For tax professionals advising clients on the deductibility of losses stemming from defunct investments and complex litigation, the Sixth Circuit’s recent unpublished opinion in Michael H. Shaut v. Commissioner, No. 25-1568, CA6 (March 12, 2026) serves as a critical reminder of the strict evidentiary burdens placed on taxpayers. In affirming the United States Tax Court’s decision, the appellate panel addressed the substantiation requirements for ordinary and necessary business expenses under Internal Revenue Code (IRC) § 162, theft losses under IRC § 165, and net operating loss (NOL) carryovers under IRC § 172.

Facts of the Case

The petitioner, Michael Shaut, is an attorney and entrepreneur with a history of starting and selling businesses. In 2014, Shaut joined a partnership called Downing Investment Partners as its president, initially agreeing to invest $500,000, of which $250,000 was substantiated by bank records. Facing funding difficulties by October 2014, Shaut stopped drawing a salary, agreed to secure additional investors, and transitioned from an officer to a role similar to a managing director. Shaut claimed to have made subsequent loans to Downing that brought his total investment to $794,000, though he only proffered evidence supporting $508,500.

By 2016, Shaut realized the business was stagnating and began to distrust David Wagner, a founding principal. Shaut discovered that Wagner and another principal, Marc Lawrence, were improperly funneling Downing’s resources into a new entity. This resulted in substantial litigation, with Shaut named in 17 lawsuits and facing a $2.5 million liability from one arbitration.

Concurrently, the government launched a criminal investigation into Downing, resulting in Wagner pleading guilty to securities and wire fraud for directing “a Ponzi-like investment scheme that resulted in the loss of approximately $10 million” (Wagner v. United States, Nos. 19-CR-0437, 22-CV-0360, 2023 WL 2330690, *1 (S.D.N.Y. March 2, 2023)). Lawrence also pleaded guilty to related charges (United States v. Lawrence, No. 19-CR-0437, 2022 WL 4000904, at *1 (S.D.N.Y. Sep. 1, 2022)). Shaut was not criminally charged and subsequently returned to his law practice.

The Taxpayer’s Request for Relief and Tax Court Proceedings

On his 2019 income tax return, Shaut claimed a $720,000 long-term capital loss for his shares in Downing and a $570,806 carryover loss from his law practice. The IRS disallowed both deductions, ultimately issuing a notice of deficiency for $38,149 for the 2019 tax year.

In response, Shaut submitted an amended filing accompanied by a letter from his accountant. The amended return recharacterized the deductions, claiming a $720,000 theft loss for the Downing investments and a $570,806 carryover loss attributed to a previous business venture, Carbon Vision. Furthermore, the accountant’s letter asserted that Shaut incurred roughly $600,000 in legal expenses defending his Downing investments, though these were not originally included on the return.

Shaut petitioned the Tax Court, which held a two-day trial in April 2024 limited to the deductibility of these claims. Following the trial, the Tax Court concluded that Shaut failed to provide sufficient evidence to support his deductions for business expenses, theft losses, and NOL carryovers. The Tax Court entered a decision determining Shaut owed $3,548 for the 2019 tax year. Shaut appealed to the Sixth Circuit.

Standard of Review and the Burden of Proof

The Sixth Circuit heavily anchored its affirmation on the standard of review applied to Tax Court decisions, noting it reviews legal conclusions de novo and factual findings for clear error pursuant to 26 U.S.C. § 7482(a) (Oquendo v. Comm’r, 148 F.4th 820, 827 (6th Cir. 2025)). Citing Indmar Prods. Co. v. Comm’r, 444 F.3d 771, 777-78 (6th Cir. 2006), the appellate panel emphasized that it must defer to the Tax Court’s factual findings and afford "even greater discretion to any credibility determinations made by the [t]ax [c]ourt".

Because IRS deficiency determinations are generally presumed accurate, the taxpayer bears the burden of clearly demonstrating a right to a claimed deduction (McGowan v. United States, 143 F.4th 686, 701 (6th Cir. 2025), quoting INDOPCO, Inc. v. Comm’r, 503 U.S. 79, 84 (1992)). If credible evidence is introduced, the burden shifts to the government, but the Tax Court is well within its rights to disregard self-serving testimony that lacks credibility or is “improbable, unreasonable[,] or questionable” (Conti v. Comm’r, 39 F.3d 658, 664 (6th Cir. 1994); Davis v. Comm’r, 866 F.2d 852, 859 (6th Cir. 1989)).

Court’s Analysis and Application of the Law

Section 162 Business Expenses

Shaut attempted to deduct his legal expenses related to the Downing litigation as ordinary and necessary business expenses under IRC § 162(a). The Sixth Circuit reiterated that a § 162 deduction requires the existence of a trade or business, and the expense must be “ordinary,” “necessary,” “paid or incurred by the taxpayer in the taxable year,” and “arise in connection with or proximately result from that trade or business” (Dargie v. United States, 742 F.3d 243, 245 (6th Cir. 2014)). Determining the existence of a trade or business "requires an examination of the facts in each case" (Comm’r v. Groetzinger, 480 U.S. 23, 36 (1987), quoting Higgins v. Comm’r, 312 U.S. 212, 217 (1941)).

The court relied on established precedent to differentiate between an investor and an individual engaged in a trade or business. “[A] shareholder ordinarily may not deduct expenses he has incurred on behalf of a corporation. ’When the only return is that of an investor, the taxpayer has not satisfied his burden of demonstrating that he is engaged in a trade or business’” (Dietrick v. Comm’r, 881 F.2d 336, 338–39 (6th Cir. 1989), quoting Whipple v. Comm’r, 373 U.S. 193, 202 (1963)).

Applying the law to Shaut’s facts, the Sixth Circuit found no clear error in the Tax Court’s determination. First, most of Shaut’s claimed legal fees were "incurred or paid prior to the 2019 tax year," meaning they were not paid or incurred in the taxable year as required by Dargie. Furthermore, the court determined that by the time the litigation arose, Shaut was not involved in daily operations and received no salary; his role was limited to that of an investor. The court concluded that his legal fees could not be claimed as carrying out operations, directly quoting Whipple: “[I]nvesting is not a trade or business and the return to the taxpayer, though substantially the product of his services, legally arises not from his own trade or business but from that of the corporation”.

Section 165 Theft Loss

Shaut also challenged the denial of his $720,000 theft loss deduction under IRC § 165(c)(3). A taxpayer must prove the existence of the theft, the amount, and the year the loss was discovered (26 U.S.C. § 165(e); 26 C.F.R. § 1.165-8(a); Alioto v. Comm’r, 699 F.3d 948, 955 (6th Cir. 2012)). The Tax Court must look to the criminal law of the jurisdiction where the loss occurred—in this case, Ohio—to determine if a theft happened (Alioto, 699 F.3d at 955). Under Ohio Rev. Code § 2913.02(A) and Ohio v. Edmondson, 750 N.E.2d 587, 592 (Ohio 2001), theft by deception requires a wrongdoer to act deceptively to obtain property, causing the owner to transfer it.

The Sixth Circuit upheld the Tax Court’s finding that Shaut failed to prove he was personally a victim of theft by deception. Despite Wagner’s eventual conviction, there was "no evidence on this record that Downing’s principals intentionally coerced Shaut to invest to steal his funds". The Tax Court found Shaut’s self-serving testimony insufficient, finding it "implausible that Shaut was unaware of the scheme at Downing because he was a sophisticated businessman and investor who had significant involvement in the partnership". The appellate court deferred to the Tax Court’s credibility determinations, concluding there was no clear error.

Furthermore, Shaut failed the timing requirements for a § 165 deduction. Under 26 C.F.R. §§ 1.165-1(d)(3) and 1.165-8(a)(2), a loss cannot be deducted in the year of discovery if a reasonable prospect of recovery exists, until the year it can be ascertained with reasonable certainty that reimbursement will not be received. Shaut argued that "after CliniFlow was discovered by Petitioner, there was no reasonable likelihood of recovery," but he admitted discovering this between late 2017 and early 2018. Because Shaut objectively discovered the loss before 2019 and "did not explain to the tax court why the prospect of recovery ended at that date," he was barred from claiming the deduction in 2019 (Roth Steel Tube Co. v. Comm’r, 800 F.2d 625, 632 (6th Cir. 1986)).

Section 172 Net Operating Loss Carryover

Shaut’s attempt to carry forward a $570,806 net operating loss from 2018 to 2019 under IRC § 172(b)(2) was similarly rejected. Taxpayers must establish both the existence of the NOL and the allowable carryover amount (26 C.F.R. § 1.172-4(a)(1)(i), (b)(2); United Dominion Indus., Inc. v. United States, 532 U.S. 822, 835 (2001)). Crucially, the court noted that "the tax court is not required to view tax returns as conclusive absent additional evidentiary support" (Wilkinson v. Comm’r, 71 T.C. 633, 639 (1979); Sparkman v. Comm’r, 509 F.3d 1149, 1156–57 (9th Cir. 2009)).

The Sixth Circuit found that Shaut "failed to prove both his right to a carryover deduction and the amount of the deduction" (Simpson v. Comm’r, 23 F. App’x 425, 427–28 (6th Cir. 2001)). Shaut relied heavily on his previous tax returns to support a patchwork of claimed losses, including $74,000 from Carbon Vision, a $109,000 carryover from 2017, and $124,000 from his law practice. The court pointed out severe evidentiary gaps: Shaut produced corporate returns but not his own individual returns for key years regarding Carbon Vision, his 2017 return showed a different carryover balance than what he claimed in 2018, and he failed to map his claimed legal bills to the exact amounts deducted. Without this underlying substantiation, the Sixth Circuit ruled the Tax Court did not clearly err.

Evidentiary Rulings and Harmless Error

Finally, the appellate court addressed an evidentiary dispute regarding an arbitration opinion establishing a $2.5 million judgment against Shaut, which the Tax Court initially admitted for impeachment purposes before ultimately excluding it as hearsay. Reviewing for abuse of discretion (Craddock v. FedEx Corp. Servs. Inc., 102 F.4th 832, 841 (6th Cir. 2024)), the Sixth Circuit noted that even if improper evidence is admitted, a ruling may be affirmed if the error was harmless because sufficient alternative evidence supports the court’s opinion (Barnes v. City of Cincinnati, 401 F.3d 729, 742-43 (6th Cir. 2005)). Because the Tax Court explicitly stated it did not consider testimony related to the exhibit, and substantial other evidence supported the denial of the theft loss deduction, the Sixth Circuit held that "any error was therefore harmless".

Conclusions

In affirming the decision of the Tax Court, the Sixth Circuit provided a textbook application of the rules surrounding taxpayer substantiation burdens. For tax professionals, this opinion reinforces that mere assertions and previous tax return entries are insufficient to sustain carryovers, theft losses, or business expense deductions upon examination. The courts will rigorously scrutinize the actual facts and circumstances, applying state criminal statutes for theft definitions and strictly enforcing the "trade or business" requirement to distinguish legitimate business expenses from non-deductible investor outlays.

Prepared with assistance from NotebookLM.