Sixth Circuit Upholds Tax Court Ruling Denying Business Deductions Over Lack of Records

WASHINGTON – A federal appeals court has affirmed a U.S. Tax Court decision that denied a taxpayer’s claimed business expense deductions, reinforcing the critical and unyielding requirement for taxpayers to provide thorough substantiation for all claimed expenses. The ruling serves as a stark reminder for small and mid-sized businesses that the burden of proof rests squarely on them when facing IRS scrutiny.

In an unpublished opinion issued on March 12, 2026, the U.S. Court of Appeals for the Sixth Circuit sided with the Internal Revenue Service in the case of Michael H. Shaut v. Commissioner. The court upheld the Tax Court’s prior determination that Shaut was liable for a tax deficiency of $3,548 for the 2019 tax year because he failed to provide sufficient evidence to support deductions for business expenses under Internal Revenue Code (IRC) § 162, theft losses under § 165, and net operating loss (NOL) carryovers under § 172.

The case originated after the IRS disallowed Shaut’s deductions related to complex investments and litigation. Shaut contested the determination, leading to a two-day trial in the U.S. Tax Court in April 2024. The Tax Court concluded that Shaut had not met his evidentiary burden, a decision he subsequently appealed to the Sixth Circuit.

The core of the dispute revolved around a fundamental principle of U.S. tax law: taxpayers must maintain and present adequate records to prove they are entitled to any deduction they claim. Under IRC § 162, businesses can deduct all “ordinary and necessary” expenses paid or incurred during the taxable year in carrying on any trade or business. However, as numerous court cases have established, simply incurring an expense is not enough. Taxpayers must be able to prove both the amount of the expense and its direct connection to their business activities.

This principle has been a frequent subject of litigation. A report from the IRS’s Taxpayer Advocate Service has previously identified substantiation of trade or business expenses as one of the most litigated issues before the Tax Court. In cases like Sherman v. Commissioner (2023), the court disallowed an emergency physician’s claimed deductions for advertising, travel, and meals, stating there was a “pervasive” lack of substantiation. Similarly, in Tarighi v. Commissioner (2015), deductions for a new engineering consulting business were denied because the taxpayer could not prove the business had actually commenced operations, meaning the expenses were considered non-deductible startup costs rather than ordinary business expenses.

The taxpayer’s testimony alone is rarely sufficient. Courts consistently seek documentary evidence such as receipts, invoices, canceled checks, bank statements, and detailed logs for travel and meals. For certain expenses listed under IRC § 274(d), including travel, meals, and certain listed property, the substantiation requirements are even more stringent, and courts are explicitly barred from applying the “Cohan rule,” a judicial doctrine that sometimes allows for the estimation of an expense amount if the taxpayer can prove an expense was incurred but lacks exact records.

In the Shaut case, the Sixth Circuit also addressed a procedural matter concerning a $2.5 million arbitration opinion against Shaut, which the Tax Court had excluded as hearsay. The appellate court determined that even if the evidence had been improperly excluded, the error would have been “harmless.” It reasoned that sufficient alternative evidence already supported the Tax Court’s denial of the deductions, illustrating the high legal bar for overturning a lower court’s decision on such grounds.

The ruling underscores the non-negotiable nature of meticulous record-keeping for all businesses. The IRS and the courts presume the agency’s deficiency determination is correct, and it is up to the taxpayer to present credible evidence to overcome that presumption. Without a clear paper trail connecting expenditures to business purposes, deductions are likely to be disallowed, resulting in additional taxes, interest, and potential penalties for substantial understatement.

In our experience, cases like Shaut are cautionary tales for business owners who might treat record-keeping as a secondary task. The burden of proof always falls on the taxpayer, and the IRS and courts have shown little patience for disorganized, incomplete, or after-the-fact documentation. We often see entrepreneurs, passionate about their core operations, neglect the back-office discipline required to defend their financial statements under audit. Simply having a receipt is not enough; a business must also be able to prove the 'ordinary and necessary' business purpose for every claimed expense. This is where professional guidance becomes invaluable in establishing systems before an audit is ever initiated. For businesses looking to ensure their financial records can withstand scrutiny, robust tax preparation and compliance services are essential. To build a resilient financial foundation, business owners can contact C&S Finance Group LLC at csfinancegroup.com for expert assistance.

Looking ahead, tax professionals will continue to monitor how courts apply these strict substantiation standards, particularly as business operations become more digitized and complex. The consistent pattern of rulings, however, suggests that the fundamental requirement for clear, contemporaneous, and comprehensive documentation is unlikely to change. For business owners, the message from the courts remains clear: document everything or risk losing the deduction.