr. Olsen had intended big tax losses to offset his wage income; and the Olsens have not shown clear error in this finding. So the Ninth Circuit’s explanation doesn’t apply here.

To reverse on this ground, we would need to conclude that taxpayers have a profit motive whenever their primary motives are to save in taxes. But we’ve said that a taxpayer lacks a good-faith profit motive when a transaction “was ‘the naked sale of tax benefits.’” Nickeson v. Comm’r, 962 F.2d 973, 977-78 (10th Cir. 1992) (quoting Brock v. Comm’r, 58 T.C.M. (CCH) 826, 836 (1989)). We thus can’t assume a profit motive whenever the taxpayer’s primary motive is to save in taxes.[19]

Court’s Conclusion

The panel, concluding that Mr. Olsen had no profit motive, agreed with the IRS that there was no trade or business for which a depreciation deduction on the lenses could be claimed.

To obtain the solar energy credits, the Olsens needed to show a right to deductions for depreciation or amortization. I.R.C. § 48(a)(3)(C). But the Olsens could not claim the depreciation deductions because Mr. Olsen had lacked a profit motive. See Part IV, above. And the Olsens don't assert eligibility for amortization. So the Olsens could not obtain the solar energy credits.[20]

[1] Olsen v. Commissioner, CA10, CIR No. 26469-14 & No. 21247-16, November 4, 2022, https://www.taxnotes.com/research/federal/court-documents/court-opinions-and-orders/tenth-circuit-affirms-denial-of-solar-energy-deductions%2c-credits/7fb0r (retrieved November 5, 2022)

[2] Olsen v. Commissioner, CA10, CIR No. 26469-14 & No. 21247-16, November 4, 2022

[3] Olsen v. Commissioner, CA10, CIR No. 26469-14 & No. 21247-16, November 4, 2022

[4] Olsen v. Commissioner, CA10, CIR No. 26469-14 & No. 21247-16, November 4, 2022

[5] Olsen v. Commissioner, CA10, CIR No. 26469-14 & No. 21247-16, November 4, 2022

[6] Olsen v. Commissioner, CA10, CIR No. 26469-14 & No. 21247-16, November 4, 2022

[7] Olsen v. Commissioner, CA10, CIR No. 26469-14 & No. 21247-16, November 4, 2022

[8] Olsen v. Commissioner, CA10, CIR No. 26469-14 & No. 21247-16, November 4, 2022

[9] Olsen v. Commissioner, CA10, CIR No. 26469-14 & No. 21247-16, November 4, 2022

[10] Olsen v. Commissioner, CA10, CIR No. 26469-14 & No. 21247-16, November 4, 2022

[11] Olsen v. Commissioner, CA10, CIR No. 26469-14 & No. 21247-16, November 4, 2022

[12] Olsen v. Commissioner, CA10, CIR No. 26469-14 & No. 21247-16, November 4, 2022

[13] Olsen v. Commissioner, CA10, CIR No. 26469-14 & No. 21247-16, November 4, 2022

[14] Olsen v. Commissioner, CA10, CIR No. 26469-14 & No. 21247-16, November 4, 2022

[15] Olsen v. Commissioner, CA10, CIR No. 26469-14 & No. 21247-16, November 4, 2022

[16] Olsen v. Commissioner, CA10, CIR No. 26469-14 & No. 21247-16, November 4, 2022

[17] Olsen v. Commissioner, CA10, CIR No. 26469-14 & No. 21247-16, November 4, 2022

[18] Olsen v. Commissioner, CA10, CIR No. 26469-14 & No. 21247-16, November 4, 2022

[19] Olsen v. Commissioner, CA10, CIR No. 26469-14 & No. 21247-16, November 4, 2022

[20] Olsen v. Commissioner, CA10, CIR No. 26469-14 & No. 21247-16, November 4, 2022