Sixth Circuit: No Deduction Where Investor Fails to Establish Elements of a Theft Loss

(Parker Tax Publishing April 2026)

The Sixth Circuit affirmed the Tax Court and held that an investor in a Ponzi-like investment scheme, who also secured additional investors for that scheme, was not entitled to deduct legal expenses relating to litigation involving that investment, was not entitled to a theft loss for his alleged $720,000 investment loss in that scheme, and was not entitled to a net operating loss (NOL) carryover of approximately $571,000 from a prior year. The court concluded that the investor failed to meet his burden of establishing his right to the legal expense deduction, did not establish the elements of a theft loss under Code Sec. 165 for his alleged $720,000 investment loss, and could not document the details necessary to substantiate his NOL carryover. Shaut v. Comm'r, 2026 PTC 61 (6th Cir. 2026).

Facts

Michael Shaut is an attorney and entrepreneur. Previously, he founded Carbon Vision, a solar energy company. In 2014, Shaut learned about Downing Investment Partners (Downing), a partnership which was developing patent-pending medical software. After meeting with David Wagner, a founding principal of the partnership, he joined Downing as its president in March of 2014. His salary was initially $200,000. As part of the employment offer, Shaut invested $250,000 in Downing and subsequently made additional investments. Shortly thereafter, given funding difficulties, Shaut stopped taking a salary from Downing and agreed to secure additional investors in the partnership. He recruited several individuals to invest substantial sums, each investing $1 million or more.

In 2016, Shaut realized Downing's business ventures were stagnating and he began to distrust Wagner. Shaut eventually learned about a new entity into which Wagner and fellow Downing principal Marc Lawrence were improperly funneling resources. Beginning in 2016, Downing's activities led to substantial litigation. For his part, Shaut was named in 17 lawsuits. One arbitration resulted in a $2.5 million liability for Shaut and other Downing officers. Additionally, the government launched a criminal investigation into Downing and some of its officers and charged Wagner for "his direction of a Ponzi-like investment scheme that resulted in the loss of approximately $10 million and harmed approximately 40 investors."

Meanwhile, no progress was made on the development of Downing technology. Eventually, investors determined that the principals of Downing had been misleading them and mismanaging Downing. These discoveries led to legal action, including approximately 17 lawsuits in which Shaut was named as a defendant. The lawsuits were resolved several years later and the government did not pursue charges against Shaut, who returned to the practice of law.

On his 2019 tax return, Shaut claimed deductions for a $720,000 long-term capital loss for his shares in Downing and a $570,806 carryover loss from his 2018 tax return which was comprised of $74,00 from Carbon Vision losses, $124,000 from his law practice, and $260,000 from Downing losses relating legal expenses and travel. The IRS disallowed those losses. In 2022, the IRS notified Shaut of a deficiency of $38,149 for the 2019 tax year. Shaut then submitted an amended return, along with a letter from his accountant, where he claimed deductions for a $720,000 theft loss for his investments in Downing and a $570,806 net operating loss (NOL) carryover loss from his 2018 tax return Carbon Vision. The accountant's letter stated that Shaut incurred approximately $600,000 in legal expenses to defend his Downing investments, but these expenses were not included on Shaut's return. The IRS again disallowed Shaut's deductions and Shaut took his case to the Tax Court.

In Shaut v. Comm'r, T.C. Memo. 2024-103, the Tax Court held that Shaut could not deduct as a theft loss under Code Sec. 165 legal fees he incurred after he was named as a defendant in lawsuits brought by investors in a company he managed and invested in, which later turned out to be a Ponzi scheme. The court rejected Shaut's claim that the legal expenses were related to his protection and defense of his investment in the company. Also, given his extensive business background and his efforts to bring on investors who were ultimately victims of the scheme, the court found Shaut's claim of being a victim of theft implausible.

Shaut appealed to the Sixth Circuit, arguing that the Tax Court erred by (1) disallowing his legal expenses related to the Downing litigation as necessary and ordinary business expenses under Code Sec. 162(a); (2) finding both that he did not establish the elements of theft for his alleged $720,000 investment in Downing and that the loss was not deductible in 2019; and (3) disallowing his NOL of $570,806 from his 2018 tax year on his 2019 return.

Analysis

The Sixth Circuit affirmed the Tax Court's determination that Shaut was not entitled to any of the claimed deductions. With respect to the deduction for his legal expenses, the court found that Shaut failed to establish his right to those expenses. For starters, the court noted, Shaut's legal invoices pertained to years other than 2019. The court also noted that, although Shaut was employed by Downing for a time, by early 2015 he was not involved in the day-to-day operations of the partnership and did not receive a salary and, by the time litigation around Downing arose, Shaut's role was limited to that of an investor.

With respect to Shaut's argument that the Tax Court erred in finding he did not establish the elements of theft for his alleged $720,000 investment in Downing and that the loss was not deductible in the 2019 tax year, the court concluded that Shaut's argument failed on multiple accounts. First, the court noted, Ohio criminal law governed in determining if a theft occurred because that is the jurisdiction where the loss took place. Ohio law, the court pointed out, prohibits a person from knowingly obtaining or exerting control over a person's property "with purpose to deprive the owner of property" without the owner's consent, outside the scope of the owner's express or implied consent, or by deception, threat, or intimidation. Thus, to be guilty of theft by deception, a wrongdoer must deceptively act to obtain the owner's property, and as a result, the owner must transfer the property to the wrongdoer.

The Sixth Circuit found no evidence that Downing's principals intentionally coerced Shaut to invest in Downing and to steal his funds or that Shaut provided funding based on any deception, threat, or intimidation. Although Shaut spoke with Wagner before joining the partnership and Wagner was eventually convicted of wire and securities fraud, the Sixth Circuit agreed with the Tax Court's conclusion that (1) Shaut's self-serving testimony was insufficient to meet his burden of demonstrating that he in particular was a victim of theft, and (2) that it was 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 and, to the extent that he was unaware of the scheme, he failed to demonstrate that his investments were more than bad business decisions.

The Sixth Circuit also found that Shaut failed to introduce objective evidence that he discovered the loss in 2019, or alternatively, that a reasonable prospect of recovery existed at the time of his discovery of the loss and continued until the prospect was lost in 2019. Thus, the Tax Court did not clearly err in finding that Shaut objectively discovered the theft loss before 2019.

Finally, with respect to Shaut's contention that he was entitled to claim an NOL carryover of $570,806 from the 2018 tax year on his 2019 return, the Sixth Circuit found that Shaut failed to prove both his right to a carryover deduction and the amount of the deduction. The court rejected his reliance on previous tax returns, which the court said are not conclusive, and without additional evidence to support this claimed loss, Shaut failed to meet his burden to substantiate his claimed carryover loss.

For a discussion of theft losses in general, see Parker Tax ¶84,510. For a discussion of the deduction for ordinary and necessary business expenses, see Parker Tax ¶90,110.

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