# Hie Holdings, Inc. v. Comm'r > United States Tax Court · June 8, 2009 · 97 T.C.M. 1672 URL: https://www.frixlaw.com/law-library/cases/4337629 ## Case - **Full name:** HIE HOLDINGS, INC., HAWAIIAN ISLES KONA COFFEE CO., LTD., AND ROYAL HAWAIIAN WATER CO., LTD., 1 v. COMMISSIONER OF INTERNAL REVENUE - **Court:** United States Tax Court - **Decided:** June 8, 2009 - **Citations:** 97 T.C.M. 1672; 2009 T.C. Memo. 130; 2009 Tax Ct. Memo LEXIS 142 - **Precedential status:** Unpublished - **Opinion:** Opinion - **Judges:** "Laro, David" - **Cited by:** 9 later opinions in the Frix Law Library ## Citator (automated) - No negative treatment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/4337629 ## Opinion text T.C. Memo. 2009-130 UNITED STATES TAX COURT HIE HOLDINGS, INC., HAWAIIAN ISLES KONA COFFEE CO., LTD., AND ROYAL HAWAIIAN WATER CO., LTD., ET AL.,1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket Nos. 5045-05, 5046-05, Filed June 8, 2009. 5047-05. William C. McCorriston, Jonathan H. Steiner, Lisa W. Cataldo, R. John Seibert, Paul B. K. Wong, Christopher J. Cole, Brian R. Lynn, Christopher S. Rizek, Lawrence Inouye, Richard W. Craigo, and John Gaims, for petitioners.2 1 Cases of the following petitioners are consolidated herewith: Hawaiian Isles Enterprises, Inc., docket No. 5046-05; and Michael H. Boulware, docket No. 5047-05. 2 On Mar. 15, 2005, Sidney E. Boulware, Jr. (an officer), filed the petitions with the Court in docket Nos. 5045-05 and (continued...) - 2 - Kenneth C. Peterson, Paul K. Webb, Gordon L. Gidlund, and L. Katrine Shelton, for respondent. CONTENTS FINDINGS OF FACT............................................. 21 I. Preliminaries................................... 21 II. NODs............................................ 22 A. NOD Issued to HIE.............................. 22 1. General Information....................... 22 2. First Adjustment--Disallowance of Portion of Deductions for NOLs.................... 22 a. Overview............................. 22 b. Primary Determination................ 22 c. Alternate Determination.............. 23 i. Overview..................... 23 ii. Adjustments Related to Criminal Indictment.......... 24 iii. Adjustments Unrelated to Criminal Indictment.......... 25 iv. Some Specifics of Adjustments.................. 26 3. Second Adjustment--Disallowance of Portion of Deductions for Professional Fees....... 27 a. Overview............................ 27 2 (...continued) 5046-05, and Michael H. Boulware filed the petition with the Court in docket No. 5047-05. Richard W. Craigo and John Gaims entered their appearances in each of the three resulting cases on Dec. 9 and 21, 2005, respectively, and were allowed to withdraw from those cases on Nov. 15 and Sept. 22, 2006, respectively. Lawrence Inouye, Jonathan H. Steiner, William C. McCorriston, Lisa W. Cataldo, R. John Seibert, Paul B. K. Wong, Brian R. Lynn, Christopher S. Rizek, and Christopher J. Cole entered their appearances in each of the cases on Jan. 19, 2006, July 10, 2006, July 14, 2006, Sept. 8, 2006, Nov. 27, 2006, Dec. 1, 2006, Dec. 7, 2006, Dec. 7, 2006, and July 9, 2007, respectively. - 3 - b. Personal Expenses of Michael Boulware............................ 28 c. Unsubstantiated Expenses............ 29 d. Capital Expenditures................ 29 e. Summary............................. 30 4. Third Adjustment--Disallowance of Deduction for Bad Debt.................... 31 B. NOD Issued to Holdings......................... 31 1. General Information....................... 31 2. Sole Relevant Adjustment--Disallowance of Portion of Deductions for Professional Fees...................................... 31 C. NOD Issued to Michael Boulware................. 32 1. General Information....................... 32 2. Sole Relevant Adjustment--Constructive Dividends................................. 33 III. Background of Michael Boulware.................. 33 IV. Relevant Corporations........................... 34 A. HIE............................................ 34 1. Formation of Business..................... 34 2. Officers and Directors.................... 36 a. Initially........................... 36 b. August 31, 1982, to July 10, 1991, or Thereabouts ..................... 37 c. On or About July 10, 1991, Through an Effective Date of April 15, 2000. 38 d. Effective April 15, 2000............ 39 e. Board Meetings...................... 40 3. Shareholders.............................. 40 4. Michael Boulware’s Control................ 42 B. Holdings....................................... 42 C. Other Corporations Organized in 1994........... 43 D. Restructuring of HIE........................... 43 E. Royal Hawaiian Water........................... 44 F. Holdings After the Restructuring............... 44 - 4 - G. Payment of Common Costs........................ 45 H. Various Names Used by HIE To Conduct Its Business During the Subject Years.............. 45 I. No Payment of Formal Dividends by HIE.......... 46 J. E&P of HIE and Its Predecessor for 198206 Through 198806................................. 46 1. 198206.................................... 46 2. 198306.................................... 46 3. 198406.................................... 46 4. 198506.................................... 47 5. 198606.................................... 47 6. 198706.................................... 48 7. 198806.................................... 49 K. E&P of Holdings for 199706 and 199806.......... 50 1. 199706.................................... 50 a. Accumulated E&P...................... 50 b. Current E&P.......................... 50 2. 199806.................................... 50 L. Number of Holdings and HIE Employees........... 50 V. Officer Loan Account............................ 50 A. Overview....................................... 50 B. Mechanics of Account........................... 50 C. Repayment of Officer Loans..................... 52 D. Michael Boulware’s Claimed Coffee Transactions................................... 52 E. Promissory Notes............................... 54 F. Lack of Collection on Promissory Notes......... 55 VI. Personal Bank Accounts........................... 55 A. Michael Boulware Individually.................. 55 B. Michael Boulware and Mal Sun Boulware Jointly.. 56 - 5 - C. Jin Sook Lee................................... 56 VII. Mal Sun Boulware................................ 56 VIII. Jin Sook Lee.................................... 57 A. Background..................................... 57 B. Jin Sook Lee Meets Michael Boulware............ 58 C. Paradise Roasting.............................. 60 D. Video Consultant............................... 62 1. Overview.................................. 62 2. Formation................................. 62 3. Payments From HIE for False Invoices...... 63 E. Michael Boulware’s Divorce From Mal Sun Boulware....................................... 64 1. Discussions Concerning Divorce............ 64 2. Glenn Lee Boulware Trust.................. 65 3. Divorce Proceeding........................ 66 F. Transfers of HIE Assets to Jin Sook Lee........ 68 1. Overview.................................. 68 2. Atkinson Condominium...................... 69 3. Makaiwa House............................. 70 4. Koloa House............................... 71 5. Punahou Condominium....................... 73 6. Understanding as to the Transferred Assets.................................... 74 7. Jin Sook Lee’s Use of the Transferred Funds..................................... 75 8. Michael Boulware Takes Some of the Transferred Funds From Jin Sook Lee Without Her Knowledge..................... 76 IX. Off-Book Bank Accounts.......................... 77 X. Off-Book Activities............................. 78 A. Overview....................................... 78 - 6 - B. OTC Sales of Tobacco Products.................. 79 C. Michael Boulware’s Personal Sales of HIE Coffee Unknown at the Time to HIE..................... 81 1. Overview.................................. 81 2. Sales to Hawaii Misuzu.................... 82 3. Sales to Pele Trading..................... 83 4. Referenced Coffee Sold by Michael Boulware Included in HIE’s COGS.................... 85 D. Bonded Construction............................ 85 1. Background................................ 85 2. Michael Boulware Causes HIE To Pay to Remodel Jin Sook Lee’s Residence.......... 85 3. Paving of the Back Lot at HIE............. 86 a. Overview............................ 86 b. Automated Equipment................. 87 E. Michael Boulware’s Fictitious Leasing Transactions................................... 88 1. Overview.................................. 88 2. Michael Boulware’s First Scheme........... 89 3. Michael Boulware’s Second Scheme.......... 90 a. Need for the Second Scheme.......... 90 b. HIE’s Relationship With GECC........ 91 c. Seven False Invoices................ 92 i. Overview..................... 92 ii. Four False Invoices Totaling $271,382.80.................. 92 iii. Three False Invoices Totaling $224,432............ 93 d. First Four Referenced False Invoices. 94 e. Last Three Referenced False Invoices. 95 4. Funds Transferred to Lorin Kushiyama...... 96 F. Michael Boulware’s International Circular Flow of Funds....................................... 96 1. Overview.................................. 96 2. Relevant Foreign Entities................. 97 a. Forest Trading...................... 97 b. Pacific Vendors..................... 98 c. Harvest International............... 99 i. Roxca Limited................ 99 ii. Reinvoicing Operation........ 99 iii. Bank Accounts................100 - 7 - iv. Rationale Underlying Formation....................101 v. Actual Operation.............101 vi. False Invoices From Harvest International................101 1. Overview...................101 2. Payments of Invoices.......102 3. Transfers From Harvest International..............103 a. Overview..............103 b. Transfers to Personal Account of Michael Boulware..............103 c. Transfers on Behalf of Michael Boulware to Paragon Coffee, Gloria Oh Young, and Antoinette Hirai......103 d. Transfer on Behalf of Michael Boulware to Briggs Cockerham......104 vii. Coffee Rebagging.............105 3. Role of Nathan Suzuki.....................105 4. Harold Okimoto............................106 a. Overview............................106 b. Harold Okimoto’s Employment.........106 c. Administration of Harold Okimoto’s Estate..............................107 d. U.S. Attorney Contacts Okimoto Family..............................109 e. Claim of an Approximately $1.7 Million Debt........................110 f. After-the-Fact Creation of Promissory Notes....................110 XI. Michael Boulware’s Removal of Funds From the Off-Book Bank Accounts..........................111 A. Overview.......................................111 B. Michael Boulware Causes Checks To Be Cashed for Him by Employees and Friends...................112 1. Stanley Hirai and Antoinette Hirai........112 2. Morris Miyasota...........................113 3. Thomas Okimoto............................114 - 8 - 4. Milton Ikeda..............................115 5. Sydney Murayama...........................116 6. Neal Taira................................116 7. Paul Takekawa.............................116 8. John Torres...............................117 9. Other Check Cashers.......................118 XII. Criminal Investigation of Michael Boulware......118 A. Jerry Yamachika Contacts and Meets With Michael Boulware...............................118 B. Michael Boulware Obtains Professional Representation.................................120 C. Focus of Criminal Investigation................122 D. Applicability of HIE’s Indemnification Provision Relating to Certain Personal Legal Fees Incurred by Its Directors and Officers....124 XIII. Civil Litigation Initiated by Jin Sook Lee......126 A. Background.....................................126 B. JSL Litigation.................................127 1. Complaint.................................127 2. Counterclaim..............................129 C. Trust Case.....................................131 D. Shareholder Derivative Case....................132 E. HIE’s Perception of Civil Litigation...........133 F. Actions Taken by HIE Board of Directors........133 1. Resolution................................133 2. Payment of Legal Expenses.................134 XIV. Referral of Michael Boulware for Prosecution and Michael Boulware’s Grand Jury Indictment....134 A. Referral to DOJ for Prosecution................134 B. Referral to Grand Jury.........................137 - 9 - C. Grand Jury Indictment..........................138 XV. Resolution of JSL Litigation....................139 A. Overview.......................................139 B. Jury Verdict...................................140 C. Equitable Issues Decided by State Court........140 D. Final Judgment Entered.........................142 E. HIE Records Receivable From Jin Sook Lee.......142 XVI. Bankruptcy Case of Jin Sook Lee.................142 A. Overview.......................................142 B. Property Transfers and Claims..................143 C. Adversary Proceedings Commenced in 1998........145 D. Settlement of 1997 Adversary Proceeding........146 E. May 1998 Settlement Agreement..................147 1. Overview..................................147 2. Property Distributions....................147 a. Cash and Cash Equivalents...........147 b. Automobiles.........................147 c. Real Properties.....................147 d. Jewelry and Furs....................148 e. Judgment Against Michael Boulware...148 f. Summary.............................148 3. Disbursements by HIE......................149 F. Settlement of 1998 Adversary Proceedings.......149 G. Claimed Bad Debt Deductions Related to Amounts Considered Due From Jin Sook Lee, Trustee......151 XVII. NOL Adjustments.................................151 A. HIE’s Filing of Its Federal Income Tax Returns for 198906 Through 199906......................151 - 10 - B. Pre-199806 Reported NOLs and Applications......152 C. HIE Claims on Its Federal Income Tax Return for 199806 That Its NOL Carryover From Earlier Years Is Larger Than That Previously Reported..153 D. Source of Larger NOL Carryover Reported For 199806.........................................154 E. HIE’s 199906 Federal Income Tax Return.........155 1. Overview..................................155 2. Exhibit 18-J..............................156 3. Claim to Additional COGS..................158 F. HIE’s Position as to Its NOL Carryovers Reported for 199806 and Later Years............159 1. Overview..................................159 2. HIE’s Liability for Hawaii Tobacco Tax....160 3. HIE’s Purported Overpayment of Hawaii Tobacco Tax...............................160 4. Tobacco Tax Liability Adjustment..........162 5. HIE’s Monthly Book Adjustments............164 6. HIE’s AJEs................................165 7. Tobacco Tax Refund Income Claimed Reported and Reportable by HIE.....................166 a. Income Claimed Reportable............166 b. Income Claimed Reported Through Monthly Adjustments..................167 c. Income Claimed Reported Through AJEs.168 d. Summary..............................168 8. HIE’s Purported Income Shift..............169 XVIII. Michael Boulware’s Criminal Trials..............169 A. First Trial....................................169 1. General Information.......................169 2. Relevant Evidence and Arguments...........169 3. Jury Verdict..............................170 B. Sentencing Phase and First Appeal..............171 1. Positions as to Sentencing................171 2. Sentence Imposed..........................171 3. Appeal of Conviction......................172 C. Michael Boulware’s Retrial.....................172 - 11 - D. Criminal Case Heard by U.S. Supreme Court......173 E. Remand From U.S. Supreme Court.................174 XIX. Civil Examinations and Requests for Information.....................................175 A. Start of Civil Examinations....................175 B. Requests for Information.......................175 1. HIE.......................................175 2. Holdings..................................177 3. Actions During This Proceeding............180 XX. Professional Fees...............................180 A. Overview.......................................180 B. Source of Professional Fees....................181 1. HIE.......................................181 2. Holdings..................................182 C. Categories of Disputed Professional Fees.......182 1. Overview..................................182 2. Specifics of Expenses in Each Category....183 a. Criminal Investigation..............183 b. Grand Jury Proceedings..............183 c. Michael Boulware’s Criminal Trial...184 d. Fees Involving Jin Sook Lee.........184 e. Fees Accepted as Ordinary and Necessary...........................185 f. Other Fees..........................185 3. Amounts of Fees Attributable to Each Category..................................185 D. Providers of the Professional Services Underlying the Legal Costs.....................186 1. Criminal Investigation....................186 a. Representation of HIE Employees.....186 i. Overview.....................186 ii. Peter Wolff..................186 iii. Benjamin Cassidy.............186 b. Damon Key...........................187 c. Irell Manella.......................188 d. Shiotani Inouye.....................188 - 12 - e. Wachi Watanabe......................189 2. Grand Jury Proceedings....................190 a. Birney Bervar.......................190 b. Brook Hart..........................190 c. Chee Markham........................191 d. Damon Key...........................191 e. Graham James........................192 f. Hochman Salkin......................194 g. Howard Chang........................194 h. Irell Manella.......................195 i. Lopeti Foliaki......................195 j. Perkin Hosoda.......................195 k. Reinwald O’Connor...................196 l. Shiotani Inouye.....................198 m. Stephen Pingree.....................198 n. Wachi Watanabe......................198 3. Criminal Trial............................199 a. Accucopy............................199 b. Ayabe Chong.........................199 c. Bird Marella........................200 d. Bowen Hunsaker......................200 e. Brook Hart..........................201 f. Candon Consulting/John Candon.......201 g. Chicoine Hallett....................203 h. Corniel.............................203 i. Overview......................203 ii. Specifics.....................204 i. Damon Key...........................204 j. Gaims Weil..........................204 k. Goodenow............................205 l. Graham James........................205 m. Hawaii National Bank................205 n. Leonard Sharenow....................206 o. Lyle Hosoda Associates..............206 p. McCorriston Miller..................206 q. Michael McCarthy....................207 r. Nathan Suzuki.......................207 s. Perkin Hosoda.......................207 t. PWC.................................207 u. Professional Image..................208 v. Reinwald O’Connor...................208 w. Robert Waters.......................209 x. Saranow Pagani......................210 y. Sherman Sherman.....................210 z. Sheila Balkan.......................211 - 13 - aa. Shiotani Inouye.....................211 i. 200006.......................211 ii. 200106.......................211 iii. 200206.......................212 bb. Squire Sanders......................212 cc. Stephen Platt.......................213 dd. Wachi Watanabe......................213 ee. Wilmington Institute ...............213 4. Fees Concerning Jin Sook Lee..............214 a. Chee Markham........................214 b. Damon Key...........................214 c. Gaims Weil..........................215 d. Glenn Lee Boulware Trust............216 e. Reinwald O’Connor...................216 5. Fees Accepted as Ordinary and Necessary...217 a. Carlsmith Ball......................217 b. Damon Key...........................217 c. Marr Hipp...........................218 d. Seyfarth Shaw.......................218 e. Other Legal.........................219 6. Other Fees................................219 a. Accucopy............................219 b. Case Bigelow........................219 c. Damon Key...........................220 d. Foley Jones.........................221 e. GMK Consulting......................221 f. King King...........................222 g. Laird Christianson..................222 h. Louis Wai...........................222 i. Michael McCarthy....................223 j. Nathan Suzuki.......................223 k. Robert Holland......................223 l. Yoshida, Inc........................223 m. Other Legal.........................224 E. Other Professional Fees........................224 1. Fees Related to Criminal Trial............224 2. Fees Accepted as Ordinary and Necessary...224 a. Antoneita DeWang-Seo................224 b. Applied Computer....................224 c. ASI Food Safety.....................225 d. Back to Basics Plus.................225 e. Brewer Environmental................225 f. Business Consulting.................225 g. Ceridian Employer...................225 h. Charles Abraham.....................226 - 14 - i. COLIFORM............................226 j. Commercial Plumbing.................226 k. Communications Pacific..............226 l. Datahouse...........................227 m. Dataprofit Corp.....................227 n. Dunn Bradstreet.....................227 o. Electra Form........................227 p. EMS Solutions.......................227 q. Fidelity Investments................228 r. Foley Jones.........................228 s. Food Products.......................228 t. GEM Communications..................229 u. GT Service..........................229 v. Hawaiian Hardware...................229 w. Intrastate..........................229 x. IW..................................229 y. John Ching..........................230 z. Kimura International................230 aa. KPMG................................230 bb. L.C. Financial .....................230 cc. Leung Pang..........................231 dd. Melvin Kam..........................231 ee. Michael Toigo.......................231 ff. Pension Services....................231 gg. Procomm.............................232 hh. Professional Image..................232 ii. Profit Concepts.....................232 jj. Quadrel Labeling....................232 kk. Rhanda Kim..........................232 ll. Richard Kitagawa....................233 mm. RJR Packaging.......................233 nn. Servend of Hawaii...................233 oo. Stewart Engineering.................233 pp. Tricia Young........................233 qq. Wayne Arakaki.......................234 3. Other Fees................................234 a. Henry Yokogawa......................234 b. Kobayashi Doi.......................234 i. Overview......................234 ii. 199806........................235 iii. 199906........................235 iv. 200006........................236 v. 200106........................236 vi. 200206........................236 c. Lorin Kushiyama.....................236 - 15 - d. Richard Kitagawa....................236 e. TRI Pac.............................237 f. Vending Consulting..................237 g. Watson Wyatt........................237 h. Amortization........................237 XXI. Kona Coffee.....................................238 A. Background.....................................238 B. Season for Kona Coffee.........................239 C. Shelia David...................................239 OPINION......................................................241 I. Perception of Witnesses..........................241 II. Burden of Proof..................................244 A. Overview.......................................244 B. Applicability of Section 7491..................245 C. Claim That NODs Are Arbitrary..................249 III. NOL Deduction....................................251 IV. Bad Debt Deduction...............................263 V. Professional Fees................................269 A. Overview of Dispute............................269 B. Applicable Law in General......................270 1. Deduction of Ordinary and Necessary Business Expenses.........................270 2. Corporate Taxpayer’s Burdens Underlying Deduction.................................271 3. Payment of Another Taxpayer’s Expense.....272 a. First Prong of Two-Prong Test........273 b. Second Prong of Two-Prong Test.......275 C. Whether HIE Incurred Any of the Disputed Expenses.......................................278 - 16 - D. Whether All Expenses Were Substantiated........280 E. “Fees Accepted as Ordinary and Necessary” and “Other Fees”...................................281 F. Expenses of Michael Boulware’s Criminal Defense........................................282 1. Background................................282 2. Expenses Stemmed From Personal Pursuits...284 G. Professional Fees Related to Civil Litigation Initiated by Jin Sook Lee......................288 1. Overview..................................288 2. Analysis..................................289 a. Fees Determined To Be Capital Expenditures.........................289 b. Fees Determined To Be Michael Boulware’s Personal Expenses.........290 H. Applicability of Indemnification Agreement.....292 1. Overview..................................292 2. Arrangements Under Section 62(a)(2)(A)....293 3. Mandatory Indemnity.......................295 a. Overview.............................295 b. Analysis.............................296 4. Permissive Indemnity......................298 5. Repayment Obligation......................299 VI. Constructive Dividends...........................300 A. Overview.......................................300 B. Rules Applicable to Distributions..............301 C. E&P............................................302 1. Background................................302 2. Lack of Comprehensive Definition..........302 3. Calculation...............................303 a. Overview.............................303 i. ATI.............................303 ii. Increases and Decreases to ATI..304 b. Current E&P..........................306 c. Accumulated E&P......................307 d. Summary of Calculation...............307 - 17 - D. Adjustments Applicable to These Cases..........309 1. Overview..................................309 2. First Adjustment..........................309 3. Second Adjustment.........................309 4. Third Adjustment..........................310 5. Fourth Adjustment.........................310 6. Fifth Adjustment..........................311 E. Conclusion.....................................311 VII. Additions to Tax.................................312 VIII. Epilog...........................................313 Appendix A...................................................314 Appendix B...................................................321 Appendix C...................................................322 MEMORANDUM FINDINGS OF FACT AND OPINION LARO, Judge: These cases are before the Court consolidated for purposes of trial, briefing, and opinion.3 In docket No. 5045-05, HIE Holdings, Inc. (Holdings), and two of its subsidiaries, Hawaiian Isles Kona Coffee Co., Ltd. (Hawaiian Isles Kona Coffee), and Royal Hawaiian Water Co., Ltd. (Royal Hawaiian Water), petitioned the Court to redetermine respondent’s determination of deficiencies of $242,546, $77,602, $470,461, $280,489, and $519,760 in the affiliated group’s Federal income taxes for its taxable years ended June 30, 1997, 1999, 2000, 3 The cases were consolidated on Feb. 27, 2006, pursuant to the joint motion of the parties. - 18 - 2001, and 2002, respectively.4 In docket No. 5046-05, Hawaiian Isles Enterprises, Inc. (HIE), petitioned the Court to redetermine respondent’s determination of deficiencies of $1,057,181, $125,317, $175,524, and $799,433 in HIE’s Federal income taxes for 199806, 200006, 200106, and 200206, respectively, and a $264,295 addition to HIE’s 199806 tax under section 6651(a)(1).5 In docket No. 5047-05, Michael Boulware petitioned the Court to redetermine respondent’s determination of deficiencies of $497,926, $603,406, $935,124, $1,339,019, and $874,551 in Michael Boulware’s 1998 through 2002 Federal income taxes, respectively. 4 We hereinafter refer to each relevant fiscal year by using a six-digit number. The first four digits refer to the year in which the fiscal year ended. The last two digits refer to the month in which the fiscal year ended. 5 Unless otherwise indicated, section references are to the applicable versions of the Internal Revenue Code, Rule references are to the Tax Court Rules of Practice and Procedure, and dollar amounts are rounded to the dollar. References to sections and chapters of the Bankruptcy Code are to tit. 11 of the United States Code after the effective date of amendments made thereto by the Bankruptcy Reform Act of 1994, Pub. L. 103-394, 108 Stat. 4106, that were effective for bankruptcies filed on and after Oct. 22, 1994. Id. sec. 702, 108 Stat. 4150. Throughout this Memorandum Opinion, we reference various law, accounting, and other professional firms, many of which changed their names during the relevant period. We refer to each firm by one of its names and include within that name each of the firm’s relevant predecessors and successors. - 19 - Following a trial of these cases held primarily in Honolulu, Hawaii, we decide five issues.6 First, we decide whether to sustain respondent’s disallowances of HIE’s deductions of net operating losses (NOLs), reported as arising from NOL carryovers from 198906 through 199606, to the extent of $1,636,322 for 199806 and of $1,184,192, $324,767, and $145,145 for 200006, 6 These cases were originally scheduled to be tried in Los Angeles, California, but the Court granted the parties’ joint motion to change the situs of trial to Honolulu, Hawaii, where most of the witnesses resided. Because Michael Boulware would otherwise have been detained at a U.S. penitentiary in California during the trial, the Court, pursuant to sec. 7456 and joint motions of the parties, issued writs of habeas corpus ad testificandum causing the U.S. Marshal for the District of Hawaii to move Michael Boulware to a prison in the vicinity of Honolulu and then to transport Michael Boulware (under the escort of Deputy U.S. Marshals) to and from the courtroom in Honolulu on each day that Michael Boulware wanted to attend his trial. For purposes of the trial, the parties generally made electronic copies of each document that was introduced into evidence, and petitioners caused five large electronic screens (including a 42-inch screen) to be present in the courtroom. The parties generally used those screens to display to themselves, to the Court, and to each witness any exhibit that was the subject of the witness’s testimony. The Court imposed a time limit on each side’s presentation of evidence. On Aug. 28, 2007, these cases were initially submitted to the Court for decision. On Mar. 3, 2008, the U.S. Supreme Court decided Boulware v. United States, 552 U.S. , 128 S. Ct. 1168 (2008), a case involving Michael Boulware and much of the same evidence that is in the record here. In the light of that case, this Court granted petitioners’ request to reopen the record in these cases so that they could solicit additional testimony and present additional documents during a further trial in Honolulu. The issues tried at the further trial were limited to determinations of the earnings and profit (E&P) of HIE and Holdings and a determination of Michael Boulware’s adjusted basis in each of those corporations. - 20 - 200106, and 200206, respectively.7 We shall sustain those disallowances in full. Second, we decide whether to sustain respondent’s disallowance of a $905,340 bad debt deduction HIE claimed for 199806. We shall sustain none of that disallowance. Third, we decide whether to sustain respondent’s disallowances of professional fees deducted by HIE to the extent of $1,241,995, $1,159,635, $1,156,364, and $2,208,588 for 199806, 200006, 200106, and 200206, respectively, and of professional fees deducted by Holdings to the extent of $228,240, $1,383,710, $794,404, and $2,253,652 for 199906 through 200206, respectively. We shall sustain those disallowances to the extent stated herein. Fourth, we decide whether to sustain respondent’s determinations that Michael Boulware received constructive dividends of $1,406,343, $1,513,055, $2,332,643, $3,380,947, and $2,231,120 for 1998 through 2002, respectively, primarily because the just-referenced professional fees were paid by his constructive withdrawals of funds from HIE and Holdings (collectively, subject corporations). We shall sustain those determinations to the extent stated herein. Fifth, we decide whether to sustain respondent’s determination that HIE is liable for the addition to 7 For 199806, HIE claimed an NOL deduction of $2,086,891. Respondent determined that the NOL deduction was $450,569; i.e., $1,636,322 less than claimed. - 21 - tax under section 6651(a). We shall sustain that determination in full.8 FINDINGS OF FACT I. Preliminaries Many facts were stipulated, and those facts are found accordingly. The approximately 2,000 stipulated facts and the thousands of exhibits submitted therewith are incorporated herein by this reference. The trial transcripts total 5,255 pages, and the number of pages in the exhibits total approximately 50,000. The Court has recorded on the docket sheets of these cases over 900 index entries. The subject corporations are C corporations that during the relevant years used accrual methods to report their income and expenses for Federal income tax purposes on the basis of fiscal years ended on June 30.9 When the petitions commencing these 8 In their posttrial briefs, petitioners attempt to raise certain issues that were not pleaded in their petitions. We decline to decide those issues as they are not properly before us. See Rules 34(b)(4), 41(a) and (b); see also Bob Wondries Motors, Inc. v. Commissioner, 268 F.3d 1156, 1161 (9th Cir. 2001), affg. Toyota Town, Inc. v. Commissioner, T.C. Memo. 2000-40; Foil v. Commissioner, 92 T.C. 376, 418 (1989), affd. 920 F.2d 1196 (5th Cir. 1990). 9 The Federal income tax return of a corporate taxpayer such as HIE or Holdings that uses a fiscal year ending on June 30 is generally due on Sept. 15 of the year in which its fiscal year ends, unless the corporation receives an extension to file its return 6 months later; i.e., by Mar. 15 of the following year. - 22 - cases were filed, the principal place of business of each subject corporation was in Hawaii.10 Also at that time, the “legal residence” of Michael Boulware as stipulated by the parties was in Hawaii; we understand him then to have been imprisoned at a U.S. penitentiary in California, specifically, the Lompoc Correctional Facility in Lompoc, California. II. NODs A. NOD Issued to HIE 1. General Information On December 15, 2004, respondent issued a notice of deficiency (NOD) to HIE for 199806 and 200006 through 200206. The NOD contained three adjustments which are relevant herein. 2. First Adjustment--Disallowance of Portion of Deductions for NOLs a. Overview Respondent disallowed HIE’s claim of NOL deductions for each year, except for $450,569 that was allowed for 199806. b. Primary Determination Respondent determined primarily that HIE failed to establish that it was entitled to an NOL deduction for 199806 of more than $450,569 or that it had an NOL carryover to apply to any of the 10 Unless otherwise noted, all references to Hawaii are to the State of Hawaii. - 23 - other subject years. As part of this primary determination, respondent also determined that HIE was entitled to reduce its “miscellaneous income related to HIE’s tobacco tax ‘self- correction’” (discussed infra) by $1,927,648 for 200006 and $962,426 for 200106.11 c. Alternate Determination i. Overview Respondent determined alternatively that adjustments to HIE’s income and deductions for 198906 through 199706, the years in which HIE claims its NOL carryover to 199806 originated, limited HIE’s NOL carryover to 199806 (and hence HIE’s NOL deduction for that year) to $450,569 and resulted in no NOL carryover to any of the other subject years. Many of those adjustments, as discussed infra, related to the criminal indictment of Michael Boulware in part with respect to his 1989 through 1997 Federal income taxes.12 11 During respondent’s civil examination of HIE, respondent also verified that HIE had reported as taxable income for 199906 “miscellaneous income related to HIE’s tobacco tax ‘self- correction’”. Respondent did not determine a deficiency for that year. 12 As discussed infra, Michael Boulware’s indictment also related in part to certain false invoicing schemes. - 24 - ii. Adjustments Related to Criminal Indictment The adjustments for 198906 through 199706 that were related to the criminal indictment reflected the following determinations by respondent: (1) For 199006 through 199306, HIE failed to report $3,583,725 of income that was diverted to Michael Boulware from HIE’s over-the-counter (OTC) sales of tobacco; (2) for 198906 through 199206, HIE failed to report $1,335,132 of income that was diverted to Michael Boulware and/or his mistress, Jin Sook Lee, from HIE’s sales of coffee beans to Pele Trading, Inc. (Pele Trading); (3) for 199006 through 199306, HIE failed to report $1,265,458 of income that was diverted to Michael Boulware and/or Jin Sook Lee from HIE’s sales of coffee beans to Hawaiian Kona Coffee Co., d.b.a. Hawaii Misuzu Coffee Co., Ltd. (Hawaii Misuzu);13 (4) for 199006, HIE improperly deducted $50,785 that HIE paid to Bonded Construction Co., Ltd. (Bonded Construction), for work that HIE reported was performed at HIE’s coffee plant but which actually was performed to renovate Jin Sook Lee’s residence in Honolulu at 1017 Makaiwa Street (Makaiwa house); (5) for 199306, HIE improperly deducted $638,427 that was diverted from HIE to Michael Boulware through certain fictitious 13 Hawaii Misuzu and Hawaiian Isles Kona Coffee are different entities and are unrelated. - 25 - leasing arrangements; (6) for 199506 through 199706, HIE improperly deducted $1,731,000 that HIE paid to a foreign entity, Harvest International King Coffee, Ltd. (Harvest International), which was then transferred to Michael Boulware through a second foreign entity, Forest Trading Corp. (Forest Trading); (7) for 199506, HIE improperly deducted $29,984 that HIE paid to Harvest International, which was then transferred on behalf of Michael Boulware to a domestic entity, Briggs Cockerham, L.L.C. (Briggs Cockerham); and (8) for 199506 and 199606, HIE improperly deducted $89,936 that HIE paid to Harvest International, which was then transferred on behalf of Michael Boulware to Anthony Oh Young and Gloria Oh Young through a foreign entity, Pacific Vendors Equipment, Ltd. (Pacific Vendors). iii. Adjustments Unrelated to Criminal Indictment The adjustments for 198906 through 199706 that were unrelated to the criminal indictment of Michael Boulware reflected respondent’s determinations that HIE was not entitled to deduct: (1) Salaries totaling $1,040,000 reportedly paid during 198906 through 199406 to Michael Boulware’s then wife, Mal Sun Boulware; (2) payments totaling $385,000 that HIE made during 198906 and 199006 to Paradise Roasting, Inc. (Paradise Roasting), a nonoperating entity that was the alter ego of Jin Sook Lee and - 26 - was established to hide the transfer of HIE funds to Jin Sook Lee; (3) professional fees totaling $175,000 reportedly paid to Jin Sook Lee’s sole proprietorship, Video Consultant, during 199006 and 199106;14 (4) bad debts totaling $1,800,000 that were written off during 199306, 199406, 199506, and 199706 as uncollectible but otherwise due HIE from Jin Sook Lee in her capacity as the sole trustee of the Glenn Lee Boulware Trust, a trust established for the primary benefit of the oldest son of Jin Sook Lee and Michael Boulware; and (5) certain other professional fees totaling $4,269,980 for 199406 through 199706. iv. Some Specifics of Adjustments Some specifics of the adjustments for 198906 through 199706 are as follows: 14 The record sometimes lists this entity as “Video Consultant” and other times as “Video Consultants”. We consistently refer to this entity in the singular. - 27 - 198906 199006 199106 199206 199306 199404 199506 199606 199706 Total OTC sales -0- $506,464 $1,337,213 $719,755 $1,020,293 -0- -0- -0- -0- $3,583,725 Pele Trading $264,790 1,029,963 21,175 19,204 -0- -0- -0- -0- -0- 1,335,132 Hawaii Misuzu -0- 116,832 382,403 347,866 418,357 -0- -0- -0- -0- 1,265,458 Bonded Construction -0- 50,785 -0- -0- -0- -0- -0- -0- -0- 50,785 Leasing arrangement -0- -0- -0- -0- 638,427 -0- -0- -0- -0- 638,427 Forest Trading -0- -0- -0- -0- -0- -0- $837,000 $819,000 $75,000 1,731,000 Briggs Cockerham -0- -0- -0- -0- -0- -0- 29,984 -0- -0- 29,984 Anthony Oh Young and Gloria Oh Young -0- -0- -0- -0- -0- -0- 34,986 54,950 -0- 89,936 Salaries 30,000 95,000 190,000 275,000 300,000 $150,000 -0- -0- -0- 1,040,000 Paradise Roasting 185,000 200,000 -0- -0- -0- -0- -0- -0- -0- 385,000 Video Consultant -0- 84,000 91,000 -0- -0- -0- -0- -0- -0- 175,000 Bad debts -0- -0- -0- -0- 300,000 100,000 700,000 -0- 700,000 1,800,000 Other professional fees -0- -0- -0- -0- -0- 521,690 903,695 1,296,308 1,548,287 4,269,980 Total 479,790 2,083,044 2,021,791 1,361,825 2,677,077 771,690 2,505,665 2,170,258 2,323,287 16,394,427 3. Second Adjustment--Disallowance of Portion of Deductions for Professional Fees a. Overview For each subject year, respondent disallowed a portion of HIE’s deduction for professional fees. The disallowed fees totaled $1,241,995, $1,159,635, $1,156,364, and $2,208,588 for 199806, 200006, 200106, and 200206, respectively. Respondent determined that some disallowed fees were the personal expenses of HIE’s controlling shareholder, Michael Boulware. Respondent determined that other disallowed fees were unsubstantiated. Respondent determined that the remaining disallowed fees were capital expenditures incurred in connection with HIE’s acquisition of property from the bankruptcy estate of Jin Sook Lee. - 28 - b. Personal Expenses of Michael Boulware The disallowed fees determined to be personal expenses of Michael Boulware stemmed from professional representation that he received in his individual capacity. He received some of that representation while respondent’s Criminal Investigation Division (CID) was conducting a criminal investigation of Michael Boulware and Jin Sook Lee as to their personal Federal income taxes (criminal investigation); while a grand jury was conducting its investigation of Michael Boulware, proceeding to his indictment (grand jury proceedings); and during Michael Boulware’s first criminal trial and his appeal of his conviction resulting from that trial.15 Michael Boulware received the remainder of that representation while he and HIE were involved in civil litigation initiated by Jin Sook Lee. Respondent determined that 50 percent of the expenses related to that civil litigation were the personal expenses of Michael Boulware and that the other 50 percent were the business expenses of HIE. 15 As discussed infra, the criminal investigation began on or about June 16, 1993; the grand jury proceedings began at or about the beginning of August 1997; Michael Boulware was indicted on May 19, 1999 (a superseding indictment and second superseding indictment occurred on Apr. 6, 2000, and Feb. 14, 2001, respectively); the jury in Michael Boulware’s first criminal trial convicted him on Nov. 29, 2001; and Michael Boulware appealed that conviction in May 2002. - 29 - In sum, the amounts of Michael Boulware’s personal expenses determined to be attributable to the criminal and civil cases are as follows:16 199806 199906 200006 200106 200206 Total Criminal investigation, grand jury proceedings, first criminal trial, and appeal $598,602 $810,688 $1,016,103 $1,156,364 -0- $3,581,757 50 percent of expenses related to civil litigation initiated by Jin Sook Lee 411,678 36,245 58,588 -0- -0- 506,511 Total 1,010,280 846,933 1,074,691 1,156,364 -0- 4,088,268 c. Unsubstantiated Expenses The disallowed fees determined to be unsubstantiated totaled $103,313 for 199806, $10,000 for 199906, $66,671 for 200006, and $2,208,588 for 200206. d. Capital Expenditures Respondent determined that $157,979 of the total disallowed fees was capital expenditures attributable to various assets that HIE acquired from the bankruptcy estate of Jin Sook Lee. The specific amounts underlying the $157,979 were $128,402 for 199806, $11,304 for 199906, and $18,273 for 200006 ($128,402 + $11,304 + $18,273 = $157,979). The acquired assets were the Makaiwa house, a condominium in Honolulu at 1117 Punahou Street (Punahou condominium), a condominium in Honolulu at 475 Atkinson 16 Although 199906 is not a year that was the subject of the NOD issued to HIE, we include that year in our findings because it relates to the constructive dividends determined in the NOD issued to Michael Boulware. - 30 - Drive (Atkinson condominium), a 1992 Rolls Royce, and jewelry and furs. Of the $157,979, respondent determined that $16,391, $60,134, $22,308, $19,398, and $39,747 were allocable to those respective assets. Respondent determined the allocable amounts as follows: Applicable Percent of Capitalized Value Whole Fees Makaiwa house $845,000 Less: A life estate retained by Jin Sook Lee in the house 760,500 Acquired interest 84,500 10.38 $16,391 Punahou condominium 310,000 38.06 60,134 Atkinson condominium 115,000 14.12 22,308 1992 Rolls Royce 100,000 12.28 19,398 Jewelry and furs 204,900 25.16 39,747 Total 814,400 100.00 157,979 For each of the taxable years 200006, 200106, and 200206, respondent determined that HIE was entitled to deduct $2,459 of depreciation as to the capital expenditures. Respondent determined that depreciation as follows: Capitalized Allocation Depreciable Fees to Building Basis 200006 200106 200206 Punahou condominium $60,134 85% $51,114 $1,859 $1,859 $1,859 Atkinson condominium 22,308 74 16,508 600 600 600 Total 2,459 2,459 2,459 e. Summary In sum, the disallowed professional fees are as follows: 199806 199906 200006 200106 200206 Total Personal expenses $1,010,280 $846,933 $1,074,691 $1,156,364 -0- $4,088,268 Unsubstantiated expenses 103,313 10,000 66,671 -0- $2,208,588 2,388,572 Capital expenditures 128,402 11,304 18,273 -0- -0- 157,979 Total 1,241,995 868,237 1,159,635 1,156,364 2,208,588 6,634,819 - 31 - 4. Third Adjustment--Disallowance of Deduction for Bad Debt For 199806, respondent disallowed HIE’s claimed bad debt deduction of $905,340. That deduction was attributable to HIE’s writeoff of a further portion of the debt reportedly due to HIE from Jin Sook Lee in her capacity as trustee of the Glenn Lee Boulware Trust. Respondent determined that the deduction was not allowed primarily because HIE had failed to establish a debtor/creditor relationship with Jin Sook Lee. Respondent determined alternatively that the deduction was not allowed because HIE had failed to establish the accuracy of the amount claimed as the deduction or its worthlessness. B. NOD Issued to Holdings 1. General Information On December 15, 2004, respondent issued an NOD to Holdings for 199706 and 199906 through 200206. The NOD related to Holdings and to its wholly owned subsidiaries, Hawaiian Isles Kona Coffee and Royal Hawaiian Water. 2. Sole Relevant Adjustment--Disallowance of Portion of Deductions for Professional Fees The NOD contained one adjustment which is relevant herein; i.e., respondent disallowed a portion of Holdings’ deduction of - 32 - professional fees for 199906 through 200206.17 The disallowed fees totaled $228,240, $1,383,710, $794,404, and $2,253,652 for 199906 through 200206, respectively. Respondent determined that some of the disallowed fees were the personal expenses of Michael Boulware. Those personal expenses were determined to stem mainly from the professional representation Michael Boulware received during the criminal investigation; during the grand jury proceedings; and during Michael Boulware’s first criminal trial and his appeal of his conviction resulting from that trial. Respondent determined that the remaining disallowed fees were unsubstantiated. Respondent determined the specific amounts attributable to the two reasons for disallowance as follows: 199906 200006 200106 200206 Personal expenses -0- $1,110,435 $575,114 $1,678,579 Unsubstantiated expenses $228,240 273,275 219,290 575,073 Total 228,240 1,383,710 794,404 2,253,652 C. NOD Issued to Michael Boulware 1. General Information On December 15, 2004, respondent issued an NOD to Michael Boulware for 1998 through 2002. 17 For 199706, Holdings had carried back and claimed a deduction for a $713,370 NOL from 200206. Because respondent’s disallowance of the amount of professional fees Holdings deducted for 200206 was greater than $713,370, respondent determined that Holdings did not have an NOL for 200206 and thus was not entitled to its claimed NOL deduction for 199706. - 33 - 2. Sole Relevant Adjustment--Constructive Dividends The NOD contained one adjustment which is relevant herein; i.e., respondent determined that most of the above-mentioned unsubstantiated expenses and personal expenses were personal withdrawals of funds by Michael Boulware from the subject corporations and that the amounts of these funds were includable in Michael Boulware’s taxable income as constructive dividends. Respondent determined that the constructive dividends totaled $1,406,343, $1,513,055, $2,332,643, $3,380,947, and $2,231,120 for 1998 through 2002, respectively, Respondent determined these amounts as follows: Distribution 1998 1999 2000 2001 2002 Total HIE 199806 $891,242 -0- -0- -0- -0- $891,242 HIE 199906 400,981 $472,235 -0- -0- -0- 873,216 HIE 200006 -0- 477,969 $596,722 -0- -0- 1,074,691 HIE 200106 -0- -0- 485,610 $670,754 -0- 1,156,364 HIE 200206 -0- -0- -0- 1,104,294 $1,104,294 2,208,588 Subtotal 1,292,223 950,204 1,082,332 1,775,048 1,104,294 6,204,101 Holdings 199906 Unsubstantiated 114,120 114,120 -0- -0- -0- 228,240 Holdings 200006 Personal expenses -0- 312,094 798,341 -0- -0- 1,110,435 Unsubstantiated -0- 136,637 136,638 -0- -0- 273,275 Holdings 200106 Personal expenses -0- -0- 205,687 369,428 -0- 575,115 Unsubstantiated -0- -0- 109,645 109,645 -0- 219,290 Holdings 200206 Personal expenses -0- -0- -0- 839,290 839,290 1,678,580 Unsubstantiated -0- -0- -0- 287,536 287,536 575,072 Subtotal 114,120 562,851 1,250,311 1,605,899 1,126,826 4,660,007 Total 1,406,343 1,513,055 2,332,643 3,380,947 2,231,120 10,864,108 III. Background of Michael Boulware Michael Boulware was born on the Island of Maui on March 14, 1948, and he was raised on the Island of Oahu in a lower-middle- income neighborhood. He attended college for approximately 2 - 34 - years and then served in the National Guard through 1970. He later attended college for one more semester and then quit school to work for a telephone company. He subsequently stopped working for the telephone company and performed a variety of jobs including driving a cab and working at a restaurant bar. IV. Relevant Corporations A. HIE 1. Formation of Business In the late 1970s, Michael Boulware started his own business, the operation of a pool hall, and he began working for that business. On the premises of the business were pool tables, video games, and vending machines. In or about 1980, Michael Boulware changed his business to one of video games. Shortly thereafter, on July 10, 1981, Michael Boulware transferred most if not all of the assets and liabilities of his video game business to a newly formed corporation, M&S Vending, Inc. (M&S Vending), in exchange for all of its stock. M&S Vending was initially a cash business that involved owning and maintaining coin-operated video games and jukebox, pinball, karaoke, and vending machines (including vending machines that sold cigarettes) and leasing those games and machines to hotels, bars, restaurants, and other establishments for use on their premises. M&S Vending generally shared the cash - 35 - receipts of each of its games and machines with the establishment in which the game or machine was located. The establishment generally received 50 percent of the cash receipts in each game or machine (other than a cigarette machine) located on its premises; sometimes, the establishment received the first 10 percent of the cash receipts plus 50 percent of the remaining cash receipts (in other words, the establishment received 55 percent of the cash receipts). As to the cigarette machines, M&S Vending paid an establishment 10 percent of the receipts from those machines on the premises of that establishment. In addition to the remaining 90 percent of the cigarette machine receipts that it kept as income, M&S Vending also earned income from cigarette manufacturers that paid M&S Vending to place their brands in the cigarette machines. In or about the mid-1980s’, M&S Vending expanded its business to include the purchase of cigarettes and the sale of those cigarettes through its leased cigarette machines. Initially, M&S Vending purchased its cigarette inventory from Island Tobacco, a local wholesaler owned by Harold Okimoto and run by his brother Thomas Okimoto. Because M&S Vending had a lot of cigarette machines, it was eventually able to (and did) purchase cigarettes directly from the manufacturers (e.g., Philip Morris), rather than from the wholesalers. - 36 - M&S Vending eventually changed its name to Hawaiian Isles Vending and later, on or about June 30, 1987, to HIE. Shortly thereafter, HIE expanded its business further to include the sale of coffee and candy through its vending machines. HIE’s coffee business involved selling coffee to business offices through machines that HIE lent to the businesses. In 1988 or 1989, HIE expanded its business even further to include the processing and distribution of a blend of Kona coffee. Kona coffee is grown and sold at approximately 600 small farms in a central region of Kona, a section of the Island of Hawaii, and Kona coffee is one of the most expensive coffees in the world.18 In order to be labeled and sold as “Kona coffee”, a blend of coffee must contain at least 10 percent Kona coffee. HIE’s blend of Kona coffee was a mix of 10 percent Kona coffee beans and 90 percent coffee beans grown in places such as Brazil, Costa Rica, or Sumatra. 2. Officers and Directors a. Initially Initially, Michael Boulware was the president, treasurer, and secretary of M&S Vending, and he was one of two directors on its board. Through August 31, 1982, M&S Vending’s vice president and only other director was Matthew S.K. Pyun, Jr. 18 The average size of each of the approximately 600 farms is less than 5 acres, and the owners of those farms are natives. - 37 - b. August 31, 1982, to July 10, 1991, or Thereabouts From August 31, 1982, through July 10, 1991, or thereabouts, Michael Boulware was the only officer of HIE (inclusive of its predecessor), serving simultaneously as president, vice president, secretary, and treasurer. During that time, Michael Boulware also was either the sole director on the corporation’s board or one of its two directors. Stanley Hirai was the other director of HIE (and its predecessor) during some of that time. Stanley Hirai helped Michael Boulware form the business that became the business of M&S Vending and was one of M&S Vending’s original employees. Stanley Hirai’s role as a director of HIE (and its predecessor) was limited and scripted by Michael Boulware; among other things, Stanley Hirai signed corporate documents as directed by Michael Boulware, without fully reading the documents or understanding them. In or about 1991, Stanley Hirai contracted diabetes and was instructed by Michael Boulware not to come into the office but to remain at home on full salary. Afterwards, Stanley Hirai was paid approximately $50,000 per year through at least 1997, and he performed few services for HIE in return for that salary. - 38 - c. On or About July 10, 1991, Through an Effective Date of April 15, 2000 From July 10, 1991, or thereabouts, through an effective date of April 15, 2000, HIE had two directors in addition to Michael Boulware. One was Michael Boulware’s brother, Sidney E. Boulware, Jr. (Sidney Boulware). The other was Merwyn Manago, a friend of a friend of Michael Boulware. Sidney Boulware began working for HIE in or about 1983. Before that time, Sidney Boulware had worked for the Department of Education as a counselor at a high school. Sidney Boulware worked part time for HIE through June 1987, at which time he began (and has continued) to work full time for HIE as a chief operations officer. As of July 10, 1991, Sidney Boulware also took over Michael Boulware’s role as vice president of HIE. Merwyn Manago began working for HIE in or about November 1988. His position at that time was chief financial officer under the title of controller. Merwyn Manago has continued to date to work for HIE (and later also Holdings) as chief financial officer. Merwyn Manago also served as a board member of HIE (and Holdings) through 2006. In 2006, Michael Boulware removed Merwyn Manago from the board and replaced him with Michael Boulware’s daughter. - 39 - When Merwyn Manago began working for HIE, HIE’s accounting department was weak to inadequate, and its accounting records were not current. Merwyn Manago aimed to make that department stronger. Initially, Merwyn Manago caused HIE to hire a vending accountant and an assistant controller. Later, in 1995 or 1996, Merwyn Manago caused HIE to hire another assistant controller. Scott Yoshida, an employee of HIE and then Holdings from December 1991 to date, was employed as assistant controller through December 1995. In December 1995, Scott Yoshida was promoted to controller of Hawaiian Isles Kona Coffee. d. Effective April 15, 2000 Effective April 15, 2000, Michael Boulware resigned his position as president, secretary, and treasurer of HIE. HIE’s board (Michael Boulware, Sidney Boulware, and Merwyn Manago) accepted that resignation and appointed Sidney Boulware and Florence Boulware as HIE’s sole officers for the next corporate year.19 Sidney Boulware was appointed president, vice president, and treasurer. Florence Boulware was appointed secretary. Sidney Boulware has continued to date to work for HIE as its president. 19 While we find in the record that Florence Boulware is related to Michael Boulware, we are unable to find the specific relationship between the two. - 40 - e. Board Meetings HIE’s board of directors met frequently (either formally or informally) and memorialized those meetings in minutes. The minutes were typically typed into form by an administrative secretary of HIE, who was not at the meeting but who would receive from either Michael Boulware or Sidney Boulware the statements that she would type. The typed document would then be circulated to the officers who were present at the meeting for their signature. 3. Shareholders Initially, Michael Boulware was the sole shareholder of M&S Vending. Through September 8, 1987, Michael Boulware also was the sole shareholder of HIE. On September 8, 1987, Michael Boulware transferred 50 percent of his stock in HIE to Jin Sook Lee as trustee of the Glenn Lee Boulware Trust.20 Jin Sook Lee was Michael Boulware’s mistress from 1982 through 1994, and she is the mother of their two children. Their oldest child is Glenn Lee Boulware. At the time of the transfer, HIE did not issue a stock certificate to Jin Sook Lee, as trustee, or otherwise record the 20 Immediately before this transfer, Michael Boulware’s adjusted basis in his HIE stock was $1,000. Immediately after the transfer, Michael Boulware’s adjusted basis in his HIE stock was $500. - 41 - transfer in its books. In 1995, Jin Sook Lee, as trustee, commenced a lawsuit in the Circuit Court of the First Circuit of Hawaii by filing with the court a “Petition of Jin Sook Lee to Enforce Trust and For An Accounting in Favor of Glenn Lee Boulware, A Minor, Beneficiary” (trust case). The court docketed the trust case as No. 95-0029. On June 14, 1996, while the lawsuit was pending, HIE issued a stock certificate to Jin Sook Lee, as trustee, reflecting the ownership of 47.5 percent of the outstanding shares of HIE. Contemporaneously, HIE also issued stock to Sidney Boulware so that thereafter Sidney Boulware reportedly owned a 5-percent interest in HIE and Michael Boulware and Jin Sook Lee, as trustee, each reportedly owned a 47.5- percent interest in HIE. On or about March 15, 1998, Sidney Boulware rescinded his reported 5-percent interest in HIE so that thereafter Michael Boulware and Jin Sook Lee, as trustee, each owned 50 percent of HIE’s stock. Sidney Boulware’s action of rescission was in response to a ruling made by the court in the trust case. Specifically, on July 31, 1997, the court ruled that the Glenn Lee Boulware Trust was entitled to own 50 percent of the stock of HIE as of September 8, 1987. - 42 - 4. Michael Boulware’s Control Michael Boulware was viewed by the directors, officers, and employees of HIE as the “boss”. When he was a director on HIE’s board, Michael Boulware always had the final say at board meetings, and he always had the final say with respect to the operation and the business of HIE. Michael Boulware controlled HIE during the relevant years, and its employees routinely followed his directions and instructions without questioning the propriety of his actions. B. Holdings On April 4, 1994, Holdings was formed by Michael Boulware as a corporation with 1,000 outstanding shares all owned by HIE. Holdings began its operations in and filed its initial Federal corporate income tax return for 199706. As of the first day of that taxable year, i.e., July 1, 1996, Michael Boulware caused HIE to effect a tax-free reorganization (spinoff) through which it transferred its shares in Holdings as follows: 475 shares to Michael Boulware, 475 shares to Jin Sook Lee, as trustee of the Glenn Lee Boulware Trust, and 50 shares to Sidney Boulware. As of the first day of the following taxable year, i.e., July 1, 1997, Holdings reverse-split its stock tenfold so that thereafter Holdings had 100 outstanding shares and the numbers of shares - 43 - owned by the three just-mentioned individuals were 47.5, 47.5, and 5, respectively. For each of the taxable years 199906 through 200206, Michael Boulware was Holdings’ principal officer, principal employee, and controlling shareholder. At some point, Sidney Boulware also served as a director of Holdings. From 199706 to date, Sidney Boulware worked for Holdings as an officer, including as its president from April 15, 2000, or thereabouts, to date. C. Other Corporations Organized in 1994 Three other relevant corporations also were organized in 1994: Hawaiian Isles Vending, Inc.; Hawaiian Isles Distributors, Ltd.; and Hawaiian Isles Kona Coffee. HIE owned all of the shares of each of these corporations. D. Restructuring of HIE Effective June 30, 1995, Michael Boulware and HIE entered into an Agreement and Plan of Reorganization and Corporate Separation (restructuring). Pursuant to the restructuring, Hawaiian Isles Vending, Inc., changed its name to Holdings, and all shares of Hawaiian Isles Kona Coffee owned by HIE were transferred to Holdings. Also pursuant to the restructuring, HIE reorganized its businesses so that thereafter HIE generally sold cigarettes and Holdings generally sold and leased vending machines and processed and sold coffee. - 44 - E. Royal Hawaiian Water Royal Hawaiian Water bottles purified drinking water and sells that bottled water to retailers in Hawaii. Royal Hawaiian Water conducts its business under the name “Hawaiian Isles Water Company”. Royal Hawaiian Water is presently a subsidiary of Holdings. In September 1995, Michael Boulware formed Royal Hawaiian Water as his wholly owned corporation and elected to have that corporation taxed as an S corporation. As of July 1, 1997 (but after the reverse split mentioned supra), Michael Boulware contributed the net assets of Royal Hawaiian Water to Holdings in exchange for 162.5 newly issued shares of Holdings. This transaction increased Michael Boulware’s ownership interest in Holdings to 210 shares (47.5 + 162.5 = 210) or in other words to 80 percent of its stock (210/(100 + 162.5) = 80%). F. Holdings After the Restructuring As now relevant, the primary business of Holdings and its subsidiaries is the wholesaling, distribution, leasing, and maintenance of vending machines (it was the largest vending company in Hawaii before its vending operation was sold on December 29, 2006); the bottling, wholesaling, and distribution of purified drinking water (it has approximately 40 percent of the market in Hawaii); and the processing, wholesaling, and - 45 - distribution of coffee (it has approximately 60 percent of the “gourmet end coffee” market in Hawaii). Holdings conducts most of its business in Hawaii but also exports coffee to the continental United States and to some foreign countries. For 199706, 199906, 200006, 200106, and 200206, Holdings had the following compensated officers, each of whom received the indicated compensation: Taxable Year Officer Compensation 199706 Michael Boulware $1,372,008 Sidney Boulware 126,322 199906 Michael Boulware 375,700 Sidney Boulware 177,769 200006 Michael Boulware 1,496,006 Sidney Boulware 192,200 200106 Michael Boulware 396,006 Sidney Boulware 142,000 200206 Michael Boulware 396,006 Sidney Boulware 142,000 G. Payment of Common Costs At all relevant times, Holdings shared certain common costs with HIE, d.b.a. Hawaiian Isles Distributors. At one point, Holdings began paying HIE’s overhead and other expenses. H. Various Names Used by HIE To Conduct Its Business During the Subject Years During the subject years, HIE sometimes did business as Hawaiian Isles Distributors, sometimes as Hawaiian Isles Vending, or sometimes as Kona Coffee Service. - 46 - I. No Payment of Formal Dividends by HIE From in or about November 1988 until the end of 2005, HIE paid no formal dividends. J. E&P of HIE and Its Predecessor for 198206 Through 198806 1. 198206 As of June 30, 1982, the accumulated E&P of HIE’s predecessor, M&S Vending, was $189,252. 2. 198306 For 198306, the current E&P of M&S Vending was $234,989. The current E&P reflected M&S Vending’s taxable income as reported on its Federal income tax return for 198306 ($339,960), less negative adjustments totaling $104,971 for Federal income taxes ($103,324) and political contributions and penalties ($1,647). As of June 30, 1983, the accumulated E&P of M&S Vending was $424,241 ($189,252 + $234,989). 3. 198406 For 198406, the current E&P of M&S Vending was $341,224. The current E&P reflected M&S Vending’s taxable income as reported on its Federal income tax return for 198406 ($424,392), less negative adjustments totaling $83,168 for Federal income taxes ($77,319) and political contributions and penalties ($5,849). As of June 30, 1984, the accumulated E&P of M&S Vending was $765,465 ($424,241 + $341,224). - 47 - 4. 198506 For 198506, the current E&P of M&S Vending was $126,955. The current E&P reflected M&S Vending’s taxable income as reported on its Federal income tax return for 198506 ($151,550), plus a $34,779 positive adjustment to reflect an error on that return, less negative adjustments totaling $59,374 for Federal income taxes ($45,589), political contributions and penalties ($8,649), prior period income included in the return ($136), and a bad debt ($5,000). In addition to that year’s current E&P, the calculation of the accumulated E&P of M&S Vending as of June 30, 1985, included a $10,110 positive adjustment to reflect an overaccrual of prior years’ taxes. As of June 30, 1985, the accumulated E&P of M&S Vending was $902,530 ($765,465 + $126,955 + $10,110). 5. 198606 For 198606, the current E&P of M&S Vending was $252,942. The current E&P reflected M&S Vending’s taxable income as reported on its Federal income tax return for 198606 ($271,420), less the sum of various positive and negative adjustments totaling negative $18,478. The positive adjustments totaled $133,981 and were attributable to a prior year adjustment for “FA” ($120,000), bad debt reversals ($4,000), depreciation ($3,733), an NOL carryover ($5,798), and a recording of the - 48 - correct book value of “FA” ($450). The negative adjustments totaled $152,459 and were attributable to Federal income taxes ($70,001), depreciation adjustments ($11,094), an overaccrual of tax ($60,871), and penalties ($10,493). In addition to that year’s current E&P, the calculation of the accumulated E&P of M&S Vending as of June 30, 1986, included two positive adjustments. The first positive adjustment, $17,132, was made to reflect an adjustment to HIE’s net income for 198506 as reported in its books. The second positive adjustment, $16,283, was made to reflect an adjustment to HIE’s net income as reported in its books for years before 198506. As of June 30, 1986, the accumulated E&P of M&S Vending was $1,188,887 ($902,530 + $252,942 + $17,132 + $16,283). 6. 198706 For 198706, the current E&P of M&S Vending was negative $329,574. The current E&P reflected M&S Vending’s taxable loss as reported on its Federal income tax return for 198706 ($367,487), less the sum of various positive and negative adjustments totaling negative $37,913. The positive adjustments totaled $68,912 and were attributable to a Federal income tax refund ($39,377) and depreciation ($29,535). The negative adjustments totaled $30,999 and were attributable to Federal income taxes ($1,193), goodwill ($4,065), depreciation on capital - 49 - leases ($10,815), contribution carryovers ($2,473), bad debt expenses ($5,955), and book depreciation greater than tax depreciation ($6,498). As of June 30, 1987, the accumulated E&P of M&S Vending was $859,313 ($1,188,887 + (-$329,574)). 7. 198806 For 198806, the current E&P of HIE was negative $859,431. The current E&P reflected HIE’s taxable loss as reported on its Federal income tax return for 198806 ($813,106), less the sum of various positive and negative adjustments totaling negative $46,325. The positive adjustments totaled $930,937 and were attributable to an income tax benefit ($273,200), depreciation ($21,393), and a lease rental expense ($636,343). The negative adjustments totaled $977,262 and were attributable to Federal income taxes ($107), an adjustment to a bad debt reserve ($2,250), gain on investment property ($132,978), inventory capitalization ($18,000), pension contribution adjustments ($96,858), goodwill ($6,093), interest on leases ($103,942), further depreciation ($5,500), contribution carryover ($1,425), depreciation on leases ($436,761), penalties ($172,877), and meals ($471). As of June 30, 1988, the accumulated E&P of HIE was negative $118 ($859,313 + (-$859,431)). - 50 - K. E&P of Holdings for 199706 and 199806 1. 199706 a. Accumulated E&P As a result of HIE’s spinoff of Holdings on July 1, 1996, 45.9206 percent of HIE’s accumulated E&P is allocated to Holdings as of that date. b. Current E&P For 199706, the current E&P of Holdings was $722,937. 2. 199806 For 199806, the current E&P of Holdings was $346,579. L. Number of Holdings and HIE Employees At all relevant times, HIE and Holdings each had fewer than 500 employees. V. Officer Loan Account A. Overview Before the restructuring, an officer loan account was kept on the books of HIE. After the restructuring, that account was kept on the books of Holdings. B. Mechanics of Account Michael Boulware routinely requested that checks be written to him from HIE’s checking accounts. Those checks were written as requested. HIE did not always know how Michael Boulware would use the funds reflected in those checks. Merwyn Manago - 51 - anticipated that the dollar amounts of the checks written to Michael Boulware would be charged to Michael Boulware’s officer loan account (officer loan account) as borrowings by him and that the officer loan account would be reduced by any amount repaid by or on behalf of Michael Boulware. Merwyn Manago kept a running balance of the amounts that he knew that Michael Boulware borrowed (including by way of checks written to him) and that Michael Boulware repaid. Merwyn Manago generally caused those transactions to be recorded in the officer loan account contemporaneously with the transactions. As discussed infra, Michael Boulware participated in certain transactions that were not reported on the books of either subject corporation (off-book activities), and he caused deposits and withdrawals to be made to and from two bank accounts (off- book bank accounts) that were neither reported on the books of either subject corporation nor known about by Merwyn Manago or the other independent (of Michael Boulware) managers of the subject corporations (collectively, independent managers). Merwyn Manago did not know about the funds that were deposited into or withdrawn from the off-book bank accounts, and he did not reflect those funds in the officer loan account. Merwyn Manago did not know about or cause HIE to record contemporaneously in - 52 - the officer loan account transactions related to the off-book activities. C. Repayment of Officer Loans Bonuses were declared to Michael Boulware at the end of each year to repay some of the balance in the officer loan account. Merwyn Manago caused to be recorded as reductions of the officer loan account any portion of a loan to Michael Boulware that was repaid. Michael Boulware’s repayments were not always made in cash. D. Michael Boulware’s Claimed Coffee Transactions Michael Boulware told Merwyn Manago that Michael Boulware was using HIE funds in his individual capacity to purchase coffee for resale to HIE. Merwyn Manago caused the balance of the officer loan account to be increased by the amount of HIE funds that Merwyn Manago believed that Michael Boulware was using for that purpose. Michael Boulware told Merwyn Manago when Michael Boulware purportedly sold and delivered coffee to HIE, and Merwyn Manago recorded those sales and alleged deliveries as reductions to the balance in the officer loan account. Merwyn Manago told Michael Boulware that HIE needed invoices to document any coffee transaction between him and HIE. Afterwards, Michael Boulware gave Merwyn Manago invoices stating that Michael Boulware had sold Kona coffee to Hawaiian Isles Kona - 53 - Coffee or to HIE and that he had delivered that coffee to the purchasing corporation. Michael Boulware did not always give those invoices to HIE contemporaneously with the dates that Michael Boulware said he had delivered coffee to HIE. Other than through Merwyn Manago’s receipt of the invoices from Michael Boulware and Merwyn Manago’s related discussions with Michael Boulware, Merwyn Manago did not attempt to verify that HIE received the coffee Michael Boulware said he sold to HIE; Merwyn Manago relied primarily upon the representations and actions of Michael Boulware. From November 1988 through June 1994, Michael Boulware gave HIE various invoices for coffee that he purportedly sold to HIE or one of its subsidiaries. These invoices for the most part are consecutively numbered. One invoice stated that Michael Boulware sold and delivered to Hawaiian Isles Kona Coffee 80,000 pounds of Kona coffee. Merwyn Manago did not see this coffee but credited Michael Boulware’s loan account for the $500,000 sales price listed on the invoice. Nor did Merwyn Manago verify that Hawaiian Isles Kona Coffee had received 40,000 pounds of Kona coffee that a second invoice stated that Michael Boulware had sold and delivered to Hawaiian Isles Kona Coffee for $250,000. Merwyn Manago also did not verify that Hawaiian Isles Kona Coffee received 200,000 pounds of Kona coffee that a third invoice - 54 - stated that Michael Boulware had sold and delivered to Hawaiian Isles Kona Coffee for $800,000. Michael Boulware did not actually deliver this 320,000 pounds of coffee (200,000 + 40,000 + 80,000 = 320,000) but through the officer loan account was credited with doing so.21 E. Promissory Notes Before 1993, the year in which the CID investigation began, Michael Boulware was not required to sign promissory notes for checks written to him from an HIE account. Afterwards, at the end of each year, Merwyn Manago generally took the total amount of checks written to Michael Boulware in each month of that year and drafted promissory notes for each of those months. None of the funds that were deposited into the off-book bank accounts were reflected in the promissory notes. Payment of the promissory notes was not secured. The promissory notes set forth a repayment date within 24 months after their making and stated that a holder of a note in default could declare that the entire unpaid balance was immediately due and payable. 21 In addition to these amounts credited to the officer loan account as coffee repayments, we are unable to verify other items for which Merwyn Manago credited the officer loan account. - 55 - F. Lack of Collection on Promissory Notes Some of the loans recorded as made to Michael Boulware were not repaid, and defaults occurred on the related and some of the other promissory notes. Merwyn Manago never declared that any amount due under a promissory note related to Michael Boulware was immediately due and payable. Nor did Merwyn Manago ever attempt to collect repayment of an obligation of Michael Boulware that was in default; Merwyn Manago viewed Michael Boulware as the owner of the subject corporations and, hence, as the boss of Merwyn Manago and every other employee of one or both of the subject corporations. When the period of limitations expired on the enforcement of a promissory note related to Michael Boulware, Merwyn Manago never recorded on the books of either subject corporation that those amounts were uncollectible. The board of directors never took any action with respect to collection on the promissory notes. VI. Personal Bank Accounts A. Michael Boulware Individually As relevant herein, Michael Boulware had three personal bank accounts listed in his name. These accounts were checking account No. 05-389054 at First Interstate Bank of Hawaii, checking account No. 49-507151 at First Hawaiian Bank, and checking account No. 09-365508 at First Hawaiian Bank. Michael - 56 - Boulware also maintained a checking account at the Bank of Hawaii in his reported capacity as president, treasurer, and secretary of his wholly owned corporation, Automated Equipment, Ltd. (Automated Equipment). That account number was 17-134698. B. Michael Boulware and Mal Sun Boulware Jointly Michael Boulware and Mal Sun Boulware had a joint savings account, account No. 17-009762 at Liberty Bank. They also had a joint checking account, account No. 37-251410 at First Hawaiian Bank. C. Jin Sook Lee Jin Sook Lee had a personal checking account, account No. 65-565579 at First Hawaiian Bank. Jin Sook Lee also maintained a savings account at First National Bank in her capacity as trustee of the Glenn Lee Boulware Trust. That account number was 65-570109. VII. Mal Sun Boulware Mal Sun Boulware was born in Korea in 1944, and she moved to the United States in 1963. She was married to Michael Boulware from 1975 through May 5, 1994. She and Michael Boulware have one child, Karen Min Boulware, a Korean girl whom they adopted. Karen Min Boulware was born on May 2, 1979. M&S Vending reportedly paid Mal Sun Boulware wages of $16,560 and $21,210 during 1981 and 1982, respectively, and - 57 - $24,000 during each of the years 1983 through 1986. HIE reportedly paid Mal Sun Boulware wages of $47,000, $59,000, $60,000, $130,000, $250,000, $300,000, $300,000, and $75,000 during 1987 through 1994, respectively. Mal Sun Boulware generally received her reported wages in equal installments throughout the corresponding year. For 198906 through 199406, HIE deducted wages paid to Mal Sun Boulware of $30,000, $95,000, $190,000, $275,000, $300,000, and $150,000, respectively. Respondent disallowed the deductions for 198906 through 199406 in the total amount of $1,040,000. Mal Sun Boulware has just a few years of education, all in Korea, and she reads little English. She did not have either an office or a desk at HIE (or at any related entity). Mal Sun Boulware performed no meaningful work for HIE (or M&S Vending) that would support characterizing the disputed payments to her as compensation. VIII. Jin Sook Lee A. Background Jin Sook Lee was born in Seoul, Korea, in 1955, and she moved to the United States in 1980. When she moved, Jin Sook Lee had a high school education and had been married for approximately 2 years to a man who lived in Hawaii. Shortly after her move, Jin Sook Lee divorced her husband because he was - 58 - jobless and, she believed, incapable of supporting her desired lifestyle. After her divorce, Jin Sook Lee started working at a Korean hostess bar in Hawaii as a hostess retained by the bar owners to socialize with their patrons and to allure the patrons to buy a lot of drinks from the bar. Such bars usually involve prostitution and are generally staffed with young women from Korea who speak little English, have few job skills, and are looking for someone to take care of them. Jin Sook Lee and the other hostesses were paid for their services at the Korean hostess bar through commissions earned on the drinks they caused to be sold and through their receipt of tips left for them by the patrons. B. Jin Sook Lee Meets Michael Boulware In or about 1981, Jin Sook Lee met Michael Boulware at the Korean hostess bar where and while she was working. Shortly thereafter, Michael Boulware and Jin Sook Lee began an intimate relationship which Michael Boulware endeavored to keep hidden from Mal Sun Boulware and others.22 Throughout their relationship, Michael Boulware provided Jin Sook Lee with housing and supported her financially. 22 Merwyn Manago, for example, did not know of Jin Sook Lee until June 1993 or thereafter. - 59 - Jin Sook Lee stopped working at the Korean hostess bar soon after she met Michael Boulware, and she moved from her studio apartment to what she considered to be Michael Boulware’s Atkinson condominium. Jin Sook Lee lived at the Atkinson condominium rent free. Later, Jin Sook Lee moved from the Atkinson condominium to what she considered to be Michael Boulware’s house in Honolulu at Hawaii Kai, 3 Lumahai Street. She lived at that house rent free. Later, after Mal Sun Boulware learned that Jin Sook Lee was living at the house at 3 Lumahai Street, Jin Sook Lee moved from that house to the Punahou condominium, which Jin Sook Lee bought with money given to her by Michael Boulware. Jin Sook Lee has not worked since she stopped working at the Korean hostess bar. During her relationship with Michael Boulware, Jin Sook Lee attended business college, and she received a diploma and certificate in 1994. Jin Sook Lee currently receives $10,000 a year from HIE as a “settlement”. Jin Sook Lee began her relationship with Michael Boulware because she thought she would be better off financially, and she almost daily told him during their relationship that they should get married to each other. Michael Boulware eventually told Jin Sook Lee that they would marry but that he first had to divorce Mal Sun Boulware. Jin Sook Lee repeatedly fought with Michael Boulware about his not getting a divorce, and Jin Sook Lee - 60 - repeatedly told Michael Boulware that she would leave him unless he got a divorce. Michael Boulware informed Jin Sook Lee that he would divorce Mal Sun Boulware in due time. Jin Sook Lee did not believe that Michael Boulware actually wanted to or would divorce Mal Sun Boulware. During their relationship, Jin Sook Lee and Michael Boulware had two children together. Both of those children were planned. The older child, Glenn Lee Boulware, was born on September 15, 1985. The younger child, Steven Boulware, was born on October 13, 1988. Currently, Michael Boulware’s relationship with each of his sons is good. C. Paradise Roasting Beginning at least in 1986, Michael Boulware caused M&S Vending to pay Jin Sook Lee wages although she did not perform any work for M&S Vending in return for the wages. After M&S Vending was renamed HIE, HIE continued to pay Jin Sook Lee wages although she performed no work for HIE in return for the wages. In or about 1987, Mal Sun Boulware learned that Michael Boulware was having an affair with Jin Sook Lee and that Michael Boulware and Jin Sook Lee had a son, Glenn Boulware. Because Michael Boulware believed he could no longer cause HIE to pay wages to Jin Sook Lee, he sought an indirect, surreptitious way to give her money. Michael Boulware helped Jin Sook Lee form - 61 - Paradise Roasting as her wholly owned corporation and instructed her to open a bank account for Paradise Roasting in part so that he could give her money in the form of checks. Jin Sook Lee was named president of Paradise Roasting, and her sister, Hong Sun Hirai, was named vice president. During 198906 and 199006, Paradise Roasting had no employees. Paradise Roasting sent invoices to HIE indicating it had sold coffee to HIE, and Michael Boulware caused HIE to pay those invoices. During 198906, HIE generally sent Paradise Roasting one check every month. The first four checks were each in the amount of $10,000. The next three checks were each in the amount of $15,000. The last five checks were each in the amount of $20,000. During 199006, HIE generally sent to Paradise Roasting one check in the amount of $20,000 for each of the first 10 months. In total, HIE paid Paradise Roasting $185,000 and $200,000 during 198906 and 199006, respectively. HIE deducted those payments for Federal income tax purposes. Paradise Roasting never sold or delivered any coffee to HIE. Nor did Paradise Roasting ever have a business, ever have any customers, or ever sell any goods (e.g., coffee) or perform any services. Jin Sook Lee used the money that HIE transferred to Paradise Roasting as she pleased, including to pay her living expenses, to travel, and to purchase expensive jewelry for - 62 - herself. When HIE wrote the above-referenced checks to Paradise Roasting, HIE did not reflect those checks as loans on its books. Except by means of the adjusting journal entries (AJEs) discussed infra, HIE did not ever record those payments as loans on its books. D. Video Consultant 1. Overview HIE also paid Jin Sook Lee at least $175,000 during the 2-year period beginning in July 1988 purportedly for work as a video consultant. Jin Sook Lee received those funds through Video Consultant, an entity that was formed as her sole proprietorship. Jin Sook Lee was not a video consultant, and she has never worked as such. Nor did Video Consultant ever have any employees or any customers. Michael Boulware caused that money to be paid to Jin Sook Lee for her living expenses and for her other desires. 2. Formation Michael Boulware helped Jin Sook Lee form Video Consultant as another way to get money to her indirectly and surreptiously. Michael Boulware filled in a form application for a general excise license for Video Consultant, and he had Jin Sook Lee sign the application. Michael Boulware caused Jin Sook Lee to open an account at First Interstate Bank of Hawaii in the name of Jin - 63 - Sook Lee d.b.a. Video Consultant. That account, No. 24-100804, was a market interest investment account, with check writing privileges. 3. Payments From HIE for False Invoices During 198906 and 199006, Video Consultant invoiced HIE for goods or services totaling $84,000 and $91,000, respectively, and Michael Boulware caused HIE to pay Video Consultant the amount of the invoices and to deduct those payments on HIE’s Federal income tax returns. HIE paid those amounts to Video Consultant through 22 checks. During 198906, 12 of those checks were written monthly in the amount of $7,000. During 199006, the first three monthly payments were in the amount of $7,000 and the next seven monthly payments were in the amount of $10,000. All 22 payments were received by Video Consultant and deposited into First Interstate bank account No. 24-100804. Neither Jin Sook Lee nor Video Consultant performed any service for or provided any good to HIE in exchange for any of the 22 payments. Jin Sook Lee spent the money that HIE transferred to Video Consultant as she pleased. When HIE wrote the above-referenced checks to Video Consultant, HIE did not reflect those checks as loans on its books. Except by means of the AJEs discussed infra, HIE did not ever record those payments as loans on its books. Although Michael Boulware knew Jin Sook - 64 - Lee was not performing any service for HIE as Video Consultant, he never told that to Merwyn Manago during the period she was being paid by HIE. It was not until later that Merwyn Manago learned that Video Consultant was related to Jin Sook Lee. E. Michael Boulware’s Divorce From Mal Sun Boulware 1. Discussions Concerning Divorce In 1987, Michael Boulware informed his attorney, Michael McCarthy, a general practitioner who is now deceased, that he wanted to divorce Mal Sun Boulware and to marry Jin Sook Lee.23 Mal Sun Boulware had recently informed Michael Boulware that she knew he was having an affair with Jin Sook Lee and that Jin Sook Lee and Michael Boulware had a child from that relationship. Mal Sun Boulware also informed Michael Boulware that they should divorce and that she desired as a condition of their divorce one- half of the value of HIE, which she estimated had a total value of at least $10 million, plus their house in Honolulu at 382 Puu Ikena Drive, which she believed was worth $1 million. Michael Boulware contemplated that HIE would be the source of any cash that he needed to effect his divorce from Mal Sun Boulware, and 23 Shortly thereafter, Michael Boulware informed Jin Sook Lee that their relationship was over because of actions she had taken against Glenn Lee Boulware. At or about that time, Michael Boulware also agreed with Mal Sun Boulware that he would end his relationship with Jin Sook Lee. Michael Boulware later made up with Jin Sook Lee. - 65 - Mal Sun Boulware was content to postpone their divorce until Michael Boulware had the necessary funds to pay her. Michael Boulware understood from his conversations with Michael McCarthy that Mal Sun Boulware might be entitled to receive less than $5 million as to HIE (i.e., one-half of the $10 million that Mal Sun Boulware believed HIE was then worth) if the value of HIE as shown on its books decreased from the current date to the applicable valuation date for his divorce. 2. Glenn Lee Boulware Trust In 1987, while Michael Boulware and Mal Sun Boulware were discussing the terms of their divorce, Jin Sook Lee became concerned about the welfare and future of herself and Glenn Lee Boulware should Michael Boulware die before that divorce. Jin Sook Lee asked Michael Boulware to transfer one-half of his shares in HIE to her for the future benefit of Glenn Lee Boulware. Michael McCarthy advised Michael Boulware not to put the shares in the name of Jin Sook Lee personally but to transfer the shares to Jin Sook Lee as trustee of a trust that Michael Boulware could establish for the benefit of Glenn Lee Boulware. Michael Boulware understood from his conversations with Michael McCarthy that it was not permissible for him (as an employee, officer, or director of HIE) to give HIE property to Jin Sook Lee to hold for his divorce from Mal Sun Boulware. - 66 - On September 8, 1987, Michael Boulware established the Glenn Lee Boulware Trust as an irrevocable trust with Jin Sook Lee as the sole trustee. Michael Boulware funded the trust with $500 plus 50 percent of his stock in HIE. The principal beneficiary of the trust was Glenn Lee Boulware, who at the sole discretion of Jin Sook Lee, as trustee, could receive distributions of income and/or principal until he was 35 years old; alternatively, until that time, Jin Sook Lee, as trustee, had sole discretion to expend any or all of the principal or income of the trust for the benefit of Glenn Lee Boulware. The trust was stated to terminate when Glenn Lee Boulware became 35 years old, at which time he would receive all of the trust estate. If Glenn Lee Boulware died beforehand, the trust was stated to terminate upon his death at which time all of the trust estate would be distributed to Jin Sook Lee. Under the terms of the trust, Jin Sook Lee, as trustee, was entitled to receive compensation for ordinary services, and Jin Sook Lee, as trustee, was entitled to receive additional compensation for extraordinary services. 3. Divorce Proceeding On May 5, 1994, the Family Court of the First Circuit of Hawaii decreed in the uncontested divorce proceeding of Boulware v. Boulware, FC-D No. 94-1225, that Michael Boulware and Mal Sun - 67 - Boulware were thereafter divorced.24 The court ordered as part of the property settlement that Michael Boulware pay Mal Sun Boulware $3.65 million and transfer to her full ownership of their property in Honolulu at 382 Puu Ikena Drive. The court also ordered Michael Boulware to pay Mal Sun Boulware child support of $1,500 per month, starting April 5, 1994, to maintain sufficient health coverage for his daughter, and to pay for his daughter’s education. The court also ordered Michael Boulware to pay off the approximately $1,350,000 mortgage debt on the property at 382 Puu Ikena Drive, by February 20, 1999. As to the division of property, the court order states: The parties assume and intend that the division of property incident to their divorce shall not itself result in any tax consequences. Each party will take each property interest awarded to him or her at its pre-divorce basis, and that any tax which must be paid upon the subsequent sale or exchange of such interest shall be paid by the party who received and subsequently sold or exchanged such interest. Immediately after his divorce, Michael Boulware informed Jin Sook Lee about the divorce, and he asked Jin Sook Lee to marry him. Jin Sook Lee declined, and she ended their relationship. Michael Boulware and Jin Sook Lee presently speak to each other very little, and they have difficulty dealing with each other. 24 Following their divorce, Michael Boulware and Mal Sun Boulware continue to have a good relationship, and his relationship with their daughter is excellent. - 68 - When Jin Sook Lee testified at the trial of these cases, it was the first time that Michael Boulware had seen her in approximately 18 months. Mal Sun Boulware has yet to receive all of the payments that Michael Boulware owes her incident to their divorce. Mal Sun Boulware lost through gambling most of the money she received from Michael Boulware incident to their divorce. F. Transfers of HIE Assets to Jin Sook Lee 1. Overview From 1987 through 1994, Michael Boulware delivered to Jin Sook Lee a total of at least $6.7 million of assets diverted from HIE. During that time, Michael Boulware also regularly gave Jin Sook Lee at least another $2 million in cash and other assets (e.g., jewelry). Michael Boulware did not contemporaneously record or otherwise keep track of the funds and other assets that he gave to Jin Sook Lee.25 The diverted assets included primarily cash obtained by Michael Boulware mainly by way of checks drawn against HIE’s bank 25 Michael Boulware testified at trial that he kept accurate records of the funds of HIE that he transferred to Jin Sook Lee. We consider that testimony incredible. Michael Boulware at various times has stated the total amount of funds as drastically different amounts. Moreover, at trial, he failed to produce any accurate documentation and admitted that no such documentation existed as of the time he testified at trial. - 69 - accounts and against the off-book bank accounts, and from funds sourced in the off-book activities. The diverted assets also reflected at least four real properties in Honolulu that were purchased with HIE funds and that were put in the name of Jin Sook Lee without any offsetting debt. The four real properties were the Atkinson condominium, a house at 1050 Koloa Street (Koloa house), the Makaiwa house, and the Punahou condominium. Michael Boulware diverted HIE’s assets from HIE to hide the assets from Mal Sun Boulware in connection with their divorce and to accumulate personal wealth for what he hoped to be the benefit of himself, Jin Sook Lee, and their children. Michael Boulware diverted those assets from HIE for his personal use in that he then gave the underlying assets to Jin Sook Lee to use, hold, or spend as she desired, but with his expectation and belief (neither told to her) that she would chose on her own to hold, use, or spend the assets for the common benefit of himself, her, and their children. 2. Atkinson Condominium On September 9, 1987, Jin Sook Lee purchased the Atkinson condominium for $115,000. Jin Sook Lee paid for that purchase with funds that came from Michael Boulware which in turn came from HIE without the knowledge of the independent managers. - 70 - Jin Sook Lee rented the Atkinson condominium out to tenants, she freely spent the money received as rent, and she reported that rent as her taxable income. Michael Boulware never told Jin Sook Lee to save the rent money from the Atkinson condominium for his divorce or that the rent money was his or HIE’s. Michael Boulware never told Jin Sook Lee that she would someday have to transfer the Atkinson condominium to him or to HIE. Michael Boulware never told Jin Sook Lee that the Atkinson condominium would be used (or was otherwise needed) to effect his divorce from Mal Sun Boulware. After the start of the criminal investigation discussed infra, the Atkinson condominium was added to the books of HIE by recording it as an asset of HIE. 3. Makaiwa House On or about March 21, 1989, Jin Sook Lee purchased the Makaiwa house from an unrelated party for $560,000. Jin Sook Lee paid for that purchase with money that came from Michael Boulware which in turn came from HIE without the knowledge of the independent managers. Michael Boulware never told Jin Sook Lee that she would someday have to transfer the Makaiwa house to him or to HIE. Michael Boulware never told Jin Sook Lee that the Makaiwa house would be used (or was otherwise needed) to effect his divorce from Mal Sun Boulware. - 71 - Jin Sook Lee lived (and continues to live) in the Makaiwa house. Jin Sook Lee has never paid any rent to live in the Makaiwa house. After the start of the criminal investigation discussed infra, the Makaiwa house was added to the books of HIE by recording it as an asset of HIE. 4. Koloa House On February 7, 1991, Jin Sook Lee purchased the Koloa house from an unrelated party for $1,150,000, and the property was placed in the name of Jin Sook Lee. Jin Sook Lee paid for that purchase with funds that came from Michael Boulware which in turn came from HIE without the knowledge of the independent managers. Michael Boulware never told Jin Sook Lee that she would someday have to transfer the Koloa house back to him or to HIE. Michael Boulware never told Jin Sook Lee that the Koloa house would be used (or was otherwise needed) to effect his divorce from Mal Sun Boulware. On or about November 24, 1992, in connection with a rift between Michael Boulware and Jin Sook Lee, Michael Boulware forged Jin Sook Lee’s name without her permission to the deed for the Koloa house, caused a notary who was an employee of HIE to attest in writing that Jin Sook had signed the deed personally, and caused that property to be transferred into the name of Michael Boulware. Contemporaneously, Michael Boulware deeded the - 72 - Koloa house to HIE in return for a credit against the amount reflected in his officer loan account. Afterwards, when Jin Sook Lee did not receive the tax bill for the Koloa house as she usually did, Jin Sook Lee learned that Michael Boulware had transferred the Koloa house from her name. Jin Sook Lee was upset and confronted Michael Boulware about the transfer. Michael Boulware promised Jin Sook Lee that he would pay her back for inappropriately taking the Koloa house from her. On July 25, 1993, Michael Boulware agreed in a writing bearing his signature to pay Jin Sook Lee $1.2 million, the amount they agreed was the value of the Koloa house, and to secure his payment of the $1.2 million with a security interest in HIE’s vending machines. The writing states:26 I, Michael H. Boulware, president of Hawaiian Isles Enterpr. Inc. do hereby acknowledge that I owe Jin Sook Lee of 1017 Makaiwa St. the sum of One Million, Two Hundred Thousand Dollars, $1,200,000. For which I agree to pay the sum of Twenty Thousand Dollars, $20,000, for each and every month starting September 1, 1993 up until August 1, 1993 [sic]. On September 1, 1994 a balloon payment of the balance is on demand + payable on this day. The loan will be secured by way of vending machines equal to the balance of Loan even by ways of Auction or any other means. 26 Michael Boulware stated in the writing that he was the president of HIE as a way to further identify himself in his individual capacity. - 73 - Michael Boulware later signed and executed a more formal, but undated, promissory note promising to pay $1.2 million to Jin Sook Lee as follows: $25,000 on September 1, 1993, and on the first day of each of the 12 months thereafter; and on September 1, 1994, any amount remaining due on the note. The note stated that interest accrued on any unpaid amount at the rate of 12 percent per year. The note stated that it was secured by a “Security Agreement and Financing Statement of even date herewith”. 5. Punahou Condominium Jin Sook Lee purchased and initially lived in the Punahou condominium with money that came from Michael Boulware which in turn came from HIE without the knowledge of the independent managers. Subsequently, Jin Sook Lee rented the Punahou condominium out to a tenant, she freely spent the money received as rent, and she reported that rent as her taxable income. Michael Boulware never told Jin Sook Lee to save the rent money from the Punahou condominium for his divorce or that the rent money was his or HIE’s. Michael Boulware never told Jin Sook Lee that she would someday have to transfer the Punahou condominium to him or to HIE. Michael Boulware never told Jin Sook Lee that the Punahou condominium would be used (or was otherwise needed) to effect his divorce from Mal Sun Boulware. - 74 - After the start of the criminal investigation discussed infra, the Punahou condominium was added to the books of HIE by recording it as an asset of HIE. 6. Understanding as to the Transferred Assets Jin Sook Lee understood that the funds that Michael Boulware gave her during their relationship came from Michael Boulware, and not from HIE, and that the funds were hers to spend as she desired. Michael Boulware never told Jin Sook Lee she had to save the money he gave her so that he could use the money for his divorce. Nor did HIE’s board of directors sign any resolution that specifically approved of Michael Boulware’s taking HIE money for him to save for his divorce from Mal Sun Boulware. Jin Sook Lee believed that Michael Boulware was giving her money because she was his girlfriend and the mother of one (and later two) of his children. Jin Sook Lee sometimes demanded money from Michael Boulware; other times, he just gave money to her. On one occasion, in or about December 1992, Michael Boulware asked Jin Sook Lee to lend him $200,000 to use for his divorce from Mal Sun Boulware. Michael Boulware claims that he transferred HIE’s assets to Jin Sook Lee between 1987 and 1994 for her to hold and to save for him so he could accumulate funds to satisfy his property settlement incident to his divorce from Mal Sun Boulware. - 75 - Michael Boulware claims that Jin Sook Lee wanted to hold the money that he was saving for his divorce, that Jin Sook Lee knew the money he was giving her was to be saved for his divorce, and that Jin Sook Lee agreed to give the money back to him upon his request. We find these claims incredible. Michael Boulware never told Jin Sook Lee any reason for giving her money or what she had to do with the money. Jin Sook Lee understood that Michael Boulware gave her the money to use as her own for whatever she desired. 7. Jin Sook Lee’s Use of the Transferred Funds Jin Sook Lee spent the transferred funds as she desired, and Michael Boulware knew that Jin Sook Lee was spending a lot of the funds that he gave her. During their relationship, Michael Boulware provided Jin Sook Lee with an extravagant lifestyle that included her driving a Mercedes, z Porsche, a Rolls Royce, and a BMW (some of which she owned), her owning and wearing expensive designer clothes and jewelry (e.g., a $70,000 diamond), her traveling to foreign countries and to New York City, and her regularly receiving cash from Michael Boulware. Jin Sook Lee charged freely and extravagantly on her credit cards (e.g., charging more than $240,000 from August 24, 1991, through December 15, 1994), and she paid her credit card bills with money that Michael Boulware gave to her. - 76 - Jin Sook Lee used some of the funds that she received from Michael Boulware to purchase certificates of deposit earning over $220,000 in interest in 1992 and 1993. Michael Boulware did not tell Jin Sook Lee that the interest was not hers, and Jin Sook Lee spent that interest on herself and otherwise as she desired. Jin Sook Lee transferred out of the country some of the funds she received from Michael Boulware, including at least $100,000 that she sent to her mother in Korea. After commencing the civil litigation against Michael Boulware and HIE, Jin Sook Lee paid to her attorneys approximately $1 million using some of the funds given to her by Michael Boulware. 8. Michael Boulware Takes Some of the Transferred Funds From Jin Sook Lee Without Her Knowledge Jin Sook Lee kept in a safe at her house (the Punahou condominium) some of the funds given to her by Michael Boulware. The combination to the safe was known by both Jin Sook Lee and Michael Boulware. On one occasion, in or about the fall of 1990, Michael Boulware removed from the safe $840,000 of the approximately $1.5 million that was then there. Jin Sook Lee was upset by that action, and she demanded that Michael Boulware give the money back to her because it was hers. Michael Boulware gave Jin Sook Lee a check drawn on HIE’s corporate bank account in return for the money he removed from the safe. Michael Boulware - 77 - promised Jin Sook Lee that he would not borrow or steal any money from her again. IX. Off-Book Bank Accounts Michael Boulware surreptiously caused the opening of the two off-book bank accounts. In or about October 1990, the first account, No. 03-038866, was opened at Hawaii National Bank in the name of “Hawaiian Isles Distributors, Inc.” In or about October 1991, the second account, checking account No. 01-06586-6, was opened at Central Pacific Bank in the name of “Hawaiian Isles Enterprises, Inc. DBA Hawaiian Isles Distributors”. Activity in the earlier off-book bank account stopped shortly after the later off-book bank account was opened. Activity in the later off-book bank account stopped 2 days after Michael Boulware learned he was under criminal investigation by the CID. The deposits into the off-book bank accounts totaled at least $6,139,567 during 199006 through 199306. The off-book bank accounts were not reported on the books of any of the relevant corporations (including the subject corporations), and those accounts (and the deposits therein and the withdrawals therefrom) were kept secret during the subject years from the independent managers. Michael Boulware told Sidney Boulware about the off-book bank accounts so that Sidney Boulware could oversee those accounts personally and could keep - 78 - the accounts secret from the independent managers. Sidney Boulware kept the deposit slips for the off-book bank accounts in his office. The deposit slips for the subject corporations’ bank accounts which the independent managers knew about were kept outside Sidney Boulware’s office by others. X. Off-Book Activities A. Overview During the relevant years, Michael Boulware engaged in a number of off-book activities and other improper transactions (collectively, off-book activities). The off-book activities were OTC sales of HIE tobacco products, Michael Boulware’s personal sales of HIE coffee to Pele Trading and Hawaii Misuzu, Michael Boulware’s fabrication of work performed for HIE by Bonded Construction, Michael Boulware’s fictitious equipment leasing transactions by HIE, and Michael Boulware’s fictitious international transactions by HIE. Michael Boulware kept the off-book activities secret from the independent managers. Much of the money that Michael Boulware diverted from HIE through the off-book activities was deposited into the off-book bank accounts or into a personal account of Michael Boulware or Jin Sook Lee. Michael Boulware caused Jin Sook Lee to receive at least $3,147,923 of the funds deposited into the off-book bank accounts. When Jin Sook Lee received those funds, and during - 79 - 198906 through 199306, HIE did not record those receipts as loans on its books and records. The $3,147,923 received by Jin Sook Lee was in addition to the payments that Jin Sook Lee received through Paradise Roasting and Video Consultant (i.e., at least $385,000 and $175,000, respectively). Jin Sook Lee also received other amounts from Michael Boulware that he diverted from HIE. Jin Sook Lee used some of the funds referenced in this paragraph to purchase the Punahou condominium, the Atkinson condominium, the Makaiwa house, and the Koloa house. B. OTC Sales of Tobacco Products HIE had a “cash and carry business” where small wholesalers and retailers (mostly mom-and-pop type stores and employees of the subject corporations) came to HIE’s warehouse and bought HIE’s tobacco products over the counter by paying cash or by using checks. The warehouse was separate from the building that housed HIE’s accounting department. The warehouse had a register, an order desk, and a computer to use with respect to HIE’s OTC sales. The register in the warehouse related to the cash and carry business, and the computer in the warehouse was neither connected to HIE’s main computer nor part of HIE’s regular accounting system. Each day, the receipts from the OTC sales were given to Irene Takamiya, a cashier at HIE. Irene Takamiya forwarded those - 80 - receipts to Sidney Boulware, either directly or through Thomas Okimoto, the general manager of Hawaiian Isles Distributors. Sidney Boulware, or sometimes Thomas Okimoto, deposited those receipts into the off-book bank accounts. Sidney Boulware never told the independent managers about the receipts from the OTC sales or that those receipts were deposited into the off-book bank accounts. HIE’s accounting department also did not know that OTC proceeds were deposited into the off-book bank accounts. Unbeknownst to the independent managers, Michael Boulware caused HIE’s OTC sales not to be recorded on HIE’s invoice register, not to be reported in HIE’s books, and not to be reported as income by HIE. The funds deposited into the off-book bank accounts came primarily from the receipts of HIE’s OTC sales. Of the total deposits into those accounts, the funds that Michael Boulware diverted from OTC sales totaled $506,464, $1,337,213, $719,755, and $1,020,293 for 199006 to 199306, respectively, or $3,583,725 in total. When those OTC proceeds were deposited into the off- book bank accounts, the transactions were not recorded as loans on HIE’s books. Nor were the proceeds reflected in the promissory notes related to the officer loans. - 81 - C. Michael Boulware’s Personal Sales of HIE Coffee Unknown at the Time to HIE 1. Overview HIE sold blended coffee to consumers. HIE purchased coffee beans from third parties, and the beans were delivered directly to HIE’s warehouse, where they were stored. When coffee beans were delivered to HIE, an HIE employee checked the shipping document to see that the coffee purchased was in fact delivered. HIE’s accounting department relied on the shipping document and the signature of a designated employee to verify that the coffee beans were delivered. As relevant herein, Robert Kong was the employee designated by HIE to sign the shipping documents verifying that the coffee beans purchased by HIE were delivered. Upon the request of Sidney Boulware, Robert Kong sometimes signed such shipping documents after the coffee was supposedly delivered. The shipping documents did not always list the date on which the coffee was purportedly received, and Robert Kong did not always read the invoices that he signed. When Robert Kong signed shipping documents upon the request of Sidney Boulware, Robert Kong neither read those documents nor checked them for accuracy. Merwyn Manago knew that Michael Boulware was selling coffee beans to companies other than the subject corporations, and - 82 - Michael Boulware led Merwyn Manago to believe that the coffee beans sold by Michael Boulware were not from HIE’s inventory. Unbeknownst to the independent managers, Michael Boulware sold coffee beans that were inventoried by HIE to at least two purchasers and diverted from HIE the proceeds from those sales. The first purchaser, Hawaii Misuzu, was a coffee roasting company that during the relevant years was buying Kona coffee from HIE regularly. The second purchaser, Pele Trading, was an independent company that also bought coffee from HIE. 2. Sales to Hawaii Misuzu Hawaii Misuzu purchased and roasted coffee beans and then sold the roasted coffee to its customers. From 199006 through 199306, Michael Boulware sold HIE’s coffee beans to Hawaii Misuzu and caused HIE to invoice Hawaii Misuzu for those sales. Michael Boulware caused HIE to specify on the invoices that payment be made directly to Michael Boulware, or in some cases directly to Jin Sook Lee, or in still other cases directly to HIE. Hawaii Misuzu paid the invoices by check made payable to the payee specified on the invoice; i.e., Michael Boulware, Jin Sook Lee, or HIE. Of the amount that Hawaii Misuzu paid for HIE’s coffee, at least $1,265,458 was deposited into bank accounts controlled by either Michael Boulware or Jin Sook Lee; the deposits totaled $116,832 for 199006, $382,403 for 199106, $347,866 for 199206, - 83 - and $418,357 for 199306. These payments were not reflected as officer loans at the time of the transactions. Merwyn Manago did not know that Michael Boulware was selling coffee to Hawaii Misuzu and causing Hawaii Misuzu to pay Michael Boulware or Jin Sook Lee directly. Neither HIE nor Michael Boulware reported these payments as income. 3. Sales to Pele Trading In 1989, Pele Trading was an exporter of coffee that was seeking a new supplier of coffee beans. Timothy Inoue was Pele Trading’s vice president who was responsible for purchasing coffee beans for Pele Trading. From 1989 through 1993, Timothy Inoue purchased coffee from Michael Boulware and from Marvin Fukumitsu, an HIE employee, believing that HIE was the seller of the coffee. Timothy Inoue received his purchased coffee in HIE burlap bags, and he received invoices from HIE for the purchases. At the direction of Michael Boulware, Timothy Inoue paid for his coffee purchases with checks that he made payable to Michael Boulware. Those checks totaled at least $1,335,132; by taxable year, the deposits underlying this total aggregated $264,790 for 198906, $1,029,963 for 199006, $21,175 for 199106, and $19,204 for 199206. All but seven of such checks received from Timothy Inoue were deposited into a personal checking account of Michael Boulware, specifically, account No. 05-389054 or account No. - 84 - 49-507151. In one instance, a check in the amount of $73,500 was deposited in 199006 into Jin Sook Lee’s trustee account No. 65-570109. In a second instance, a check in the amount of $65,000 was deposited in 199006 into Jin Sook Lee’s personal account No. 65-570109. On five other instances, a check was cashed in 199006, rather than deposited; those five checks totaled $196,532. Some of the checks were written payable to HIE, but at the direction of Michael Boulware, “HIE” was crossed out by Timothy Inoue and the name of Michael Boulware (or in one case Jin Sook Lee) was written in. The proceeds from the checks rewritten to Michael Boulware ended up in the accounts he controlled. The proceeds from the check rewritten to Jin Sook Lee ended up in her account. At the time of the transactions, Merwyn Manago did not know that Michael Boulware was selling coffee to Pele Trading or that HIE was supplying coffee sold to Pele Trading. The $1,335,132 that Pele Trading paid Michael Boulware was not directly recorded as income on HIE’s books. From 1989 through 1993, the coffee sales to Pele Trading were not booked as loans to Michael Boulware. Michael Boulware did not report these payments as income. - 85 - 4. Referenced Coffee Sold by Michael Boulware Included in HIE’s COGS As to its coffee sales, HIE computes its cost of goods sold (COGS) using a system that takes into account the difference in weight (i.e., shrinkage) between actual coffee bean inventory at the beginning and end of the accounting period. That “shrinkage” is a plug number that reflects the loss in weight from roasting coffee beans and from any other unexplained loss in weight of inventory between the inventory dates. The coffee that Michael Boulware sold to third parties was included in HIE’s COGS as shrinkage. D. Bonded Construction 1. Background Bonded Construction is a general construction company owned and operated by John Yamada. Bonded Construction performed work for both HIE and Michael Boulware. Bonded Construction rented and occupied a warehouse from HIE. 2. Michael Boulware Causes HIE To Pay to Remodel Jin Sook Lee’s Residence In 199006, Bonded Construction completely renovated the Makaiwa house where Jin Sook Lee lived (and continues to live today) and which was then titled in her name. The renovation cost $156,647. Bonded Construction invoiced HIE for part of the work and at the direction of Michael Boulware stated on two of - 86 - the invoices that a total of $50,785 of the [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/4337629. Public record. Not legal advice.