ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – INVESTMENT LOSSES VS CASUALTY LOSSES – WHAT’S THE DIFFERENCE?

By Robert S. Schriebman

2024

Introduction

Both the IRS and the FTB allow deductions arising from several categories of losses. The Internal Revenue Code (IRS) and the Revenue Taxation Code (FTB) have the same rules when it comes to losses.

In the case of an individual, the deduction for losses shall; be limited to:

1. Losses incurred in a trade or business;
2. Losses incurred in any transaction entered into for profit though not connected with a trade or business; and,
3. Losses of property not connected with a trade or business, or a transaction entered into for profit, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft.

May a loss arising from an investment be considered a casualty loss? Casualty losses usually follow a pattern when a loss is sudden, unusual, and unexpected. Casualty losses are deductible if they are over $100 and not covered by insurance. In other words, there is a $100 “deductible” when it comes to a casualty loss deduction.

An attorney, Michael H. Shaut, attempted to deduct an investment fraud loss as a casualty loss. Investment losses are usually deductible and limited to the extent of investment gains. Casualty losses are unlimited.

In this article I will review the case of Michael Shaut and the ruling in the US Tax Court case.

The Case of Michael Shaut

Michael H. Shaut v. Commissioner, TC Memo. 2024-103, November 6, 2024.

Michael Shaut was not only a lawyer, but he was also quite an entrepreneur. He started a student loan company which he ultimately sold to a Fortune 200 company. He also started a solar energy company. He began investing in a company called Downing Investment Partners, LLP (Downing). He invested his own money in Downing and eventually became Downing’s President. After serving as President, he became a managing director and recruited several individuals to invest substantial sums, each investing $1 million or more. Unfortunately, Downing was operated by thieves who eventually left Downing insolvent. Two of Downing’s principals where eventually investigated, prosecuted, and sentenced to prison in 2019 for their roles. Shaut continued to invest money in Downing, and he also defended several lawsuits where he was named as a defendant. All of this occurred before 2019. Shaut claims that he spent approximately $600,000 in legal fees relating to Downing. Further, Downing cost him all the money he had previously made, leaving him broke. In 2019, Shaut began practicing law again at the age of 67. He attempted to deduct his losses in 2019 including the $600,000 in legal fees. He took the position that his losses were casualty losses in the year 2019. All the losses and expenditures incurred between 2014 and 2018.

IRC § 165(c) allows a deduction for losses arising from a qualifying casualty or loss, including theft, not compensated by insurance or otherwise. To deduct a theft loss, a taxpayer must prove the existence of a theft, the amount of the deductible loss, and the year in which the loss was discovered. The theft loss must have been a criminal act under state law. The measure of theft loss is the difference between the fair market value of the property before and after the theft. Further, any loss arising from theft shall be treated as sustained during the taxable year in which the taxpayer discovers such loss.

During the trial in the Tax Court, Mr. Shaut did not introduce any reliable evidence indicating when he discovered that the theft loss occurred. The losses were sustained between 2016 and 2018. They were not sustained in 2019. Moreover, Shaut could not prove that he actually spent $600,000 in legal fees. He knew before 2019 that Downing was a financial failure, that improper activity occurred, and that he would not recover his investments. For these reasons alone, Shaut failed to carry his burden on demonstrating that his purported theft losses were “discovered” in 2019, thus entitling him to a casualty loss deduction for that year. The Tax Court concluded that his investments in Downing were anything more than a bad business decision. He could not deduct his losses as business-related under IRC § 162 because his primary business was practicing law. He was only an investor in Downing.

Conclusion

Losses arising out of bad investments are not considered casualty losses generally. One must prove that losses arising from theft by those in control occurred during the year of deductibility The casualty and theft loss provision under §165(c) is not designed to take care of all losses that the economic world may bestow on its inhabitants. See Friedman v. Commissioner, TC Memo. 192-588, 1992. Shaut was allowed investment loss deductions limited only to the extent of investment profits.

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Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 50 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments. Mr. Schriebman is in private practice. He is not affiliated in any way with the EDD, and he is not employed by the EDD or any other agency of the State of California.

Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.

Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House.

Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.

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