# Estate of Kanter v. Comm'r > United States Tax Court · February 1, 2007 · 2007 T.C. Memo. 21 URL: https://www.frixlaw.com/law-library/cases/4336306 ## Case - **Full name:** ESTATE OF BURTON W. KANTER, JOSHUA S. KANTER, AND NAOMI R. KANTER, 1 v. COMMISSIONER OF INTERNAL REVENUE - **Court:** United States Tax Court - **Decided:** February 1, 2007 - **Citations:** 2007 T.C. Memo. 21; 2007 Tax Ct. Memo LEXIS 21 - **Precedential status:** Unpublished - **Opinion:** Opinion - **Judges:** "Haines, Harry A." - **Cited by:** 0 later opinions in the Frix Law Library ## Citator (automated) - No negative treatment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/4336306 ## Opinion text T.C. Memo. 2007-21 UNITED STATES TAX COURT ESTATE OF BURTON W. KANTER, DECEASED, JOSHUA S. KANTER, EXECUTOR, AND NAOMI R. KANTER, ET AL.,1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket Nos. 712-86, 1350-87, Filed February 1, 2007. 31301-87, 33557-87, 3456-88, 32103-88, 16421-90, 26251-90, 20211-91, 21555-91, 21616-91, 1984-92, 16164-92, 23743-92, 7557-93, 22884-93. 1 Cases of the following petitioners are consolidated herewith: Estate of Burton W. Kanter, Deceased, Joshua S. Kanter, Executor, and Naomi R. Kanter, docket Nos. 1350-87, 31301-87, 33557-87, 3456-88, 32103-88, and 26251-90; Claude M. and Mary B. Ballard, docket Nos. 16421-90, 20211-91, 21616-91, 1984-92, 23743-92, and 22884-93; and Estate of Robert W. Lisle, Deceased, Thomas W. Lisle and Amy L. Albrecht, Independent Co- Executors, and Estate of Donna M. Lisle, Deceased, Thomas W. Lisle and Amy L. Albrecht, Independent Co-Executors, docket Nos. 21555-91, 16164-92, and 7557-93. -2- Matthew J. Gries, Randall G. Dick, and N. Jerold Cohen, for petitioner Estate of Burton W. Kanter, Deceased, Joshua S. Kanter, Executor, in docket Nos. 712-86, 1350-87, 31301-87, 33557-87, 3456-88, 32103-88, and 26251-90. Karen L. Hawkins, for petitioner Naomi R. Kanter in docket Nos. 712-86, 1350-87, 31301-87, 33557-87, 3456-88, 32103-88, and 26251-90. Steven S. Brown and Royal B. Martin, for petitioners Claude M. and Mary Ballard in docket Nos. 16421-90, 20211-91, 21616-91, 1984-92, 23743-92, and 22884-93, and for petitioners Estate of Robert W. Lisle, Deceased, Thomas W. Lisle and Amy L. Albrecht, Independent Co-Executors, and Estate of Donna M. Lisle, Deceased, Thomas W. Lisle and Amy L. Albrecht, Independent Co-Executors, in docket Nos. 21555-91, 16164-92, and 7557-93. John J. Comeau, Frederic J. Fernandez, James M. Klein, and Mark J. Miller, for respondent. CONTENTS I. Procedural History . . . . . . . . . . . . . . . . . . . 12 II. Amendment to Rule 183 . . . . . . . . . . . . . . . . . 17 III. Notices of Deficiency . . . . . . . . . . . . . . . . . 19 IV. New Rule 183 and the Court’s Review and Adoption Procedure . . . . . . . . . . . . . . . . . . . . . . . 26 V. Standard of Deference Due to General Findings of Fact and Credibility Determinations Contained in the STJ Report . 28 -3- VI. Structure of the Court’s Report . . . . . . . . . . . . 35 ISSUE I. Whether Kanter, Ballard, and Lisle Earned and Are Taxable on the Income in Dispute . . . . . . . . . 37 FINDINGS OF FACT I. Petitioners . . . . . . . . . . . . . . . . . . . . . . . 38 A. Burton W. Kanter . . . . . . . . . . . . . . . . . 38 B. Claude M. Ballard . . . . . . . . . . . . . . . . . 41 C. Robert W. Lisle . . . . . . . . . . . . . . . . . . 43 D. Additional Findings of Fact Regarding Ballard and Lisle . . . . . . . . . . . . . . . . . . . . . 45 1. Ballard . . . . . . . . . . . . . . . . . . . . 45 2. Lisle . . . . . . . . . . . . . . . . . . . . . 46 E. Kanter-Related Entities . . . . . . . . . . . . . . 47 1. Investment Research Associates, Ltd.(IRA) . . . 47 a. IRA’s Shareholders . . . . . . . . . . . . 48 b. The Bea Ritch Trusts . . . . . . . . . . . 49 c. IRA’s Officers and Directors . . . . . . . 50 d. IRA’s Subsidiaries . . . . . . . . . . . . 52 e. IRA’s Business Activities . . . . . . . . . 53 2. Carlco, Inc., TMT, Inc., and BWK, Inc. . . . . 53 3. Additional Findings of Fact Regarding The Holding Co. . . . . . . . . . . . . . . . . . . 56 a. THC’s Shareholders, Officers, and Directors . . . . . . . . . . . . . . . 57 b. THC’s Tax Returns . . . . . . . . . . . . . 58 4. The Administration Co., Inc., and Principal Services Accounting Corp. . . . . . . . . . . . 59 II. Introductory Statement and Brief Introduction of The Five . . . . . . . . . . . . . . . . . . . . . . . . . . 66 A. The STJ Report . . . . . . . . . . . . . . . . . 66 B. Comments Regarding the Introductory Statement and Brief Introduction of The Five . . . . . . . . 71 III. Details Regarding The Five . . . . . . . . . . . . . . 73 A. Certain Payments Made by The Five . . . . . . . . 73 1. Hyatt Corp.’s Payment of a Share of Its Profits on the Embarcadero Hotel’s Management Contract to KWJ Corp. . . . . . . . . . . . . . 74 2. Bruce Frey’s Payments to IRA From 1980 Through 1985 and to THC in 1981, 1983, 1984, and 1987 . 91 a. The Frey/THC Agreement . . . . . . . . . . 100 b. The Frey/Zeus Agreement . . . . . . . . . . 102 c. BJF Partnership . . . . . . . . . . . . . . 104 d. Summary of Frey Payments to Zeus . . . . . 106 e. Summary of Frey Payments to THC . . . . . . 107 3. Payments From William Schaffel to IRA From 1979 Through 1983 and to THC From 1984 Through 1986 . . . . . . . . . . . . . . . . . 107 -4- a. Sale of IBM Building . . . . . . . . . . . 110 b. Torcon Transactions With Prudential . . . . 110 c. Walters’s Transactions With Prudential . . 112 d. Walters’s Transactions With Travelers . . . 113 e. Schaffel’s Payments to IRA and THC . . . . 116 f. Four Ponds, FPC Subventure, and One River Partnerships . . . . . . . . . . . . . . . 118 (i). Four Ponds Partnership . . . . . 118 (ii). FPC Subventure Partnership . . . 119 (iii). One River Partnership . . . . . . 119 (iv). Meyers’s Memorandum Regarding Four Ponds Partnership . . . . . 120 (v). FPC Subventure’s Tax Returns . . 122 4. Schnitzer/PMS Payments From 1979 Through 1989 . 124 5. Payments from Eulich/Essex Partnership to IRA and THC From 1982 Through 1989 . . . . . . 131 a. John Eulich . . . . . . . . . . . . . . . 131 b. Allen Ostroff . . . . . . . . . . . . . . 133 c. Hotel Management Industry Trends . . . . . 134 d. The Gateway Hilton and John Connolly . . . 135 e. Gateway Hotel Management Co. and Essex Corp . . . . . . . . . . . . . . . . . . . 138 f. MHM and GHM Hotel Management Contracts . . 140 g. Essex Partnership . . . . . . . . . . . . 141 h. Essex Partnership Operations . . . . . . . 144 i. GHM’s and MHM’s Representation and Marketing Agreements . . . . . . . . . . . 145 j. Transfer of IRA’s Essex Partnership Interest . . . . . . . . . . . . . . . . . 151 k. Payments to Essex Partnership and Essex Partnership Distributions . . . . . . . . 152 B. Certain Loans, Payments, and Other Benefits That Ballard and Lisle and/or Their Family Members Received . . . . . . . . . . . . . . . . . . . . . 153 IV. Additional Findings of Fact: The Flow of Funds . . . . . 159 A. Payments Made by The Five to IRA and Its Subsidiaries From 1977 to 1989 . . . . . . . . . . 160 1. Payments Made During 1977 Through 1983 . . . . 162 2. Payments Made During 1984 to 1989 . . . . . . . 164 B. Distribution of the Funds Paid by The Five in Connection With the Various Prudential Transactions to Kanter, Ballard, Lisle, and Their Respective Family Members . . . . . . . . . . . . . 166 1. Additional Details Regarding Management and Control of Carlco, TMT and BWK . . . . . . . . 166 a. Carlco . . . . . . . . . . . . . . . . . . 166 b. TMT . . . . . . . . . . . . . . . . . . . 167 c. BWK . . . . . . . . . . . . . . . . . . . 167 -5- 2. IRA’s Transfers to Carlco, TMT and BWK of Funds Paid by The Five . . . . . . . . . . . 168 a. Funds Paid by The Five to IRA During 1977 Through 1983 Transferred to Carlco, TMT, and BWK . . . . . . . . . . . . . . . . . 168 (i). Transfers From Zeus to IRA . . . 169 (ii). IRA’s Transfer of Its Interest in Essex Partnership . . . . . . 170 (iii). IRA’s Transfer of Its Interest in Sherwood Partnership . . . . . 171 (iv). Accounting Treatment . . . . . . 172 (v). Additional Capital Contributions to Sherwood Partnership . . . . . 173 b. Transfer of Funds Paid by The Five During 1984 Through 1989 to Carlco, TMT, and BWK 174 (i). Hyatt Corp. . . . . . . . . . . . 174 (ii). Frey . . . . . . . . . . . . . . 176 (iii). Schnitzer/PMS . . . . . . . . . . 176 (iv). Essex Partnership . . . . . . . . 176 c. Carlco, TMT, and BWK Capital Accounts . . 177 3. The Disposition of Funds From Carlco, TMT, and BWK for the Benefit of Ballard, Lisle, Kanter, and Their Families . . . . . . . . . . . . . . 178 a. Ballard’s Use and Enjoyment of TMT’s Assets . . . . . . . . . . . . . . . . . . 178 (i). TMT’s Various Accounts . . . . . 178 (ii). Loans From TMT to Ballard and Ballard Entities . . . . . . . . 178 (iii). TMT’s Property Transferred to Ballard . . . . . . . . . . . . . 181 (iv). Investment in Melinda Ballard’s Company . . . . . . . . . . . . . 184 (v). Ballard’s Disclosures to Goldman Sachs . . . . . . . . . . 185 (vi). TMT’s Assets . . . . . . . . . . 187 b. Lisle’s Use and Enjoyment of Carlco’s Assets . . . . . . . . . . . . . . . . . . 188 (i). Carlco’s Various Accounts . . . . 188 (ii). Lisle’s Personal Use of Carlco’s Funds . . . . . . . . . . . . . 189 (iii). Carlco’s Assets . . . . . . . . 189 c. Kanter’s Use and Enjoyment of BWK’s Assets . . . . . . . . . . . . . . . . . . 190 (i). Salaries and Officer Compensation Paid to Kanter and His Son . . . 190 (ii). Loans . . . . . . . . . . . . . 190 (iii). Gifts . . . . . . . . . . . . . 191 -6- C. Other Means Used To Transfer Funds for the Benefit of Ballard, Lisle, Kanter, and Their Respective Families . . . . . . . . . . . . . . . . 191 1. Payments From IRA, KWJ Corp., and KWJ Partnership . . . . . . . . . . . . . . . . . . 191 a. IRA Payments to Ballard and Lisle in 1982 . . . . . . . . . . . . . . 191 b. Consulting Fees Paid by KWJ Corp. and KWJ Partnership to Ballard’s and Lisle’s Adult Children . . . . . . . . 192 2. Additional Loans . . . . . . . . . . . . . . . 194 a. IRA Loans to Kanter . . . . . . . . . . . 194 b. Loans to Ballard, Lisle, Their Family Members, and Their Trusts . . . . . . . 194 (i). Ballard’s Grantor Trusts . . . . 194 (ii). Lisle’s Grantor Trusts . . . . . 195 (iii). International Films, Inc. . . . . 196 (iv). Harbor Exchange Lending Operation 196 (v). Loans to Lisle and His Trusts. . 197 (vi). Loans to the Ballards and Their Trusts . . . . . . . . . . 197 (vii). Writeoff of Loans and Claimed Losses. . . . . . . . . . . . . . 197 (viii). Loans to Lisle’s RWL Cinema Trust During 1988 to 1990 . . . . 205 D. Summary of Funds Paid by The Five to IRA and Disposition of Those Funds for the Benefit of Kanter, Ballard, Lisle, and Their Families . . . . 205 E. Payments Made by The Five to THC and Its Subsidiaries During 1981 Through 1989 . . . . . . . 207 F. Distribution of Funds From THC to Kanter . . . . . 208 G. The Flow of Funds From Four Ponds and One River Through FPC Subventure to Kanter and Lisle . . . . 211 V. Additional Findings of Fact Regarding the Examination Process and Summons Enforcement Proceedings . . . . . . . 213 A. Failure To Cooperate During the Audit . . . . . . . 213 B. IRS Summonses . . . . . . . . . . . . . . . . . . . 214 C. Summons Enforcement . . . . . . . . . . . . . . . . 215 D. Requests for Production of Documents . . . . . . . 219 OPINION A. The Parties’ Positions . . . . . . . . . . . . . . 222 B. The Assignment of Income Doctrine . . . . . . . . . 224 C. Errors in the STJ Report . . . . . . . . . . . . . 228 1. The STJ Report Reflects a Misunderstanding of Respondent’s Theory Regarding the Kickback Scheme . . . . . . . . . . . . . . . . . . . . 229 2. Discussion Regarding Assignment of Income . . 231 -7- 3. Failure To Address Respondent’s Flow-of-Funds Argument . . . . . . . . . . . . . . . . . . . 232 4. Incomplete Discussion Regarding Loan Arrangements . . . . . . . . . . . . . . . . . 232 5. Discussion Regarding Consulting Payments to Ballard’s and Lisle’s Adult Children . . . . . 234 6. Manifestly Unreasonable Credibility Determinations . . . . . . . . . . . . . . . . 235 a. Testimony Offered by The Five . . . . . . 235 b. Ballard’s Testimony Regarding the Hyatt Transaction . . . . . . . . . . . . . . . 235 c. Kanter’s Testimony Regarding Deconsolidation . . . . . . . . . . . . . 236 d. Kanter’s Testimony Regarding IRA . . . . . 237 e. Kanter’s, Ballard’s, and Lisle’s Denials 237 D. Summary of Kanter’s, Ballard’s and Lisle’s Transactions With The Five . . . . . . . . . . . . 238 1. An Overview . . . . . . . . . . . . . . . . . . 238 2. The Hyatt Transaction . . . . . . . . . . . . . 244 3. Shaffel . . . . . . . . . . . . . . . . . . . . 249 4. Frey . . . . . . . . . . . . . . . . . . . . . 253 5. Schnitzer/PMS . . . . . . . . . . . . . . . . . 257 6. Eulich/Essex Partnership . . . . . . . . . . . 260 E. Flow-of-Funds Analysis . . . . . . . . . . . . . . 267 1. Payments to IRA: 1977 Through 1983 . . . . . . 268 2. Payments to IRA: 1984 Through 1989 . . . . . . 269 3. IRA Loans to Kanter, Ballard, and Lisle . . . . 270 a. IRA Loans to Ballard and Ballard’s Trusts 270 b. IRA Loans to Lisle and Lisle’s Trusts . . 270 c. Sale of Grantor Trust Notes for $1 . . . . 271 d. IRA Loans to Kanter . . . . . . . . . . . 271 e. Additional Loans to Lisle’s Grantor Trust 272 f. Consulting Payments to Ballard’s and Lisle’s Adult Children . . . . . . . . . . 272 4. Payments to THC: 1981 to 1989 . . . . . . . . 273 a. FPC Subventure Partnership . . . . . . . . 274 b. THC Transfers to Kanter . . . . . . . . . 276 F. Kanter-Related Entities Were Shams . . . . . . . . 276 1. IRA and THC . . . . . . . . . . . . . . . . . . 276 2. Carlco, TMT, and BWK . . . . . . . . . . . . . 278 a. Diversification and Deconsolidation . . . 278 b. Use and Enjoyment of Carlco’s, TMT’s, and BWK’s Assets . . . . . . . . . . . . . 282 (i). Carlco . . . . . . . . . . . . . 282 (ii). TMT . . . . . . . . . . . . . . . 283 (iii). BWK . . . . . . . . . . . . . . . 287 G. Cracks in the Kanter Facade . . . . . . . . . . . . 288 1. The Hyatt Transaction . . . . . . . . . . . . . 288 -8- 2. Frey . . . . . . . . . . . . . . . . . . . . . 289 3. Schaffel . . . . . . . . . . . . . . . . . . . 290 4. Schnitzer/PMS . . . . . . . . . . . . . . . . . 291 5. Loans to Ballard . . . . . . . . . . . . . . . 292 6. Ballard’s Disclosures to Goldman Sachs . . . . 292 7. Kanters’s Letters to the Ballard and Lisle Children . . . . . . . . . . . . . . . . . . . 293 H. Conclusion and Schedule of Income Adjustments . . . 295 ISSUE II. Whether Kanter and Ballard Are Liable for Additions to Tax for Fraud . . . . . . . . . . . . 298 OPINION A. Failure To Report Substantial Amounts of Income . . 300 B. Concealment of the True Nature of the Income and the Identity of the Earners of the Income . . . . . 301 C. Use of Sham, Conduit, and Nominee Entities . . . . 301 D. Reporting Kanter’s and Ballard’s Income on IRA’s and THC’s Tax Returns . . . . . . . . . . . . . . . 302 E. Commingling of Kanter’s and Ballard’s Income With Funds Belonging to Others . . . . . . . . . . . . . 303 F. Phony Loans . . . . . . . . . . . . . . . . . . . . 303 G. False and Misleading Documents . . . . . . . . . . 304 H. Failure to Cooperate During the Examination Process 304 I. Conclusion . . . . . . . . . . . . . . . . . . . . 306 ISSUE III. Whether Commitment Fees Paid to Century Industries, Ltd., During 1981 to 1984 and 1986 are Includable in Kanter’s Income . . . . . . . . 307 FINDINGS OF FACT OPINION A. The Parties’ Arguments . . . . . . . . . . . . . . 316 B. TEFRA Partnership Provisions . . . . . . . . . . . 317 C. The STJ Report . . . . . . . . . . . . . . . . . . 318 D. Analysis . . . . . . . . . . . . . . . . . . . . . 319 ISSUE IV. Whether Kanter Received Unreported Income From Hi-Chicago Trust During 1981 to 1983 . . . . . . . 324 FINDINGS OF FACT OPINION A. The Assignment of Income Doctrine . . . . . . . . . 326 B. The Parties’ Arguments . . . . . . . . . . . . . . 327 C. Analysis . . . . . . . . . . . . . . . . . . . . . 327 ISSUE V. Whether Kanter Is Taxable on Income Attributed to the Bea Ritch Trusts for 1986 and 1987 . . . . . 330 FINDINGS OF FACT A. The Bea Ritch Trusts . . . . . . . . . . . . . . . 330 B. Oyster Bay Associates Partnership . . . . . . . . . 332 -9- OPINION A. Grantor Trust Provisions of Sections 671 Through 678 . . . . . . . . . . . . . . . . . . . . . . . . 341 B. The Parties’ Arguments . . . . . . . . . . . . . . 343 C. The STJ Report . . . . . . . . . . . . . . . . . . 344 D. Analysis . . . . . . . . . . . . . . . . . . . . . 345 ISSUE VI. Whether Kanter Received Unreported Income From CMS Investors Partnership for 1982 to 1984 and 1987 to 1989 . . . . . . . . . . . . . . . . . 349 FINDINGS OF FACT OPINION A. The Parties’ Arguments . . . . . . . . . . . . . . 352 B. Analysis . . . . . . . . . . . . . . . . . . . . . 354 1. Subject Matter Jurisdiction . . . . . . . . . . 354 2. Whether Kanter Improperly Assigned Income to THC Through CMS Investors . . . . . . . . . . . 356 ISSUE VII. Whether Kanter Received Unreported Income From Equitable Leasing Co., Inc., During 1983 . . . . 357 FINDINGS OF FACT OPINION ISSUE VIII. Whether Kanter Received Unreported Income for 1982 According to the Bank Deposits Method of Income Reconstruction . . . . . . . . . . . . 361 FINDINGS OF FACT OPINION A. The Commissioner’s Use of the Bank Deposits Method of Income Reconstruction . . . . . . . . . . 363 B. The Parties’ Arguments . . . . . . . . . . . . . . 364 C. The STJ Report . . . . . . . . . . . . . . . . . . 365 D. Analysis . . . . . . . . . . . . . . . . . . . . . 365 ISSUE IX. Whether Kanter Received Barter Income From Principal Services Accounting Corp. During 1988 and 1989. . . . . . . . . . . . . . . . . . . . . 367 ISSUE X. Whether the Kanters Received Unreported Interest Income During 1988 . . . . . . . . . . . . . . . . 368 ISSUE XI. Whether the Kanters Are Entitled to Certain Deductions They Claimed on Schedules A and C for 1986 to 1989 . . . . . . . . . . . . . . . . . 368 FINDINGS OF FACT OPINION A. The Parties’ Arguments . . . . . . . . . . . . . . 372 B. Analysis . . . . . . . . . . . . . . . . . . . . . 372 -10- ISSUE XII. Whether Kanter Realized and Must Recognize Capital Gains as a Result of Transactions Involving Cashmere Investments Associates, Inc., During 1983 and Whether the Kanters May Use the Installment Method To Report Gains . . . . . 374 FINDINGS OF FACT A. Transfer of Real Estate Partnership Interests to Cashmere . . . . . . . . . . . . . . . . . . . . 380 B. Sale of Cashmere Stock to Waco . . . . . . . . . . 383 C. Sale of Cashmere Stock From Waco to Zell . . . . . 386 OPINION A. The Parties’ Arguments . . . . . . . . . . . . . . 387 B. Analysis . . . . . . . . . . . . . . . . . . . . . 389 1. Applicability of Section 357(b)(1) . . . . . . 391 2. Applicability of Section 357(c) . . . . . . . . 392 3. Kanter’s Use of the Installment Method . . . . 394 ISSUE XIII. Whether Kanter Is Entitled to Research and Development and Business Expense Deductions Related to Immunological Research Corp. for 1979 . . . . . . . . . . . . . . . . . . . . 396 FINDINGS OF FACT OPINION A. Trade or Business Requirement of Section 174 . . . 404 B. The Parties’ Arguments . . . . . . . . . . . . . . 407 C. Analysis . . . . . . . . . . . . . . . . . . . . . 408 ISSUE XIV. Whether Kanter Received Unreported Partnership Income During 1978 . . . . . . . . . . . . . . . 415 FINDINGS OF FACT OPINION ISSUE XV. Whether the Kanters Are Entitled to a Loss From GLS Associates for 1981 . . . . . . . . . . . . . 417 OPINION ISSUE XVI. Whether the Kanters Are Entitled to Losses From Equitec for 1983 and 1984 . . . . . . . . . . . . 420 OPINION A. The Parties’ Arguments . . . . . . . . . . . . . . 420 B. Analysis . . . . . . . . . . . . . . . . . . . . . 421 ISSUE XVII. Whether the Kanters Are Entitled to an Investment Interest Expense Deduction for 1981 . . . . . . 421 OPINION A. The Parties’ Arguments . . . . . . . . . . . . . . 422 B. Analysis . . . . . . . . . . . . . . . . . . . . . 422 -11- ISSUE XVIII. Whether the Kanters Are Entitled to an Investment Tax Credit Carryover for 1978 . . . 423 OPINION A. The Parties’ Arguments . . . . . . . . . . . . . . 423 B. Analysis . . . . . . . . . . . . . . . . . . . . . 424 ISSUE XIX. Whether the Kanters Are Entitled to an Interest Deduction for 1986 . . . . . . . . . . . 426 OPINION A. The Parties’ Arguments . . . . . . . . . . . . . . 426 B. Analysis . . . . . . . . . . . . . . . . . . . . . 427 ISSUE XX. Whether the Kanters Are Entitled to a Business Deduction of $104,231 for 1980 . . . . . . . . . . 429 OPINION A. The STJ Report . . . . . . . . . . . . . . . . . . 429 B. The Parties’ Arguments . . . . . . . . . . . . . . 429 ISSUE XXI. Whether the Kanters Are Entitled to a Deduction for a Charitable Contribution to the Jewish United Fund for 1982 . . . . . . . . . . . . . . 430 FINDINGS OF FACT OPINION A. The Parties’ Arguments . . . . . . . . . . . . . . 431 B. The STJ Report . . . . . . . . . . . . . . . . . . 432 C. Analysis . . . . . . . . . . . . . . . . . . . . . 432 ISSUE XXII. Whether Kanter Is Liable for Self-Employment Tax for 1982 . . . . . . . . . . . . . . . . . . 434 OPINION ISSUE XXIII. Whether the Kanters Realized Capital Gains and Losses as Reported on Their 1987 Tax Return . . . . . . . . . . . . . . . . . . . . 434 ISSUE XXIV. Additions to Tax and Related Matters . . . . . . 435 OPINION APPENDIXES Appendix 1 . . . . . . . . . . . . . . . . . . . . . . . . . 437 Appendix 2 . . . . . . . . . . . . . . . . . . . . . . . . . 238 Appendix 3 . . . . . . . . . . . . . . . . . . . . . . . . . 439 Appendix 4 . . . . . . . . . . . . . . . . . . . . . . . . . 440 Appendix 5 . . . . . . . . . . . . . . . . . . . . . . . . . 441 Appendix 6 . . . . . . . . . . . . . . . . . . . . . . . . . 443 Appendix 7 . . . . . . . . . . . . . . . . . . . . . . . . . 444 -12- Appendix 8 . . . . . . . . . . . . . . . . . . . . . . . . . 445 Appendix 9 . . . . . . . . . . . . . . . . . . . . . . . . . 446 Appendix 10 . . . . . . . . . . . . . . . . . . . . . . . . . 447 Appendix 11 . . . . . . . . . . . . . . . . . . . . . . . . . 448 Appendix 12 . . . . . . . . . . . . . . . . . . . . . . . . . 449 Appendix 13 . . . . . . . . . . . . . . . . . . . . . . . . . 451 Appendix 14 . . . . . . . . . . . . . . . . . . . . . . . . . 452 Appendix 15 . . . . . . . . . . . . . . . . . . . . . . . . . 453 Appendix 16 . . . . . . . . . . . . . . . . . . . . . . . . . 454 Appendix 17 . . . . . . . . . . . . . . . . . . . . . . . . . 455 MEMORANDUM FINDINGS OF FACT AND OPINION HAINES, Judge: These consolidated cases are before the Court on separate remands from the U.S. Courts of Appeals for the Fifth, Seventh, and Eleventh Circuits2 for further proceedings consistent with the Supreme Court’s opinion in Ballard v. Commissioner, 544 U.S. 40 (2005), revg. 321 F.3d 1037 (11th Cir. 2003) and Estate of Kanter v. Commissioner, 337 F.3d 833 (7th Cir. 2003). I. Procedural History These cases, along with a number of cases instituted by another taxpayer, Investment Research Associates, Ltd., originally were consolidated for trial, briefing, and opinion. Special Trial Judge D. Irvin Couvillion tried the cases but was statutorily prohibited from entering the decisions. See sec. 2 See Estate of Kanter v. Commissioner, 406 F.3d 933 (7th Cir. 2005); Ballard v. Commissioner, 429 F.3d 1026 (11th Cir. 2005); Estate of Lisle v. Commissioner, 431 F.3d 439 (5th Cir. 2005). -13- 7443A(c).3 Special Trial Judge Couvillion prepared an initial report that included his recommended findings of fact and opinion (the STJ report). The cases were then assigned to Judge Howard A. Dawson, Jr., for adoption of the STJ report and entry of decisions. Under Rule 183 as in effect at the time, the STJ report was not filed or otherwise entered into the record of the cases.4 Special Trial Judge Couvillion subsequently collaborated with Judge Dawson in preparing a final report, Inv. Research Associates, Ltd. v. Commissioner, T.C. Memo. 1999-407, in which the Court sustained, inter alia, respondent’s determinations that petitioners Burton W. Kanter (Kanter),5 Claude M. Ballard (Ballard), and Robert W. Lisle (Lisle)6 (collectively petitioners) failed to report income from a kickback scheme and were liable for additions to tax for fraud. The Court also sustained a number of adjustments respondent determined with 3 Unless otherwise indicated, section references are to sections of the Internal Revenue Code, as amended, and Rule references are to the Tax Court Rules of Practice and Procedure. 4 As discussed in greater detail below, Rule 183 was amended effective Sept. 20, 2005. We shall refer to the amended Rule as new Rule 183. 5 Burton W. Kanter died on Oct. 31, 2001--after he testified at the trial in the consolidated cases. Thereafter, his estate was substituted as a party in each of his dockets. 6 Robert W. Lisle died before the trial in the consolidated cases, and his estate was substituted as a party in each of his dockets. -14- regard to Kanter that were unrelated to the alleged kickback scheme. Following entry of decisions, Kanter, Ballard, and Lisle appealed their cases to separate Courts of Appeals.7 In Ballard v. Commissioner, 321 F.3d 1037 (11th Cir. 2003), and Estate of Kanter v. Commissioner, 337 F.3d 833 (7th Cir. 2003), the Courts of Appeals for the Eleventh and Seventh Circuits, respectively, affirmed this Court’s holdings that (1) Ballard and Kanter failed to report income from the alleged kickback scheme, and (2) each was liable for additions to tax for fraud.8 The Courts of Appeals also affirmed this Court’s earlier ruling that it was not obliged to make the STJ report part of the record. In Estate of Lisle v. Commissioner, 341 F.3d 364 (5th Cir. 2003), the Court of Appeals for the Fifth Circuit affirmed this Court’s holding that 7 In Inv. Research Associates, Ltd. v. Commissioner, T.C. Memo. 1999-407, the Court sustained a number of adjustments respondent determined with regard to the tax liability of Investment Research Associates, Ltd. (IRA). The Court entered decisions in all IRA dockets on Sept. 24, 2001. No appeal having been filed, the Court’s decisions in the IRA cases are now final. See secs. 7481(a)(1), 7483. The Kanters did not appeal the decisions entered in their cases at docket Nos. 24002-91 (taxable year 1987), 26918-92 (taxable year 1988), and 25981-93 (taxable year 1989). These decisions were entered on Sept. 24, 2001, and are now final. See secs. 7481(a)(1), 7483. 8 In Estate of Kanter v. Commissioner, 337 F.3d 833, 854- 857 (7th Cir. 2003), the Court of Appeals for the Seventh Circuit also affirmed and reversed this Court’s holdings with regard to several issues that related solely to Kanter. -15- the Estate of Lisle was liable for tax deficiencies related to the alleged kickback scheme for the years 1987 to 1989 but reversed this Court’s holding that the Estate of Lisle was liable for additions to tax for fraud. Ballard and Kanter filed petitions for certiorari with the Supreme Court. The Estate of Lisle did not file a petition for certiorari. In Ballard v. Commissioner, 544 U.S. 40 (2005), the Supreme Court concluded (1) the collaborative process this Court employed in the review of the STJ report and adoption of the Court’s Memorandum Opinion in Inv. Research Associates, Ltd. v. Commissioner, supra, was not warranted by or described in the Court’s Rules of Practice and Procedure, and (2) the STJ report was required to be included in the record to permit fully informed appellate review regarding the question whether the Special Trial Judge’s “credibility and other findings made in that report were accorded ‘[d]ue regard’ and were ‘presumed . . . correct’”. Ballard v. Commissioner, supra at 60. Thus, the Supreme Court reversed the judgments of the Courts of Appeals for the Seventh and Eleventh Circuits and remanded the cases for further proceedings consistent with its opinion. In Estate of Kanter v. Commissioner, 406 F.3d 933, 934 (7th Cir. 2005), the Court of Appeals for the Seventh Circuit remanded the Kanter cases to this Court “for further proceedings -16- consistent with the Supreme Court’s decision in Estate of Burton W. Kanter v. Commissioner of Internal Revenue, No. 03-1034.” In Ballard v. Commissioner, 429 F.3d 1026, 1027 (11th Cir. 2005), the Court of Appeals for the Eleventh Circuit remanded the Ballard cases to this Court with the following instructions: (1) The “collaborative report and opinion” of the Tax Court is ordered stricken; (2) The original report of the special trial judge is ordered reinstated; (3) The Chief Judge of the Tax Court is instructed to assign this matter to a regular Tax Court Judge who had no involvement in the preparation of the aforementioned “collaborative report;” (4) The Tax Court shall proceed to review this matter in accordance with the dictates of the Supreme Court, and with the Tax Court’s newly revised Rules 182 and 183, giving “due regard” to the credibility determinations of the special trial judge and presuming correct fact findings of the trial judge. * * * The Court of Appeals also stated that Special Trial Judge Couvillion’s findings of fact are to be presumed correct “unless manifestly unreasonable”. Id. at 1032. In Estate of Lisle v. Commissioner, 431 F.3d 439 (5th Cir. 2005), the Court of Appeals for the Fifth Circuit recalled its earlier mandate and directed this Court to reexamine the question whether the Estate of Lisle is liable for tax deficiencies consistent with the instructions handed down by the Court of Appeals for the Eleventh Circuit in Ballard v. Commissioner, 429 F.3d at 1027.9 9 The Court of Appeals for the Fifth Circuit’s mandate in the Lisle cases includes a reference to the case filed with this Court at docket No. 20219-91. However, the Court’s decision in (continued...) -17- Following the remands, these cases were assigned to Judge Harry A. Haines, a Judge who was not involved in the prior proceedings in these cases.10 II. Amendment to Rule 183 In response to the Supreme Court’s holding in Ballard v. Commissioner, 544 U.S. 40 (2005), the Court amended Rule 183 to provide a procedure for service on the parties of a Special Trial Judge’s recommended findings of fact and conclusions of law and the filing of objections and responses. The pertinent portions of new Rule 183 state as follows: (c) Objections: Within 45 days after the service of the recommended findings of fact and conclusions of law, a party may serve and file specific, written objections to the recommended findings of fact and conclusions of law. A party may respond to another party’s objections within 30 days after being served with a copy thereof. The above time periods may be extended by the Special Trial Judge. After the time for objections and responses has passed, the Chief Judge shall assign the case to a Judge for preparation of a report in accordance with Code section 7460. 9 (...continued) that case, i.e., that there is no deficiency and no addition to tax due from the Lisles for the taxable year 1984, was entered Nov. 20, 2003, and is otherwise final. See secs. 7481(a)(1), 7483. Although the Clerk of the Court notified the Court of Appeals for the Fifth Circuit of this discrepancy, the Court has received no further instruction from the Court of Appeals on this point. Under the circumstances, the Court will assume that docket No. 20219-91 was included in the Court of Appeals’ mandate as the result of an inadvertent clerical error and docket No. 20219-91 shall remain closed. 10 Judges Mary Ann Cohen and Howard A. Dawson, Jr., and Special Trial Judge D. Irvin Couvillion have taken no part in the review of these cases on remand. See Ballard v. Commissioner, 429 F.3d at 1032 n.7. -18- Unless a party shall have proposed a particular finding of fact, or unless the party shall have objected to another party’s proposed finding of fact, the Judge may refuse to consider the party’s objection to the Special Trial Judge’s recommended findings of fact and conclusions of law for failure to make such a finding or for inclusion of such finding proposed by the other party, as the case may be. [Emphasis added.] (d) Action on the Recommendations: The Judge to whom the case is assigned may adopt the Special Trial Judge’s recommended findings of fact and conclusions of law, or may modify or reject them in whole or in part, or may direct the filing of additional briefs, or may receive further evidence, or may direct oral argument, or may recommit the recommended findings of fact and conclusions of law with instructions. The Judge’s action on the Special Trial Judge’s recommended findings of fact and conclusions of law shall be reflected in the record by an appropriate order or report. Due regard shall be given to the circumstance that the Special Trial Judge had the opportunity to evaluate the credibility of witnesses, and the findings of fact recommended by the Special Trial Judge shall be presumed to be correct. Consistent with new Rule 183(c), the parties were served with copies of the STJ report. In view of the recent amendment to Rule 183, and the unique procedural posture of these cases, the Court extended the dates within which the parties were directed to file the objections and responses referred to in new Rule 183(c). Respondent and Kanter filed objections to the STJ report. Ballard and Lisle filed notices of no objection to the STJ report. Kanter, Ballard, and Lisle filed responses to respondent’s objection to the STJ report, and respondent filed a response to Kanter’s objection to the STJ report. -19- III. Notices of Deficiency Respondent issued notices of deficiency to petitioners as summarized below: Burton W. and Naomi R. Kanter Additions to Tax Penalty Year Deficiency Sec. 6653 Sec. 6659 Sec. 6661 Sec. 6662 1978 $476,999.00 -- -- -- -- 1979 183,909.37 $9,190.47 -- -- -- 1980 454,396.00 22,720.00 -- -- -- 1981 340,578.00 17,029.00 $42,682 -- -- 1982 2,086,913.00 104,346.00 -- $208,691.00 -- 1983 1,150,652.00 57,532.60 -- 287,663.00 -- 1984 3,825,078.00 191,254.00 -- 949,211.00 -- 1986 897,224.00 44,861.60 -- 223,666.00 -- 1987 1,434,529.00 71,726.45 -- 358,632.25 -- 1988 523,234.00 26,162.00 -- 130,809.00 -- 1989 835,847.00 -- -- -- $167,169 Claude M. and Mary B. Ballard Additions to Tax--Secs. Penalty Year Deficiency 6651(a)(1) 6653 6659 6661 Sec. 6662 1975 $23,453 -- $1,173.00 -- -- -- 1976 34,024 -- 1,701.00 -- -- -- 1977 11,502 -- -- -- -- -- 1978 3,923 -- -- -- -- -- 1979 21,630 -- -- -- -- -- 1980 92,481 -- -- -- -- -- 1981 193,743 -- 9,687.00 $17,138 -- -- 1982 55,338 -- 2,766.90 -- $8,744.00 -- 1984 981,072 1 $51,331 88,788.05 -- 245,268.00 -- 1987 208,449 -- 10,442.45 -- 52,112.25 -- 1988 125,136 -- 6,257.00 -- -- -- 1989 179,924 -- -- -- -- $35,985 1 Respondent conceded the addition to tax under sec. 6651(a)(1) for the taxable year 1984. -20- Estate of Robert W. Lisle, Deceased, Thomas W. Lisle and Amy L. Albrecht, Independent Co-executors, and Estate of Donna M. Lisle, Deceased, Thomas W. Lisle and Amy L. Albrecht, Independent Co- Executors Additions to Tax Penalty Year Deficiency Sec. 6653 Sec. 6661 Sec. 6662 1984 $827,955 $41,397.75 $206,988.75 -- 1987 195,498 9,774.90 48,874.50 -- 1988 109,048 5,452.00 27,262.00 -- 1989 109,049 -- -- $21,810 Respondent determined in the notices of deficiency or asserted in amended pleadings that the underpayments in tax were subject to increased interest under section 6621(c), formerly section 6621(d),11 as follows: Burton W. and Naomi R. Kanter for the taxable years 1979,12 1980, 1982 to 1984, 1986, and 1987; Claude M. and Mary B. Ballard for the taxable years 1975 to 1982, 1984, 1987, and 1988; and the Estates of Robert W. Lisle, 11 Sec. 6621(d)(1) was added by the Deficit Reduction Act of 1984, Pub. L. 98-369, sec. 144(a), 98 Stat. 682, and provides for interest of 120 percent of the adjusted interest rate due on any substantial underpayment of tax attributable to tax-motivated transactions. The increased interest is effective for interest accruing after Dec. 31, 1984. In the Tax Reform Act of 1986, Pub. L. 99-514, sec. 1511(c), 100 Stat. 2744, sec. 6621(d)(1) was redesignated sec. 6621(c)(1). 12 With respect to the Kanter case at docket No. 3456-88, the applicability of sec. 6621(c) was asserted by respondent in an amendment to answer and applies only to an underpayment in tax of $206,239.63 attributable to a loss of $311,478 claimed by petitioners from Immunological Research Corp., an S corporation, which respondent disallowed. In a second amendment to answer, respondent asserted the entire underpayment in tax for 1979 was subject to increased interest under sec. 6621(c). On brief, respondent concedes the underpayment attributable to the disallowed loss from Immunological Research Corp. is not subject to increased interest under sec. 6621(c) on the basis of Estate of Cook v. Commissioner, T.C. Memo. 1993-581. -21- Deceased, and Donna M. Lisle, Deceased, for the taxable years 1984, 1987, and 1988. In amended pleadings, respondent asserted increases in the deficiencies in tax and additions to tax for the taxpayers and years as follows: Burton W. and Naomi R. Kanter for the taxable years 1978 to 1984 and 1986 to 1989; Claude M. and Mary B. Ballard for the taxable years 1975 to 1982, 1984, and 1987 to 1989; and Estates of Robert W. Lisle, Deceased, and Donna M. Lisle, Deceased, for the taxable years 1984 and 1987 to 1989. In the amended pleadings referred to above, respondent asserted that (1) the underpayments of tax with respect to all or substantial portions of the increased deficiencies in tax are subject to the addition to tax for fraud pursuant to section 6653(b);13 and (2) in the alternative, if the Court holds that petitioners are not liable for additions to tax for fraud, then petitioners are liable for additions to tax under sections 6653(a)(1) and (2) and 6659(a) and increased interest under 13 For 1976 through 1981, the addition to tax for fraud is set forth in sec. 6653(b). For 1982 through 1985, the addition to tax for fraud is set forth in sec. 6653(b)(1) and (2). For 1986 and 1987, the addition to tax for fraud is set forth in sec. 6653(b)(1)(A) and (B). For 1988, the addition to tax for fraud is set forth in sec. 6653(b)(1). For 1989, the penalty for fraud is set forth in sec. 6663(a). By prior agreement among the parties at a pretrial conference with the Court, respondent’s amended pleadings and petitioners’ replies thereto were not filed of record until the commencement of trial; however, the parties exchanged these filings with each other well before the trial date that was set by the Court. -22- section 6621(c), or if the underpayment was for 1989, subject to a penalty under section 6662.14 In the amended pleadings referred to above, respondent did not calculate or assert the amounts of the increased tax deficiencies or the amounts of the additions to tax or penalties. Respondent generally asserted the amounts of increased income or the amounts of disallowed expenses that would result in increased deficiencies in tax and additions to tax. As a result of these amended pleadings, and as a result of numerous concessions and stipulations of settlement which were effected by the parties before, during, and after the trial, as well as concessions of 14 As previously discussed, in Estate of Lisle v. Commissioner, 341 F.3d 364 (5th Cir. 2003), the Court of Appeals for the Fifth Circuit affirmed this Court’s holding that the Estate of Lisle was liable for the deficiencies in dispute for 1987 to 1989 but reversed this Court’s holding that the Estate of Lisle was liable for additions to tax for fraud (and therefore assessment for the taxable year 1984 was barred by the period of limitations). After the Lisle cases were first remanded to this Court for entry of revised decisions (but before the Court of Appeals recalled its mandate on Nov. 22, 2005), respondent asserted the Court should sustain respondent’s alternative determinations that the Estate of Lisle was liable for additions to tax under secs. 6653(a)(1) and (2) and 6659(a), increased interest under sec. 6621(c), and accuracy-related penalties under sec. 6662. Petitioners disagreed and filed with the Court of Appeals a document that was treated as a petition for writ of mandamus. Although the Court of Appeals issued an order denying the petition for writ of mandamus, the Court of Appeals intimated that issues concerning alternative additions to tax were beyond the scope of the remand. Consequently, the sole issue remaining to be decided in the Estate of Lisle cases is whether the Estate of Lisle is liable for the tax deficiencies determined in the notices of deficiency for 1987 to 1989. -23- certain issues by respondent on brief, Rule 155 computations will be necessary in these cases.15 The parties settled several issues in these cases before and during the trial. In addition, the parties’ objections and responses to the STJ report narrowed the issues remaining in dispute. The issues left to be decided are: (1) Whether payments received by various entities associated with Kanter during the years at issue represent income earned by and properly taxable to Kanter, Ballard, and Lisle; (2) if the Court sustains respondent’s determinations that Kanter, Ballard, and Lisle are taxable on the payments in question, whether Kanter and Ballard are liable for additions to tax for fraud; 15 In several of the cases in which respondent filed amended pleadings seeking increased deficiencies in tax and additions to tax, respondent left blank the amounts of additional income as to which increased deficiencies were asserted, with footnotes stating that such “amounts will be provided later”. Petitioners filed motions to strike respondent’s assertions of increased deficiencies where the amounts of increased income or disallowed expenses were not specifically asserted. The Court denied petitioners’ motions but ordered respondent to file amended pleadings by a designated date asserting the amounts of increased income or disallowed expenses. Respondent filed amended pleadings to comply with the Court’s order in all pertinent cases except two: Docket Nos. 31301-87 and 33557-87, Burton W. and Naomi R. Kanter. An order will be issued on the Court’s own motion in docket No. 31301-87 striking respondent’s assertion of increased income to the Kanters from IRA for the 1978 tax year. No such order will be issued in docket No. 33557- 87 because the transaction as to which respondent asserted increased income is an issue the parties have identified as Cablevision Programming Investments, which the parties have settled. -24- (3) whether commitment fees paid to Century Industries, Ltd., during 1981 to 1984 and 1986 represent income earned by and taxable to Kanter; (4) whether Kanter received unreported income from Hi- Chicago Trust during 1981 to 1983; (5) whether Kanter is taxable on income attributed to the Bea Ritch Trusts for 1986 and 1987; (6) whether Kanter received unreported income from CMS Investors Partnership for 1982 to 1984 and 1987 to 1989; (7) whether Kanter received unreported income from Equitable Leasing Co., Inc., during 1983; (8) whether Kanter received unreported income for 1982 according to the bank deposits method of income reconstruction; (9) whether Kanter received barter income from Principal Services Accounting Corp. during 1988 and 1989; (10) whether the Kanters received unreported interest income during 1988; (11) whether the Kanters are entitled to certain deductions they claimed on Schedules A and C for 1986 to 1989; (12) whether Kanter realized and must recognize capital gains as a result of transactions involving Cashmere Investments Associates, Inc., during 1983, and whether Kanter is entitled to use the installment method for reporting purposes; -25- (13) whether Kanter is entitled to research and development and business expense deductions related to Immunological Research Corp. for 1979; (14) whether Kanter received unreported partnership income during the taxable year 1978; (15) whether the Kanters are entitled to a loss from GLS Associates for 1981; (16) whether the Kanters are entitled to a loss from Equitec for 1983 and 1984; (17) whether the Kanters are entitled to an investment interest expense deduction for 1981; (18) whether the Kanters are entitled to an investment credit carryover of $120,566 for 1978; (19) whether the Kanters are entitled to an interest deduction for 1986; (20) whether the Kanters are entitled to a business deduction of $104,231 for 1980; (21) whether the Kanters are entitled to a deduction for a charitable contribution to the Jewish United Fund for 1982; (22) whether Kanter is liable for self-employment tax for the taxable year 1982; (23) whether the Kanters realized capital gains and losses as reported on their tax return for 1987; and -26- (24) whether Kanter is liable for various additions to tax and increased interest for the years at issue. IV. New Rule 183 and the Court’s Review and Adoption Procedure In their responses to respondent’s objection to the STJ report, petitioners assert that the Court should ignore respondent’s objections to the extent respondent (1) failed to make “specific, written objections” and merely rehashed proposed findings of fact and legal arguments from respondent’s posttrial briefs, and (2) proposed new findings of fact (not contained in respondent’s posttrial briefs). In connection with the foregoing, petitioners assert: Also, in many of his objections, respondent block- quotes directly from the now-tainted Stricken Opinion. As this Court is well aware, the published opinion in this case was found by the Supreme Court to be violative of the Tax Court’s own rules and was stricken from the record. Because the published opinion was the result of a process that has been held by the Supreme Court to be legally insufficient, it is manifestly improper for respondent to base his objections upon that opinion. Incredibly, however, respondent quotes at length from the Stricken Opinion without acknowledging that he is doing so. Also, in his objections, respondent in many instances incorporates his proposed findings which are extracted from the Stricken Opinion and therefore legally insufficient. As a result, this Court should not consider those objections or proposed findings of fact. Moreover, many of the findings from the Stricken Opinion have already been directly criticized by the Fifth Circuit in Estate of Lisle v. Commissioner, 341 F.3d 364 (5th Cir. 2003). We agree that new Rule 183(c) generally does not contemplate that a party may propose new findings of fact in the party’s -27- objection to a Special Trial Judge’s recommended findings of fact and conclusions of law. Nevertheless, Rule 183(c) does not provide a bar to new proposed findings of fact and leaves the matter within the discretion of the reviewing Judge. Moreover, a Judge who is assigned a case under new Rule 183 is obliged to review a Special Trial Judge’s recommendations against the entire record in the case and determine whether the recommended findings of fact and conclusions of law merit adoption. In this regard, new Rule 183(d) establishes a number of options that the reviewing Judge normally may exercise during the review and adoption process.16 Among these options, the reviewing Judge may adopt, modify, or reject the Special Trial Judge’s recommendations. Thus, the Court does not feel constrained from correcting manifestly unreasonable findings of fact or making additional findings of fact, so long as any additional facts find direct support in the case record. With this understanding in mind, we turn to the standard of deference to apply in reviewing the recommended findings of fact and conclusions of law contained in the STJ report. 16 Some of the options contemplated under new Rule 183(d), such as receiving additional evidence or recommitting the recommended findings of fact and conclusions of law with instructions, are not available to the Court in these cases due to limitations prescribed by the Courts of Appeals for the Eleventh and Fifth Circuits when they remanded these cases. -28- V. Standard of Deference Due to General Findings of Fact and Credibility Determinations Contained in the STJ Report It is well settled that findings of fact and credibility determinations made by the judicial officer who presided over the trial of a case are presumed to be correct. Rule 183(d); Ballard v. Commissioner, 544 U.S. 40 (2005) (and cases cited therein). The axiom that deference must be given to the trial judge’s findings of fact is rooted in the view that the trial judge (1) is uniquely positioned to evaluate the credibility of witnesses, (2) brings experience and expertise to the fact-finding process, and (3) is normally the person most familiar with the record in a case. Anderson v. City of Bessemer, N.C., 470 U.S. 564, 575, 580 (1985); see Fed. R. Civ. P. 52(a), Advisory Committee Notes (1985 amendment). As previously discussed, the Courts of Appeals for the Eleventh Circuit and the Fifth Circuit remanded the Ballard and Lisle cases to this Court and directed that the recommended findings of fact in the STJ report are presumed to be correct “unless manifestly unreasonable”. Respondent concedes that, although the Court of Appeals for the Seventh Circuit did not articulate a particular standard for review in its remand of the Kanter cases, the Court should apply the same “manifestly unreasonable” standard in all of the cases consolidated herein. Although respondent disagrees that the “manifestly unreasonable” standard is the appropriate standard to be applied under new Rule -29- 183, we need not address the point in the context of these cases. We proceed with the review of the STJ report mandated by the Courts of Appeals and apply the “manifestly unreasonable” standard of deference as more fully described in the caselaw discussed below. In Ballard v. Commissioner, 544 U.S. at 54-55, the Supreme Court addressed the deference that is due a Special Trial Judge’s recommended findings of fact under Rule 183 as follows: Rule 183(c)’s origin confirms the clear understanding, from the start, that deference is due to factfindings made by the trial judge. Commenting in 1973 on then newly adopted Rule 182(d), the precursor to Rule 183(c), the Tax Court observed that the Rule was modeled on Rule 147(b) of the former Court of Claims. Tax Ct. Rule 182 note, 60 T.C. 1150, (Tax Court review procedures were to be “comparable” to those used in the Court of Claims). Rule 182(d)’s “[d]ue regard” and “presumed to be correct” formulations were taken directly from that earlier Rule, which the Court of Claims interpreted to require respectful attention to the trial judge’s findings of fact. See Hebah v. United States, 456 F.2d 696, 698 (Cl. Ct. 1972) (per curiam) (challenger must make a “strong affirmative showing” to overcome the presumption of correctness that attaches to trial judge findings). The Tax Court’s acknowledgment of Court of Claims Rule 147(b) as the model for its own Rule, indeed the Tax Court's adoption of nearly identical language, lead to the conclusion the Tax Court itself expressed: Under the Rule formerly designated Rule 182(b), now designated 183(c), special trial judge findings carry “special weight insofar as those findings are determined by the opportunity to hear and observe the witnesses.” Tax Ct. Rule 182 note, 60 T.C. 1150 (1973); see Stone v. Commissioner, 865 F.2d 342, 345 (CADC 1989). [Fn. ref. omitted.] We briefly examine the Hebah and Stone cases cited by the Supreme Court above. -30- In Hebah v. United States, 197 Ct. Cl. 729, 456 F.2d 696, 698 (1972), the Court of Claims stated: Under our rule, the [trial] commissioner’s findings of fact are presumed to be correct because of his opportunity to hear the witnesses and to determine the weight to be accorded to their testimony. A party who undertakes to overcome this presumption must make a strong affirmative showing to the contrary. Wilson v. United States, 151 Ct.Cl. 271 (1960) and Davis v. United States, 164 Ct.Cl. 612 (1964). Although the presumption does not extend to the conclusions of law made by the trial commissioner, he saw and heard the witnesses and had a much better opportunity than the court to familiarize himself with all of the circumstances involved. In the light of this situation and a consideration of the record, we find that under the peculiar facts and circumstances of this case, his conclusions are not unreasonable or unwarranted by the record. [Emphasis added.] In Stone v. Commissioner, 865 F.2d 342 (D.C. Cir. 1989), revg. Rosenbaum v. Commissioner, T.C. Memo. 1983-113, the Court of Appeals for the District of Columbia Circuit addressed the correct standard of deference to be applied by a Tax Court Judge assigned to review a Special Trial Judge’s proposed findings of fact under former Rule 182(d).17 In short, the Court of Appeals rejected the proposition that a simple “preponderance of the evidence” standard of review would suffice and instead held that 17 Former Rule 182(d), much like new Rule 183(d), provided that “Due regard shall be given to the circumstance that the commissioner had the opportunity to evaluate the credibility of witnesses; and the findings of fact recommended by the commissioner shall be presumed to be correct.” 60 T.C. 1150. -31- a “clearly erroneous” standard of review should be applied in such cases. Stone v. Commissioner, supra at 346-347. Our understanding of the standard of deference to apply to findings of fact and credibility determinations in the STJ report is further informed by the Court of Appeals for the Eleventh Circuit: “Credibility determinations are entitled to great deference, and must not be disturbed unless manifestly unreasonable.” Ballard v. Commissioner, 429 F.3d at 1031 (citing Anderson v. City of Bessemer, N.C., supra at 575). In Anderson, the Supreme Court granted certiorari to decide whether a Court of Appeals correctly rejected the trial court’s findings of fact in support of a judgment in favor of a plaintiff in a sex discrimination case. The Supreme Court held the Court of Appeals misapplied the “clearly erroneous” standard of review governing a Court of Appeals’ review of a District Court’s findings of fact as set forth in rule 52(a) of the Federal Rules of Civil Procedure.18 Quoting United States v. United States Gypsum Co., 333 U.S. 364, 395 (1948), the Supreme Court stated that “‘[a] finding is “clearly erroneous” when although there is evidence to support it, the reviewing court on the entire evidence is left with the definite and firm conviction that a 18 Fed. R. Civ. P. 52(a) states in pertinent part: “Findings of fact, whether based on oral or documentary evidence, shall not be set aside unless clearly erroneous, and due regard shall be given to the opportunity of the trial court to judge of the credibility of the witnesses.” -32- mistake has been committed.’” Anderson v. City of Bessemer, N.C., 470 U.S. at 565. The Supreme Court embellished the “clearly erroneous” standard of review as follows: If the district court’s account of the evidence is plausible in light of the record viewed in its entirety, the court of appeals may not reverse it even though convinced that had it been sitting as the trier of fact, it would have weighed the evidence differently. Where there are two permissible views of the evidence, the factfinder’s choice between them cannot be clearly erroneous. United States v. Yellow Cab Co., 338 U.S. 338, 342 (1949); see also Inwood Laboratories, Inc. v. Ives Laboratories, Inc., 456 U.S. 844 (1982). This is so even when the district court’s findings do not rest on credibility determinations, but are based instead on physical or documentary evidence or inferences from other facts. * * * [Id. at 573-574; emphasis added.] Although the phrase “manifestly unreasonable” does not appear in the Anderson opinion, the Supreme Court did discuss the “special deference” to be paid to a trial judge’s credibility determinations. On this point, the Supreme Court stated: When findings are based on determinations regarding the credibility of witnesses, Rule 52(a) demands even greater deference to the trial court’s findings; for only the trial judge can be aware of the variations in demeanor and tone of voice that bear so heavily on the listener’s understanding of and belief in what is said. See Wainwright v. Witt, 469 U.S. 412, (1985). This is not to suggest that the trial judge may insulate his findings from review by denominating them credibility determinations, for factors other than demeanor and inflection go into the decision whether or not to believe a witness. Documents or objective evidence may contradict the witness’ story; or the story itself may be so internally inconsistent or implausible on its face that a reasonable factfinder would not credit it. Where such factors are present, -33- the court of appeals may well find clear error even in a finding purportedly based on a credibility determination. See, e.g., United States v. United States Gypsum Co., supra, [333 U.S.] at 396. But when a trial judge’s finding is based on his decision to credit the testimony of one of two or more witnesses, each of whom has told a coherent and facially plausible story that is not contradicted by extrinsic evidence, that finding, if not internally inconsistent, can virtually never be clear error. Cf. United States v. Aluminum Co. of America, 148 F.2d 416, 433 (CA2 1945); Orvis v. Higgins, supra, at 539-540. [Id. at 575-576; emphasis added.] Consistent with the foregoing, and in the light of the Courts of Appeals’ directions to this Court on remand, we are obliged to review the recommended findings of fact and credibility determinations set forth in the STJ report under a “manifestly unreasonable” standard of review, and we may reject such findings of fact and credibility determinations only if, after reviewing the record in its entirety, we conclude that the recommended finding of fact or testimony (1) is internally inconsistent or so implausible that a reasonable fact finder would not believe it, or (2) is not credible because it is directly contradicted by documentary or objective evidence. Id. at 574-575; see Boyett v. Commissioner, 204 F.2d 205, 208 (5th Cir. 1953) (a court may reject positive and uncontradicted testimony as to a particular fact if the testimony “is inherently improbable or manifestly unreasonable, even though no contradictory testimony is offered” (emphasis added)), affg. a Memorandum Opinion of this Court; Stone v. Commissioner, 865 F.2d -34- at 346 (where the Court of Appeals for the D.C. Circuit discussed Montgomery Coca-Cola Bottling Co. v. United States, 222 Ct. Cl. 356, 615 F.2d 1318 (1980), and concluded the case stands for the proposition that “reversal of the initial fact-finder is proper if the objective evidence overwhelms the initial fact-finder’s inferences from testimony and demeanor”). A final point on the subject of deference. In Ballard v. Commissioner, 429 F.3d at 1031, the Court of Appeals for the Eleventh Circuit stated that the Tax Court’s review and adoption of a Special Trial Judge’s recommended findings of fact is analogous to a District Court’s review of a magistrate judge’s findings of fact, and, citing United States v. Cofield, 272 F.3d 1303, 1306 (11th Cir. 2001), it further stated that a magistrate judge’s credibility determinations generally may not be rejected without rehearing the disputed testimony. Kanter’s response to respondent’s objections, filed under new Rule 183(c), includes an argument that the Court of Appeals for the Eleventh Circuit made it clear that this Court cannot reject the credibility determinations set forth in the STJ report. We disagree. We do not understand the Court of Appeals’ statement to mean that we are barred from rejecting credibility determinations set forth in the STJ report without first rehearing the disputed testimony. Instead, the Court of Appeals observed that the deaths of primary witnesses in these cases foreclosed retrial. Ballard v. -35- Commissioner, 429 F.2d at 1032. Rather than treating the credibility determinations as established on that account, the Court of Appeals prescribed the standard under which they are to be reviewed. Thus, we conclude we are not barred in these cases from rejecting credibility determinations recommended in the STJ report under the “manifestly unreasonable” standard of review described above. VI. Structure of the Court’s Report After comparing the recommended findings of fact and legal conclusions in the STJ report with the entire record in these cases, and taking into account the parties’ posttrial briefs and objections and responses filed pursuant to new Rule 183(c), we have determined to reject some of the recommended findings of fact in the STJ report because they are manifestly unreasonable and to supplement others because they are incomplete. In constructing the Findings of Fact portions of this report, we have included many findings of fact drawn directly from the STJ report, and we have made additional findings of fact where necessary. For clarity, the findings of fact drawn directly from the STJ report appear in italics and are accompanied by page references to the STJ report.19 Footnotes 19 Some reordering and minor additions and changes have been inserted in the recommended findings of fact adopted from the STJ report. These minor changes did not alter the substance of the adopted findings of fact and are not otherwise noted in (continued...) -36- taken from the STJ report likewise appear in italics but are renumbered. In contrast, the Court’s additional findings of fact appear in bold type accompanied by supporting citations of the trial transcript, trial exhibit(s), and/or the parties’ original posttrial briefs, as appropriate. Our departures from the recommended findings of fact in the STJ report normally are marked by a comment either in the text or in the margin (including appropriate citations of the record). See Ballard v. Commissioner, 429 F.3d at 1031. Any additions we have made in the findings of fact portions of this report that do not constitute findings of fact, such as headings and general commentary, appear in normal type. The Opinion portions of this report appear in normal type and include (1) a summary of the legal analysis set forth in the STJ report, (2) an evaluation of the credibility determinations in the STJ report as weighed against the objective evidence drawn from the entire record, and (3) a discussion and analysis of each of the issues remaining in dispute. 19 (...continued) the report. -37- Issue I. Whether Kanter, Ballard, and Lisle Earned and Are Taxable on the Income in Dispute FINDINGS OF FACT (STJ report at 14) With respect to the issues in dispute, the parties filed several stipulations of facts.20 The facts reflected in these stipulations, with the annexed exhibits, are so found and are incorporated herein by reference.21 At the time the petitions were filed, the Kanters’ legal residence was in the State of Illinois, the Ballards’ legal residence was in the State of Florida, and the Lisles’ legal residence was in the State of Texas. The independent coexecutors of the Estates of Robert W. and Donna M. Lisle, Amy L. and Thomas W. Lisle, were also legal residents of the State of Texas at the time they were substituted as representatives of the Estates of their deceased parents. 20 The STJ report does not contain any recommended findings of fact regarding the examination process and related summons enforcement proceedings that preceded the trial in these cases. These matters are relevant to the question of whether Kanter and Ballard are liable for additions to tax for fraud and are addressed in detail in additional findings of fact, infra pp. 213-222. 21 Unless otherwise clear from the context, the following words, their derivatives, and related terms are used for narrative convenience only to describe the forms of the various transactions in dispute in these cases: “invest”, “purchase”, “borrow”, “pay”, “distribute”, “promise”, “loan”, “sale”, “note”, “agreement”, “obligation”, “interest”, “capital contribution”, “paid-in capital”, “officer”, “director”, “shareholder”, and “partner”. By our use of such terms, we do not mean to suggest any conclusions concerning the actual substance or characterization of the transactions for tax purposes. -38- I. Petitioners22 A. Burton W. Kanter (STJ report at 18-20) Petitioner Burton W. Kanter is an attorney who has continuously been engaged in the practice of law at Chicago, Illinois, since about 1956. He received a J.D. degree from the University of Chicago in 1952. From 1952 to 1954, he was a teaching associate at the University of Indiana Law School. From 1954 to 1956, he was an attorney-adviser with the U.S. Tax Court at Washington, D.C. Since 1956, his law practice has been at Chicago, Illinois. His primary expertise is in Federal income and estate taxation. From 1964 to 1981, Kanter was a name partner in the law firm Levenfeld & Kanter, which later became Levenfeld, Kanter, Baskes & Lippitz. That firm dissolved in 1981, and Kanter thereafter practiced with the firm of Kanter & Eisenberg. As of the time of trial, Kanter was serving in an “of counsel” capacity with the Chicago firm of Neal, Gerber & Eisenberg. At the time of trial and for the past 10 years, Kanter taught courses in estate and gift taxation and estate planning at 22 The STJ report, at 15, opened with recommended findings of fact concerning Investment Research Associates, Ltd. (IRA). This report begins with findings of fact concerning the backgrounds of Kanter, Ballard, and Lisle, followed by findings of fact concerning IRA and other entities that Kanter employed in the transactions in dispute (hereinafter sometimes referred to as Kanter-related entities). -39- the University of Chicago Law School. Kanter has lectured and written extensively in the area of Federal tax law. He has also been an active participant in professional bar associations. For a number of years, Kanter has been a writer and contributor to the Journal of Taxation, a national monthly publication devoted exclusively to Federal taxation. One of the popular features of this publication is the Shop Talk section, which was originated and edited by Kanter. At the time of trial, Kanter was a senior editor with the Journal of Taxation. Kanter is generally recognized as renowned in his field. All of this has resulted in a successful and prolific law practice, which has led to Kanter’s not only being engaged in the practice of law but also to his being extensively involved in consultation, development, and investments in a number of various business fields and enterprises. Commensurate with his reputation as a highly successful and skillful tax lawyer, Kanter, over the years, has amassed an impressive array of business and professional clients and contacts in business and industry throughout the United States. For instance, Kanter has performed extensive legal work for the Pritzker family, majority owners of the Hyatt Corp., a major hotel company in the United States. He is and was a good friend of certain of the Pritzker family members, including the late A.N. Pritzker, the head of the Pritzker family, whom Kanter -40- personally represented. Kanter also served as a director on several corporate and charitable organization boards. Kanter has made many investments through numerous entities, including corporations, partnerships, and family trusts. Some of these family trusts are trusts the income of which is taxable to Kanter pursuant to the grantor trust provisions of sections 671 through 678. A number of Kanter’s family trusts own substantial stock interests in The Holding Co., Inc., a corporation that made extensive investments during the years at issue. Additionally, on occasion, Kanter and/or entities associated with him have entered into certain arrangements with various individuals, pursuant to which Kanter would use his business and professional contacts to assist such individuals either in obtaining potential business opportunities or in raising capital for business ventures. In exchange for such assistance from Kanter, these individuals agreed to share their profits or fees payable to an entity or entities associated with Kanter.23 23 The STJ report incorrectly stated that entities Kanter represented provided assistance to various individuals in obtaining business opportunities or in raising capital. As discussed in detail in the Court’s additional findings of fact, infra pp. 51, n. 27 (Weisgal testimony), 91-107 (Frey), 107-124 (Schaffel), 124-131 (Schnitzer), and 131-152 (Eulich), there is no evidence (1) anyone at any Kanter-related entity provided the businessmen involved in the transactions in dispute (sometimes referred to as The Five) with assistance in obtaining business opportunities or in raising capital, or (2) any of these businessmen were relying on anyone other than Kanter, in his (continued...) -41- Petitioner Naomi R. Kanter, Kanter’s wife, was not involved in any of the activities giving rise to this litigation. She is a petitioner in these proceedings solely because she filed joint Federal income tax returns with Kanter for the years at issue. After paying a small amount of tax in 1978, Kanter paid no Federal income taxes during 1979 through 1989.24 Kanter filed Federal income tax returns that reported adjusted gross income and income tax as follows: Adjusted Gross Income Year Income (Loss) Tax Paid Exhibit 1978 ($44,386) $1,671 120 1979 (105,084) -0- 121 1980 (155,026) -0- 123 1981 (53,614) -0- 125 1982 (287,536) -0- 127 1983 (819,449) -0- 128 1984 (804,482) -0- 130 1985 (954,695) -0- 130A 1986 (1,529,213) -0- 131 1987 (2,004,257) -0- 132 1988 (1,340,459) -0- 133 1989 (1,331,576) -0- 134 B. Claude M. Ballard (STJ report at 20-22) Ballard was an employee of Prudential. He began his employment with Prudential in 1948 in its real estate department. 23 (...continued) individual capacity, to assist them in obtaining business opportunities and/or in raising capital. 24 Kanter paid small amounts of self-employment tax. Exh. 120. -42- He worked continuously at Prudential until his retirement in early 1982. During the course of his career at Prudential, Ballard was assigned to several regional offices of Prudential, including Houston and Dallas, Texas, and, beginning in 1966, in the corporate headquarters of Prudential at Newark, New Jersey, and then again, for a short time, at the Houston regional office. In 1973, he was reassigned to Prudential’s Newark corporate headquarters, where he remained until his retirement in early 1982. At the time he left Prudential, Ballard was a senior vice- president in charge of equities and worked under an individual named Donald Knab who was in charge of all of Prudential’s real estate operations. After leaving Prudential, Ballard became a general partner with Goldman Sachs, a brokerage and/or an investment firm in New York City. Later, he became a limited partner with Goldman Sachs. Essentially, Ballard’s work with Prudential, in its real estate equity operations, involved the purchase and sale of existing properties, as well as the development of new properties. It included, additionally, the management of such properties, including the negotiation and sale of properties, where warranted. Ballard supervised the staff of this department at Prudential’s headquarters, as well as the real estate department staff at Prudential’s regional offices throughout the United States. -43- In his position with Prudential, Ballard met and was in contact with attorneys, developers, businessmen, and contractors involved in or affected by Prudential’s acquisition and/or development, maintenance, operation, and financing activities. Ballard first met Kanter sometime in 1972 at Houston, Texas, in connection with the opening of the Houston Hyatt Hotel. As indicated previously, Kanter represented the Pritzker family, the majority shareholder/owners of Hyatt Corp. At the Houston Hyatt Hotel’s opening, Ballard was introduced to Kanter by A.N. Pritzker (the head of the Pritzker family), who told Ballard that Kanter was A.N. Pritzker’s “everything”. In the succeeding years, Kanter and Ballard had numerous business and professional contacts with each other. Petitioner Mary B. Ballard, Ballard’s wife, was not involved, except in a very limited way, in any of the activities giving rise to this litigation. She is a petitioner in these proceedings solely because she filed joint Federal income tax returns with Ballard for the years at issue. C. Robert W. Lisle (STJ report at 22-23) Lisle was also an employee of Prudential from September 1950 to April 1982. He was also employed in the real estate department at Prudential, in real estate development and in -44- mortgage financing. The development aspect of his work was conducted under the umbrella of a subsidiary corporation of Prudential, which was known as PIC Realty Corp. (PIC Realty). Lisle was president of PIC Realty. Prudential conducted its real estate equity and joint venture operations in the name of PIC Realty in those States that prohibited insurance corporations from directly engaging in real estate development. To a large extent, the career of Lisle paralleled that of Ballard. Lisle also worked in various regional offices of Prudential and ultimately was promoted to a senior executive position at Prudential’s Newark corporate headquarters. The offices of Lisle and Ballard were next door to each other. At the time Lisle left Prudential in 1982, he was a vice president of Prudential. Lisle’s supervisor at Prudential was also Donald Knab. After leaving Prudential in April 1982, Lisle worked for The Travelers Insurance Co. (Travelers) until April 1988, doing virtually the same kind of work he had done for Prudential. Lisle met Kanter sometime between 1968 and 1970. The two had numerous contacts with each other in succeeding years, including the period after Lisle left Prudential and worked for Travelers. The record does not reflect what outside business activity Lisle was involved with that would be relevant to these cases between the time Lisle left Travelers in April 1988 until his death in 1993. -45- Donna M. Lisle, Lisle’s wife, was not involved in any of the activities giving rise to this litigation, and her estate is a party to these proceedings solely by virtue of Mrs. Lisle’s having filed joint Federal income tax returns with Lisle for the years at issue. She died in 1993. D. Additional Findings of Fact Regarding Ballard and Lisle Donald Knab (Knab) worked with Ballard and Lisle in Prudential’s Houston regional office in the late 1960s and, after being reassigned to Prudential’s corporate headquarters in Newark in the early 1970s, Knab asked Ballard and Lisle to come to work for him in the real estate investment department. Knab, Transcr. at 602-604. Knab had very high regard for Ballard’s and Lisle’s abilities. Knab, Transcr. at 608. 1. Ballard Ballard considered it common in the real estate business for intermediaries to introduce brokers to corporate real estate owners and financiers, such as Prudential, and for such intermediaries and brokers to share any fees arising from real estate transactions related to such introductions. Ballard, Transcr. at 215-216. Ballard’s high-ranking-executive position at Prudential allowed him to exert significant influence over Prudential’s real estate investment decisions, including awards of property -46- management contracts, financing transactions, and related business. Ballard, Transcr. at 215; Knab, Transcr. at 606-609; Strum, Transcr. at 511, 521-522. Ballard believed that his power to reject or veto a proposed transaction was the most significant power that he wielded at Prudential. Ballard, Transcr. at 215. 2. Lisle25 Lisle became president of PIC Realty in 1970. Exh. 2030, at 2. Lisle was first introduced to Kanter by A.N. Pritzker during the period 1968 to 1970. Id. at 10-11. At that time, PIC Realty was involved in the construction of what would become the Houston Hyatt Hotel, and Kanter was representing the Pritzkers. Ballard, Transcr. at 119-120; Exh. 2030, at 11. Lisle was authorized at both Prudential and Travelers to commit up to $20 million to real estate financing transactions and development projects. Exh. 2030, at 2, 9-10. Lisle’s position at Travelers, senior vice president for the real estate investment department, was higher than his position at Prudential. Id. at 9. Lisle’s high-ranking-executive positions at Prudential and Travelers allowed him to exert significant influence over Prudential’s and Travelers’ real estate investment 25 As previously indicated, Lisle died before the trial was held in these cases. Exh. 2030 is a transcript of an interview that IRS agents conducted with Lisle on Jan. 10, 1990. -47- decisions, including awards of construction contracts, financing transactions, development projects, and related business. Ballard, Transcr. at 215; Strum, Transcr. at 511, 521-522; Knab, Transcr. at 606-609. E. Kanter-Related Entities 1. Investment Research Associates, Ltd. (IRA) (STJ report at 15-17) IRA was incorporated as a subchapter C corporation in the State of Delaware on August 26, 1974, originally under the name Cedilla Co. In the annual franchise tax report for IRA filed with the State of Delaware, dated March 1, 1979, the name of Cedilla Co. was changed to Investment Research Associates, Ltd. To avoid confusion, we refer to the corporation at all times as IRA. IRA consistently filed annual franchise tax reports with the State of Delaware. Between 1974 and 1977, IRA was authorized to issue both common stock and several classes of preferred stock. Exhs. 4, 9071. IRA’s annual franchise reports filed with the State of Delaware from 1975 to 1988 often were not accurate in reporting the shares of its stock that were issued and outstanding. Exhs. 4, 9071. IRA has always had a board of directors and a full slate of officers. It has consistently filed Federal income tax returns. -48- During 1977 through 1989, IRA reported consolidated total income, taxable income/losses, and net operating losses as set forth in the following table: Table 1 Year Total Income Taxable Income (Loss) Net Operating Losses 1977 $234,790 ($271,394) ($7,954) 1978 1,004,475 (18,673) (271,394) 1979 1,944,332 406,771 (18,673) 1980 3,557,198 65,094 -- 1981 5,158,583 (615,852) -- 1982 4,536,122 (121,501) (143,987) 1983 3,849,742 (425,538) (121,501) 1984 3,606,785 (175,946) (89,235) 1985 3,118,893 96,363 (175,946) 1986 2,345,762 (327,854) -- 1987 299,794 (16,942) (111,843) 1988 (526,393) (637,842) (10,550) 1989 1,011,577 (116,521) (1,057,468) Exhs. 10 to 24, 9668, 9669. IRA paid tax of $94,618 for the taxable year 1979. Exh. 10. a. IRA’s Shareholders Before October 28, 1975, Delores Keating (Keating), a real estate broker, held 1,000 shares of IRA’s common stock. Exh. 9051. In 1973 or 1974, Mildred Schott (Schott) began working with Keating. Schott, Transcr. at 2122-2123. Schott previously worked as a legal secretary and had a real estate brokerage license. She was introduced to Kanter by a mutual acquaintance of theirs. -49- On October 28, 1975, Keating’s 1,000 shares of IRA common stock were exchanged for 500 shares of class B preferred stock. Exh. 9051. Although she did not recall the fact, Schott held 1,200 shares of IRA class A preferred stock until 1982. Schott, Transcr. at 2113, 2129; Exhs. 10, 12, 14, 17. Schott held IRA stock to enable the company to hold a corporate real estate license. Schott, Transcr. at 2119; Exh. 4022. On October 28, 1978, IRA issued 1,000 shares of common stock in equal shares to 25 trusts known collectively as the Bea Ritch Trusts. Exh. 9051; Exh. 135, at 23. By 1978, IRA redeemed Keating’s 500 shares of class B preferred stock. Exh. 4. During the examination of IRA’s returns, an IRS agent recalled being presented with IRA corporate minutes for 1983 which indicated that IRA’s shareholders at the time included the Bea Ritch Trusts, Schott, a Ballard family trust, and a Lisle family trust. Batory, Transcr. at 3151-3152. b. The Bea Ritch Trusts The Bea Ritch Trusts were established in 1969 and were named after Beatrice K. Ritch, Kanter’s mother. After 1982, IRA had only common stock outstanding, and the Bea Ritch Trusts were IRA’s sole shareholders. Originally, when the 25 Bea Ritch Trusts were established in 1969, the beneficiaries of the Bea Ritch Trusts were Kanter, -50- Kanter’s family, and other relatives of Kanter. By about 1977, Kanter had purportedly renounced all of his interest as a beneficiary in the Bea Ritch Trusts.26 Solomon Weisgal (Weisgal), an accountant and a longtime friend and business associate of Kanter, has been the sole trustee of the Bea Ritch Trusts since 1969. As trustee of the Bea Ritch Trusts, Weisgal has an extremely broad power either to accumulate the Bea Ritch Trusts’ income or to distribute (i.e., sprinkle) the trusts’ income and assets among all or any of the trusts’ beneficiaries in virtually any manner he deemed appropriate. c. IRA’s Officers and Directors Before October 27, 1975, Keating was IRA’s president and secretary. Exh. 9050. On October 27, 1975, Keating resigned as IRA’s president. Id. On October 27, 1975, Schott was elected IRA’s president, and Sharon Meyers (Meyers) was elected IRA’s secretary. Id. Meyers had originally worked as Kanter’s secretary. Meyers, 26 Whether Kanter’s alleged renunciations were shams is a factual question raised infra Issue V. In any event, numerous additional trusts were later added as beneficiaries to the Bea Ritch Trusts. Exhs. 135, 9187, 9269, 9270, 9271. See app. 17 to this report. Additional trusts (and groups of trusts) for the benefit of Kanter’s family members included the Everglades Trusts (5), the T.C. Family Trust, the Egandale-Vine Trust, the Beach Trust, the Baroque Trusts (3), the Softy Trusts (10), the Pillpoppers Trusts (3), and the Chamber Trusts (3). Exhs. 9213- 9220. -51- Transcr. at 2890-2891. By the 1970s, Meyers’s position at Kanter’s law firm evolved to that of Kanter’s administrative assistant. Meyers, Transcr. at 2894-2899. Meyers served as an officer and/or director of IRA at various times. Exh. 4. From 1975 to 1980, Schott remained the president of IRA and Weisgal was vice president.27 From 1980 to 1989, the president of IRA was Lawrence Freeman (Freeman), an attorney in Miami, Florida, and a friend and business associate of Kanter. Although Freeman was not paid for serving as IRA’s president, Freeman and his law firm received significant legal business by referrals from Kanter. Although Freeman was IRA’s president and director for most of the 1980s, he characterized his role as primarily that of a bookkeeper/accountant and administrator. Freeman, Transcr. at 1819. In 1989, Kanter became IRA’s acting president. Until 1989, Kanter had never been an officer or employee of IRA. Exhs. 4, 27 Solomon Weisgal (Weisgal) had little recall regarding his activities as either an officer or a director of IRA or The Holding Co. (THC). Weisgal, Transcr. at 434-437, 443, 445, 458- 460. Weisgal believed the Bea Ritch Trusts were IRA’s sole shareholders from its original organization through 1989. Weisgal, Transcr. at 440. Weisgal had no recollection of the person or persons at IRA or THC who would have generated business opportunities for The Five or the persons at IRA or THC who would have performed services for The Five under various agreements that he executed on behalf of IRA or THC during the years at issue. Weisgal, Transcr. at 444-446 (Schaffel), 462 (Essex). -52- 9071, 9085. Kanter and his law firm provided legal services to IRA. Gallenberger, Transcr. at 1990. From 1976 through 1980, Schott, Weisgal, and Patricia Grogan (Grogan) served as IRA’s directors. Exh. 4. Grogan was an accountant who began working at Kanter’s law firm in the mid- 1970s. Grogan, Transcr. at 1395-1396. From 1981 through 1989, Freeman served as IRA’s director. Exhs. 4, 9071. Ballard and Lisle were never shareholders, officers, directors, or employees of IRA. Exh. 4. However, in December 1981, IRA issued a check to Ballard in the amount of $12,500–-an amount identified in the memo section of the check as a director’s fee. Exh. 3007. Ballard cashed the check, and IRA deducted the payment as a director’s fee on its 1981 tax return. Id.; Ballard, Transcr. at 218; Exhs. 14, 9071. d. IRA’s Subsidiaries IRA owned, from time to time, controlling interests in several subsidiary corporations. These subsidiary corporations included Brickell Enterprises, Inc., Cedilla Co., Cedilla Investment Co., IRA Florida Apartments, Inc., KWJ Corp., Zeus Ventures (Zeus),28 Carlco, Inc. (Carlco), TMT, Inc. (TMT), and BWK, Inc. (BWK). Carlco, TMT, and BWK are discussed in 28 Zeus Ventures (Zeus), is discussed with regard to the Frey transactions described infra pp. 91-107. -53- substantial detail below. IRA also, at one point, owned a majority stock interest in International Films, Inc. e. IRA’s Business Activities IRA’s principal activity was making investments, either for itself or through its subsidiaries. It maintained bank accounts and books and records of its activities. In connection with its investment activities, IRA utilized the services of its officers, employees, advisers, and consultants, among whom was Kanter. IRA was primarily a vehicle for holding passive investments and generally had no paid employees. Meyers, Transcr. at 2911- 2912; Petitioners’ Reply Brief at 66. During the period 1983 to 1989, IRA did not claim any deductions for salaries, wages, or compensation paid to its officers. Exhs. 18-24. 2. Carlco, Inc., TMT, Inc., and BWK, Inc. (STJ report at 17-18) Kanter was a beneficiary of a trust called the Morkan Trust No. 1.29 Exh. 56. On October 17, 1983, Kanter exercised a limited power of appointment under the Morkan Trust No. 1 and directed the trustee, Roger Baskes,30 to transfer $2,500 to each of two newly formed trusts: Christie Trust and Orient Trust. 29 Morkan Trust No. 1 was named after Kanter’s father, Morris Kanter. Exh. 56. 30 Roger Baskes was a lawyer employed at one time at Kanter’s law firm. Baskes, Transcr. at 542-543. -54- Exhs. 56, 79. Meyers was named trustee of the Christie and Orient trusts. Id. Members of Lisle’s family were named as beneficiaries of the Christie Trust, and members of Ballard’s family were named as beneficiaries of the Orient Trust. Id. Carlco, TMT, and BWK were so-called shelf corporations that Kanter first incorporated in 1982 but remained dormant until late 1983. Kanter, Transcr. at 3604-3605. In December 1983, IRA acquired 1,000 shares or 100 percent of the common stock of each of Carlco, TMT, and BWK. Exh. 18, at 7. IRA paid $6,000 to each of the corporations for the shares of stock. Exhs. 68, 92, 113. In December 1983 and January 1984, Carlco, TMT, and BWK each issued preferred shares of stock. Carlco preferred shares were issued to the Christie Trust (Lisle’s family trust); TMT preferred shares were issued to the Orient Trust (Ballard’s family trust); and BWK preferred shares were issued to the BK Children’s Trust (one of the Bea Ritch Trusts). As a result of those trusts’ ownership of these preferred shares, Carlco, TMT, and BWK no longer qualified to be members of IRA’s consolidated group of corporations for tax purposes and were not included in the consolidated returns IRA filed. For 1984 and thereafter, Carlco, TMT, and BWK, each filed separate Federal corporate income tax returns. The record does not include a complete set -55- of Carlco’s, TMT’s, or BWK’s corporate minutes books, stock ledgers, or stock registers after 1984. During this period, Kanter recommended and proposed to Freeman (IRA’s president) and Weisgal (trustee of the Bea Ritch Trusts, which held 100 percent of IRA’s common stock) that generally Carlco and TMT should each receive a 45-percent share of IRA’s available investment funds and that BWK should receive the remaining 10 percent of IRA’s available investment funds. Kanter testified that the distribution of IRA’s funds to Carlco, TMT, and BWK in a 45/45/10 percent split represented (1) a “free-cashflow asset allocation” he and Freeman devised, and (2) an effort to diversify IRA’s investments. Kanter, Transcr. at 3663-3666, 3690-3691, 3694-3695. The diversification of investments was to be achieved by having Lisle manage Carlco and invest principally in municipal bonds, Ballard manage TMT and invest principally in real estate, and Kanter manage BWK and make miscellaneous investments. Id.; Ballard, Transcr. at 222.31 Kanter, in fact, did not have time to manage BWK’s investments. Kanter, Transcr. at 3695. 31 As shown in additional findings of fact regarding the flow of funds, see infra pp. 162, 187-188: (1) IRA did not allocate all of its free cashflow to Carlco, TMT, and BWK during the period in question, and (2) in addition to real estate investments, Ballard invested substantial amounts of TMT’s funds in cash and municipal bonds. -56- Kanter also testified that he recommended Carlco, TMT, and BWK be removed from IRA’s consolidated group for tax-reporting purposes because (1) he was concerned that Carlco’s earnings from tax-exempt municipal bonds might imperil IRA’s interest deductions, and (2) he wanted to shelter Ballard and Lisle from “second-guessing” by Freeman or another IRA officer. Kanter, Transcr. at 3685-3686.32 Pursuant to Kanter’s proposal, from 1984 through 1989, IRA transferred substantial funds and other assets to Carlco, TMT, and BWK in the respective 45-percent, 45-percent, 10-percent allocation. From 1984 through 1992, Ballard managed TMT’s investments, and Lisle managed Carlco’s investments. 3. Additional Findings of Fact Regarding The Holding Co. Other than identifying The Holding Co. (THC) as a Kanter- related entity that held investments, the STJ report did not include any detailed findings of fact regarding the organization and operation of THC. Inasmuch as THC and its subsidiaries received some of the disputed payments from The Five, and THC is 32 Kanter did not explain how removing Carlco and TMT from IRA’s consolidated group of corporations for tax reporting purposes would serve to shelter Ballard and Lisle from second- guessing by an officer of IRA, given that IRA purportedly continued to own all of Carlco’s and TMT’s common stock and Carlco and TMT remained IRA’s “legally controlled” subsidiaries. See Petitioners’ Reply Brief at 3. -57- discussed in the flow-of-funds analysis below, additional findings of fact are warranted.33 THC was incorporated as a subchapter C corporation on December 8, 1976. Exh. 153. THC owned several subsidiary corporations including the Citra Co., Active Business Corp., Zion Ventures, Inc.,34 Harbor Exchange Lending Operation (HELO),35 LBG Properties, Inc., The Nominee Corp., Oil Investments, Ltd., and Tanglewood Properties, Inc. Exhs. 153, 154, 156-160. THC held numerous partnership interests during the period in question. Id. a. THC’s Shareholders, Officers, and Directors The shareholders statement on each of THC’s tax returns shows that Kanter owned THC’s voting stock as follows: 1977--75 percent; 1978--76 percent; 1979--76 percent; 1980--76 percent; 1983 to 1986--not more than 50 percent.36 Exh. 153, at 25; Exh. 154, at 14, l. 10; Exh. 156, at 13, l. 10; Exhs. 157-160. THC’s shareholders between 1981 and 1983 included Kanter, his immediate 33 Payments THC received from The Five (in this case Schaffel, Frey, and Eulich) are summarized infra pp. 207-208. 34 Zion Ventures, Inc. (Zion), is discussed with regard to the Frey transactions described infra pp. 91-107. 35 Harbor Exchange Lending Operation (HELO) is discussed with regard to the flow-of-funds analysis infra pp. 196-205. 36 The record does not include a complete set of THC’s corporate minutes books, stock ledgers, or stock registers. -58- family members, and a large number of Kanter family trusts. Exh. 152, at 1, 2, 6, 7; Exh. 454. Kanter did not report on his tax returns any sales of THC stock during the years at issue. Exhs. 120-134. During 1981 to 1983, THC’s officers and directors included Kanter, Weisgal, Meyers, Gallenberger, and Joshua Kanter. Exh. 152. b. THC’s Tax Returns THC filed consolidated Federal income tax returns (and amended returns) reporting taxable income or losses for the years and in the amounts as follows: TYE Aug. 31 Losses 1978 ($132,095) 1979 (973,792) [amd.] 1980 38,351 1981 –- 1982 –- 1983 –- 1984 (7,552,865) 1985 (5,930,863) 1986 (5,652,815) 1987 (6,166,172) Exhs. 153-160. THC’s tax returns for 1981 to 1983 are not part of the record. -59- 4. The Administration Co., Inc., and Principal Services Accounting Corp. (STJ report at 28-32) The Kanter-related entities described above, particularly IRA and THC, required a clerical staff to assist in bookkeeping and ministerial tasks. Meyers, Transcr. at 2890-2892; Grogan, Transcr. at 1396-1397, 1410. During the mid-1970s to early 1980s, these ministerial tasks were performed by clerical assistants and bookkeepers, such as Meyers and Grogan, who were employees of Kanter’s law firm (Levenfeld & Kanter) but who worked for Kanter nearly full time. Id. By 1981, bookkeeping for IRA, THC, and other Kanter-related entities had become so voluminous that The Administration Co., Inc. (TACI), was organized for that purpose. Meyers, Transcr. at 2901, 2908-2909.37 TACI was incorporated in the State of Delaware on September 21, 1981, and was authorized to do business in the State of Illinois. Its articles of incorporation stated that it was “to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of Delaware.” In TACI’s application to do business in the State of Illinois, a more comprehensive statement of TACI’s purpose was 37 The Administration Co., Inc. (TACI) was organized at the insistence of some of the members of Kanter’s law firm who complained that law firm employees working under Kanter were performing extensive nonlegal services for which the law firm was not being compensated. -60- that the corporation would engage in consultant and advisory work, including investment, management, and advisory services. On the date TACI was incorporated, Weisgal, as trustee of the Pyramid Trust, subscribed to the total number of shares authorized to be issued by the corporation. Sharon Meyers was the Pyramid Trust’s sole beneficiary. Sharon Meyers was the sole director of TACI and was its initial president and treasurer from 1981 through 1985. TACI was organized to assist its clients in their financial and investment activities. TACI’s clients included individuals, corporations, partnerships, trusts, various clients of Kanter, and members of his law firm. However, not all of the clients of TACI were clients of Kanter’s law firm. At various times, TACI had hundreds of clients, including Kanter, IRA, and THC. From 1981 through 1988, TACI had between 200 to 500 clients. TACI had several employees at any given time, mostly clerical assistants, bookkeepers, and accountants. TACI received moneys for and on behalf of clients and paid out moneys either to clients or to third parties on behalf of clients. TACI maintained books and records for each of these clients and, in many instances, prepared clients’ tax returns. TACI charged a fee for its services. -61- With respect to moneys TACI collected and held for its clients, instead of having a separate bank account for each client, at the suggestion of the bank where TACI did business, a single bank account was opened, in TACI’s name, which served as a common depository fund for all of TACI’s clients. That account was known as the TACI Special E Account.38 TACI’s books and records reflected each client’s balance of money in the account and also reflected the deposits or withdrawals by each client affecting that client’s balance in the account. TACI also maintained at its bank another similar account known as the TACI Special Account, which was also for the benefit of TACI’s clients. This account was not used as an operating account for TACI’s clients but rather was used to pool or aggregate idle funds of TACI’s clients. The moneys in this account were utilized generally to buy certificates of deposit because a higher rate of return could be realized for TACI’s clients through aggregating their funds to purchase larger-denomination certificates of deposit. Funds from this account were also lent to other TACI clients. Deposits to and withdrawals from the TACI Special E Account and the TACI Special Account were posted to the 38 The bank insisted that TACI have a single bank account, as opposed to hundreds of bank accounts for separate clients, because this saved the bank considerable administrative expenses. During this period, the bank did not charge account holders banking fees either for checks deposited to their accounts or for checks written on their accounts. -62- appropriate client accounts. TACI issued annual tax statements and reports to its clients and the Internal Revenue Service on the interest income earned by each client on that client’s funds in the TACI Special E Account and the TACI Special Account. Kanter, as a client of TACI, had funds of his own in both the TACI Special E Account and the TACI Special Account. TACI, as part of its services and acting on Kanter’s behalf, paid some of Kanter’s business and personal expenses out of Kanter’s funds in these accounts. All checks issued by TACI on behalf of a client were debited against the balance such client had in the accounts. If a client had a negative balance in the accounts, that debit amount was considered an indebtedness by the client to TACI. Any positive balance a client had in the accounts was considered money belonging and owed to said client. Included among the services provided by TACI were bookkeeping services for its clients. This included keeping books and records for clients and the preparation of individual income tax returns. TACI prepared Kanter’s income tax returns for all or some of the years at issue. TACI’s offices were located either at the law firm offices of Kanter or in close proximity thereto. Meyers, who was president of TACI, directed the staff and employees of TACI until 1985. Linda Gallenberger (Gallenberger), a C.P.A., became vice president of TACI in 1982 and worked under -63- the direction of Meyers. When Meyers left TACI, Kanter briefly served as acting president of TACI and, thereafter, Gallenberger became TACI’s president from 1985 through 1988. TACI employed several other clerical assistants, bookkeepers, and accountants, including Lisa Klopman Shanker (Shanker, Transcr. at 998), Sharon Bayers (Bayers, Transcr. at 1005-1006), Rosemary Snedden (Bayers, Transcr. at 1010), Rosaline Weiss (Weiss, Transcr. at 796), Phyllis Dassinger (Dassinger, Transcr. at 629-630), and Kim Moxely Roehn (Roehn, Transcr. at 967-968). Kanter sometimes instructed Meyers, Gallenberger, and other TACI staff on how a particular transaction should be recorded, where a particular check should be deposited, or to whom moneys should be paid. Meyers, Transcr. at 2900, 2911 2934; Gallenberger, Transcr. at 1939, 1957. Grogan maintained the books and records and prepared tax returns for IRA and THC. Grogan, Transcr. at 1400-1403, 1415- 1417, 1476. Grogan also prepared Kanter’s tax returns. Grogan, Transcr. at 1479-1480. Kanter instructed Grogan on how THC’s assets were to be invested and how the tax returns for IRA and THC should be prepared. Grogan, Transcr. at 1421, 1479-1480. -64- TACI filed for bankruptcy in February 1988.39 Lawrence Korrub served as TACI’s bankruptcy attorney. Korrub, Transcr. at 1805. During TACI’s 1988 bankruptcy proceedings, the records that TACI maintained for Kanter and Kanter-related entities were not turned over to Korrub. Korrub, Transcr. at 1807-1808. The only documents that Korrub received were copies of TACI’s tax returns. Id. During TACI’s bankruptcy, Gallenberger sent TACI’s books and records, including the bank statements and canceled checks related to the TACI Special E and TACI Special Accounts, to Kanter. Gallenberger, Transcr. at 1970-1973. At the time of TACI’s bankruptcy, a new corporation, Principal Services Accounting Corp. (PSAC), was organized. All of PSAC’s outstanding shares of stock were initially owned by ARO Trust, of which trust Kanter was the trustee. In 1989, Gallenberger became the president of PSAC. Gallenberger, Transcr. at 1978-1980. In 1990, Linda Gallenberger purchased from ARO Trust all of PSAC’s shares for $100 and her assumption of PSAC’s outstanding debts, which totaled over $100,000. Prior to TACI’s filing for bankruptcy, PSAC took over a number of TACI’s clients, including Kanter, IRA, and THC. PSAC 39 The STJ report, at 32 n.14, incorrectly stated that the record was not clear as to why TACI went bankrupt. TACI filed for bankruptcy after the Internal Revenue Service (IRS) assessed a number of tax return preparer penalties against the firm for various infractions. Gallenberger, Transcr. at 1973-1974. -65- performed services for clients similar to those which TACI had provided to TACI’s clients. For a short period in 1989, PSAC also established two accounts similar to the TACI Special E Account and the TACI Special Account. The fees PSAC received from its clients were not sufficient to fund PSAC’s operations. From the time PSAC came into existence in 1989 until the time Gallenberger purchased the stock of PSAC from the ARO Trust in 1990, PSAC borrowed over $100,000 from BWK and THC to pay its employees’ salaries. Gallenberger, Transcr. at 1980-1982, 1987, 2041. BWK lent the money to PSAC either directly or through the TACI Special E Account. Gallenberger, Transcr. at 1983-1984. Beyond 1990, PSAC did not generate enough fees to cover its operational costs, continued to operate at a loss, and borrowed money from BWK. Gallenberger, Transcr. at 1985-1986. At the time the record in these cases was closed, PSAC had not repaid the loans from BWK. Id. When borrowing money, Gallenberger either contacted Kanter about the loan or went ahead and borrowed the money herself. Gallenberger, Transcr. at 1986-1987. PSAC’s bookkeeping procedures and return preparation procedures were essentially the same as TACI’s. Gallenberger, Transcr. at 1988-1989, 2078. Any questions that Gallenberger had -66- regarding accounting matters were answered by Kanter or Freeman. Id. PSAC was located at Kanter’s law firm, Neal, Gerber & Eisenberg. George, Transcr. at 1282-1283. PSAC moved simultaneously with Kanter’s law firm. George, Transcr. at 1283- 1284. II. Introductory Statement and Brief Introduction of The Five (STJ report at 24-28) A. The STJ Report A certain group of persons and/or entities has been referred to by the parties collectively as “The Five”. The Five, for the most part, play a prominent role in connection with the additions to tax for fraud. Respondent contends that The Five made payments over a number of years to Kanter, Ballard, and/or Lisle that were kickbacks or payoffs devised by Kanter, Ballard, and/or Lisle. These various transactions or activities involving The Five and the payments by them have been identified and referred to by respondent as the “Prudential scheme”, the “Travelers transaction”, and the “Kanter transaction”. For instance, under the Prudential scheme, respondent contends that Ballard and Lisle used their positions at Prudential to influence and cause Prudential to award business to individual members of The Five. In return for Ballard’s and Lisle’s services, each member of The Five made payments to an entity or entities owned -67- or controlled by Kanter. In turn, Kanter and/or entities under Kanter's control transferred some or all of those payments to one or more entities, and, through a succession of transfers, the moneys ultimately filtered down to Ballard, Lisle, and Kanter, either as corporate capital contributions or in the form of loans, which were never repaid and later written off as uncollectible. Respondent variously characterized the operation as “schemes” by which payments by The Five went figuratively into a “black box” from which there was a “drop down” to and through various entities until the moneys reached Ballard, Lisle, and Kanter. In actuality, respondent argues, the payments under the Prudential scheme constituted kickback income to Kanter, Ballard, and Lisle, which Kanter, Ballard, and Lisle fraudulently failed to report on their respective income tax returns. As the Court understands the case, respondent’s claim of fraud is not based, per se, on the payments by The Five to Kanter or any of the other entities to which such payments were directed. The record is clear, and respondent does not challenge the fact, that all payments made by The Five were reported as income on the Federal income tax returns of the entities receiving such payments. Respondent’s claim of fraud essentially is based upon (1) the failure of Ballard, Lisle, and Kanter to report, as income, amounts that were “dropped down” to them as loans that were never repaid, and (2) as to Kanter, for moneys he -68- personally earned that he directed be paid to IRA or other entities he controlled and, as to which, Kanter failed to report on his individual income tax returns. Respondent maintains that the failure of Kanter, Ballard, and Lisle to report the Prudential scheme, Travelers transaction, and Kanter transaction income constituted fraud under section 6653(b), for 1978 through 1989. The entities that make up The Five and a brief description of each follows: (1) Hyatt Hotels Corp., a subsidiary of Hyatt Corp. (Hyatt). Hyatt manages hotels in the United States, Canada, and the Caribbean. As indicated previously, members of the Pritzker family control the ownership of Hyatt. Kanter represented the Pritzkers for years as their attorney. In 1979, IRA acquired KWJ Corp., a corporation that had been receiving certain “commission” payments from Hyatt on the management fees Hyatt earned in operating the Hyatt Embarcadero Hotel at San Francisco, California. The Hyatt Embarcadero Hotel had been developed and was owned by a joint venture in which Prudential was a participant. The commission payments, respondent contends, constituted part of the kickback scheme. (2) Bruce J. Frey, D.M. Interstate, the B.J.F. Development Co. Partnership, and BJF, Inc. Bruce J. Frey was the principal in each of these latter entities. Mr. Frey, through these entities, managed apartments, office buildings, and commercial -69- properties. He and these entities were also heavily involved in a number of condominium conversion projects in various cities around the country, in many of which Prudential held interests. Mr. Frey and his related entities shared certain fees with Kanter and his related entities, which respondent also contends constituted part of the kickback scheme. (3) William D. Schaffel. Mr. Schaffel was a mortgage broker and real estate developer. Mr. Schaffel also assisted a New Jersey general contracting company to obtain certain construction contracts. From 1979 through 1986, he had extensive business dealings on behalf of individuals he represented with Prudential and Travelers. Mr. Schaffel shared with Kanter and his related entities brokerage and development fees, which respondent claimed was part of the kickback scheme. (4) Property Management Systems, Inc. (PMS). The chairman and chief executive officer of PMS was Kenneth Schnitzer. PMS managed office buildings and other commercial real estate for others pursuant to property management contracts. A relatively small portion of its business included contract cleaning or janitorial services on some Texas commercial properties it managed. At one point, IRA acquired and owned a 47.5-percent stock interest in PMS. Certain fees of PMS were also shared with -70- Kanter and his related entities, which respondent claimed was part of the kickback scheme.40 (5) Essex Hotel Management Co. (Essex Partnership). The Essex Partnership had the following partners holding the partnership interests indicated: Percentage Partner partnership interest IRA 26.125 THC 21.375 Motor Hotel Management Co.(MHM) 47.500 John Connolly 5.000 John Eulich was the majority shareholder of Motor Hotel Management Co. (MHM), a corporation, that was engaged in the hotel management business. John Connolly’s hotel management company managed two hotels that were owned by Prudential. The partnership agreement for the Essex Partnership is dated January l, 1982. One of the Essex Partnership’s purposes was to provide consulting and liaison services to some of its partners in connection with their management of certain hotels. A substantial portion of the management fees earned by John Connolly and MHM was paid to the Essex Partnership, which respondent contends was a part of the kickback scheme. 40 There is no evidence that any PMS fees were shared with Kanter and his related entities. -71- B. Comments Regarding the Introductory Statement and Brief Introduction of The Five The first two paragraphs of the introductory statement in the STJ report regarding The Five do not include findings of fact but rather represent a statement of the Special Trial Judge’s understanding of respondent’s theory of the cases. A review of respondent’s posttrial briefs reveals that the Special Trial Judge misunderstood and/or misstated respondent’s position. As an initial matter, the STJ report stated that it was respondent’s contention The Five made payments “In return for Ballard’s and Lisle’s services”. This statement suggests that respondent asserted The Five were aware Ballard and Lisle were using their influence to steer business to them and The Five intended to compensate Ballard and Lisle for their actions. To the contrary, respondent’s theory regarding the manner in which the kickback scheme was carried out is articulated in respondent’s Opening Brief at 568-567, as follows: Suppose A says to B, “If I introduce you to C, and you do business with C’s company, then I want 50% of whatever money you make on the deal.” If B did business with C, and, in turn, paid A 50% of what he made, that is not a kickback. A received a finder’s fee. However, further suppose, A went to C and said, “Whatever business you give to B, I will give you a percentage of the money B gives to me.” In this situation, B may not even know about the arrangement between A and C. B may believe he is getting business from C because he does good work. Nevertheless, respondent maintains that when C gives business to B with the understanding that he will eventually receive money generated by that business from A, that is a kickback. -72- Thus, respondent argued in his posttrial briefs that Schaffel, Frey, Schnitzer, and Eulich generally were unaware Ballard and Lisle were using their influence at Prudential to steer business opportunities to them, and they generally believed they were compensating Kanter for his influence. As discussed in greater detail, see infra pp. 229-235, in the light of respondent’s theory the STJ report gave undue weight to testimony by The Five that they did not participate in a kickback scheme. The STJ report also incorrectly stated: “respondent’s claim of fraud is not based, per se, on the payments by The Five to Kanter or any of the other entities to which such payments were directed.” Respondent clearly asserted in his opening brief that Kanter’s, Ballard’s, and Lisle’s actions were fraudulent because (1) they knew all the payments from The Five to IRA and THC represented income that was taxable to each of them individually, and (2) Kanter, Ballard, and Lisle intentionally used IRA and THC to (a) shelter the payments from The Five from taxation, and (b) to channel the payments to themselves disguised as capital contributions, loans, and payments to family members. Respondent’s Opening Brief at 556-557. In addition, the statement in the STJ report limiting respondent’s theory of fraud to the failure of Kanter, Ballard, and Lisle to report as income amounts “dropped down” to them in the form of loans is inaccurate and incomplete. In fact, -73- respondent claimed that Carlco, TMT, and BWK were owned by Lisle, Ballard, and Kanter, respectively, and, therefore, a much larger portion of the payments from The Five, a total of some $6.7 million, was transferred to Kanter, Ballard, and Lisle through so-called capital contributions to Carlco, TMT, and BWK. Id. at 459-473, 598-601. Though not to be ignored, the loans represented relatively small amounts of the moneys that respondent alleged were passed along from The Five, through Kanter-related entities, to Kanter, Ballard, and Lisle. III. Details Regarding The Five A. Certain Payments Made by The Five (STJ report at 32-33) Prior to and during the years at issue, Prudential was perhaps the largest holder of commercial real estate in the United States. By the late 1970s, it either held or was responsible for managing an estimated $20 billion in commercial real estate properties. In addition to its extensive commercial real estate holdings in numerous cities throughout the United States, since the 1960s, Prudential also was involved in developing commercial real properties and in extending financing to other real estate developers on various real estate projects around the country. As indicated previously, by the middle of 1982, Ballard and Lisle each had left Prudential. After leaving Prudential, Lisle obtained a similar position at Travelers. Respondent’s case for -74- fraud is based upon payments made over several years from several entities and/or individuals that have been collectively referred to by respondent as The Five. The following narrative describes The Five and the nature of their payments. 1. Hyatt Corp.’s Payment of a Share of Its Profits on the Embarcadero Hotel’s Management Contract to KWJ Corp. (STJ report at 33-37) From 1968 through 1972, Ballard and J.D. Weaver (Weaver), an executive with Tenneco Corp. (Tenneco) played instrumental roles in their respective employers’ joint development of what would become the Houston Hyatt Hotel. Weaver was president of Tenneco’s real estate development subsidiary. Ballard, Transcr. at 115. Ballard negotiated the Houston Hyatt Hotel’s management contract with A.N. Pritzker of Hyatt Corp. A.N. Pritzker and his sons had reputations as tough negotiators. Ballard, Transcr. at 125. Hyatt Corp. was awarded the management contract for the Houston Hyatt Hotel no later than 1970. Ballard, Transcr. at 114-120, 126.41 Lisle also worked on the Houston Hyatt Hotel project for Prudential. Friend, Transcr. at 767-768, 772-777. A.N. Pritzker 41 Hugo M. Friend, Jr. (Friend), a Hyatt Corp. vice president, met Ballard and assisted Lisle and Tenneco representatives in the selection of architects and contractors for the Houston project during 1968 or 1969, a fact which suggests that Hyatt Corp. was awarded the management contract for the Houston Hyatt Hotel well before 1970. Friend, Transcr. at 750, 767-768, 773. -75- first introduced Kanter to Lisle as one of Hyatt Corp.’s representatives during the period 1968 to 1970 in connection with the Houston Hyatt project. Exh. 2030, at 10-11. Beginning in 1970, Lisle oversaw the development and construction of the Houston Hyatt Hotel as president of PIC Realty. Ballard, Transcr. at 115, 119; Exh. 2030, at 2. During the early 1970s, before the Houston Hyatt Hotel was completed, Prudential was also participating in a joint venture to develop and own the Embarcadero Hotel in San Francisco. Along with Prudential, the other partners in the Embarcadero Hotel project were David Rockefeller, Trammel Crow, and John Portman (an architect). Ballard, Transcr. at 130; Friend, Transcr. at 759. As none of the joint venture participants possessed the experience, knowledge, and skill needed to manage and operate the hotel, they endeavored to have an experienced major hotel management company operate the hotel under a long-term management contract. Lisle was supervising the Embarcadero Hotel’s development for Prudential and was involved with Prudential and the other joint venture participants in the selection of a management company to manage the hotel. Del Webb, a well-known hotel operator and owner of a large hotel management company, and -76- Intercontinental Co., another large hotel management company, were competing for the management contract. A.N. Pritzker also was interested in having the Hyatt Corp. manage the hotel because the Embarcadero Hotel then would become the third or fourth Hyatt-operated hotel in the United States at which major conventions could be held. As a result of Ballard’s experience in negotiating the Houston Hyatt Hotel’s management contract, Knab (Ballard and Lisle’s superior at Prudential) directed Ballard to review and evaluate the terms of the proposed management contracts to be considered for the Embarcadero Hotel. Kanter addressed some tax issues on behalf of Hyatt Corp. with regard to the Embarcadero Hotel. Kanter, Transcr. at 3669. The Embarcadero Hotel was considered a spectacular property, and both Del Webb and A.N. Pritzker wanted the management contract for their respective companies. Ballard, Transcr. at 135-137, 142. Initially, Lisle was not interested in having Hyatt Corp. manage the Embarcadero Hotel. Lisle opposed Hyatt Corp.’s participation in the bidding on the Embarcadero Hotel management contract because A.N. Pritzker had recently paid John Portman to prepare a set of plans for another hotel in the Nob Hill area of San Francisco. Ballard, Transcr. at 135-137. However, Weaver, the Tenneco executive who had worked with Ballard in developing the Houston Hyatt Hotel, eventually -77- persuaded Lisle to allow Hyatt Corp. to be considered for the Embarcadero Hotel's management contract.42 Weaver intervened with Lisle on behalf of Hyatt Corp. because A.N. Pritzker promised Weaver a 10-percent share of the “retained profits” Hyatt Corp. might earn managing the Embarcadero Hotel if Weaver could persuade Lisle to allow Hyatt Corp. to bid on the contract. Ballard, Transcr. at 127, 135-137;43 Exh. 362. 42 Tenneco Corp., Weaver’s employer, apparently did not have any equity or other interest in the Embarcadero Hotel project. The record does not fully disclose the circumstances that caused and led Mr. Weaver to persuade Lisle to allow Hyatt Corp. to compete for the Embarcadero Hotel’s management contract, nor does the record disclose what specific past dealings Mr. Weaver may have had with Lisle. While both Lisle and A.N. Pritzker died before the trial of the instant cases, Mr. Weaver’s testimony was not offered by the parties. As Lisle had previously worked in Prudential’s Houston regional off [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/cases/4336306. Public record. Not legal advice.