# Dixon v. Commissioner

> United States Tax Court · March 30, 1999 · 77 T.C.M. 1630

URL: https://www.frixlaw.com/law-library/cases/4332202

## Case

- **Full name:** JERRY AND PATRICIA A. DIXON, <sup id="fnr_fnote1"><a href="fn_fnote1" id="">1</a></sup> v. COMMISSIONER OF INTERNAL REVENUE, <sup id="fnr_fnote2"><a href="fn_fnote2" id=""></a></sup>
- **Court:** United States Tax Court
- **Decided:** March 30, 1999
- **Citations:** 77 T.C.M. 1630; 1999 T.C. Memo. 101; 1999 Tax Ct. Memo LEXIS 118
- **Precedential status:** Unpublished
- **Opinion:** Opinion
- **Judges:** BEGHE
- **Cited by:** 6 later opinions in the Frix Law Library

## Citator (automated)

- No negative treatment found by the automated citator. That is not the same as a confirmation that the case is good law; read the citing cases.
- Full citator and citing cases: https://www.frixlaw.com/law-library/cases/4332202

## Opinion text

T.C. Memo. 1999-101

UNITED STATES TAX COURT

JERRY AND PATRICIA A. DIXON, ET AL.,1 Petitioners
v. COMMISSIONER OF INTERNAL REVENUE, Respondent*

Docket Nos. 9382-83, 17646-83, Filed March 30, 1999.
4201-84, 7323-84,
15907-84, 20119-84,
40159-84, 22783-85,
30010-85, 30979-85,
29643-86, 35608-86,
19464-92, 621-94,
7205-94, 9532-94,
17992-95, 17993-95.

1
Cases of the following petitioners are consolidated
herewith: Ronald L. Alverson and Mattie L. Alverson, docket No.
17646-83; Hoyt W. and Barbara D. Young, docket Nos. 4201-84,
22783-85, 30010-85; Anthony E. and Carol A. Eggers, docket No.
7323-84; Robert L. and Carolyn S. DuFresne, docket Nos. 15907-84,
30979-85; John L. and Terry E. Huber, docket No. 20119-84;
Terry D. and Gloria K. Owens, docket No. 40159-84; Richard and
Fidella Hongsermeier, docket No. 29643-86; Norman W. and
Barbara L. Adair, docket No. 35608-86; Willis F. McComas, II and
Marie D. McComas, docket No. 19464-92; Wesley Armand and Sherry
Lynn Cacia Baughman, docket No. 621-94; Joe A. and JoAnne
Rinaldi, docket No. 7205-94; Norman A. and Irene Cerasoli, docket
No. 9532-94; Stanley C. and Sharon A. Titcomb, docket No. 17992-
95; Richard B. and Donna G. Rogers, docket No. 17993-95.
*
This opinion supplements our previously filed Memorandum
Findings of Fact and Opinion in Dixon v. Commissioner, T.C. Memo.
1991-614, vacated and remanded per curiam sub nom. DuFresne v.
Commissioner, 26 F.3d 105 (9th Cir. 1994).
- 2 -

In Dixon v. Commissioner, T.C. Memo. 1991-614,
vacated and remanded per curiam sub nom. DuFresne v.
Commissioner, 26 F.3d 105 (9th Cir. 1994), following a
trial of 14 docketed test cases of eight Ps, the Court
sustained R's disallowance of interest deductions
claimed by Ps in various tax shelter programs promoted
by K. After the Court entered decisions against the
test case Ps in accordance with its opinion, R moved to
vacate the decisions entered in three test cases (T, C,
and X). R alleged that, before the trial of the test
cases, R's trial attorney and District Counsel had
entered into contingent settlement agreements with T
and C that had not been disclosed to the Court or to
the other test case Ps or their counsel. R asked the
Court to conduct an evidentiary hearing to determine
whether the undisclosed agreements with T and C had
affected the trial of the test cases or the opinion of
the Court.

The Court granted R's motions to vacate the
decisions entered in the T and C cases, entered revised
decisions in the T and C cases consistent with R's
prior agreements with T and C, denied R's motion to
vacate the decision in the X case, and denied R's
request for an evidentiary hearing on the ground that
the testimony, stipulated facts, and exhibits relating
to the T and C cases had no material effect on the
Court's opinion as it related to the remaining test
case Ps.

On appeal, the Court of Appeals for the Ninth
Circuit vacated the decisions in the remaining test
cases and remanded them to this Court with directions
"to conduct an evidentiary hearing to determine the
full extent of the admitted wrong done by the
government trial lawyers." DuFresne v. Commissioner,
supra at 107. The Court of Appeals, citing Arizona v.
Fulminante, 499 U.S. 279, 309 (1991), directed the
Court to consider "whether the extent of misconduct
rises to the level of a structural defect voiding the
judgment as fundamentally unfair, or whether, despite
the government's misconduct, the judgment can be upheld
as harmless error." Id. Further, the Court of Appeals
directed this Court to consider on the merits all
motions of intervention filed by affected parties. See
id. This Court ordered that the cases of 10 nontest
case Ps, the majority of whom had previously signed
piggyback agreements, be consolidated with the
remaining test cases for purposes of the evidentiary
hearing. Three groups of Ps participated in all
subsequent phases of the evidentiary hearing.
- 3 -

Ps argue (under various theories) that the Court's
decisions in the remaining test cases should not be
reinstated, or, in the alternative, that the piggyback
agreements are not enforceable. R counters that the
decisions in the remaining test cases should be
reinstated on the ground that Ps were not prejudiced by
the Government misconduct in the trial of the test
cases and that the piggyback agreements remain in
force.

Held: The Government misconduct in the trial of
the test cases did not result in a structural defect in
the trial. Held further: The Government misconduct in
the trial of the test cases resulted in harmless error.
Held further: The Government misconduct in the trial
of the test cases does not provide any other basis for
invalidating the Court's decisions in the remaining
test cases or for setting aside the piggyback
agreements. Held further: As a sanction against R,
program participants who have not been the subject of a
final determination are not liable for time-sensitive
additions to tax for negligence under secs. 6653(a)(2)
and 6653(a)(1)(B), I.R.C., or increased interest under
sec. 6621(c), I.R.C.

Joe Alfred Izen, Jr., counsel for petitioners in docket Nos.

9382-83, 4201-84, 15907-84, 40159-84, 22783-85, 30010-85, 30979-

85, 29643-86, and 35608-86.

Robert Alan Jones, counsel for petitioners in docket Nos.

17646-83, 19464-92, 621-94, and 9532-94.

Robert Patrick Sticht, counsel for petitioners in docket

Nos. 7323-84, 20119-84, 7205-94, 17992-95, and 17993-95.

Mary Elizabeth Wynne, Steven A. Wilson, Andrew J. Gottlieb,

Milton J. Carter, Jr., Robert E. Casey, and Richard S. Goldstein,

for respondent.
- 4 -

CONTENTS

Page
Introduction....................................................9

FINDINGS OF FACT...............................................15

I. Kersting Tax Shelter Programs and Related Matters........15
A. The Pike Case............................................15
B. Kersting Criminal Investigation..........................16
C. Assessments of Kersting Promoter Penalties...............18
D. Kersting Notice of Deficiency............................19

II. Notices of Deficiency Issued to Kersting Program
Participants ............................................20
A. Form of Notices of Deficiency............................20
B. Thompson Notices of Deficiency...........................21
C. Cravens Notices of Deficiency............................23
D. Alexander Notices of Deficiency..........................24
1. 1974 and 1975.........................................25
2. 1976 and 1977.........................................26
E. Validity of Notices of Deficiency........................27
F. Errors in Notices of Deficiency..........................27

III. Commencement of Kersting Project ........................28
A. Tax Shelter Projects and Test Case Procedures............28
1. Overview..............................................28
2. National Office Tax Shelter Branch Functions..........30
B. Petitions for Redetermination............................31
C. Brian J. Seery...........................................32
D. Respondent's Counsel.....................................33
1. Kenneth W. McWade.....................................33
2. William A. Sims.......................................34
E. Adoption of Test Case Procedures in Kersting Project.....34
1. The Honolulu Session (June 1985)......................34
2. Test Case Procedure...................................35
3. Test Case Array.......................................38

IV. The Maui Session (February 1987).........................42
A. Trial Notices............................................42
B. Piggyback Agreements.....................................44
C. Mr. Seery's Withdrawals as Counsel.......................48
1. The Thompsons.........................................49
2. The Test Cases........................................50
D. Entries of Appearance by Chicoine and Hallett............51
E. Evidentiary Issues.......................................54
1. The Maui Session......................................54
2. Dixon I Opinion.......................................55

V. Kersting Disputes With Program Participants..............55
A. The Thompsons............................................56
- 5 -

1. The Bauspar Program...................................56
2. Deterioration of Thompson/Kersting Relationship.......57
B. The Alexander Dispute....................................67
C. Collection Actions.......................................72
1. Steve Hane............................................72
2. Carl Mott, George Vermef, and Robert Peterson.........73

VI. Settlements..............................................74
A. Internal Revenue Service Policy..........................74
1. National Office Position..............................74
2. Regional Counsel......................................76
B. Official Kersting Project Settlement Offer (7-Percent
Reduction of Deficiency or Out-of-Pocket Expenses).......77
C. Deviations From Official Project Settlement Offer........78
1. Modified 7-Percent Settlement Offer...................78
2. 20-Percent Settlement Offer...........................80
3. Negotiations for 50-Percent Settlement Offer..........82
4. Revival of 20-Percent Settlement Offer................84
D. The Thompson Settlement..................................92
1. Initial Thompson Settlement Agreement.................92
2. First Revision of Thompson Settlement.................94
3. Second Revision of Thompson Settlement................98
E. The Cravens Settlement..................................100
F. The Alexander Understanding.............................106
G. The Kozak Decision......................................115

VII. Pretrial Developments...................................116
A. The Kersting Deposition--Postponed (January 1987).......116
B. John Doe Summons/Assessments of Promoter Penalties......118
C. Chicoine and Hallett's Withdrawal as Counsel............120
D. Mr. Izen's Entry of Appearance..........................120
E. The Kersting Deposition (October 1988)..................121

VIII. Trial of Test Cases (January 1989)......................123
A. Mr. Cravens.............................................124
B. Mr. Thompson............................................126
C. Mr. Kersting............................................129
D. Mr. Alexander...........................................130
E. Mr. DeCastro............................................133
F. Comfort Letters.........................................133
G. Mr. Izen's Introduction of Evidence of Collection
Litigation..............................................135

IX. Posttrial Developments..................................137
A. First Thompson Refund...................................137
B. Mr. Izen's Motion To Reopen Record......................141
C. Dixon II Opinion........................................142
D. Disclosure of Thompson Settlement.......................143
E. Disclosure of Cravens Settlement........................152
F. Respondent's Motions To Vacate..........................155
- 6 -

G. Attempted Discovery by Counsel for Nontest Case
Petitioners.............................................156
H. Closing of Thompson Cases/Further Refunds...............156
I. Closing of Cravens Cases................................160

PROCEDURAL HISTORY OF EVIDENTIARY HEARING.....................162

I. Developments Before Evidentiary Hearing.................162
A. Referral of Thompson and Cravens Settlements to Office
of Inspector General....................................162
B. Revival of 7-Percent Settlement Offer...................165
C. Disciplinary Actions....................................165
D. Indictment of Mr. Izen..................................166
E. Pretrial Conference (July 1995).........................167
F. Pretrial Conference (January 1996)......................168
G. Denial of Respondent's Motion To Disqualify Mr. Izen....168
H. Mr. DeCastro's Withdrawal...............................170
I. Discovery of Alexander Decisions and Referral to
Office of Inspector General.............................170
J. Mr. Izen's Motion To Compel Production of Documents
and Issuance of Protective Orders.......................171
K. Burden of Proof and Rule 145 Order......................173

II. The Evidentiary Hearing.................................175
A. Testimony...............................................176
1. Mr. Cravens......................................... 176
2. Mr. Thompson.........................................178
3. Mr. Alexander........................................179
4. Mr. McWade...........................................180
5. Mr. Sims.............................................182
6. Mr. DeCastro.........................................183
7. Mr. Izen.............................................184
B. Mr. Sticht's Allegations of Potential Witness
Intimidation............................................186
C. Mr. Bradt's June 12, 1996, Letter to Mr. Kersting.......187
D. Denial of Mr. Izen's Motion To Refer Thompson and
Cravens Settlements and Alexander Agreement to
Department of Justice (Public Integrity Section)........189

III. Developments Following Initial Evidentiary Hearing......189
A. Denial of Respondent's Motion for Further Hearing
Regarding Potential Witness Intimidation................189
B. Supplemental Evidentiary Hearing (August 18, 1997)......192
C. Denial of Mr. Izen's Motion To Compel Production of
Documents...............................................194
D. Denial of Mr. Sticht's Motion To Reopen Record..........195
E. Denial of Mr. Izen's Motion To Take Judicial Notice.....196
F. Denial of Mr. Sticht's Motions for Release From
Piggyback Agreements....................................198
G. Reports Regarding the Court's Protective Orders.........199
- 7 -

ULTIMATE FINDINGS OF FACT.....................................200

OPINION.......................................................202

I. Burden of Proof.........................................203

II. Structural Defect.......................................211
A. Case Law................................................211
B. Arguments...............................................215
C. Summary of Government Misconduct........................218
D. Discussion..............................................225

III. Harmless Error Analysis.................................233
A. Review of Dixon II......................................236
1. Mr. Kersting's Lack of Credibility...................237
2. Sham Analysis........................................238
3. Lack of Genuine Debt/Waltz of Funds..................240
i. Subscription Interest...........................241
ii. Primary Loans...................................242
iii. Leverage Loans..................................244
4. Collection Litigation................................244
5. CAT-FIT Plan.........................................245
6. Additions to Tax.....................................247
i. Negligence......................................247
ii. Late Filing.....................................247
iii. Substantial Understatement......................247
iv. Increased Interest..............................248
B. Discussion..............................................249
1. Mr. Cravens.........................................249
i. Sham Analysis...................................251
ii. Lack of Genuine Debt/Waltz of Funds.............254
2. Mr. Thompson.........................................255
i. Sham Analysis...................................257
ii. Lack of Genuine Debt/Waltz of Funds.............258
iii. Additions to Tax................................262
3. Mr. Alexander........................................264
4. Summary..............................................266

IV. Fraud, Misrepresentation, and Misconduct................267

V. Fraud on the Court......................................271
A. Case Law Survey.........................................271
B. Discussion..............................................281

VI. Mr. Izen's Allegations That Mr. DeCastro Was a "Mole"...283

VII. Enforceability of Piggyback Agreements..................284
A. Principles of Contract Law..............................285
B. Discussion..............................................290
1. Benefit of the Bargain...............................290
2. Mr. Seery's Purported Conflict of Interest...........294
- 8 -

3. Rejection of Mr. Izen's Argument for Entry of
Decision On the Basis of Thompson Decisions..........296

VIII. Mary Carter Agreements..................................296

IX. Mr. Sticht's Motion To Sever Case and for Entry of
Decision or Alternatively To Sever Case and Set for
Trial ..................................................300

X. Protective Orders.......................................302

XI. Sanctions...............................................305

Conclusion....................................................307

SUPPLEMENTAL MEMORANDUM FINDINGS OF FACT AND OPINION

BEGHE, Judge: Eight of these consolidated cases--with five

petitioners represented by Joe Alfred Izen, Jr. (Mr. Izen),--are

test cases before the Court on remand from the Court of Appeals

for the Ninth Circuit in DuFresne v. Commissioner, 26 F.3d 105

(9th Cir. 1994), vacating and remanding per curiam Dixon v.

Commissioner, T.C. Memo. 1991-614.

The other 10 consolidated cases--with petitioners in one

case represented by Mr. Izen and the other petitioners

represented by Robert Alan Jones (Mr. Jones) and Robert Patrick

Sticht (Mr. Sticht)--are nontest cases that have been added to

the consolidated group in order to effectuate the direction of

the Court of Appeals "to consider on the merits all motions of

intervention filed by parties affected by this case." Id. at

107.

Unless otherwise indicated, section references are to the

Internal Revenue Code, as amended, and Rule references are to the

Tax Court Rules of Practice and Procedure.
- 9 -

Introduction

These consolidated cases are part of a group of more than

1,300 remaining cases--more than 500 cases have settled--arising

from respondent's disallowance of interest deductions claimed by

participants in various tax shelter programs promoted by Henry

F.K. Kersting (Mr. Kersting). The Kersting group of cases

(hereinafter the Kersting project) was assigned to Judge

William A. Goffe (Judge Goffe) for disposition. By agreement of

the parties and the Court, the merits of the Kersting programs

were to be litigated in a consolidated trial of 14 docketed cases

of eight petitioners that had been designated as "test cases".

The vast majority of the remaining Kersting project petitioners

signed stipulations to be bound (sometimes referred to herein as

piggyback agreements) in which they agreed with respondent that

their cases would be resolved in accordance with the Court's

opinion in the test cases.

Before the trial of the test cases, some test case

petitioners argued that a 1981 search of Mr. Kersting's office

had been illegal, that materials seized during the search should

be suppressed in the test case proceedings, and that the burden

of proof and burden of going forward with evidence should be

shifted to respondent. In Dixon v. Commissioner, 90 T.C. 237

(1988) (Dixon I), the Court held, in an opinion by Judge Goffe,

that the petitioners had failed to establish standing to contest

the Kersting search and seizure.
- 10 -

Judge Goffe held the trial of the test cases in Honolulu,

Hawaii, during January 1989. The majority of the test case

petitioners were represented at trial by Mr. Izen. However, test

case petitioners John R. and Maydee L. Thompson (docket Nos.

19321-83, 31236-84, and 30965-85) were represented at trial by

Luis C. DeCastro (Mr. DeCastro), and test case petitioners John

R. and E. Maria Cravens (docket Nos. 16900-83 and 15135-84)

appeared pro sese.

Following the trial of the test cases, the Court issued its

memorandum opinion in Dixon v. Commissioner, T.C. Memo. 1991-614,

62 T.C.M. (CCH) 1440, 1991 T.C.M. (RIA) par. 91,614 (Dixon II),

sustaining virtually all of respondent's determinations in each

of the test cases, and entered decisions against the test case

petitioners in accordance with its opinion.

On March 13, 1992, the Court entered the following decisions

in the Thompson and Cravens cases:

John R. and Maydee L. Thompson

Additions to Tax
Sec. Sec. Sec. Sec.
Year Deficiency 6651(a) 6653(a) 6653(a)(1) 6653(a)(2)

1979 $18,161.00 --- $908 --- ---
1980 24,838.00 --- --- --- ---
1981 36,294.52 $4,934.32 --- $1,958.28 50 percent of
the interest
due on the
deficiency

John R. and E. Maria Cravens
Additions to Tax
Year Deficiency Sec. 6653(a)

1979 $4,508.00 $225.40
1980 5,893.45 294.67
- 11 -

On June 9, 1992, respondent filed motions for leave to file

motions to vacate the decisions entered against the Thompsons,

the Cravenses, and another test case petitioner, Ralph J. Rina

(Mr. Rina), docket No. 17640-83. Respondent's motions to vacate

alleged that, before the trial of the test cases, respondent's

trial attorney, Kenneth W. McWade (Mr. McWade), and his

supervisor, Honolulu District Counsel William A. Sims (Mr. Sims),

had entered into contingent settlement agreements with the

Thompsons and the Cravenses that had not been disclosed to the

Court or to the other test case petitioners or their counsel.

Respondent asked the Court to conduct an evidentiary hearing to

determine whether the undisclosed agreements with the Thompsons

and the Cravenses had affected the trial of the test cases or the

opinion of the Court.

On June 22, 1992, Judge Goffe granted respondent's motions

to vacate filed in the Thompson and Cravens cases, vacated the

decisions entered in those cases, ordered the parties to file

agreed decisions with the Court, or otherwise move as

appropriate, and denied respondent's request for an evidentiary

hearing. By order dated June 22, 1992, Judge Goffe also denied

respondent's motion to vacate the decision entered against

Mr. Rina, on the ground that the testimony, stipulated facts, and

exhibits relating to the Thompson and Cravens cases had no

material effect on the Court's Dixon II opinion as it related to

Mr. Rina.
- 12 -

On July 22, 1992, the test case petitioners represented by

Mr. Izen filed a motion for reconsideration of the Court's order

denying respondent's motion to vacate the decision in the Rina

case. By order dated August 4, 1992, Judge Goffe denied

petitioners' motion for reconsideration.

In August 1992, the Court entered revised decisions in the

Thompson and Cravens cases consistent with Mr. McWade's prior

agreements with the taxpayers in those cases. Specifically, the

Court entered the following decisions in the Thompson and Cravens

cases:

John R. and Maydee L. Thompson

Year Deficiency Additions to Tax

1979 --- ---
1980 $15,000 ---
1981 15,000 ---

John R. and E. Maria Cravens

Year Deficiency Additions to Tax

1979 $3,606.40 ---
1980 6,175.76 ---

The decisions entered in the Thompson and Cravens cases are now

final.2

2
Mr. Izen and Mr. Sticht filed separate motions with the
Court to intervene in the Thompson and Cravens cases. The Court
denied these motions to intervene. Although Mr. Izen and
Mr. Sticht filed separate appeals in the Thompson and Cravens
cases with various courts, including the Courts of Appeals for
the Second, Ninth, and Tenth Circuits, all appeals in the
Thompson and Cravens cases eventually were dismissed. In an
unpublished opinion filed June 15, 1994, the Court of Appeals
for the Ninth Circuit stated:

(continued...)
- 13 -

Because of Judge Goffe's termination, on September 30, 1992,

of his recall status as a Senior Judge of the Court, all cases in

the Kersting project group were reassigned to Judge Renato Beghe.

The other test case petitioners, including Mr. Rina,

appealed the decisions entered in their cases to the Court of

Appeals for the Ninth Circuit. On appeal, those petitioners

argued that the trial of the test cases had been tainted by the

Thompson and Cravens settlement agreements. The response of the

Court of Appeals was to vacate the decisions in the remaining

test cases and remand them to this Court with directions "to

conduct an evidentiary hearing to determine the full extent of

the admitted wrong done by the government trial lawyers."

DuFresne v. Commissioner, 26 F.3d at 107. The Court of Appeals,

citing Arizona v. Fulminante, 499 U.S. 279, 309 (1991), directed

the Court to consider "whether the extent of misconduct rises to

the level of a structural defect voiding the judgment as

fundamentally unfair, or whether, despite the government's

misconduct, the judgment can be upheld as harmless error."

DuFresne v. Commissioner, supra at 107. Further, the Court of

2
(...continued)
The Tax Court's August 25 and 26, 1992 decisions
entering settlement in the Cravens and Thompson cases,
respectively, are final. 26 U.S.C. § 7481(a)(1); Fed.
R. App. P. 13. The Tax Court lacks jurisdiction to
vacate those decisions. Billingsley v. CIR, 868 F.2d
1081, 1084 (9th Cir. 1989). Because there is no case
remaining in which the taxpayers can intervene, this
appeal is moot. [Adair v. Commissioner, No. 92-70812,
26 F.3d 129 (9th Cir. 1994).]
- 14 -

Appeals directed this Court to consider on the merits all motions

of intervention filed by parties affected by Dixon II. See id.3

On February 2, 1995, respondent filed a Motion for an

Evidentiary Hearing. On September 14, 1995, the Court granted

respondent's motion. To effectuate the direction of the Court of

Appeals regarding intervention, the Court ordered that the cases

of 10 nontest case petitioners, the majority of whom had

previously signed piggyback agreements, be consolidated with the

remaining test cases for purposes of the evidentiary hearing.4

As a result, three groups of petitioners have participated in all

subsequent phases of the evidentiary hearing: Test case and

nontest case petitioners represented by Mr. Izen; nontest case

petitioners represented by Mr. Jones; and nontest case

petitioners represented by Mr. Sticht.5 The positions taken by

3
The appellate panel in DuFresne v. Commissioner, 26 F.3d
105, 107 (9th Cir. 1994), vacating and remanding per curiam Dixon
v. Commissioner, T.C. Memo. 1991-614, 62 T.C.M. (CCH) 1440, 1991
T.C.M. (RIA) par. 91,614 (Dixon II), issued an order stating that
the panel would retain jurisdiction over any subsequent appeal.
4
On June 13, 1995, test case petitioner Mr. Rina conceded
his case in full, resulting in entry of a stipulated decision in
docket No. 17640-83 that was identical with the decision
originally entered in that case on the basis of the Court's
opinion in Dixon II.
5
The group of cases that were consolidated for purposes of
the evidentiary hearing initially included the case of William D.
and Karen S. Booth, docket No. 28950-88, in which Declan J.
O'Donnell (Mr. O'Donnell) had entered his appearance. However,
at the start of the evidentiary hearing, the Court granted
Mr. O'Donnell's motion to sever the Booth case from the cases
consolidated for the evidentiary hearing. Mr. O'Donnell argued
that, in light of the theory underlying a Motion for Summary
Judgment that he had filed on behalf of the Booths, they had no
(continued...)
- 15 -

the various groups of petitioners during these proceedings have

not been consistent in all respects and in some respects the

positions of counsel--primarily Messrs. Izen and Sticht--have

become adversarial.6

Following pretrial conferences on the record in Los Angeles

on July 17, 1995, and January 16, 1996, the evidentiary hearing

was held at special trial sessions of the Court conducted in Los

Angeles on May 13 to 30 and June 10 to 26, 1996, and August 18,

1997.

In the interest of chronology and as an aid to understanding

this opinion, the procedural history of the evidentiary hearing

comes after the Court's detailed findings of fact and before the

ultimate findings of fact.

FINDINGS OF FACT

I. Kersting Tax Shelter Programs and Related Matters

A. The Pike Case

Mr. Kersting began promoting tax shelter programs in Hawaii

in the early 1970's. Mr. Kersting's early tax shelter programs

included an "Auto-Leasing Plan" and an "Acceptance Corporation

Plan." Those plans generally required participants to purchase

5
(...continued)
need to participate in the evidentiary hearing. In Gridley v.
Commissioner, T.C. Memo. 1997-210, the Court rejected the
argument, raised in the Booths' Motion for Summary Judgment,
that Kersting petitioners who signed stipulations to be bound
to Dixon II were entitled to entry of decisions in their cases
consistent with the decision entered by the Court in the Thompson
case at docket No. 19321-83.
6
See infra pp. 168-169, 171-172, and 187-188.
- 16 -

stock in a subchapter S leasing corporation or an acceptance

corporation and/or enter into a subscription agreement to

purchase stock, all in connection with loans to the participants

by various entities created by Mr. Kersting. The plans were

primarily designed to generate income tax deductions for interest

that the participants purportedly paid to the Kersting entities

on the loans.

The Commissioner determined that participants in

Mr. Kersting's auto-leasing and acceptance corporation plans were

not entitled to deduct: (1) "Interest" that participants claimed

to have paid on either the Auto-Leasing stock purchase or

leverage loans; (2) the participants' pro rata shares of losses

or investment credits from the auto leasing companies; and

(3) "interest" that participants claimed to have paid either on

the acceptance corporation stock purchase or stock subscription

loans.

In Pike v. Commissioner, 78 T.C. 822 (1982), affd. without

published opinion 732 F.2d 164 (9th Cir. 1984), this Court

sustained the Commissioner's disallowances of all deductions for

interest, losses, and credits claimed by participants in

Mr. Kersting's early programs.

B. Kersting Criminal Investigation

While the Pike litigation was underway, Mr. Kersting

continued to promote additional tax shelter programs, which came

to be known as the stock purchase plan, the stock subscription

plan, the leasing company plan, and the CAT-FIT plan. The
- 17 -

Court's opinion in Dixon II describes the mechanics of these

programs in detail.7

On January 22, 1981, following an undercover criminal

investigation, the Internal Revenue Service searched

Mr. Kersting's offices in Hawaii pursuant to a search warrant

issued by the U.S. District Court for the District of Hawaii.

Seventy-seven boxes and two filing cabinets of records were

seized from Mr. Kersting's office, including lists identifying,

by name and address, approximately 1,800 participants in

Mr. Kersting's programs, and schedules of the interest

purportedly paid by each participant to one or more Kersting

companies during the taxable years 1977, 1978, and 1979.

On January 24, 1981, Mr. Kersting wrote a form letter to the

participants of his programs, one of his many "Dear Friend"

letters, stating that he had been entrapped by an undercover

Internal Revenue Service special agent into creating a backdated

"tax deduction" of $21,600.8 By letter dated February 15, 1981,

Mr. Kersting provided participants in his programs with "tax

reporting notices", presumably for the 1980 tax year, and

encouraged them to "take full advantage of the deductions

7
The Kersting programs involved a number of corporations
(hereinafter Kersting corporations). Mr. Kersting served as both
a director and president of most of these corporations and also
sometimes owned stock. For those corporations in which he served
as president during the years in issue, he had exclusive
management authority.
8
The record in these cases contains no fewer than 38 "Dear
Friend" letters.
- 18 -

reported to you." Mr. Kersting further informed participants

that the Internal Revenue Service had "accomplished only a

temporary disruption of our operations" and that his office was

"back to almost normal workings". All records seized in the

January 22, 1981, search were returned to Mr. Kersting by 1987.

In January 1983, Mr. Kersting filed suit in the U.S.

District Court for the District of Hawaii (docket No. CV-83-0018-

MP) against the United States, the Internal Revenue Service, and

certain Internal Revenue Service agents alleging, inter alia,

that the January 1981 search was illegal and that the defendants

had abused the grand jury process by shopping for a favorable

grand jury, by violating grand jury secrecy, and by using the

grand jury as a civil investigation tool. Through a number of

unpublished orders, the District Court and the Court of Appeals

for the Ninth Circuit rejected Mr. Kersting's claims. See

Kersting v. United States, 865 F. Supp. 669, 674-675 (D. Haw.

1994).

C. Assessments of Kersting Promoter Penalties

Mr. Kersting's tax shelter activities did not lead to an

indictment. However, in October 1989, the Commissioner assessed

promoter penalties of $1,545,201 and $2,330,000 against

Mr. Kersting, pursuant to sections 6700 and 6701, respectively,

for the years 1982 through 1988.9 The District Court for the

9
Sec. 6700 provides for imposition of a penalty of a
percentage of the gross income derived from promoting an abusive
tax shelter, and sec. 6701 provides for imposition of a penalty
(continued...)
- 19 -

District of Hawaii sustained the Commissioner's assessments. See

Kersting v. United States, Civil Nos. 90-00304, 91-00747, 92-

00593 (D. Haw., Sept. 30, 1994). Mr. Kersting's appeal of that

decision to the Court of Appeals for the Ninth Circuit, docket

No. 94-16942, was argued and submitted on May 8, 1996, but

subsequently withdrawn from submission (with an opportunity for

supplemental briefing) until after this Court issues its opinion

in these consolidated cases.

D. Kersting Notice of Deficiency

The Commissioner sent Mr. Kersting a notice of deficiency

determining deficiencies in and additions to his Federal income

taxes for the taxable years 1982 through 1988. The deficiencies

were based upon the Commissioner's determination that cash

payments of so-called leverage loan interest received by Kersting

corporations, which were characterized by the District Court in

the promoter penalty cases as "alter egos" of Mr. Kersting, and

which the Court's Dixon II opinion characterized as fees paid to

Mr. Kersting by program participants in exchange for tax

deductions, were includable in Mr. Kersting's gross income.

Mr. Kersting filed a timely petition for redetermination with

this Court (assigned docket No. 7448-96), and the case was tried

at a Honolulu special trial session that commenced January 27,

1999.

9
(...continued)
of $1,000 (per incident) upon a person who knowingly aids or
assists another in understating his tax liability.
- 20 -

II. Notices of Deficiency Issued to Kersting Program
Participants

In 1982, respondent began to issue notices of deficiency to

Kersting program participants, disallowing interest deductions

claimed with respect to the stock purchase plan, the stock

subscription plan, the leasing company plan, and the CAT-FIT plan

for a number of taxable years.

A. Form of Notices of Deficiency

The notices of deficiency issued by respondent to many

Kersting program participants used a common format, stating in

pertinent part as follows:

EXPLANATION OF ADJUSTMENTS

1. It is determined that the following amounts claimed
on your income tax return as interest deductions
are not allowable:

Amount Purported Payee[10]

$--------- Any entity owned, associated
with, or controlled, either
directly or indirectly, by
Henry Kersting

This disallowance is based on the determination that
the transactions giving rise to the claimed interest
deduction are shams. This disallowance is further
based upon your failure to establish that the above
amounts were paid or properly accrued, or that the
transactions purportedly generating the claimed amounts
resulted either in any bona fide indebtedness or in any
enforceable and bona fide obligation to pay
compensation for use or forbearance of money on
indebtedness within the meaning of I.R.C. Section 163.

Furthermore, if it is established that any portion
of the above disallowed "interest" is a properly

10
In some instances, respondent's notices of deficiency
listed specific Kersting corporations under "Purported Payee".
- 21 -

allowable deduction, it is further determined that such
interest constitutes interest in investment
indebtedness and deduction of such amounts is limited
under the provisions of I.R.C. 163(d).

Further, and in support of a portion of the
determined deficiency, if you establish that you are
entitled to the above-mentioned interest deduction, it
is determined that you improperly failed to report the
income resulting from the same transaction.

2. It is determined that part of the underpayment of
tax for the taxable year ____ is due to your negligent
of [sic] intentional disregard of the rules and
regulations. Consequently, the 5 percent addition to
the tax is charged for ____ as provided by Section
6653(a) of the Internal Revenue Code.

B. Thompson Notices of Deficiency

John R. Thompson (Mr. Thompson) was a pilot with Continental

Airlines from 1946 until his retirement in October 1982.

Mr. Thompson became aware of Mr. Kersting's programs through a

conversation with another pilot, Michael Provan (Mr. Provan), who

had solicited other pilots to participate in Mr. Kersting's

programs.11 The Thompsons began participating in Mr. Kersting's

programs in 1977.12 In addition to their participation in

11
Mr. Provan, who was at one time the president of one of
the Kersting companies, eventually became an adversary of
Mr. Kersting. See infra p. 66.
12
Although the Thompsons participated in one of
Mr. Kersting's programs during 1977, the Thompsons did not
claim any Kersting-related interest deductions on their 1977
return because their accountant-return preparer refused to
include them on the return.

The record suggests that the Thompsons' 1978 tax return
was prepared by Phil Scheff (an accountant recommended by
Mr. Kersting) and that the Thompsons claimed Kersting program
interest deductions on their return for that year. The Thompsons
experienced audit problems with their 1978 tax return that were
(continued...)
- 22 -

certain programs that were the subject of this Court's opinion in

Dixon II, the Thompsons, along with some 40 other investors,

including Mr. Provan, participated in a transaction arranged by

Mr. Kersting in early 1978 to acquire First Savings and Loan

Association of Hawaii (First Savings).

The Thompsons filed joint Federal income tax returns for

1979, 1980, and 1981 in which they claimed interest deductions

attributable to their participation in certain Kersting programs.

On May 5, 1983, June 13, 1984, and May 31, 1985, respondent

mailed notices of deficiency to the Thompsons determining

deficiencies in and additions to their Federal income taxes for

the taxable years 1979, 1980, and 1981, as follows:

Additions to Tax
Sec. Sec. Sec. Sec.
Year Deficiency 6651(a) 6653(a) 6653(a)(1) 6653(a)(2)

1979 $18,161.00 --- $908 --- ---
1980 24,838.00 --- --- --- ---
1981 36,294.52 $4,934.32 --- $1,958.28 50 percent of
the interest due
on the deficiency

Respondent further determined that the Thompsons were liable for

increased interest for 1981 pursuant to section 6621(d).13 The

12
(...continued)
due, in part, to their failure to attach to the return a Form W-2
showing the amount of tax that Continental Airlines had withheld
from Mr. Thompson's wages. In early to mid-1986, the Thompsons'
counsel, Samuel M. Huestis, negotiated a settlement of their tax
liability for 1978. The record does not disclose the terms of
the settlement.
13
Sec. 6621(d) was redesignated sec. 6621(c) by sec.
1511(c)(1)(A)-(C) of the Tax Reform Act of 1986 (TRA), Pub. L.
99-514, 100 Stat. 2744. We will hereinafter refer to the
(continued...)
- 23 -

Thompsons filed timely joint petitions for redetermination of the

above-described deficiencies.

C. Cravens Notices of Deficiency

John R. Cravens was a pilot with American Airlines during

1979 and 1980. Mr. Cravens became aware of Mr. Kersting's

programs through conversations with other pilots.

The Cravenses filed joint Federal income tax returns for

1979 and 1980 in which they claimed interest deductions

attributable to their participation in certain Kersting programs.

On April 15, 1983, and March 20, 1984, respondent mailed notices

of deficiency to the Cravenses determining deficiencies in and

additions to their Federal income taxes for the taxable years

1979 and 1980, as follows:

Additions to Tax
Year Deficiency Sec. 6653(a)

1979 $4,508.00 $225.40
1980 19,251.70 962.59

The notice of deficiency issued to the Cravenses for 1979, while

disallowing interest deductions of $9,810, included a credit for

personal exemptions of $4,000, resulting in a net adjustment of

$5,810. The notice of deficiency issued to the Cravenses for

1980 included disallowed interest deductions of $19,620 and, as

an alternative to the disallowance of such interest, the

inclusion of $18,000 in unreported dividend income from a

Kersting controlled entity known as Candace Acceptance Corp.

13
(...continued)
provision as sec. 6621(c).
- 24 -

(Candace). The notice of deficiency issued to the Cravenses for

1980 also included the disallowance of two personal exemptions

claimed for the Cravenses' children. The Cravenses filed timely

joint petitions for redetermination contesting the above-

described notices of deficiency.

The Cravenses' reporting position was unique among the test

case petitioners insofar as the Cravenses had adjusted (reduced)

their tax basis in their Candace stock by the amount of a "non-

taxable distribution" from Candace in 1980. Having reduced the

basis of their Candace stock, the Cravenses reported a capital

gain of $7,200 on their 1980 tax return after surrendering the

stock to Mr. Kersting in exchange for cancellation and return of

the note evidencing their primary loan.14

D. Alexander Notices of Deficiency

Denis Alexander (Mr. Alexander) is a broker and investor

who first met Mr. Kersting in Los Angeles in the early 1960's.

Mr. Alexander lent money to Mr. Kersting's subchapter S leasing

corporations in the 1970's, participated in the acquisition of

First Savings, and participated in some of the Kersting programs

at issue in Dixon II.

14
Although the Cravenses' reporting position was unique
insofar as they had reported a capital gain in a taxable year in
dispute before the Court, we note that test case petitioners
Robert L. and Carolyn S. DuFresne had also reported a capital
gain (albeit in a year subsequent to the years in dispute)
upon the surrender of stock in Charter Financial Corp. to
Mr. Kersting. Like the Cravenses', the DuFresnes' capital gain
was attributable to their reduction of the tax basis of their
stock as opposed to an increase in its value.
- 25 -

1. 1974 and 1975

Mr. Alexander and his wife, Freida, filed joint Federal

income tax returns for the taxable years 1974, 1975, 1976, and

1977. Following an examination of their returns for 1974 and

1975, the Alexanders conceded certain adjustments proposed by

respondent, resulting in agreed assessments of $2,133 and $811

for 1974 and 1975, respectively.15 However, because the

Alexanders declined to agree to other proposed adjustments,

respondent, on November 29, 1979, issued a notice of deficiency

determining deficiencies of $4,891.83 and $40,760.38,

respectively, in their Federal income taxes for 1974 and 1975.

Respondent's deficiency determinations against the

Alexanders for 1974 and 1975 were based, in part, on disallowance

of interest deductions of $2,917 and $46,500, respectively,

attributable to their participation in Kersting programs for

those taxable years. Additional adjustments included

disallowance of an $18,500 capital loss claimed by the Alexanders

for 1974 on a sale of stock in Mendocino Financial Corp. and

respondent's determination that they had failed to report a

$59,080 capital gain for 1975 from a sale of real estate to the

Cadillac Drive Apartments partnership.

15
The Alexanders were represented during the audit
by their accountant, Gilbert Matsumoto (Mr. Matsumoto). Mr.
Matsumoto had served as the accountant for some of Mr. Kersting's
subchapter S leasing corporations, and Mr. Kersting had
recommended that program participants use Mr. Matsumoto, among
others, to prepare their tax returns.
- 26 -

On February 28, 1980, the Alexanders filed a timely petition

with the Court, assigned docket No. 2758-80, contesting the

notice of deficiency for 1974 and 1975.

2. 1976 and 1977

Respondent also examined the Alexanders' joint income tax

returns for 1976 and 1977. On April 17, 1986, respondent issued

the Alexanders a notice of deficiency determining deficiencies in

and additions to their 1976 and 1977 Federal income taxes, as

follows:

Additions to Tax
Year Deficiency Sec. 6653(a)

1976 $3,596 $180
1977 876 44

Respondent also determined that the Alexanders were liable for

increased interest for 1976 pursuant to section 6621(c).

The deficiencies that respondent determined against the

Alexanders for 1976 and 1977 resulted, in part, from respondent's

disallowance of interest deductions of $8,665 and $12,993,

respectively, attributable to their participation in Kersting

programs for those years. Respondent also disallowed a $5,149

partnership loss claimed by the Alexanders for 1976 on their

investment in the Avista Epsilon and Sarbonne partnership.

On July 21, 1986, the Alexanders filed a petition through

Mr. Kersting's office, assigned docket No. 30413-86, contesting

the notice of deficiency for 1976 and 1977.
- 27 -

E. Validity of Notices of Deficiency

In Dixon II, the Court considered and rejected arguments by

the test case petitioners represented by Mr. Izen that the

notices of deficiency issued to them were invalid under Scar v.

Commissioner, 814 F.2d 1363 (9th Cir. 1987), revg. 81 T.C. 855

(1983). After the evidentiary hearing in these proceedings, the

Court rejected the Scar argument advanced by Mr. Jones on behalf

of a Kersting participant who had settled his case before the

trial of the test cases in Dixon II. See Richards v.

Commissioner, T.C. Memo. 1997-149, supplemented by T.C. Memo.

1997-299, affd. without published opinion 165 F.3d 917 (9th Cir.

1998).16

F. Errors in Notices of Deficiency

Although this Court rejected the argument that notices of

deficiency issued to Kersting program participants were invalid,

it is evident that some notices of deficiency issued to Kersting

program participants did contain errors. For instance, in

Richards v. Commissioner, supra, it appears that respondent

overstated the deficiency using an excessive tax rate of 70

percent. In addition, the petition filed in the Richards case

included an allegation that respondent disallowed interest

16
Although Luis C. DeCastro had negotiated the settlement
on behalf of Mr. and Mrs. Richards, he did not participate in the
filing or prosecution of Mr. Jones' motion to vacate the decision
entered in their case.
- 28 -

deductions in excess of Kersting interest deductions that the

Richardses actually claimed.17

Similarly, as observed in the Court's Dixon II opinion,

respondent's alternative determinations in the notice of

deficiency issued to the Cravenses overstated their deficiency

for 1980. The Court ordered that the Cravenses' deficiency for

1980 be reduced to account for: (1) The elimination of

respondent's alternative determination that the Cravenses failed

to report $18,000 in dividends paid by Candace; and (2)

respondent's failure to eliminate the capital gain of $7,200

reported by the Cravenses for 1980 on the disposition of their

Candace stock.

III. Commencement of Kersting Project

A. Tax Shelter Projects and Test Case Procedures

1. Overview

The large volume of cases generated by the Commissioner's

disallowances of deductions claimed by taxpayers participating in

large tax shelter programs during the late 1970's and early

1980's created the largest inventory of cases ever docketed in

the Tax Court. Among the responses of the Internal Revenue

Service and the Tax Court were the development of procedures that

17
Test case petitioners Terry D. and Gloria K. Owens
alleged in their petition that respondent disallowed legitimate
interest deductions in their notice of deficiency. However, it
appears that the allegation was not pursued by or on behalf of
the Owenses, inasmuch as the decision entered by the Court in
their case, following the issuance of the Court's opinion in
Dixon II, was consistent with the deficiency determined by
respondent.
- 29 -

were intended to streamline the litigation process, economize on

the use of administrative and judicial resources, and reduce the

costs incurred by taxpayers in resolving disputes over tax

shelter adjustments. The Internal Revenue Service, Office of

Chief Counsel, created the Tax Shelter Branch in the National

Office to oversee tax shelter litigation across the country and

to organize individual tax shelter projects. Concurrently, the

Tax Court began working with the Internal Revenue Service and

private parties in tax shelter cases to create what became known

as the test case procedure; i.e., the selection of representative

or test cases from a particular tax shelter project for a single

trial on the merits. See, e.g., Drobny v. Commissioner, T.C.

Memo. 1995-209 (citing H. Conf. Rept. 98-861, at 985-986 (1984),

1984-3 C.B. (Vol. 2) 1, 239-240), affd. 113 F.3d 670 (7th Cir.

1997).

The test case procedure is intended to streamline the

litigation process. To this end, taxpayers who are not selected

as test cases are encouraged to execute a piggyback agreement;

i.e., a stipulation to be bound by the outcome of the test cases.

As a practical matter, the effectiveness of the test case

procedure depends in large part upon the agreement of the

taxpayers not selected as test cases to be bound by the outcome

of the test cases. Normally, taxpayers in a tax shelter project

who decline or otherwise fail to sign a piggyback agreement will

either have their cases set for trial with the test cases or,

after the trial of the test cases, will be ordered to show cause
- 30 -

why their case should not be decided the same way as the test

cases. See, e.g., Krause v. Commissioner, 99 T.C. 132 (1992),

affd. sub nom. Hildebrand v. Commissioner, 28 F.3d 1024 (10th

Cir. 1994); Acierno v. Commissioner, T.C. Memo. 1997-441;

Karlsson v. Commissioner, T.C. Memo. 1997-432. Using the order

to show cause procedure to dispose of nontest cases in a tax

shelter project is more cumbersome and consumes more time and

judicial, administrative, and private party resources than using

piggyback agreements. As discussed in greater detail below, the

Court used the test case procedure in the Kersting project; the

vast majority of the Kersting project participants signed

piggyback agreements. See infra pp. 34-41.

2. National Office Tax Shelter Branch Functions

The Tax Shelter Branch, established by the Office of Chief

Counsel in the National Office, was given the responsibilities of

coordinating the examination, appeals, and litigation functions

and of overseeing tax shelter projects from the National Office

perspective. The Tax Shelter Branch provided advice and prepared

material for use by the field in tax shelter cases, reviewed

legal briefs, monitored the status of tax shelter case inventory,

and prepared reports for Internal Revenue Service executives.

The Tax Shelter Branch monitored tax shelter projects by

reviewing and extracting information from quarterly tax shelter

reports that were required to be submitted by the project

attorney; i.e., the District Counsel trial attorney with primary

responsibility for the project. Each project attorney was
- 31 -

required to submit a quarterly tax shelter report providing an

update on the status of the project, including a summary of the

current project settlement offer and any recent court action

affecting the project.

One of the goals of the tax shelter program was consistent

treatment of similarly situated taxpayers. The Tax Shelter

Branch monitored settlement offers in similar tax shelter

projects for disparities and tried to determine whether the

project settlement offers should be similar. However, actual

supervisory responsibility in a tax shelter project was left

primarily in the Regional Counsel and District Counsel offices

to which the project was assigned.

B. Petitions for Redetermination

In or around June 1982, Mr. Kersting facilitated the filing

of petitions with the Tax Court by Kersting program participants.

In letters issued in June and July 1982, Mr. Kersting informed

Kersting program participants that a joint petition was being

prepared on behalf of a large group of taxpayers. On July 12,

1982, Lu N. Nevels, Jr., filed a consolidated Tax Court petition,

assigned docket No. 17445-82, on behalf of 60 Kersting program

participants.18

18
Lu N. Nevels, Jr., had represented the test case
taxpayers in Pike v. Commissioner, 78 T.C. 822 (1982), affd.
without published opinion 732 F.2d 164 (9th Cir. 1984). For an
example of the problems created by using one petition on behalf
of so many different petitioners, see Aaronson v. Commissioner,
T.C. Memo. 1985-131, involving the Hongsermeier petitioners in
what is now docket No. 29643-86. See infra p. 38.
- 32 -

C. Brian J. Seery

In early 1982, Brian J. Seery (Mr. Seery) began assisting

Kersting program participants with issues arising from the audit

of their income tax returns. On April 14, 1982, Mr. Kersting

issued a letter to Kersting program participants informing them

that they soon would receive a letter from the Commissioner

proposing to disallow their Kersting program interest deductions.

Mr. Kersting advised program participants that they should not

remit any amount to the Internal Revenue Service until their

liability was determined in court. On February 15, 1983, Mr.

Kersting issued a letter to Kersting program participants stating

in pertinent part: "I trust that you have placed the tax

retrievals which we have accomplished for you over the years into

profitable investments and that you are receiving a reasonable

rate of return. You will not lose any ground if your funds earn

at least a return equal to the interest charges imposed by the

IRS from time to time."

On March 1, 1985, Mr. Kersting issued a letter to Kersting

program participants stating that he had retained Mr. Seery to

represent them in the Tax Court at no charge to the individual

petitioners.19 The letter requested that each Kersting program

participant provide written authorization for Mr. Seery's

19
Initially, Mr. Kersting or the entities that he
controlled paid the legal fees associated with the Tax Court
litigation. Later, however, some Kersting program participants
began paying $100 per month to a legal defense fund managed by
Mr. Kersting.
- 33 -

representation. In a letter to program participants dated August

11, 1986, Mr. Kersting recommended that program participants not

attempt to resolve their cases on their own and instead rely on

counsel that he had hired.

Mr. Seery subsequently entered his appearance in the Tax

Court on behalf of several hundred Kersting petitioners,

including the Thompsons and the Cravenses. Mr. Seery's

compensation for legal services rendered to Kersting program

participants was always paid by one of the corporations

controlled by Mr. Kersting.

D. Respondent's Counsel

1. Kenneth W. McWade

In 1970, Mr. McWade began his career as a trial attorney

with the Office of Chief Counsel. Mr. McWade's duties with the

Office of Chief Counsel included litigating tax cases.

In January 1982, Mr. McWade transferred from respondent's

District Counsel office in Seattle, Washington, to respondent's

District Counsel office in Honolulu, Hawaii. Mr. McWade

initially assisted with the Pike group of cases. On or about

July 1, 1984, the Kersting project was officially established in

the Honolulu Appeals Office, and Mr. McWade was appointed to

serve as the project attorney. Wally Kobayashi was appointed to

serve as the key Appeals officer for the Kersting project.

By late 1986, Mr. McWade had litigated 40 to 50 Tax Court

cases. However, Mr. McWade had never litigated any cases that

were part of a tax shelter project.
- 34 -

2. William A. Sims

In 1972, Mr. Sims began his career with the Office of Chief

Counsel, General Litigation Division, National Office. Except

for a 6-month assignment doing Tax Court work, Mr. Sims handled

general litigation matters concerning collection, bankruptcy, and

tax liens. Mr. Sims eventually became Assistant Director of the

General Litigation Division in the National Office.

In February 1986, Mr. Sims was appointed District Counsel

for Honolulu, Hawaii. Before his appointment as District

Counsel, Mr. Sims had never worked on a tax shelter project in

any capacity.

E. Adoption of Test Case Procedures in Kersting Project

1. The Honolulu Session (June 1985)

The Court set for trial the cases of approximately 375

Kersting program participants at a Tax Court session scheduled to

commence on June 10, 1985, in Honolulu, Hawaii (the June 1985

session).

Before the June 1985 session, Mr. McWade and Mr. Seery

agreed to use the test case procedure in the Kersting project.

During the June 1985 session, Mr. McWade and Mr. Seery discussed

the use of the test case procedure with Judge Goffe during a

chambers conference. During the conference, Mr. Seery informed

Judge Goffe that, although he was representing petitioners who

were Kersting program participants, he was being paid by Mr.

Kersting. Judge Goffe indicated that he saw no conflict of

interest as long as Mr. Seery had not participated in the
- 35 -

planning or promotion of the Kersting programs. See Rule

24(f).20

Consistent with counsels' agreement to use the test case

procedure in the Kersting project, Judge Goffe granted the

parties' joint motions to continue the cases called at the June

1985 session. At the same time, the parties began filing

piggyback agreements (discussed in greater detail below), which

they did in the vast majority of the Kersting project cases.

Mr. Seery reported the results of the June 1985 proceedings

to Mr. Kersting and kept him abreast of developments. Mr. Seery

relied upon Mr. Kersting to distribute correspondence from

Mr. Seery to petitioners in the Kersting project.

2. Test Case Procedure

Mr. McWade and Mr. Seery agreed to select test cases that

would be representative of all the Kersting programs for all

years in dispute, including the taxable years 1975 through 1983.

At the time that Mr. Seery selected his test cases, he assumed

that the test case petitioners would bear the burden of proof at

trial.

In selecting test cases, Mr. Seery was not concerned with

whether a case involved other tax issues. Mr. Seery was simply

looking for cases "where someone did everything right."

20
Rule 24(f), which became effective on July 1, 1990, see
93 T.C. 857, addresses conflicts of interest in Tax Court
litigation. Rule 24(f) was redesignated Rule 24(g) effective
Aug. 1, 1998. See 109 T.C. 542.
- 36 -

Mr. Seery selected two or three test cases, including the

Cravenses and the Hongsermeiers.

In an effort to find the best cases for trial from

petitioners' point of view, Mr. Seery selected test cases by

reference to the manner in which the taxpayers had reported the

transactions. Mr. Seery selected test cases that he thought he

could win, but, as he testified at the evidentiary hearing, he

had difficulty identifying such cases in addition to the

Cravenses and the Hongsermeiers.21

Mr. Kersting and Mr. Cravens discussed having Mr. Cravens'

case serve as a test case. Mr. Kersting told Mr. Cravens that

Mr. Seery wanted to use him as a test case because, unlike other

Kersting program participants, the Cravenses had reported a

capital gain when they surrendered their stock in the Kersting

holding company in conjunction with the annual termination of the

Kersting program. The Cravenses' reporting position was

consistent with Mr. Kersting's advice to program participants

that distributions by Kersting holding companies used by program

participants to pay the principal amount of leverage loans were

tax-free returns of capital rather than taxable dividends.

Mr. Seery viewed the Cravens cases as "unique" in this respect.

Mr. Cravens believed that he had a choice whether his case

would serve as a test case. When Mr. Cravens agreed to have his

21
Mr. Seery's testimony: "I was having trouble selecting
cases beyond those two that I thought would be good vehicles for
that."
- 37 -

case serve as a test case, he did so without condition. He

believed that he would win his case because he had correctly

reported his tax liabilities, as reduced by reason of his

participation in the Kersting programs.

Mr. Seery selected the Hongsermeier case because it was his

impression that the Hongsermeiers had used their own funds to pay

the principal of a Kersting leverage loan, rather than using a

"nontaxable distribution" from a Kersting holding company.22

Mr. Seery also selected the Hongsermeiers because they had

participated in the CAT-FIT program, which Mr. Seery viewed as

the strongest Kersting program from the standpoint of sustaining

the interest deductions claimed.

Mr. McWade analyzed between 400 and 500 project cases; he

selected test cases that he thought would be representative of

all Kersting programs for all years in dispute. Mr. McWade

selected "clean" cases; i.e., cases that did not include issues

other than Kersting interest deductions. Mr. McWade tried to

avoid cases that were unique or atypical of the Kersting

programs. Although Mr. McWade selected at least five of the test

cases, he could not recall the specific cases that he selected.

In June 1986, Mr. McWade and Mr. Seery agreed on the dockets

that were to serve as the test cases. By letter dated June 10,

22
Mr. Seery's impression was not quite right. The Court
found in Dixon II that the Hongsermeiers were unique insofar as
they paid $250 per month out-of-pocket (rather than use the
proceeds from a leverage loan) to satisfy the interest due on
a CAT-FIT primary loan. See Dixon II, 62 T.C.M. (CCH) at 1480,
1991 T.C.M. (RIA), at 91-3023.
- 38 -

1986, Mr. McWade notified Judge Goffe that he and Mr. Seery had

selected the following 14 dockets to serve as test cases with

respect to the Kersting project:

Case Name Docket No.

Dixon v. Commissioner 9382-83
Cravens v. Commissioner 16900-83
Rina v. Commissioner 17640-83
Thompson v. Commissioner 19321-83
Young v. Commissioner 4201-84
Cravens v. Commissioner 15135-84
DuFresne v. Commissioner 15907-84
Thompson v. Commissioner 31236-84
Owens v. Commissioner 40159-84
Young v. Commissioner 22783-85
Young v. Commissioner 30010-85
Thompson v. Commissioner 30965-85
DuFresne v. Commissioner 30979-85
1
Hongsermeier v. Commissioner 29643-86
1
By order dated Aug. 13, 1986, the Court severed the
Hongsermeiers from docket No. 17445-82 (the Aaronson consolidated
petition filed by Mr. Nevels) and assigned them new docket No.
29643-86. See supra note 18 and accompanying text.

With the exception of the Cravens case assigned docket No.

16900-83, and the Hongsermeier case assigned docket No. 17445-82,

each of the test case petitioners had filed pro se petitions. By

August 1986, Mr. Seery had entered his appearance in each of the

test cases with the exception of the Young cases assigned docket

Nos. 4201-84, 22783-85, and 30010-85, the DuFresne case assigned

docket No. 30979-85, and the Thompson case assigned docket No.

30965-85.

3. Test Case Array

The test case petitioners had participated in Kersting

programs during the taxable years 1975 through 1983 as follows:
- 39 -

Taxable Year 1975

Program Petitioner(s)

CAT-FIT Owens
MAURIER LEASING1 Owens
NORWICK 20/20 Owens

Taxable Year 1976

Program Petitioner(s)

UNIVERSAL LEASING Owens
FORBES 30/30 Owens

Taxable Year 1977

Program Petitioner(s)

CAT-FIT Dixon
ESCON LEASING Dixon
FARGO 30/30 Dixon
NORWICK 20/20 Owens

Taxable Year 1978

Program Petitioner(s)

CAT-FIT Hongsermeier
CAT-FIT Dixon
UNIVERSAL LEASING Hongsermeier
ESCON LEASING Dixon
ESCON LEASING Hongsermeier
MAHALO 30/30 Owens
MAHALO 60/60 Dixon

Taxable Year 1979

Program Petitioner(s)

CAT-FIT Hongsermeier
CAT-FIT Dixon
UNIVERSAL LEASING Hongsermeier
ANSETH LEASING Rina
ANSETH LEASING Young
ESCON LEASING Hongsermeier
ESCON LEASING Dixon
ESCON LEASING Thompson
CANDACE 60/60 Dixon
CANDACE 60/60 Cravens
CANDACE 60/60 Rina
- 40 -

CANDACE 60/60 Thompson
CANDACE 60/60 Young
CHARTER 80,000 Rina
CHARTER 120,000 Young
INVESTORS 80,000 Rina
INVESTORS 120,000 Young

Taxable Year 1980

Program Petitioner(s)

CAT-FIT Dixon
CAT-FIT DuFresne
CAT-FIT Hongsermeier
ANSETH LEASING Hongsermeier
ANSETH LEASING Rina
ANSETH LEASING Young
ESCON LEASING Dixon
ESCON LEASING Hongsermeier
ESCON LEASING Thompson
CANDACE 60/60 Cravens
CANDACE 60/60 Rina
DELTA 40/40 Hongsermeier
DELTA 60/60 Cravens
DELTA 60/60 Dixon
DELTA 60/60 DuFresne
DELTA 60/60 Rina
DELTA 60/60 Thompson
DELTA 60/60 Young
CHARTER 40,000 Rina
CHARTER 80,000 Rina
CHARTER 120,000 Dixon
CHARTER 120,000 DuFresne
CHARTER 120,000 Thompson
CHARTER 120,000 Young
INVESTORS 80,000 DuFresne
INVESTORS 80,000 Rina
INVESTORS 80,000 Thompson
INVESTORS 120,000 Dixon
INVESTORS 120,000 Young

Taxable Year 1981

Program Petitioner(s)

ANSETH LEASING Young
ESCON LEASING Dixon
DELTA 60/60 Young
CHARTER 120,000 Dixon
CHARTER 120,000 DuFresne
CHARTER 120,000 Young
- 41 -

INVESTORS 80,000 DuFresne
INVESTORS 120,000 Dixon
INVESTORS 120,000 Young

Taxable Year 1982

Program Petitioner(s)

ANSETH LEASING Young
CHARTER 120,000 DuFresne
CHARTER 120,000 Young
INVESTORS 80,000 DuFresne
INVESTORS 120,000 Young

Taxable Year 1983

Program Petitioner(s)

ANSETH LEASING Young
CHARTER 120,000 DuFresne
INVESTORS 80,000 DuFresne
1
Maurier Leasing, a subch. S leasing program, was
considered by the Court in Pike v. Commissioner, 78 T.C. 822
(1982).

The notice of deficiency issued to the Thompsons for the

taxable year 1981 states in pertinent part: "Based on

examination information from the 1978, 1979, and 1980 returns,

the investment interest is generated from the interest deduction

tax shelter. The purported payees cannot be identified from the

1981 income tax return filed by the taxpayers." Respondent has

not been able to identify specifically the Kersting programs that

the Thompsons participated in during 1981. However, the record

suggests that, in addition to the Kersting programs that the

Thompsons participated in during 1979 and 1980, the Thompsons

participated in the Anseth Leasing Program during 1981.

If the Thompson and Cravens cases had been removed from the

test case array, there would have been no reduction in coverage
- 42 -

of the test cases. In other words, each program in which the

Thompsons and Cravenses participated during the years in issue

was also a program before the Court in which one or more of the

other test case petitioners had participated.

IV. The Maui Session (February 1987)

After Messrs. Seery and McWade had selected the test cases,

they initiated settlement negotiations and began to prepare the

test cases for trial.23 Their trial preparations included work

on a proposed stipulation of facts and an attempt to take

Mr. Kersting's deposition. During this period (June 1986 or

thereabout), Mr. Seery and Mr. Kersting's attorney, L.T. Bradt

(Mr. Bradt), discussed using the 1981 search of Mr. Kersting's

office as a basis for filing a motion to shift the burden of

proof to respondent in the test cases.

A. Trial Notices

By letter dated July 30, 1986, Judge Goffe informed

Messrs. Seery and McWade that the test cases would be set for

trial during a special session of the Court commencing on

February 9, 1987, in Wailuku, Maui, Hawaii (the Maui session).

Judge Goffe's letter also informed Messrs. Seery and McWade that

he intended to notify each Kersting petitioner who had not filed

a piggyback agreement that his or her case would be set for trial

during the Maui session.

23
Settlement negotiations between Mr. McWade and Mr. Seery
are discussed in greater detail infra pp. 78-80.
- 43 -

In August 1986, the Court issued orders setting the 14 test

cases for trial during the Maui session. By letter dated

August 5, 1986, Judge Goffe informed all Kersting petitioners who

had not already executed piggyback agreements that their cases

would be set for trial at the Maui session unless they executed

piggyback agreements by September 29, 1986. Judge Goffe's letter

states as follows:

August 5, 1986

Dkt #
Dear _______________:

Your case involves matters concerning promotions
by Henry Kersting. Cases with issues identical to the
issues in your case have been set for trial on
February 9, 1987, at the courtroom of the Circuit Court
for the Second Circuit in Wailuku, Maui, Hawaii.

In order to conserve the time and expense of the
taxpayers, the government and the Court, all of the
cases with identical issues will be tried at one time
unless the parties agree in advance, in writing, to be
bound by the outcome of the cases set for trial. In
most of the pending cases, the parties have so agreed
to be bound.

You should contact at your earliest convenience the
lawyer for the government in the Kersting cases if you
decide to agree to be bound. He is Mr. Kenneth McWade,
PJKK Federal Building, Room 3304, Box 50089, 300 Ala
Moana Boulevard, Honolulu, Hawaii 96850. His telephone
number is (808) 546-7333. If, however, you do not wish
to be bound, you should advise my office promptly, in
writing at the above address, in order that your case
may be set for trial on February 9, 1987. In either
event, you must advise Mr. McWade or me by
September 29, 1986.

If you fail to advise Mr. McWade by September 29,
1986, that you wish to be bound and have executed a
stipulation to be bound by that time and if you fail to
advise me by September 29, 1986, that you wish to have
your case set for trial, it will automatically be set
for trial on February 9, 1987. If your case is set for
- 44 -

trial and you do not appear for trial, your case will
likely be dismissed and you will be required to pay all
of the income tax which the government contends you
owe, plus interest thereon as provided by law.

William A. Goffe
Judge

In November 1986, the Court issued orders notifying Kersting

petitioners who had not filed piggyback agreements that their

cases were set for trial at the Maui session. As additional

Kersting project cases were docketed and identified, the Court

issued orders setting them for trial at the Maui session, subject

to being stricken if the parties executed a piggyback agreement.

B. Piggyback Agreements

As early as June 1985, Kersting program participants had

begun executing piggyback agreements (1985 piggyback

agreements),24 drafted by Messrs. McWade and Seery, that stated

as follows:

Stipulation of Settlement for Tax Shelter Adjustments

With respect to all adjustments in respondent's
notice of deficiency relating to the Kersting interest
deduction tax shelter(s), the parties stipulate to the
following terms of settlement:

1. The term Kersting programs refers to interest
expense deductions or other related deductions
associated with various programs promoted by Henry
Kersting.

2. The Kersting program deduction adjustments
shall be redetermined on the same basis that the same
program adjustments are resolved with respect to
taxpayers trying the same program adjustments at the

24
Before 1987, there was no uniform format for piggyback
agreements. In 1987 or early 1988, respondent's Tax Shelter
Branch issued a standard form of piggyback agreement.
- 45 -

June 10, 1985 session of the Court in Honolulu, Hawaii,
or such session as these cases may be adjourned or
continued to by the Court (hereinafter "TRIED CASE").

3. All issues involving the Kersting programs
shall be resolved as if the petitioner(s) in this case
is the same as the taxpayers in the TRIED CASE;

4. A decision shall be submitted in this case
when the decision in the TRIED CASE is entered;

5. Following entry of the decision in this case,
petitioner(s) consents to the assessment and collection
of the deficiencies, attributable to the adjustments
formulated by reference to the Tax Court's opinion,
notwithstanding the restrictions contained in I.R.C.
§ 6213(a);

6. The petitioner(s) in this case will testify or
provide information in any case involving the same tax
shelter adjustments, if subpoenaed; and

7. The petitioner(s) in this case consents to the
disclosure of all tax returns and tax return
information for the purpose of respondent's discovering
or submitting evidence in any case involving the same
Kersting shelter adjustments.

The parties agree to this stipulation of
settlement.

Piggyback agreements executed by Kersting program

participants after 1985 differed from those executed in 1985. In

particular, post-1985 piggyback agreements stated as follows:

Stipulation of Settlement for Tax Shelter Adjustments

With respect to all adjustments in respondent's
notice of deficiency relating to the Kersting interest
deduction tax shelter(s), the parties stipulate to the
following terms of settlement:

1. The Kersting interest deduction tax shelter
adjustments shall be redetermined on the same basis
that the same tax shelter adjustments are resolved with
respect to taxpayers trying the same shelter
adjustments at the February 9, 1987 session of the
Court in Wailuku, Maui, Hawaii, or such session as
- 46 -

these cases may be adjourned or continued to by the
Court (hereinafter "TRIED CASE").

2. All issues involving the Kersting interest
deduction tax shelter(s) shall be resolved as if the
petitioner(s) in this case is the same as the taxpayers
in the TRIED CASE;

3. A decision shall be submitted in this case
when the decision in the TRIED CASE becomes final under
I.R.C. § 7481;

4. Following entry of the decision in this case,
petitioner(s) consent to the assessment and collection
of the deficiencies, attributable to the adjustments
formulated by reference to the Tax Court's opinion,
notwithstanding the restrictions contained in I.R.C.
§ 6213(a);

5. The petitioner(s) in this case will testify or
provide information in any case involving the same tax
shelter adjustments, if subpoenaed; and

6. The petitioner(s) in this case consents to the
disclosure of all tax returns and tax return
information for the purpose of respondent's discovering
or submitting evidence in any case involving the same
shelter adjustments.

7. If the Court determines the I.R.C. § 6621(d)
penalties are applicable in the test case controlling
petitioner's(s') case, then the petitioner(s) concedes
that I.R.C. § 6621(d) is applicable to any underpayment
of tax determined in their case(s) attributable to the
Kersting interest deduction tax shelter(s), if such
underpayment exceeds $1,000.00 in any one taxable year.

8. With respect to adjustments in respondent's
notice of deficiency relating to additions to the tax
under I.R.C. § 6653(a), the parties agree to the
following:

(a) Respondent concedes that the
petitioner(s) are not liable for additions to tax under
I.R.C. § 6653(a) or § 6653(a)(1) or § 6653(a)(2) for
any year prior to the taxable year 1982.

The parties agree to this stipulation of
settlement.
- 47 -

In sum, whereas paragraph 4 of the 1985 piggyback agreements

states that a decision will be entered in the piggyback case

following entry of decision in the test cases, paragraph 3 of the

post-1985 piggyback agreements states that a decision will be

entered in the piggyback case once the decision in the test cases

becomes final.25 See Gridley v. Commissioner, T.C. Memo. 1997-

210. Unlike 1985 piggyback agreements, post-1985 piggyback

agreements state (at paragraph 7) that petitioners agree to be

bound to the Court's holding in the test cases respecting the

applicability of increased interest under section 6621(c) on any

underpayment of tax of more than $1,000. Further, while 1985

piggyback agreements make no reference to additions to tax, post-

1985 piggyback agreements state (at paragraph 8) that petitioners

are not liable for additions to tax for negligence for any year

before the taxable year 1982.26

25
Despite this distinction, respondent did not move for
entry of decision--upon entry of decisions in the Kersting test
cases in early 1992--in any of the cases in which Kersting
petitioners had executed the 1985 version of the piggyback
agreement. Respondent has taken the position that no decisions
should be entered in any of the piggyback cases until the
decisions in the test cases become final. Cf. Abatti v.
Commissioner, 859 F.2d 115 (9th Cir. 1988), affg. 86 T.C. 1319
(1986).
26
Although the record does not reveal why post-1985
piggyback agreements limit respondent's concession of additions
to tax for negligence to taxable years before 1982, a plausible
explanation for selecting 1982 as the line of demarcation would
be that the Tax Court had released its opinion in Pike v.
Commissioner, 78 T.C. 822 (1982), in May 1982, putting taxpayers
on notice for 1982 and later taxable years that Mr. Kersting's
programs did not generate legitimate interest deductions.
- 48 -

When Messrs. McWade and Seery drafted the piggyback

agreements, Mr. Seery did not consider the possibility that a

test case might be settled.27

Nontest case petitioners Ronald L. and Mattie E. Alverson

(docket No. 17646-83) executed their piggyback agreement in June

1985. Nontest case petitioners Anthony E. and Carol A. Eggers

(docket No. 7323-84), John L. and Terry E. Huber (docket No.

20119-84), Stanley C. and Sharon A. Titcomb (docket No. 17992-

95), and Richard B. and Donna G. Rogers (docket No. 17993-95)

executed piggyback agreements in late November 1986. Nontest

case petitioners Norman W. and Barbara L. Adair (docket No.

35608-86) executed their piggyback agreement in March 1987.

Nontest case petitioners Willis F. McComas, II and Marie D.

McComas (docket No. 19464-92), Wesley Armand and Sherry Lynn

Cacia Baughman (docket No. 621-94), Joe A. and JoAnne Rinaldi

(docket No. 7205-94), and Norman A. and Irene Cerasoli (docket

No. 9532-94) did not execute piggyback agreements for their cases

on these dockets.

C. Mr. Seery's Withdrawals as Counsel

During late 1986 and early 1987, and shortly before the Maui

session, Mr. Seery began to withdraw as counsel in the Kersting

cases in the circumstances described below.

27
A piggyback agreement that binds the piggyback case to
the outcome of the test case, whether by litigation or
settlement, is not unprecedented. See, e.g., Fisher v.
Commissioner, T.C. Memo. 1994-434.
- 49 -

1. The Thompsons

In 1985, the Thompsons had retained Samuel M. Huestis

(Mr. Huestis) to prepare an estate plan for them. Eventually,

the scope of Mr. Huestis' representation was extended to include

settlement of the Thompsons' 1978 tax liabilities and their

dispute with Mr. Kersting, as described infra pp. 56-67.

One result of that dispute was Mr. Huestis' letter of

September 10, 1986, to Mr. Seery, notifying him that the

Thompsons were seeking substitute counsel and requesting the

Thompson files. On September 15, 1986, Mr. Seery sent the

Thompson files to Mr. Huestis and informed him that the Thompsons

were test case petitioners. Mr. Seery indicated that he was

withdrawing as the Thompsons' counsel in the Tax Court.

On October 28, 1986, Mr. Huestis wrote to Mr. Seery to

express dissatisfaction with the sufficiency of the Thompsons'

files and to warn Mr. Seery that his earlier representation of

the Thompsons, while he was also apparently representing

Mr. Kersting, could be viewed as a conflict of interest and lead

to an action for "professional negligence".

On October 31, 1986, Mr. Seery filed motions to withdraw as

counsel in the Thompsons' cases.28 The Court granted Mr. Seery's

motions in November 1986.

28
Mr. Seery had entered his appearance only in the
Thompson cases assigned docket Nos. 19321-83 and 31236-84, not
docket No. 30965-85.
- 50 -

In the interim, Mr. Huestis assisted the Thompsons in

locating and interviewing Mr. DeCastro to serve as their counsel

in the Tax Court.29 On November 15, 1986, Mr. Thompson and

Mr. DeCastro's associate, Phillip Hoskins, executed a retainer

agreement under which Mr. Thompson agreed to pay Mr. DeCastro

$5,000 for his effort to negotiate a settlement of the Thompson

tax cases. The agreement provided that the retainer fee was

limited to settlement negotiations and did not include

preparation for or representation at trial. In early January

1987, Mr. DeCastro filed an entry of appearance in the Thompson

cases.

2. The Test Cases

On November 7, 1986, Mr. Seery filed a motion to change

the place of trial of the test cases from Maui to Honolulu.

Mr. Seery asserted that a trial in Maui would be inconvenient and

a hardship to Mr. Kersting, who lived and operated a business in

Honolulu. Mr. Seery's motion included the statement that

4. Mr. Kersting is providing the financial
support for the litigation of this and the related
cases and the additional expense involved in
transporting witnesses and staff to Wailuku as well
as paying for accommodations for the staff while in
Wailuku is a great financial burden to him.

On November 14, 1986, the Court issued an order denying

Mr. Seery's motion to change the place of trial. In so doing,

29
Mr. Huestis had initially referred the Thompsons to a
law firm, Loeb & Loeb, in Los Angeles, California. The Loeb firm
declined to represent the Thompsons because of the short time to
prepare for the Maui session and the incompleteness of the
Thompson files.
- 51 -

the Court noted that the motion "implies that * * * [Mr. Seery]

represents not only petitioners but also Henry Kersting, the

promoter of the tax shelters which are the subject of this

litigation." The Court went on to observe that, if Mr. Seery

were representing both Mr. Kersting and petitioners, the dual

representation would constitute a conflict of interest. The

Court attached to the order copies of several authorities

concerning conflicts of interest, including Adams v.

Commissioner, 85 T.C. 359 (1985). Mr. Seery subsequently filed

motions to withdraw as counsel in the Kersting project cases

(both test cases and nontest cases), citing concerns about a

possible conflict of interest. The Court granted Mr. Seery's

motions.

By letter dated December 12, 1986, Mr. Kersting informed

Kersting program participants that Judge Goffe had "inferred"

that Mr. Seery might have a conflict of interest. Although

Mr. Kersting denied that he was represented by Mr. Seery, he

stated that he and Mr. Seery had decided that it would be prudent

for Mr. Seery to withdraw as counsel. Mr. Kersting further

stated that substitute counsel had been retained to represent

test case and nontest case petitioners alike.

D. Entries of Appearance by Chicoine and Hallett

Following Mr. Seery's withdrawal, Mr. Bradt recommended that

Mr. Kersting hire Mr. Izen to serve as counsel for the test
- 52 -

cases.30 However, Mr. Kersting, with his son-in-law, an

attorney, Roger Moseley (Mr. Moseley), contacted Robert J.

Chicoine (Mr. Chicoine) and Darrell D. Hallett (Mr. Hallett)

(collectively Chicoine and Hallett), to determine whether they

would represent the test case petitioners at the Maui session.

On November 22, 1986, Mr. Kersting sent Mr. Hallett a

letter describing the Kersting programs. Shortly thereafter,

Mr. Kersting interviewed Mr. Hallett in Hawaii. On December 9,

1986, Chicoine and Hallett reached an agreement with Mr. Kersting

to represent the test case petitioners (other than the

Thompsons). On December 12, 1986, Mr. Kersting wrote to Kersting

program participants informing them that Mr. Seery had withdrawn

as counsel and that Chicoine and Hallett had been retained. At

the same time, either Mr. Kersting or Chicoine and Hallett

informed the test case petitioners that they would have to

provide Chicoine and Hallett with written authorization to enter

appearances in their cases.

Although Mr. Seery sent Chicoine and Hallett his files for

the test cases, most of the documents that Mr. Seery had intended

to use at trial remained in Mr. Kersting's possession. By

letter dated December 19, 1986, Chicoine and Hallett reminded

Mr. Kersting that they needed all documents in the possession of

Mr. Kersting and Mr. Seery that pertained to the Kersting

programs in dispute in the Tax Court.

30
Mr. Bradt and Mr. Izen had been law partners from 1978
to 1981.
- 53 -

By letter dated January 7, 1987, Chicoine and Hallett

outlined the conditions underlying their agreement with

Mr. Kersting to represent the test case petitioners in the Tax

Court. Chicoine and Hallett's letter states in pertinent part:

Our representation is conditioned upon the
following however:

1. We will represent only the individuals
selected as test cases and who request us to do so. We
are not representing or acting on behalf of any other
taxpayers or litigants who have invested in various
companies in which you are affiliated and who have
stipulated to be bound by the outcome of the litigation
or desire legal advice with respect to whether they
should accept the Internal Revenue Service's settlement
proposal.

2. All parties understand and agree that under
the circumstances, the Petitioners involved in the test
cases who have expressly authorized us to represent
them will be our clients and that we do not represent
you individually, although you have agreed with those
Petitioners that you will pay the legal fees to defer
[sic] the costs of their defense. We will discuss the
fee arrangement with each of the Petitioners in the
test cases and their perception of any possible
conflict of interest which we would require that they
waive.

3. It is understood that there will be no
restrictions on the advice which we may provide to our
clients and after review of the relevant facts and
documents, we are free to propose such settlements as
we may deem appropriate. We need not proceed with
trial in any situation if which we consider our
position to be indefensible or frivolous.

In early January 1987, Messrs. Chicoine and Hallett filed

entries of appearance as counsel in each of the test cases other

than the Thompson and Cravens cases.

As discussed in greater detail infra pp. 100-106, at the

time of Mr. Seery's withdrawal from the Cravens cases,
- 54 -

Mr. Cravens and Mr. McWade had agreed to a settlement of the

Cravens cases. After reaching an agreement with Mr. McWade, Mr.

Cravens did not authorize Chicoine and Hallett to enter an

appearance in his cases.

E. Evidentiary Issues

After undertaking to represent the test case petitioners,

Chicoine and Hallett decided to challenge their deficiency

notices on the ground that the search of Mr. Kersting's office in

January 1981 had been illegal. Chicoine and Hallett thereupon

filed motions for leave to file amendments to the petitions and

lodged the amendments with the Court. The amendments included

arguments that the materials seized by the Internal Revenue

Service during the search of Mr. Kersting's office should be

suppressed at trial of the test cases and that the burden of

proof and burden of going forward with evidence should be shifted

to respondent. On January 14, 1987, the Court granted Chicoine

and Hallett's motions for leave to file amendments to the

petitions and subsequently directed respondent to file answers to

the petitions as amended.

1. The Maui Session

Although the test cases were originally scheduled for trial

at the Maui session, the trial was delayed by the need to use the

Maui session to receive testimony and evidence on the evidentiary

issues raised by Chicoine and Hallett.

Mr. McWade and Henry E. O'Neill (Mr. O'Neill), another trial

attorney assigned to the Honolulu District Counsel Office,
- 55 -

appeared on behalf of respondent at the Maui session.

Mr. DeCastro appeared at the Maui session on behalf of the

Thompsons. The Cravenses did not appear at the Maui session.

Following the Maui session, the Court ordered respondent and

petitioners, by May 18 and June 17, 1987, respectively, to file

opening and reply briefs addressing the evidentiary issues raised

by Chicoine and Hallett. On motions by the parties, the Court

extended the dates for the filing of opening and reply briefs to

June 8 and August 10, 1987, respectively.

2. Dixon I Opinion

On February 11, 1988, the Court issued its Dixon I opinion

rejecting Chicoine and Hallett's evidentiary arguments.

Specifically, the Court held that petitioners had failed to

establish standing to contest the Kersting search. Dixon v.

Commissioner, 90 T.C. 237 (1988).

By order dated July 1, 1988, the Court set the test cases

for trial in San Diego, California, on January 9, 1989. By order

dated October 24, 1988, the Court granted Mr. Izen's motion to

reconsider and set the test cases for trial in Honolulu, Hawaii,

on January 9, 1989.

V. Kersting Disputes With Program Participants

Before the trial of the test cases, Mr. Kersting had

disputes, summarized below, with the Thompsons and the

Alexanders.
- 56 -

A. The Thompsons

1. The Bauspar Program

On August 13, 1979, the Thompsons purchased a condominium

unit in Wahiawa, Hawaii (the Wahiawa property), from Pacific

Universal Corp. (not a Kersting company). On April 24, 1981, the

Thompsons entered a Kersting program known as Bauspar--not one of

the Kersting programs in dispute at the trial of the test cases--

to effect the payoff of seller-provided financing on the Wahiawa

property. The Thompsons executed a first mortgage and promissory

note reflecting a loan from Bauspar, Inc. (Bauspar), in the

principal amount of $80,000. The Thompsons agreed to repay the

$80,000 Bauspar loan, with interest at 7 percent per year,

through monthly payments of principal and interest of $532.24 for

a 10-year period, followed by a balloon payment of $69,182.47.31

In conjunction with the Bauspar loan, the Thompsons agreed to

purchase $80,000 worth of Bauspar stock. The Thompsons borrowed

$80,000 to purchase the Bauspar stock from another Kersting

company, Paragon Investments, Inc. (Paragon), at an annual

interest rate of 18 percent. The Thompsons further agreed to

participate in a "savings program" by depositing $1,200 per month

into an account with Citizen's Financial, Inc. (Citizen's

Financial), another Kersting company.

On August 12, 1982, the Thompsons agreed to sell the Wahiawa

property to Kevin and Ada Shea for $122,500 by an "Agreement of

31
It appears that the Thompsons actually made monthly
payments of $535 to Bauspar.
- 57 -

Sale" under which the Thompsons apparently took back a purchase

money mortgage on the property. The Thompsons continued to

participate in the Bauspar program until 1986 when the Sheas

decided to sell the Wahiawa property to a third party.

On January 30, 1985, Mr. Kersting sent Mr. Thompson a

schedule listing the interest payments that Mr. Thompson had made

during 1984 as follows:

Payee Amount

Bauspar, Inc. $6,420.00
Paragon Investments, Inc. 9,611.04
Citizens Financial, Inc. 14,400.00

Upon sale of the Wahiawa property by the Sheas in 1986,

Bauspar received a check in the amount of $75,511.74 in

satisfaction of the principal amount remaining due on the

Thompsons' loan from Bauspar.

2. Deterioration of Thompson/Kersting Relationship

While working on the Thompsons' estate plan, Mr. Huestis

asked Mr. Kersting for an accounting of the Thompsons'

investments in Kersting programs. By letter dated March 3, 1986,

Mr. Kersting responded by providing Mr. Huestis a summary list of

the Kersting programs that the Thompsons had participated in

during 1977, 1978, 1979, 1980, and 1981. By letter dated

March 12, 1986, Mr. Huestis informed Mr. Kersting that the

Thompsons wished to terminate their participation in all Kersting

programs and obtain a complete accounting of their investments.

Mr. Huestis also requested that all future communications
- 58 -

regarding the matter be directed to Mr. Huestis rather than to

the Thompsons.

By letter dated March 17, 1986, Mr. Kersting complained to

Mr. Huestis about his "assertive approach" and said he would

continue to communicate directly with the Thompsons. By letter

dated March 17, 1986, Mr. Kersting wrote to Mr. Thompson,

confirmed that he would terminate Mr. Thompson's programs, and

inquired whether Mr. Thompson still had any stock certificates

issued in connection with his participation in Kersting programs.

Mr. Kersting's letter also states that Mr. Thompson would incur

tax liability for capital gains that would be realized upon the

termination of his accounts in the Kersting programs.

On March 21, 1986, Mr. Huestis again wrote to Mr. Kersting,

stating that the Thompsons were disappointed with Mr. Kersting's

failure to respond to their requests or to assist them with the

tax problems arising from their participation in his programs.

By letter to the Thompsons dated March 25, 1986, Mr. Kersting

confirmed that he would liquidate their investments, as discussed

with Mr. Thompson in a recent telephone conversation.

Mr. Kersting requested that Mr. Thompson endorse all relevant

stock certificates and return them to Mr. Kersting so that the

proceeds from the sale of stock represented by such certificates

could be used to retire Mr. Thompson's debts to Kersting

companies.

By letter dated March 31, 1986, Mr. Kersting wrote to

Mr. Thompson and admitted that he was having difficulty
- 59 -

reconciling Mr. Thompson's Bauspar account because Earl LeMond,

Mr. Kersting's son-in-law and the manager of the Bauspar program,

did not keep reliable records. Nonetheless, Mr. Kersting

prepared an accounting of Mr. Thompson's Bauspar account

indicating that Mr. Thompson had paid $90,769.72 under the

program and had received nontaxable dividends of $27,000 and

Federal tax and State income tax savings (presumably from

interest deductions) of $36,307.79 and $9,000, respectively.

Mr. Kersting further indicated that, in light of Mr. Thompson's

apparent dissatisfaction, he would waive the normal requirement

that the Bauspar program run for a 10-year period, allow

Mr. Thompson to terminate the program prematurely, and pay

Mr. Thompson $27,000 reflecting 3 years of "equity build-up" in

the program. On the basis of his accounting, Mr. Kersting

concluded that Mr. Thompson would realize a net gain of $8,538.07

from the Bauspar program. Mr. Kersting advised Mr. Thompson to

check his accounting carefully, and that, if necessary, Mr.

Kersting would make adjustments in Mr. Thompson's favor to avoid

a legal dispute.

On March 31, 1986, Mr. Kersting wrote a second letter to

Mr. Thompson stating that the Thompsons owed a total of $11,844

to Avalon Acceptance Corp., Aztec Acceptance Corp., Mahalo

Acceptance Corp., Lombard Acceptance Corp., and Candace, for

interest due on leverage notes during 1983 and 1984.

Mr. Kersting's letter states in pertinent part:
- 60 -

I will assume that you will take the position
that you should not be paying interest on notes which
produced deductions which you might not have used.
While this, of course, would not go well with a bank or
Credit Union (they would charge you interest whether
you use the deductions or not) I am willing to make
adjustments to your advantage. To get that underway I
suggest that you tell us which of the deductions were
claimed by you in 1983 and 1984.

* * * * * * *

To keep the spirit of accommodation alive and to remove
all elements of dissatisfaction we are quite willing to
lean over into your direction. It has troubled me
considerably that of all people you would be displeased
with our services.

On May 6, 1986, Mr. Thompson wrote to Mr. Kersting

requesting a full accounting for his participation in the Bauspar

program. Mr. Thompson informed Mr. Kersting that the property

subject to the Bauspar mortgage had been sold. Mr. Thompson also

said that he was reminding Mr. Kersting that, upon his retirement

in 1982, he had asked to terminate his participation in the

programs for which Mr. Kersting was now seeking interest payments

for leverage loans.

Beginning in June 1986, Mr. Thompson stopped making the

$1,200 monthly deposits to Citizens Financial as required under

the Bauspar program. At the same time, Mr. Thompson ignored

Mr. Kersting's written requests to explain his failure to make

the deposits. Further, on June 23, 1986, at the suggestion of

Mr. Huestis, the Thompsons retained John A. Chanin (Mr. Chanin),

an attorney practicing in Honolulu, to assist them in their

dispute with Mr. Kersting. Mr. Chanin assigned the matter to his

associate, Keith Y. Yamada (Mr. Yamada).
- 61 -

On August 1, 1986, Mr. Yamada spoke with Mr. Kersting by

telephone and requested a detailed accounting of the amounts that

the Thompsons had paid to Bauspar and Citizen's Financial, as

well as a status report on the promissory notes executed by the

Thompsons in favor of Bauspar, Signet Financial, Inc., and

Paragon. Following the telephone call from Mr. Yamada,

Mr. Kersting called Mr. Thompson. During this conversation,

Mr. Thompson reminded Mr. Kersting that the Wahiawa property had

been sold. Mr. Kersting stated that he would provide Mr. Chanin

with copies of the documents relating to Mr. Thompson's

participation in the Bauspar program as soon as Mr. Thompson

provided Mr. Kersting with a written authorization to release

them.

By letter dated August 23, 1986, Mr. Kersting notified the

Thompsons that he had turned their file over to Mr. Moseley for

collection and that he sensed that litigation was imminent.

Mr. Kersting's letter states in pertinent part:

Since the odds, however, are in favor of imminent
litigation I consider it to be my obligation to point
out to you the consequences:

The day after you have allowed your attorneys to file
suit I will declare all notes which you have executed
to our companies in default and begin collection
proceedings. We will make an effort to collect from
you not only the $11,844.00 of interest on promissory
notes of which we have sent you billings several times
we will also file suit to collect the principal of all
notes which we hold. The aggregate sum is well in
excess of $250,000.00, as you know.

I will also ask you to return to us the $40,000.00 we
advanced to you after the First Savings debacle. We
will start collection proceedings on the $75,000.00
- 62 -

note which you executed in favor of FEDERATED FINANCE
COMPANY to facilitate the acquisition of your stock in
First Savings & Loan Ass. We will ask you to pay a
pre-payment penalty on your mortgage on the house in
Wahiawa.

We will NOT arrange for you a capital gain in your
BAUSPAR HOLDINGS INC. stock which I had considered--
even though not due you because of premature withdrawal
from the Plan--and we will NOT render assistance in
saving you capital gains taxes on the re-capture of
basis in your stock holdings.

We will NOT provide legal assistance free of cost to
you any longer in US Tax Court proceedings. You will
have to retain your own attorney to make an appearance
for you on February 9/1987 in US Tax Court.

By letter dated August 24, 1986, Mr. Kersting notified

Mr. Seery that he expected to be in litigation with the Thompsons

and directed Mr. Seery not to "render any services, at our

expense," to the Thompsons.

By letter dated August 28, 1986, Mr. Huestis notified

Mr. Moseley that he represented the Thompsons in connection with

their Kersting transactions and the pending Tax Court litigation.

Mr. Huestis advised Mr. Moseley to direct all future

communications regarding the Thompsons to Mr. Chanin.32

By letter dated September 5, 1986, Mr. Kersting again

notified Mr. Seery of his dispute with the Thompsons and

the likelihood of litigation. Mr. Kersting included a copy

of Mr. Huestis' August 28, 1986, letter to Mr. Moseley.

32
As previously mentioned, this was around the time that
Mr. Seery began the process of withdrawing as counsel for the
Thompsons, following Mr. Huestis' notification to Mr. Seery that
the Thompsons were in the process of retaining substitute
counsel.
- 63 -

Mr. Kersting told Mr. Seery that he considered it "mandatory"

that the Thompsons be removed as test case petitioners. On

September 24, 1986, Mr. Kersting again wrote to Mr. Seery,

reminding him of the need to remove the Thompsons from the list

of test cases. During this period, Mr. Thompson began talking

with other Kersting program participants about filing a class

action lawsuit against Mr. Kersting.

On January 1, 1987, Mr. Kersting wrote to Bill Witthorne, a

Kersting program participant, requesting help in dealing with

Mr. Thompson. Mr. Kersting's letter states in pertinent part:

Yet, I consider it important that someone would bring
home to Jack the dangers of the action he has in mind.
He has been hoodwinked by the attorneys out in
California and I think he is blind to the
ramifications. Can you think of anyone in California
who is close to Jack and willing to talk to him?

That same day Mr. Kersting wrote to Benness M. Richards, another

Kersting program participant, stating in pertinent part:

We have been unsuccessful over the last six months or
so to convince Jack that he will be better off with the
legal representation provided by us. Neither has
anyone be [sic] able to bring home to him that the IRS
does NOT make him a better deal than offered to all the
other Petitioners.

On March 10, 1987, Mr. DeCastro and Mr. Huestis informed

Mr. Thompson that Mr. Kersting would not return the Thompsons'

promissory notes. Mr. DeCastro indicated that he wanted to

discuss the possible involvement of his firm in bringing legal

action against Mr. Kersting.

On April 10, 1987, Mr. Thompson wrote a letter to other

Kersting program participants, saying that Mr. Kersting had
- 64 -

deceived him. In his letter, Mr. Thompson said that he had gone

to Mr. Kersting to reduce his tax liabilities but that he now

believed the cost to him would be great because the Internal

Revenue Service was challenging Mr. Kersting's programs.

Mr. Thompson suggested that the biggest worry for Kersting

program participants was Mr. Kersting's "ultimate weapon", the

promissory notes. Mr. Thompson enclosed a copy of a letter that

he had received from Mr. Kersting as an example of what the

others might face.33 Mr. Thompson informed the other

participants that, although Mr. Kersting had promised to cancel

all promissory notes in exchange for the surrender of the

Kersting company stock that was purchased with the proceeds of

the primary loan, Mr. Thompson had tried to surrender his

Kersting company stock but Mr. Kersting had refused to cancel

Mr. Thompson's promissory notes. Mr. Thompson indicated that

he no longer trusted Mr. Kersting, and that he had retained

Mr. DeCastro.

By letter dated May 5, 1987, Mr. Yamada advised Mr. Thompson

that a lawsuit against Mr. Kersting would have merit, and that a

class action lawsuit should be considered. Around this time,

Mr. DeCastro had proposed to file suit on behalf of the Thompsons

against Mr. Kersting in Federal District Court.

33
Although the Court's copy of Mr. Thompson's Apr. 10,
1987, letter does not include a copy of a letter from
Mr. Kersting, we assume that Mr. Thompson circulated
Mr. Kersting's letter of Aug. 23, 1986.
- 65 -

On May 26, 1987, Mr. Huestis called Mr. DeCastro and learned

that, after Mr. Kersting had obtained a copy of Mr. Thompson's

April 10, 1987 letter, Mr. Moseley had written to Mr. DeCastro

on behalf of Mr. Kersting and proposed a settlement of the

Kersting/Thompson dispute. During a later meeting that day with

Mr. Thompson, Mr. Huestis agreed to contact another lawyer in

Honolulu, Charles R. Kozak (Mr. Kozak), to discuss whether

Mr. Kozak might represent the Thompsons in a lawsuit against

Mr. Kersting.

On May 27, 1987, Mr. Huestis contacted Mr. Kozak on behalf

of the Thompsons. Mr. Kozak informed Mr. Huestis that he had

represented two other Kersting participants (David L. Bigelow34

34
David L. Bigelow and Patricia L. Bigelow had
participated in the CAT-FIT program during the taxable years
1975 and 1976. In Bigelow v. Commissioner, T.C. Summary 1983-6
(docket No. 3147-78S), the Court held that the Bigelows were
entitled to interest deductions that they had claimed under the
CAT-FIT program, partly on the basis of evidence that the
Bigelows had successfully sued a related Kersting finance company
in State court. Because the Bigelows' case was tried under the
small tax case procedure, the case was not subject to appeal and
is not treated as precedent for any other case. See sec.
7463(b).

Mr. Kozak had represented Mr. Bigelow in a lawsuit against
Mr. Kersting for payment of the "equity build-up" in a mortgage
funding program (presumably Bauspar) following Mr. Bigelow's
termination of the program. Mr. Bigelow won the suit and
collected damages. According to Mr. Kozak, Mr. Bigelow had
prevailed by virtue of Mr. Kersting's promise not to enforce
notes that Mr. Bigelow had signed in connection with his
participation in other Kersting programs. Mr. Bigelow used
Mr. Kersting's written promise that he would not enforce
promissory notes to prevent Mr. Kersting from asserting the
principal on the notes as a defense or offset to Mr. Bigelow's
claim to the equity buildup in the mortgage funding program.
- 66 -

and Michael Provan35) and that he knew the Kersting programs and

how to locate Mr. Kersting's assets.36 On June 2, 1987,

Mr. Huestis agreed to send a copy of the Thompson file to

Mr. Kozak. On the same date, Mr. Huestis notified Mr. Yamada

that the Thompsons did not plan to retain the Chanin firm to

bring suit against Mr. Kersting.

Messrs. Bigelow, Provan, and Thompson all asked Mr. Kozak to

investigate the filing of a lawsuit against Mr. Kersting. On

August 6, 1987, Mr. Kozak wrote to Mr. Thompson and suggested

that there was a good chance of obtaining a large judgment

against Mr. Kersting through a class action lawsuit, but that

collection of any such judgment would be uncertain. In addition,

Mr. Kozak's letter states in pertinent part:

As you know, Kersting is now embroiled with the
IRS on behalf of his clients. I recently had a
conference with Ken McWade, local counsel for the IRS.
He tells me the trial of these cases will be no sooner
than late Spring 1988. I suspect 12-18 months is a
more realistic date. Also McWade stated he is 100%
sure Kersting will be unable to show any "purposive"
function of his corporations other than to avoid taxes.
Several witnesses including yourself are available to
McWade to prove Kersting never had any intention of
enforcing the notes he had his clients execute. Also,
I am suspicious that Kersting's representation that his

35
Mr. Kozak had represented Mr. Provan when he had been
sued as a director of First Savings. The representation ended
with a settlement with the company that provided First Savings'
officers and directors liability insurance. Mr. Kozak did not
represent Mr. Provan in any tax controversies with the Internal
Revenue Service related to the Kersting programs.
36
As discussed in greater detail, infra pp. 115-116,
Mr. Kozak and his wife, Susan K. Kozak, had participated in one
or more of the Kersting programs that were the subject of this
Court's opinion in Pike v. Commissioner, 78 T.C. 822 (1982).
- 67 -

companies are making loans, leasing cars and factoring
accounts in any meaningful business sense is without
any merit.

Further, I believe we will find that Kersting did
not do many of the "house keeping" accounting and legal
matters which needed to be done to qualify his schemes
before the IRS, even if there was an arguable business
purpose position for his schemes under the tax code.

In my estimation, those clients of Kersting who
continue to be represented by Kersting's lawyers are
headed towards a nightmare. Interest continues to
mount on the taxes due. By the time the pilots finally
get a decision from the tax court, they will be in
terrible financial condition. Of course, they will
still have to pay the tax since bankruptcy will not
terminate their tax liability.

Those who are smart enough should disassociate
themselves from Kersting's lawyers now, obtain their
own counsel, offer their testimony as part of their
negotiations with the IRS and buy out as cheap as they
can now!

There is no evidence in the record that the Thompsons have

ever filed a lawsuit against Mr. Kersting or that Mr. Kersting

has ever filed a lawsuit against the Thompsons. There is no

documentation in the record to support Mr. Thompson's statement

to Mr. Kersting in 1986 that in 1982 he had asked Mr. Kersting to

terminate Mr. Thompson's participation in the Kersting programs.

B. The Alexander Dispute

As previously mentioned, Mr. Alexander first met

Mr. Kersting in Los Angeles in the early 1960's. In the mid-

1970's, Mr. Alexander lent over $100,000 to Mr. Kersting to

assist him in the acquisition of Cosmopolitan Financial Corp.

Mr. Alexander's creditor's interest in Cosmopolitan evolved into

a stock interest in Charter Financial. Mr. Alexander also lent
- 68 -

$80,000 to Mr. Kersting's subchapter S leasing corporations in

the 1970's.

In 1977, Mr. Alexander, a minority shareholder of First

Savings, met with Mr. Kersting to discuss the possible

acquisition of the company. Mr. Alexander participated in the

acquisition of First Savings and added to his First Savings stock

holdings in the process. Mr. Alexander participated in certain

Kersting programs at issue in Dixon II during the taxable years

1974 through 1977.

In 1980, Mr. Alexander brought suit against Mr. Kersting

in Hawaii State court seeking the repayment or return of

approximately $450,000 that Mr. Alexander claimed he had lent to

or invested with Mr. Kersting. Mr. Kozak initially represented

Mr. Alexander in this litigation. Mr. Kersting and/or his

companies eventually filed counterclaims in excess of $4 million

against Mr. Alexander. Mr. Moseley represented Mr. Kersting in

the Alexander litigation.

In March 1982, Mr. Alexander received a telephone call from

Internal Revenue Service Special Agents George Scott and Mike

Duncan, who were interested in questioning Mr. Alexander

regarding Mr. Kersting's various programs. The record does not

reflect whether Mr. Alexander ever agreed to be questioned by the

agents.

The Alexander/Kersting litigation eventually was submitted

to arbitration during a week-long proceeding in July 1987.

During the arbitration proceeding, Mr. Kersting discovered that
- 69 -

Messrs. Alexander, Kozak, and Matsumoto had contacted Mr. McWade

to discuss whether the Government would pay a finder's fee

for information pertaining to Mr. Kersting's programs.

Mr. Alexander's discussions with Mr. McWade on the subject of

a finder's fee are discussed in greater detail, infra pp. 106-

115.

In a letter dated July 24, 1987, Mr. Kersting brought his

dispute with Alexander to the attention of Chicoine and Hallett,

stating as follows:

Dear Darrell:

I have spent the better part of this week in
arbitration hearings concerning a case whereby we are
attempting to accomplish an offset of debt owed us by a
Mr. Denis Alexander against certain obligations we have
to him. The matter has been going on for more than six
years and has become sheer agony.

During the course of the proceedings, however, certain
matters came to the surface which will become apparent
to you as you will read the enclosed material. The
material will disclose a conspiracy between McWade,
DEnis [sic] Alexander, an accountant by the name of
Gilbert Matsumoto and an attorney by the name of
Charles Kozak.

Here are some short facts to illuminate the case:

DEnis [sic] Alexander was a long-time friend going back
more than 25 years, until we locked horns over the debt
referred to above.

Gilbert Matsumoto is an accountant who was for years
the tax preparer for our Finance Company in Aiea,
Federated Finance Company, and for about 10 to 14 of
our clients which we had referred to him. He had given
me an opinion with respect to the viability of the
SubChapter S concept which we employed in the mid-70s
for our Leasing Companies. He, in fact, did the filing
of SubChapter S qualification forms for us with the IRS
in Fresno, Calif. and did some of the Tax Returns. I
- 70 -

adapted the SubChapter S principles on the strength of
his advise [sic].

Charles Kozak is an attorney here in town who was at
one time a shareholder in one of our SubChapter S
Leasing Companies and also a participant in other
programs. He did some legal work for us in the mid-70s
in chasing a dead-beat by the name of Feliciano and he
obtained judgement for us. He became an adversary
after he had made no lease payments on a car which we
had leased to him which compelled us to repossess the
car. He was delinquent by more than one year. He has
stirret [sic] up trouble for me ever since.

These three characters now conspired with McWade to
initiate criminal proceedings again against me and, as
you will read, already discussed among themselves how
to divide the "finders fee" (more precisely the Judas
ducats) which they expected to receive from IRS. As we
took Alexanders [sic] testimony this week it became
apparent to Kozak that he had acted unethically and he
read a statement into the records that "he had advised
his client (Alexander) not to engage in reporting me to
the IRS in order to extract from me a settlement of his
claims" which, of course, is self-defeating since he
was an active participant in the scheme.

I have reason to believe that all of this led nowhere.
If even entrapment and subsequent raid on our premises
did not yield the evidence for the CID characters to
take me out of circulation the Kozak / Alexander /
Matsumoto / McWade conspiracy had no prospect of
success. More than a year has gone by since these rats
tried to make money by setting me up for execution.

I will assume that this incident will become a piece
of the mosaic which should be made known to the US Tax
Court Judge in support of my contention that IRS and
it's [sic] representatives have conspired to ruin my
business and inflict harm on me personally, one way or
another.

Following the arbitration hearing, Mr. Moseley filed a

complaint with the Supreme Court of the State of Hawaii, Office

of Disciplinary Counsel (HODC), accusing Mr. Kozak of conflict of

interest and of attempting to extort money from Mr. Kersting in a

civil suit. On March 17, 1988, Mr. Kozak submitted a written
- 71 -

response to the HODC in response to Mr. Moseley's complaint.

Mr. Kozak alleged that he had been offered inducements by the

Internal Revenue Service in exchange for his cooperation in an

Internal Revenue Service investigation of Mr. Kersting,

suggested that HODC should contact Mr. McWade, denied that he

used the threat of Internal Revenue Service litigation against

Mr. Kersting, and denied any conflict of interest. On April 12,

1988, Mr. Kozak wrote another letter to HODC stating that the

Internal Revenue Service had agreed to pay Mr. Kozak and

Mr. Alexander for their cooperation in an Internal Revenue

Service investigation of Mr. Kersting. At the evidentiary

hearing in this proceeding, Mr. Kozak testified that his

statements to HODC that the Internal Revenue Service had agreed

to pay him for cooperation in an investigation of Mr. Kersting

were false.

On July 12, 1988, the arbitrator released his Arbitration

Decision and Award denying all claims and counterclaims between

Messrs. Alexander and Kersting.37 The arbitrator's decision

37
Following the issuance of the arbitration decision, the
Alexanders claimed a net operating loss (NOL) on their 1988 tax
return in the amount of $321,000 identified as amounts "expended
for the purpose of starting new businesses deemed to be
unretrievable by the American Arbitration Association". The
Alexanders later claimed an NOL in the amount of $360,260 on
their 1990 tax return and an NOL carryforward of $201,955 and a
loss "due to fraud" in the amount of $129,000 on their 1991 tax
return. The Alexanders' 1991 tax return included the following
statement:

The loss was $450,000. $321,000 was claimed on the
1988 returns. $129,000 was not claimed because
(continued...)
- 72 -

turned largely on the lack of credibility of both parties.

The record does not reflect the outcome of Mr. Kersting's

complaint filed with HODC against Mr. Kozak.

C. Collection Actions

In Dixon II, the Court described Mr. Kersting's 1980 dunning

letter to more than 30 program participants and several lawsuits

brought during the period 1983-86 in the names of Kersting

corporations against Kersting program participants to collect

amounts purportedly due on promissory notes. See Dixon II, 62

T.C.M. (CCH) at 1466-1467, 1505-1506, 1991 T.C.M. (RIA), at 91-

3007 to 91-3008, 91-3048 to 91-3050. Summarized below are the

Court's findings and conclusions in Dixon II regarding the

collection lawsuits.

1. Steve Hane

In 1983, a Kersting company, Atlas Funding, commenced an

action on a $30,000 renewal primary note for a stock subscription

plan against Kersting program participant Steve Hane. The Court

noted that the Hane litigation was the only example in the record

37
(...continued)
recovery was expected in the future. In 1991 the
assets on which the recovery was anticipated
disappeared because the corporation was absorbed and
ceased to exist.

Upon examination of the Alexanders' returns for 1990 and
1991, the Commissioner disallowed the claimed NOL's and fraud
loss. After the Alexanders agreed to these adjustments, the
Commissioner issued a notice of deficiency to the Alexanders
determining accuracy-related penalties attributable in part to
the disallowed losses. In Alexander v. Commissioner, T.C.
Summary 1997-80 (docket No. 8948-95S), the Court sustained the
Commissioner's determinations.
- 73 -

of litigation on a primary note. The Court concluded that the

evidence of the Hane litigation was inconsequential because of

the lack of any testimony about the matter and the fact that

Atlas Funding dismissed the action voluntarily after obtaining a

default judgment.

2. Carl Mott, George Vermef, and Robert Peterson

In Dixon II, the Court found that Kersting corporations

pursued collection lawsuits in 1985-86 on leverage loans against

Kersting program participants Carl Mott, George Vermef, and

Robert Peterson. The Court noted that while Carl Mott had been

sued only for interest on leverage loans, Messrs. Vermef and

Peterson had been sued for both interest and principal on

leverage loans. The Court found that there was no explanation in

the record how Messrs. Vermef and Peterson could have owed

principal on leverage loans that would be consistent with the way

the Kersting programs were intended to operate nor with the way

that th

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Source: Frix Law Library, https://www.frixlaw.com/law-library/cases/4332202. Public record. Not legal advice.