# UNITED STATES TAX COURT > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A5c45f4473c548ff0 ## Record - **Collection:** Agency decision - **Document type:** Agency decision ## Text T.C. Memo. 2006-90 UNITED STATES TAX COURT JERRY AND PATRICIA A. DIXON, ET AL.,1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket Nos. 1 9382-83, 17642-83, 10588-83, 17646-83, Filed May 2, 2006. Cases of the following petitioners have been treated as cases related to the above-captioned case for purposes of the additional evidentiary hearing required to give effect to the mandates of the Court of Appeals for the Ninth Circuit in Dixon v. Commissioner, 316 F.3d 1041, 1047 (9th Cir. 2003), as amended Mar. 18, 2003 (Dixon V), revg. and remanding T.C. Memo. 1999-101 (Dixon III): Robert H. and Barbara A. Gridley, docket Nos. 10588-83, 10931-84, 38757-84; Norman W. and Barbara L. Adair, docket Nos. 17642-83, 38965-84, 35608-86, 479-89, 8070-90; Ronald L. and Mattie L. Alverson, docket No. 17646-83; Russell L. Fleer, Sr. and Sally A. Fleer, docket Nos. 27053-83 and 13477-87; Hoyt W. and Barbara D. Young, docket Nos. 4201-84, 22783-85, 30010-85; Robert L. and Carolyn S. DuFresne, docket Nos. 15907-84, 30979-85; John L. and Terry E. Huber, docket No. 20119-84; Arden L. and Barbara G. Blaylock, docket No. 28723-84; Terry D. and Gloria K. Owens, docket No. 40159-84; Richard and Fiorella Hongsermeier, docket No. 29643-86; Willis F. McComas, II and Marie D. McComas, docket No. 19464-92; Wesley Armand and Sherry Lynn Cacia Baughman, docket No. 621-94; Joe A. and JoAnne Rinaldi, docket No. 7205-94; Norman A. and Irene Cerasoli, docket No. 9532-94; Stanley C. and Sharon A. Titcomb, docket No. 1799295; Richard B. and Donna G. Rogers, docket No. 17993-95. The 27 related cases have been consolidated for briefing and opinion. - 2 27053-83, 10931-84, 20119-84, 38757-84, 40159-84, 30010-85, 29643-86, 13477-87, 8070-90, 621-94, 9532-94, 17993-95. 4201-84, 15907-84, 28723-84, 38965-84, 22783-85, 30979-85, 35608-86, 479-89, 19464-92, 7205-94, 17992-95, In Dixon v. Commissioner, 316 F.3d 1041 (9th Cir. 2003), revg. and remanding T.C. Memo. 1999-101, the Court of Appeals held that the misconduct of R’s trial attorney and his supervisor in the trial of the test cases for the Kersting tax shelter project, in agreeing with counsel for T, one of the test case Ps, to a secret settlement of T’s deficiencies (not disclosed to IRS management, to this Court, or to counsel for other test case Ps), was a fraud on the Court. The Court of Appeals ordered this Court to sanction R by entering judgment in favor of the remaining test case Ps and other Ps in the Kersting tax shelter group before the Court on “terms equivalent to those provided in the [final] settlement agreement with [T] and the IRS”, leaving to this Court’s discretion “the fashioning of such judgments, which to the extent possible and practicable, should put these taxpayers in the same position as provided in the [T] settlement”. R argues that the substance of the T settlement was a 20-percent reduction of T’s 1979-1981 deficiencies, plus the payment of T’s attorney’s fees. Ps argue that the T settlement was, in form and substance, a 62.17-percent reduction of T’s 1979-1981 deficiencies, plus other benefits that bring the T settlement to a 79.92-percent reduction in the deficiencies. The parties agree that the T settlement also included cancellation of all additions and penalties, including nonshelter-related additions and penalties, and the use of a “burnout” to reduce the accrual of interest on the remaining deficiencies. Ps - 3 argue that interest on the deficiencies should not be charged beyond Dec. 31, 1986, which, in their view, marks the inception of the fraud on the court. R has conceded that no interest will be charged on the deficiencies for the period of the appeals to the Ninth Circuit commencing in 1992. Held: The final settlement of T’s 1979-1981 deficiencies amounts to a 62.17-percent reduction of those deficiencies. Held, further: Two minor additional benefits included in the T settlement bring the reduction percentage up to 63.37 percent. Held, further: The T settlement encompasses and requires the vacating of the portion or portions of the deficiencies determined against any Ps that may be attributable to the “Bauspar” shelter that was also promoted by Kersting and to any other issues not arising from shelters promoted by Kersting. Held, further: Interest on the reduced deficiencies shall not be charged beyond the date in 1992 fixed by R’s concession and shall not be stopped as of any earlier date. Henry G. Binder and John A. Irvine, for petitioners in docket Nos. 9382-83, 15907-84, and 30979-85. Joe Alfred Izen, Jr., for petitioners in docket Nos. 17642-83, 4201-84, 38965-84, 40159-84, 22783-85, 30010-85, 35608-86, 479-89, and 8070-90. Robert Alan Jones, for petitioners in docket Nos. 17646-83, 10931-84, 38757-84, 19464-92, 621-94, and 9532-94. Declan J. O’Donnell, for petitioners in docket Nos. 10588-83, 27053-83, 28723-84, and 13477-87. - 4 Michael Louis Minns and Enid M. Williams, for petitioners in docket No. 29643-86. Robert Patrick Sticht and Boris Orlov, for petitioners in docket No. 7205-94. Robert Patrick Sticht, for petitioners in docket Nos. 20119-84, 17992-95, and 17993-95. Henry E. O’Neill and Peter R. Hochman, for respondent. CONTENTS Page FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 11 I. The Kersting Tax Shelters . . . . . . . . . . . . . . . A. Background . . . . . . . . . . . . . . . . . . . . B. Respondent’s Kersting Project . . . . . . . . . . . 1. In General . . . . . . . . . . . . . . . . . . 2. Bauspar . . . . . . . . . . . . . . . . . . . C. Respondent’s Project Settlement Offer . . . . . . 12 12 13 13 14 15 II. The Thompsons’ Participation in the Kersting Tax Shelters . . . . . . . . . . . . . . . . . . . A. The Thompsons’ Tax Returns . . . . . . . . . . . . 1. Prepetition Years--1977 and 1978 . . . . . . . 2. Years Before the Court . . . . . . . . . . . . 1979 . . . . . . . . . . . . . . . . . . . . . 1980 . . . . . . . . . . . . . . . . . . . . . 1981 . . . . . . . . . . . . . . . . . . . . . 3. Years Following Those Before the Court . . . . 1982 . . . . . . . . . . . . . . . . . . . . . 1983 . . . . . . . . . . . . . . . . . . . . . 1984 . . . . . . . . . . . . . . . . . . . . . 1985 . . . . . . . . . . . . . . . . . . . . . B. Examination of the Thompsons’ 1978-1981 Returns . . 16 16 16 16 16 17 17 17 17 18 18 18 19 III. The Test Case Litigation and the Thompson Settlements . A. Selection of the Test Cases . . . . . . . . . . . . 22 22 - 5 B. C. D. E. F. G. H. I. J. IV. Deterioration of the Thompson-Kersting Relationship . . . . . . . . . . . . . . . . . . . The Thompsons Engage DeCastro, Who Settles Their Cases . . . . . . . . . . . . . . . . . . . . IRS Activity Regarding the Thompsons’ 1983-85 Returns . . . . . . . . . . . . . . . . . . The Reporting and Resolution of the Thompsons’ Deficiency Interest Payments for 1986 and 1987 . . The Thompson Settlement Revised as Trial Approaches . . . . . . . . . . . . . . . . . . . . Trial and Entry of Decisions . . . . . . . . . . . Discovery and Disclosure of the Thompson Settlements . . . . . . . . . . . . . . . . . . . . Implementation and Effects of the Final Thompson Settlement . . . . . . . . . . . . . Respondent’s Disciplinary Action Against Sims and McWade . . . . . . . . . . . . . . 23 25 30 33 35 38 42 52 57 Ninth Circuit Remand and Subsequent Proceedings . . . . A. Ninth Circuit Orders in the DuFresne Case . . . . . B. Evidentiary Hearing and Opinions After the Remand in DuFresne . . . . . . . . . . . C. The Ninth Circuit’s Opinion and Mandates in These Cases . . . . . . . . . . . . . . D. Proceedings Following Remand . . . . . . . . . . . E. Further Disciplinary Proceedings . . . . . . . . . 58 58 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 Preliminary Comments . . . . . . . . . . . . . . . . . . . . 70 I. Procedural Issues Following Remand . . . . . . . . . . . A. Procedural Posture . . . . . . . . . . . . . . . . B. Law of the Case . . . . . . . . . . . . . . . . . C. Parties Before the Court . . . . . . . . . . . . . D. Burden of Proof . . . . . . . . . . . . . . . . . . 77 78 79 80 81 II. Defining and Applying the Thompson Settlement . . . . . A. Overview . . . . . . . . . . . . . . . . . . . . . B. Areas of Agreement . . . . . . . . . . . . . . . . C. Starting Point: The Thompsons’ Settlement of Proposed Deficiencies for 1979-1981 . . . . . . 1. Respondent’s Position . . . . . . . . . . . . 2. Petitioners’ Position . . . . . . . . . . . . 3. Analysis . . . . . . . . . . . . . . . . . . . D. Other Benefits Relating to the Thompsons’ 1981 Tax Year . . . . . . . . . . . . . . . . . . . 84 84 86 60 64 67 68 88 88 90 91 99 - 6 1. E. F. G. Elimination of the Thompsons’ Late Filing (Non-Kersting) Addition for 1981 . . . 99 2. Respondent’s Failure To Address the Bauspar Issue in the Thompsons’ Statutory Notice for 1981 . . . . . . . . . . . . . . . 100 Benefits to the Thompsons Relating to Years Other Than 1979-1981 . . . . . . . . . . . . . . . 100 1. In General . . . . . . . . . . . . . . . . . . 100 2. The Thompsons’ Escape From Kersting Liability with Respect to 1982 . . . . . . . . 102 3. The Thompsons’ 1983 Kersting Deficiency and the Disappearing Statutory Notice . . . . 108 4. The Thompsons’ 1983-85 Bauspar Deductions . . . . . . . . . . . . . . . . . 109 5. The Thompsons’ Deduction of Prepaid Interest on Their 1986 and 1987 Returns . . . 111 1986 . . . . . . . . . . . . . . . . . . . . . 111 1987 . . . . . . . . . . . . . . . . . . . . . 115 6. The Thompsons’ Attorney’s Fee Deduction for 1993 . . . . . . . . . . . . . . 117 7. The Thompsons’ Failure To Report Tax Benefit Income for 1993 . . . . . . . . . 119 8. Payment of Witness Fees to Mr. Thompson . . . 122 9. Release of Lien on the Thompsons’ Property and Other Intangible Benefits . . . . 123 The Percentage Reduction Summarized . . . . . . . . 125 Additional Relief . . . . . . . . . . . . . . . . . 126 1. Elimination of Non-Kersting Additions . . . . 126 2. Allowance of Bauspar Deductions . . . . . . . 127 3. Elimination of Non-Kersting Deficiencies . . . 127 4. Attorney’s Fees . . . . . . . . . . . . . . . 128 III. Interest on Deficiencies and Overpayments . . . . . . . 129 - 7 MEMORANDUM FINDINGS OF FACT AND OPINION2 BEGHE, Judge: With this opinion, the Court hopes to provide a template for resolution of the more than 1,3003 remaining cases 2 This opinion is issued pursuant to the mandates of the Court of Appeals for the Ninth Circuit in Dixon V, revg. and remanding Dixon III. Dixon III had supplemented our Memorandum Findings of Fact and Opinion in Dixon v. Commissioner, T.C. Memo. 1991-614 (Dixon II), vacated and remanded per curiam sub nom. DuFresne v. Commissioner, 26 F.3d 105 (9th Cir. 1994). For the record, Dixon I is reported as Dixon v. Commissioner, 90 T.C. 237 (1988), holding that petitioners had failed to establish standing to contest a search of Kersting’s office, thereby sustaining the validity of the deficiency notices generated by the information discovered in that search. Dixon IV, reported as Dixon v. Commissioner, T.C. Memo. 2000-116, provided for awards of attorney’s fees under sec. 6673(a)(2) to petitioners in Dixon III. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. 3 In addition to the more than 1,300 open cases, petitioners in 52 of the more than 500 other dockets in the Kersting project in which stipulated decisions were entered, both before and after discovery and disclosure of the misconduct held by the Court of Appeals in Dixon V to have constituted fraud on the Court, have filed motions for leave to file motions to vacate their decisions. The Court has returned unfiled numerous other such motions because of procedural defects. Petitioners filing or attempting to file such motions have thereby sought to become entitled to the benefits of the Thompson settlement as mandated by the Court of Appeals in Dixon V. Motions for reconsideration have been filed in the three dockets addressed in Lewis v. Commissioner, T.C. Memo. 2005-205, in which we denied petitioners’ motions for leave to file motions to vacate stipulated decisions in Kersting-related cases. - 8 of petitioner participants in the second generation4 of tax shelter programs (the Kersting project) promoted by Henry F.K. Kersting (Kersting).5 During the trial on the merits of the test cases used to try to resolve the vast majority of the pending cases in the Kersting project,6 respondent’s trial counsel Kenneth W. McWade (McWade) (with the knowledge and connivance of 4 In Pike v. Commissioner, 78 T.C. 822 (1982), affd. without published opinion 732 F.2d 164 (9th Cir. 1984), this Court sustained respondent’s disallowance of all deductions for interest, losses, and credits claimed by participants in Kersting’s first-generation programs. 5 For additional information about the Kersting project, see infra Parts I.A. and I.B. Before his death on Mar. 4, 2000, Kersting and the tax shelter programs he promoted were frequently before the courts. In addition to those cases cited supra notes 2, 3, and 4, see also, e.g., United States v. Kersting, 891 F.2d 1407 (9th Cir. 1989) (holding that an IRS summons was enforceable against some Kersting program participants); Richards v. Commissioner, T.C. Memo. 1997-149, Supplemental Opinion T.C. Memo. 1997-299 (upholding Kersting project deficiency notice), affd. without published opinion 165 F.3d 917 (9th Cir. 1998); Gridley v. Commissioner, T.C. Memo. 1997-210 (denying petitioners’ motions for summary judgment to obtain benefit of Thompson settlement); Kersting v. United States, 206 F.3d 817 (9th Cir. 2000) (promoter penalties upheld); Kersting v. Commissioner, T.C. Memo. 1999-197 (sustaining deficiencies against Kersting personally); United States v. Kersting, 77 AFTR 96-1717 (Bankr. D. Haw. 1996) (denying Kersting bankruptcy discharge). 6 In 1986, counsel for the parties in the Kersting-related cases agreed to a test case procedure, under which a few typical cases are selected as test cases, while the petitioners whose cases are not selected as test cases are encouraged to execute a “piggyback” agreement, i.e., a stipulation to be bound by the outcome of the test cases. The majority of petitioners in the Kersting-related cases executed piggyback agreements. See the discussion in Gridley v. Commissioner, supra note 5. - 9 his supervisor, Honolulu District Counsel William A. Sims (Sims)), entered into secret settlements with Luis DeCastro (DeCastro), counsel for test case petitioners John R. and Maydee Thompson (the Thompsons). The financial terms of the final settlement were much more advantageous to the Thompsons than the settlements generally made available to other petitioner participants in the Kersting project.7 The final settlement with the Thompsons was intended to provide refunds of tax and interest paid by the Thompsons under a prior settlement, plus interest thereon, that were to be used--and the bulk of the refunds was used--to pay DeCastro’s fees for providing the appearance of his independent representation of the Thompsons at the trial of the test cases. After this Court upheld respondent’s determinations and entered decisions in favor of respondent in all the test cases, see Dixon v. Commissioner, T.C. Memo. 1991-614 (Dixon II), respondent’s senior management discovered the settlements, moved this Court to vacate the decisions (including the decisions in the Thompsons’ cases) that had not already been appealed to the 7 One nontest case petitioner, Denis Alexander, in exchange for his acting as a witness and serving as an undeclared consultant to McWade during the original trial of the test cases, as described in Dixon III at Findings of Fact V.B. and VI.F., received a settlement even more favorable than that afforded the Thompsons. Although the Court of Appeals in Dixon V noted Alexander’s settlement, the Court of Appeals did not rely on or refer to that settlement in formulating the sanction to be imposed by its mandates. - 10 Court of Appeals for the Ninth Circuit, and requested an evidentiary hearing. After vacating the decisions, the Court denied the motion for evidentiary hearing, entered decisions for the Thompsons in accordance with their final settlement, and reentered or allowed to stand its decisions in the other test cases. The Court thereafter denied motions by test case and nontest case petitioners to intervene in the Thompsons’ cases shortly before the new decisions in those cases became final. In DuFresne v. Commissioner, 26 F.3d 105 (9th Cir. 1994) (hereafter DuFresne), the Court of Appeals for the Ninth Circuit vacated the decisions against the other test case petitioners on the ground that the misconduct of Sims and McWade required further inquiry. The Court of Appeals directed this Court to hold an evidentiary hearing to determine: “whether the extent of misconduct rises to the level of a structural defect voiding the judgment as fundamentally unfair, or whether, despite the government’s misconduct, the judgment can be upheld as harmless error.” Id. at 108. This Court conducted the evidentiary hearing directed by the Court of Appeals and held that the misconduct of the Government attorneys did not create a structural defect but rather resulted in harmless error. 101 (Dixon III). See Dixon v. Commissioner, T.C. Memo. 1999We imposed sanctions against respondent in the form of relief from the accrual of interest on additions to tax - 11 for negligence as well as relief from additional interest under section 6621(d)/(c) (hereafter, section 6621(c)).8 The other test case petitioners again appealed. The Court of Appeals for the Ninth Circuit reversed and remanded our decisions in those test cases in Dixon v. Commissioner, 316 F.3d 1041 (9th Cir. 2003), as amended on March 18, 2003 (Dixon V). The Court of Appeals held that the misconduct of respondent’s counsel constituted a fraud on the court and directed this Court to enter decisions “in favor of Appellants and all other taxpayers properly before this Court on terms equivalent to those provided in the settlement agreement with Thompson and the IRS.” Id. at 1047. In this opinion, we determine the terms of the Thompson settlement and their application to the Kersting project participants before the Court. FINDINGS OF FACT The parties have filed a stipulation of facts for evidentiary hearing on September 20, 2004; a first supplemental stipulation of facts for evidentiary hearing on September 20, 2004; a second supplemental stipulation of facts for evidentiary hearing on November 22, 2004; a third supplemental stipulation of 8 Sec. 6621(d) was redesignated sec. 6621(c) by the Tax Reform Act of 1986 (TRA), Pub. L. 99-514, sec. 1511(c)(1)(A)-(C), 100 Stat. 2744, and repealed by sec. 7721(b) of the Omnibus Budget Reconciliation Act of 1989, Pub. L. 101-239, 103 Stat. 2399. - 12 facts for evidentiary hearing on March 29, 2005; a fourth supplemental stipulation of facts, filed on June 17, 2005, and a stipulation of settled issues, filed on June 22, 2005. stipulated therein are so found. The facts The stipulation of facts and the attached exhibits are incorporated herein by this reference. The parties have further stipulated that, for purposes of the present opinion, the Court may incorporate its findings of fact as stated in earlier proceedings unless such facts are inconsistent with the opinion of the Court of Appeals in Dixon V or are inconsistent with facts stipulated or proven in proceedings held after the issuance of Dixon V. I. The Kersting Tax Shelters A. Background All the cases before the Court concern proposed deficiencies, additions to tax, and interest that related to petitioners’ participation in tax shelter programs promoted by Kersting. All the programs involved both “primary” loans and notes and “leverage” loans and notes with corporations organized by Kersting that have been held to be his alter egos. Kersting v. Commissioner, T.C. Memo. 1999-197. See These notes sometimes bore dates that were long before the date on which the documents were actually executed and even before the date on which the participant informed Kersting he was ready to participate in a particular program. Kersting advised - 13 participants in his programs that the programs created legitimate investments that would entitle participants to interest deductions that they should claim on their individual tax returns. B. Respondent’s Kersting Project 1. In General Kersting’s promotion of his tax shelter programs had attracted the attention of the Internal Revenue Service (IRS), which instituted a tax shelter project known as the Kersting project.9 In furtherance of that project, respondent sent deficiency notices to more than 1,800 taxpayers who had participated in the Kersting programs. The IRS established the Kersting project in its Honolulu Appeals Office. In any given tax shelter project, a project Appeals officer typically works with a project attorney from the District Counsel’s Office. 9 In the Kersting project, McWade, from Tax shelter projects were initiated to deal with the large volume of cases generated by tax shelter examinations during the late 1970s and the early 1980s. Among the responses of the IRS and the Tax Court were the development of procedures, including tax shelter projects, that were intended to streamline the litigation process, economize on the use of administrative and judicial resources, and reduce the costs incurred by taxpayers in resolving disputes over tax shelter adjustments. The IRS, Office of Chief Counsel, created the Tax Shelter Branch in the National Office to oversee tax shelter litigation across the country and to organize individual tax shelter projects. The projects generally focused upon a specific type of tax shelter, such as those promoted by Kersting that constituted the Kersting project. - 14 the Honolulu District Counsel’s Office, served as the project attorney. Once a tax shelter project is assigned to a particular District Counsel’s Office, that District Counsel has the authority to settle any individual case in the project. The District Counsel generally is expected to adhere to the official project settlement offer. Nevertheless, the District Counsel has the authority in special circumstances to settle individual tax shelter project cases on a basis different from the project settlement offer. 2. Bauspar One Kersting program that was not part of respondent’s Kersting project was known as Bauspar. Kersting had promoted the Bauspar program as a combination savings and low interest mortgage plan. While the precise manner in which the Bauspar program operated for each participant remains uncertain, the total amount of home mortgage interest deducted by Bauspar participants appears to have been overstated. Respondent’s officials believed that there were relatively few participants in the Bauspar program, that there was no easy way to identify participants in the Bauspar program from a review of their income tax returns, and that an investigation of Bauspar deduction claimants would not be cost effective. Accordingly, respondent ultimately decided not to systematically pursue - 15 Bauspar participants through the Kersting project. Respondent’s identification of Bauspar participants appears instead to have been a “hit or miss” proposition; although respondent has disallowed some Bauspar deductions claimed by a few Kersting project petitioners, those disallowances have been sporadic. Because the Bauspar program was not included in respondent’s Kersting project, we refer to interest deductions claimed under the Bauspar program as Bauspar deductions rather than Kersting deductions. C. Respondent’s Project Settlement Offer Between 1982 and 1988, respondent had in effect an official settlement offer for the Kersting project. In general, the offer permitted participants in the Kersting programs to resolve their cases by agreeing to pay income tax deficiencies that averaged 7 percent less than those determined in their deficiency notices. The offer also released participants from negligence additions and increased interest. By September 1986, respondent’s counsel had agreed to modify the 7-percent reduction settlement offer to incorporate a new feature, called the “burnout”, that would apply in cases involving more than one taxable year. Under this procedure, the interest on a taxpayer’s total unpaid deficiencies for the first and second years of tax liability would not begin to accrue until the return due date for the second year. The burnout thus - 16 postponed for a year the accrual of interest on the first year’s deficiency, thereby reducing the total interest that accrued on the deficiencies. This was accomplished by zeroing out the taxpayer’s agreed deficiency for the first year and adding it to the agreed deficiency for the second year. II. The Thompsons’ Participation in the Kersting Tax Shelters A. The Thompsons’ Tax Returns 1. Prepetition Years--1977 and 1978 Although the Thompsons participated in one of Kersting’s programs during 1977, they did not claim any Kersting-related interest deductions on their income tax return for that year, because their accountant refused to claim those deductions on the return. The record suggests the Thompsons first claimed Kersting deductions on their 1978 tax return, which was prepared by an accountant recommended by Kersting. 2. Years Before the Court 1979 The Thompsons filed their 1979 tax return, pursuant to an extension, on May 29, 1980. The Thompsons reported Kersting deductions of $39,477 on that return. - 17 1980 The Thompsons received an extension of time to file their 1980 tax return until June 15, 1981. On that return (received by the IRS on June 19, 1981), the Thompsons reported Kersting deductions of $72,840. 1981 The Thompsons late filed their 1981 tax return on July 19, 1982, reporting Kersting deductions of $80,782 as investment interest expense. The Kersting deductions claimed on that return were the principal factor in reducing the Thompsons’ adjusted gross income of $113,711 to taxable income of $18,685--a reduction of $95,026. The Thompsons also reported $8,000 of home mortgage interest expense that was probably attributable to the Bauspar program, in which the Thompsons began participating in April 1981. 3. Years Following Those Before the Court 1982 The Thompsons filed their 1982 tax return on May 6, 1983.10 On that return, the Thompsons reported Kersting (and probably Bauspar) deductions sufficient to reduce their adjusted gross income of $99,364 to taxable income of $4,336--a reduction of 10 By October 1982, Mr. Thompson had retired as a pilot with Continental Airlines. - 18 $95,028. Neither petitioners nor respondent have been able to locate a copy of the Thompsons’ 1982 tax return. The 3-year period of limitations under section 6501 expired with no action by respondent concerning the Thompsons’ 1982 tax return. 1983 The IRS received the Thompsons’ 1983 income tax return on July 2, 1984. The Thompsons reported no tax liability on that return; they also reported Kersting interest expense deductions of $67,620 as well as Bauspar deductions. 1984 Respondent received the Thompsons’ 1984 income tax return in April 1985. On that return, the Thompsons claimed Kersting interest expense deductions from two Kersting programs: “Mahaio” (Mahalo), in the amount of $4,320, and Federated Finance, in the amount of $3,420. The mortgage interest deduction included in the return also included interest paid pursuant to the Bauspar program. The Thompsons paid $2,269 as tax shown on the return to be owing. 1985 On their 1985 income tax return, the Thompsons reported itemized deductions of $37,932 and reported adjusted gross income of $22,507, resulting in zero taxable income. Although the Thompsons did not claim any Kersting deductions on the return, - 19 they overstated their mortgage interest expense as a result of their participation in the Bauspar program. B. Examination of the Thompsons’ 1978-1981 Returns The Thompsons experienced audit problems with their 1978 tax return that were due, in part, to their failure to attach to the return a Form W-2, Wage and Tax Statement, showing the amount of income tax that Continental Airlines had withheld from Mr. Thompson’s wages. In early to mid-1986, the Thompsons’ personal counsel, Samuel M. Huestis (Huestis), negotiated a settlement of their income tax liability for 1978. The record does not disclose the terms of that settlement. On May 5, 1983, the Los Angeles District Director issued a statutory notice of deficiency with respect to the Thompsons’ 1979 taxable year, disallowing Kersting deductions of $39,477 and determining a deficiency in tax of $18,161. The notice of deficiency also determined a negligence addition of $908 under section 6653(a). On July 11, 1983, the Thompsons filed a pro se petition in this Court seeking a redetermination of the deficiency and addition. On June 13, 1984, the Honolulu District Director issued a statutory notice of deficiency with respect to the Thompsons’ 1980 taxable year, disallowing Kersting deductions of $72,840 and determining a deficiency in tax of $24,838. On September 4, - 20 1984, the Thompsons filed a pro se petition in this Court seeking a redetermination of the asserted deficiency. On March 1, 1985, Kersting sent a letter to Kersting program participants stating that he had retained attorney Brian Seery (Seery) to represent them in the Tax Court at no charge to individual petitioners. The letter requested that each Kersting program participant provide written authorization for Seery’s representation.11 Seery’s compensation for legal services rendered to Kersting program participants was always paid by one of Kersting’s alter ego corporations. On March 20, 1985, Seery entered appearances for the Thompsons in their Tax Court cases for their 1979 and 1980 taxable years. He also entered his appearance for hundreds of other taxpayers. On May 31, 1985, the Los Angeles District Director issued a statutory notice of deficiency with respect to the Thompsons’ 1981 taxable year, disallowing claimed Kersting deductions of $80,782 and determining a deficiency in tax of $36,294.52. The notice of deficiency also determined negligence additions against the Thompsons under section 6653(a)(1) and (2), a late filing addition under section 6651(a)(1), and increased interest under section 6621(c). 11 Respondent did not disallow the $8,000 claimed In a letter to program participants dated Aug. 11, 1986, Kersting recommended that program participants not attempt to resolve their cases on their own and instead rely on counsel he had hired. - 21 as home mortgage interest that was probably attributable to the Bauspar program. On August 13, 1985, the Thompsons filed a pro se petition in this Court seeking a redetermination of the asserted deficiency, additions, and increased interest for 1981.12 The Thompsons thus had three of their taxable years before the Court in three docketed cases. Respondent’s determinations of the Thompsons’ Federal income tax deficiencies and additions for their taxable years 1979-1981 were as follows: Additions to tax Sec. Sec. 6653(a) 6653(a)(1) Year Deficiency Sec. 6651(a) 1979 1980 1981 $18,161 24,838 36,295 ----$4,934 $908 ----- ----$1,958 79,294 4,934 908 1,958 Total Sec. 6653(a)(2) ----50% of the interest due on the deficiency --- Respondent also determined that the Thompsons were liable for increased interest for 1981 pursuant to section 6621(c). On November 21, 1985, the Chief Judge of this Court assigned all the Kersting project cases to Judge William A. Goffe (Judge Goffe) for trial or other disposition. Subsequent Kersting project cases were automatically assigned to Judge Goffe. 12 The Thompsons apparently filed their petition for their 1981 taxable year pro se, even after Seery had entered his appearance in the earlier cases. - 22 III. The Test Case Litigation and the Thompson Settlements A. Selection of the Test Cases McWade and Seery planned to use the test case procedure to dispose of the cases of the Kersting program petitioners who wished to contest the deficiencies determined against them by respondent. Most of these petitioners entered into stipulations of settlement for tax shelter adjustments, also called “piggyback agreements”. Respondent and petitioners who entered into piggyback agreements thereby agreed to be bound by the results in the selected test cases. On June 10, 1986, McWade and Seery provided the names of the test case petitioners they had selected to Judge Goffe. Seery and McWade had agreed to the selection of test cases in 14 dockets of seven married couples who had filed joint returns and one individual who had not filed jointly. Among the couples selected to be test case petitioners were the Thompsons, John R. and E. Maria Cravens (the Cravenses), and Richard and Fiorella Hongsermeier (the Hongsermeiers). Seery particularly sought to include the Cravenses as test case petitioners because they treated their payments to Kersting as basis reductions that resulted in capital gain upon the termination of their interests in the programs. The Cravenses - 23 later decided to proceed without counsel and to settle their cases.13 Seery also selected the Hongsermeiers as test case petitioners because he mistakenly believed that they had used their own funds, rather than “nontaxable distributions” from Kersting corporations, to repay loans to other Kersting corporations. The Hongsermeiers’ 1978-1980 taxable years were before the Court; respondent had failed to audit their 1981 and 1982 taxable years. There is no clear indication whether it was Seery or McWade who originally proposed the participation of the Thompsons. As noted, the Thompsons’ 1979-1981 taxable years were before the Court. Respondent had failed to audit their 1982 taxable year. B. Deterioration of the Thompson-Kersting Relationship Around the time Seery and McWade selected the test cases, the relationship between the Thompsons and Kersting deteriorated. Earlier in 1986, the Thompsons’ personal counsel, Huestis, had asked Kersting for an accounting of the Thompsons’ participation in the Kersting programs. Huestis’s request led to a dispute between the Thompsons and Kersting. On June 23, 1986, the Thompsons retained John Chanin, a Honolulu attorney, to help them in their dispute with Kersting. 13 See infra note 23. In a letter dated August 23, - 24 1986, Kersting informed the Thompsons he had turned their file over to his own attorney for collection and further stated: The day after you have allowed your attorneys to file suit I will declare all notes which you have executed to our companies in default and begin collection proceedings. * * * The aggregate sum is well in excess of $250,000.00, as you know. * * * * * * * We will NOT provide legal assistance free of cost to you any longer in US Tax Court proceedings. You will have to retain your own attorney to make an appearance for you on February 9/1987 in US Tax Court. By letter dated August 24, 1986, Kersting notified Seery that he expected to be in litigation with the Thompsons and directed Seery not to “render any services, at our expense” to the Thompsons. On September 10, 1986, Huestis wrote to Seery, notifying him that the Thompsons were seeking substitute counsel and requesting their files. On September 15, 1986, Seery sent the Thompson files to Huestis and informed him that the Thompsons were test case petitioners. Seery indicated that he was withdrawing as the Thompsons’ counsel. On October 28, 1986, Huestis again wrote to Seery to express dissatisfaction with the sufficiency of the Thompsons’ files and to warn Seery that his earlier representation of the Thompsons, while he was also apparently representing Kersting, could be viewed as a conflict of interest and lead to an action for “professional negligence”. On October 31, 1986, Seery filed - 25 motions to withdraw as counsel in the Thompsons’ cases, which the Court granted. In ruling on a subsequent motion, Judge Goffe observed that there could be a conflict of interest if Seery represented both petitioners and Kersting. Seery subsequently filed motions to withdraw as counsel in the Kersting project cases (both test cases and nontest cases), citing concerns about a possible conflict of interest. The Court granted Seery’s motions in November 1986. C. The Thompsons Engage DeCastro, Who Settles Their Cases On or about November 15, 1986, the Thompsons retained attorney Luis DeCastro (DeCastro), who was also a certified public accountant, to settle their Kersting tax issues. Mr. Thompson retained DeCastro to resolve all the Thompsons’ Kersting tax years, not only the 1979-1981 years docketed in the Tax Court. The Thompsons provided DeCastro with tax records for all those years. The retainer agreement between the Thompsons and DeCastro provided for a $5,000 fee, which covered only efforts to negotiate a settlement; it did not cover preparation for and conduct of a trial. None of the other petitioners in the Kersting project, whether test case petitioners or piggybackers, incurred any attorney’s fees in connection with the preparation and trial of the test cases. Kersting paid all such fees. - 26 Meanwhile, in the wake of Seery’s withdrawal, Kersting engaged attorneys Robert J. Chicoine (Chicoine) and Darrell D. Hallett (Hallett) to represent the test case petitioners (other than the Thompsons and the Cravenses) at the Tax Court’s trial session in Maui, Hawaii, which had been scheduled to commence February 9, 1987. Chicoine and Hallett agreed to do so with the understanding that they would not represent Kersting. In late 1986, Chicoine and Hallett apparently indicated to McWade and Sims that they intended to challenge the admissibility of evidence that had been seized in the January 1981 search of Kersting’s office that became the subject of this Court’s opinion in Dixon v. Commissioner, 90 T.C. 237 (1988) (Dixon I). supra note 2. See About the same time, McWade and Sims began to offer 20-percent reduction settlements that were based on the same general approach as their modified 7-percent reduction settlement offer that included the burnout feature. In December 1986, DeCastro traveled to Hawaii on behalf of the Thompsons and a number of other clients who had participated in the Kersting shelters. There DeCastro, accompanied by Gary Poltash (Poltash), the Thompsons’ new accountant, who was not associated with Kersting, began settlement discussions with McWade. Their initial agreement called for a reduction in the Thompsons’ 1979-1981 deficiencies of approximately 18.8 percent. The settlement also provided for the elimination of all additions - 27 to tax and for the elimination of the increased interest rate under section 6621(c) for 1981. The burnout would also apply so as to combine the agreed deficiencies for the years 1979 and 1980 in the year 1980. During this trip, DeCastro and McWade also discussed the Bauspar program in which the Thompsons were involved. On December 23, 1986, McWade signed and sent DeCastro stipulated decision documents in the Thompsons’ cases. The transmittal letter stated that: As previously indicated, the Decision documents in John R. and Maydee Thompson will not be filed with the Court until the Decision becomes final in the test cases. In the interim, the Thompsons can make an advance payment, as discussed at our conference, and stop the accrual of any additional liability for interest. On December 30, 1986, DeCastro signed and returned to McWade the executed decision documents agreeing to the reduced deficiencies. Neither McWade nor Sims communicated the terms or existence of the Thompsons’ settlement to their superiors. The result of the pending settlement upon the Thompsons’ tax liabilities would have been as follows: Determined Deficiency Proposed Settlement Percentage Reduction 1979 $39,477 1980 72,840 Total $18,161 24,838 42,999 --$34,425 34,425 20 1981 80,782 All years total 36,295 79,294 30,000 64,425 17 18.8 Year Income Adjustment - 28 - DeCastro, Poltash, and McWade had also agreed that the Thompsons would be able to deduct the interest payable on the deficiencies agreed to under the settlement by prepaying such interest by December 31, 1986.14 As of December 31, 1986, the accrued interest on the Thompsons’ newly settled deficiencies was $35,275.81 for 1980, and $24,270.62 for 1981--a total of $59,546.43, which the parties rounded to $59,545. Accordingly, the decision documents returned to McWade by DeCastro stated: “By separate cover you will also be receiving a check in the amount of $59,545 representing interest on the tax deficiencies reflected in the decision documents.” With a letter dated December 30, 1986, Mr. Thompson sent McWade two checks: check No. 54 for $34,000, and check No. 242 for $25,545, for a total of $59,545. Mr. Thompson’s letter stated: “I am at the present time doing the necessary procedures to take care of the balance.” At McWade’s direction, IRS personnel in Honolulu prepared payment posting vouchers (Form 3244) allocating the Thompsons’ prepayment of $59,545 between the 2 years before the Court, 14 The Internal Revenue Code was amended in 1986 to add a new sec. 163(h) that repealed the deduction for “personal interest”. See TRA sec. 511(b), 100 Stat. 2246. Under the new sec. 163(h), 1986 was the last taxable year in which taxpayers could deduct 100 percent of such personal interest. TRA sec. 511(e), 100 Stat. 2249. For 1987, only 65 percent of personal interest was deductible, and the deduction for personal interest was phased out entirely by the end of 1989. Sec. 163(h)(6). - 29 indicating designated interest for 1980 in the amount of $35,275.78 and designated interest in the amount of $24,269.22 for 1981. The entire amount of check No. 242 ($25,545) and $9,730.78 from check No. 54 was applied to 1980; the remainder of check No. 54 ($24,269.22) was applied to 1981. The Thompsons’ $34,000 check (check No. 54) was subsequently dishonored. This was reflected as a debit for the Thompsons’ accounts for 1980 and 1981. In February 1987, the Thompsons made a replacement payment of $34,340, representing the amount of the dishonored check plus a 1-percent bad check penalty. The replacement payment was restored as a credit as of December 31, 1986. The Thompsons were the only test case petitioners for whom the IRS processed a prepayment of interest without receiving a concurrent “advance payment on deficiency” to which the interest was attributable. In January 1987, Chicoine and Hallett filed motions in this Court seeking to suppress the evidence that had been seized in the raids on Kersting’s office and to shift to respondent the burden of proof and burden of going forward with evidence. The Chicoine and Hallett motions in effect turned the February 1987 Maui trial session into a hearing on the motions and resulted in a continuation of the trial of the test cases. On March 13, 1987, McWade sent DeCastro a revised decision document for the Thompsons’ 1980 taxable year, making a minor - 30 change that reduced the deficiency for that year from $34,425 to $33,000. McWade later explained: miscomputed something.” “It must have been I With this modification of the settlement, the Thompsons’ aggregate deficiencies for 1979-1981 were reduced by 20.55 percent of the deficiencies originally determined by respondent (i.e., from $79,294 to $63,000). On June 15, 1987, DeCastro sent a $63,000 cashier’s check “in partial payment of the total amount due” to the Internal Revenue Service Center in Fresno on behalf of the Thompsons. Respondent received the payment of $63,000 on June 17, 1987, and credited it to the Thompsons’ 1979 account as an advance payment, less offset of a credit of $775 that was applied to their 1988 tax year. Accordingly, by June 1987, the Thompsons’ payments to the IRS with respect to the taxable years 1979-1981 totaled $121,770 ($62,225 as an advance payment of tax, and $59,545 as interest). D. IRS Activity Regarding the Thompsons’ 1983-85 Returns In the meantime, an employee of respondent at the Fresno Service Center in California (with initials A.A.K.) prepared a statutory notice of deficiency (subsequently dated March 17, 1987) disallowing $67,620 of Kersting deductions claimed on the Thompsons’ 1983 income tax return. Because the Thompsons had little taxable income that year, the first whole year of Mr. - 31 Thompson’s retirement, the deficiency resulting from this disallowance was only $980. There is some indication that the notice of deficiency was mailed and that it caused an inquiry. An internal document of the IRS (Form 4700) reflects a handwritten entry dated May 8, 1987: determination – refiling case.” “No reason to change Nevertheless, no petition for the Thompsons’ 1983 taxable year was filed in this Court, and the deficiency was never assessed or collected. On October 6, 1987, Revenue Agent Carolyn Speers (Speers), based in San Jose, California, audited the Thompsons’ 1984 income tax return and noted $7,740 of Kersting deductions claimed on the return. On that date, she wrote the Thompsons a letter proposing to dispose of the Kersting issue identified on the return consistent with respondent’s general 7-percent reduction settlement proposal. In her letter, Speers also requested additional information regarding the Thompsons’ participation in the Kersting tax shelter programs, including a request for a copy of the Thompsons’ 1985 income tax return. Speers did not receive a response from the Thompsons to her October 6, 1987 letter nor to a followup letter dated November 17, 1987. On November 27, 1987, Mr. Thompson called Speers to report that he had forwarded her request to DeCastro. On December 23, 1987, DeCastro sent Speers an executed copy of the 7-percent reduction settlement agreement for 1984, along - 32 with a power of attorney executed by the Thompsons for the taxable years 1984 and 1985, and a Form 872-A, Special Consent to Extend the Time to Assess Tax. Because DeCastro did not include the requested additional information or a copy of the Thompsons’ 1985 return, Speers declined to proceed on the basis of the 7percent reduction settlement. Instead, by letter to DeCastro dated January 12, 1988, Speers proposed to dispose of the Thompsons’ 1984 year by disallowing the claimed Kersting interest expense deductions in their entirety. She again requested a copy of the Thompsons’ 1985 return “to verify that interest from Kersting was not deducted in this year.” Beginning October 6, 1987, and continuing through February 24, 1988, Speers documented (in her case history worksheet) telephone or written contact in the course of her examination of the Thompsons’ 1984 income tax return with the Thompsons, DeCastro, Philip Hoskins (of DeCastro’s firm), and an accountant named “Rick.” Speers’s case history worksheet reflects no contacts with McWade, Sims, or any other of respondent’s counsel. By letter dated February 22, 1988, DeCastro agreed to a complete disallowance of the $7,740 of Kersting deductions claimed by the Thompsons for 1984 and the resulting deficiency of $1,863. The Thompsons paid the deficiency and interest; by - 33 virtue of this disposition of the matter, respondent issued no notice of deficiency to the Thompsons for 1984. On March 4, 1988, DeCastro sent Speers a copy of the Thompsons’ 1985 income tax return. As noted above, the Thompsons’ 1985 income tax return did not reflect any Kersting deductions (although it did include Bauspar deductions). In a letter dated March 25, 1988, Speers notified the Thompsons that she “was able to verify that interest from the Kersting project was not deducted” on that return. Respondent issued no notice of deficiency to the Thompsons for 1985. E. The Reporting and Resolution of the Thompsons’ Deficiency Interest Payments for 1986 and 1987 The Thompsons claimed their $59,545 interest payments to the IRS as an itemized interest deduction on Schedule A - Itemized Deductions of their 1986 income tax return. However, because their adjusted gross income for that year was relatively low, the Thompsons were able to use only $16,251 of the $59,545 deduction. The Thompsons did not claim any Kersting or Bauspar deductions on their 1986 return. Poltash prepared the Thompsons’ 1987 income tax return. On that return, the Thompsons deducted $27,914 as interest paid to the IRS. That figure represents 65 percent of $42,945. supra note 14. See Apparently, the Thompsons were attempting to carry over the unused portion of the interest deduction of - 34 $59,545 from their 1986 taxable year.15 The Thompsons did not claim any Kersting or Bauspar deductions on their 1987 return. Poltash did not discuss the preparation of the Thompsons’ 1986 or 1987 returns with McWade or Sims. Revenue Agent Speers examined the Thompsons’ 1986 income tax return. She asked about the $59,545 interest deduction in letters to the Thompsons dated February 26 and March 25, 1988. In a telephone conversation with Speers on May 23, 1988, Mr. Thompson explained the $59,545 interest expense deduction to her satisfaction. Speers closed the examination of the Thompsons’ 1986 return without making any adjustments to the return. Her examination workpapers reflect her notation that “TP paid large interest to IRS on Schedule A--verified per transcripts.” In June 1989 a revenue agent16 screened the Thompsons’ 1987 income tax return for Kersting deductions. The return bears a stamp stating “Income Tax Survey After Assignment”, meaning that the agent saw nothing obvious for examination and returned the 15 Although Poltash claimed to lack any recollection of his attempt to claim the interest deduction, he conceded the $42,945 amount might have represented an attempt to claim for 1987 the portion of the $59,545 claimed on the 1986 return that produced no tax benefit to the Thompsons. We note a slight discrepancy between the amount of the deduction actually used on the Thompsons’ 1986 return ($16,251) and the figure underlying the $42,945 “carryover” for 1987 ($59,545 - $42,945 = $16,600). 16 The signature of the examining agent is difficult to decipher; it appears to be “Art (or Pat) Taylor.” - 35 1987 return to files without examining it or transmitting it for examination. F. The Thompson Settlement Revised as Trial Approaches Although Chicoine and Hallett ultimately recommended that their test case clients accept respondent’s 20-percent settlement offer, Kersting disagreed and replaced Chicoine and Hallett with attorney Joe Alfred Izen, Jr. (Izen) in April 1988. Counsel on both sides began to prepare for trial, which was scheduled for January 1989 in Honolulu, Hawaii. In an order dated August 30, 1988, the Court granted McWade’s motion to depose Kersting. In October 1988, while in Honolulu for the Kersting deposition, DeCastro met McWade to discuss the Thompson cases. DeCastro told McWade he wanted to withdraw the Thompsons from the test case trial. DeCastro’s reason for withdrawing the Thompsons was to avoid their having to pay the fees and expenses of the trial and to enable them to take the settlement they had already agreed to. McWade wanted to keep Mr. Thompson as a party to the trial because he was a test case petitioner who was represented by an attorney, DeCastro, who had not been hired and paid by Kersting. From respondent’s standpoint, there was also a benefit to having, as a party witness, a participant in the Kersting program who was feuding with Kersting and could be expected to testify against him. - 36 Recalling the withdrawal of Seery, Sims was concerned by the potential conflict of interest from Kersting’s paying the fees of the attorney representing the test case petitioners. Accordingly, he wanted to keep DeCastro in the trial of the test cases as an independent attorney, paid by the taxpayer, to provide an apparent safeguard against the trial appearing to be slanted toward protecting the promoter’s (as opposed to petitioners’) interest. McWade and DeCastro also apparently discussed the status of an outstanding Federal tax lien on the Thompsons’ house (unrelated to their participation in Kersting shelters), which the IRS had yet to remove more than a year after the Thompsons had satisfied the underlying liability.17 On November 22, 1988, respondent issued a certificate of release with respect to the Federal tax lien on the Thompsons’ house. Shortly before trial of the test cases in this Court in January 1989, McWade and DeCastro reached an oral agreement (the new agreement) calling for reduced amounts of agreed deficiencies for 1979-1981 of zero, $15,000, and $15,000, respectively. The purpose of the reductions was to compensate the Thompsons for the cost of having an attorney represent them at the trial of the 17 Under sec. 6325(a)(1), the IRS was required to release the lien not later than Oct. 7, 1987, 30 days after the liability had been satisfied. - 37 test cases. DeCastro estimated that his legal fees for representing the Thompsons at the trial of the test cases would be approximately $60,000.18 It was estimated that the newly agreed reductions would generate approximately $60,000 of refunds to the Thompsons from the $121,770 they had paid earlier toward satisfaction of the deficiencies and interest under the earlier settlement. The new agreement also preserved the Thompsons’ chances to prevail on the merits of the litigation. McWade and DeCastro agreed that if the results of the trial were more favorable to the Thompsons than the new agreement, the Thompsons would be entitled to the results of the trial. When the new agreement was reached, respondent’s official settlement policy still provided for a 7-percent reduction in determined deficiencies, elimination of the negligence penalty, and other minor concessions, although, as the time for trial approached, some nontest case petitioners’ attorneys continued to negotiate 20-percent reduction settlements. 18 The new agreement, As petitioners point out, DeCastro was somewhat inconsistent in his recollection of his proposed billing. On June 2, 1992, he initially denied that the new agreement was designed as a mechanism for respondent to pay his fees, but he admitted to the contrary 8 days later. On Aug. 11, 1992, DeCastro recalled estimating that it would cost a minimum of $30,000 to try the Thompsons’ case. After being shown documents indicating he had billed the Thompsons for more than $30,000, DeCastro said he had told McWade that his fees would be roughly $65,000. As respondent points out, DeCastro’s bills to the Thompsons, as of Nov. 29, 1989, totaled $58,738.20. - 38 however, reduced the Thompsons’ deficiencies for the years at issue from the originally determined $79,294 to $30,000--a reduction of 62.17 percent. The new agreement substantially deviated from respondent’s official settlement policy and from the 20-percent reduction settlements obtained by DeCastro and Chicoine and Hallett and other attorneys on behalf of other clients. agreement. None of Sims’s or McWade’s superiors approved the new To the contrary, Sims’s and McWade’s superiors did not discover the new agreement until after this Court had tried the test cases, issued its opinion, and entered its initial decisions therein. G. Trial and Entry of Decisions The trial of the test cases was conducted before Judge Goffe from January 9 through January 27, 1989, at Honolulu, Hawaii. Neither Sims, McWade, nor DeCastro informed Judge Goffe, the National Office, the Regional Office, or Izen of the Thompson settlement or the Cravens settlement before or during the January 1989 trial of the test cases, or thereafter. The Government paid the travel, food, and lodging expenses of Mr. Cravens and Mr. Thompson while they were in Hawaii. Thompson’s reimbursed expenses amounted to $1,105.13. in Dixon III, n.53: Mr. We stated “Inasmuch as respondent subpoenaed all the test case petitioners, it is assumed they were all reimbursed for their expenses.” Although there is no evidence in the record - 39 that any other test case petitioner, other than Mr. Cravens and Mr. Thompson, was reimbursed by the Government for the expenses of attending the test case trial, neither is there any record evidence that any or all of the other test case petitioners who requested reimbursement of their trial attendance expenses had their requests denied, or indeed that requests for reimbursement were made by any such petitioners. Around the time of the 1989 trial, DeCastro asked McWade to arrange for the Thompsons to receive a refund of $30,000 of their advance payments. In a memorandum dated April 10, 1989, McWade requested respondent’s administrative officials to process a $30,000 refund to the Thompsons. On July 11, 1989, the Government issued a refund check of $30,000 to the Thompsons. The Thompsons endorsed the check to DeCastro Law Corp. without depositing it in their own checking account. The Thompsons did not claim a deduction on their 1989 return for the $30,000 they paid DeCastro. On August 3, 1989, DeCastro wrote a letter to McWade confirming the revision of the Thompson settlement that had been agreed to before the trial of the test cases. states in pertinent part as follows: DeCastro’s letter - 40 Re: Jack and Maydee Thompson Dear Ken: Please confirm following is our agreement with respect to settlement of above taxpayer’s cases for open years: We have agreed that the total taxes due for all the open years are $15,000 for 1980 and $15,000 for 1981. Further, in the event a final decision in this case is more favorable they are to receive the benefit of such decision. Please sign below so I can have for my files. McWade signed the letter and returned it to DeCastro. On August 24, 1989, DeCastro wrote McWade requesting him to arrange for the Thompsons to receive the balance of their refund. McWade replied that the balance would not be released until the Tax Court had issued its opinion, and DeCastro so informed the Thompsons. DeCastro told the Thompsons that, because the IRS would be paying interest, he believed it was fair to add interest to the Thompsons’ bill. On or about November 6, 1989, McWade received an undated letter from Mr. Thompson, which stated in pertinent part as follows: Dear McWade: There are some questions in mind that I feel you can help me answer. * * * * * * * - 41 I received a check from IRS in the amount of thirty thousand dollars--($30,000). I endorsed this over to DeCastro Law Corp; this did not retire the billed amount. I am completely amazed at the billings we are receiving. I am now in receipt of additional billings that exceed realistic amounts. In fact the total comes to sixty six thousand two hundred forty three and 66/100 dollars ($66,243.66). At some point I know a reconciliation will come. Luis [DeCastro] says don’t be concerned. I am very concerned, I am the one being billed. * * * * * * * Most emphatically I did not expect to be a channel through which IRS funneled funds to any law firm. Certainly not in this magnitude. I have the feeling at this point that I am correct in this--the bill is to [sic] much. I want to know the exact legal position I occupy. We have been frustrated long enough. We wish to close this chapter. DeCastro wrote to Huestis on November 17, 1989, stating, in pertinent part: Thank you for your letter regarding the matter of the Thompsons’ fees. As I have told Jack, we are looking for payment of his fees to the IRS, not him. I am enclosing a copy of my letter to him in this regard for your information. DeCastro sent a similar letter to the Thompsons on the same date. On December 11, 1991, the Court issued its opinion in Dixon v. Commissioner, T.C. Memo. 1991-614 (Dixon II), sustaining almost all of respondent’s determinations that the Kersting programs at issue lacked merit for tax purposes. - 42 On March 13, 1992, the Court entered decisions against petitioners in the test cases in accordance with its opinion. On May 14, 1992, the test case petitioners--other than test case petitioner Ralph J. Rina (Rina) and the Thompsons and the Cravenses--appealed the decisions in their cases to the Court of Appeals for the Ninth Circuit. H. Discovery and Disclosure of the Thompson Settlements On May 8, 1992, Sims and McWade, by memorandum, requested the San Francisco Appeals Office to process the Thompsons’ account administratively in accordance with the Thompson settlement, not the Tax Court’s decisions. On May 22, 1992, Danny Cantalupo, Regional Director of Appeals for the Western Region, informed Peter D. Bakutes (Bakutes), Deputy Regional Counsel for Tax Litigation for the Western Region in San Francisco, of Sims’s and McWade’s request to process the Thompson settlement. Bakutes informed Benjamin Sanchez (Sanchez), the Western Regional Counsel in San Francisco, who informed officials in the National Office of the Office of Chief Counsel in Washington, D.C. The circumstances surrounding the Thompson settlement became a matter of widespread concern within the IRS. On May 29, 1992, Sims, at the direction of Sanchez, informed DeCastro by letter that the Thompson settlement would not be honored, and that assessments would be made in accordance with - 43 the decisions entered on March 13, 1993, pursuant to Dixon II. The letter advised that assessment of the taxes owing, plus statutory additions and interest, would be “approximately $302,396.12.” The letter further noted: “Of course, your clients’ advance payments will be credited toward the assessments.” DeCastro had several telephone conversations with respondent’s officials, in which he maintained that the Thompson settlement, as memorialized in the August 3, 1989 letter agreement, was an enforceable contract, and that he was prepared to appeal any decision to the contrary. Bakutes prepared a motion that was filed in this Court on June 9, 1992, seeking leave to vacate the decisions entered in the Thompson cases, as well as the Cravens and the Rina cases. Respondent requested the Court to conduct an evidentiary hearing to determine whether the agreements with the Cravenses and the Thompsons had affected the trial of the test cases or the ensuing decisions of the Court. On June 10, 1992, Judge Goffe granted respondent’s motions to vacate filed in the Thompson and the Cravens cases. That same day, Bakutes called DeCastro to tell him that the decisions in the Thompson cases had been vacated. During this call, DeCastro told Bakutes that in 1988 McWade had reduced the Thompsons’ deficiencies to keep the Thompsons in the case. Although he had - 44 earlier told Bakutes that attorney’s fees were not awarded in the settlement, DeCastro admitted in this conversation that the deficiencies were reduced to pay the Thompsons’ legal fees for his representation of them in the test case trial. On or about June 11, 1992, Sanchez decided that Sims and McWade should no longer have any authority over the Kersting cases and that the cases should be assigned to other attorneys who had been involved in the Kersting project. Bakutes accordingly reassigned the 14 test case dockets to Thomas A. Dombrowski (Dombrowski) and the nontest cases to Henry E. O’Neill (O’Neill). On June 22, 1992, Judge Goffe denied respondent’s request for an evidentiary hearing and ordered the parties to file agreed decisions with the Court, “or otherwise move within 30 days of the date hereof.” In a separate order filed on the same date, the Court denied respondent’s motion to vacate the decision filed in Rina’s case, stating: The Court has reviewed the testimony of Cravens, the testimony of Thompson, the stipulated facts and stipulated exhibits relating to the Cravenses and the Thompsons, and the exhibits offered through Thompson as a witness. The Court finds that these reviewed items had no material effect on the opinion which the Court filed on December 11, 1991, as that opinion relates to petitioner Rina. If the reviewed items were stricken from the record, the Court would file an opinion in all material respects like the opinion it filed on December 11, 1991 (with the exception of certain portions - 45 relating specifically and expressly to the Cravenses or the Thompsons), and the Court’s findings, analyses, and conclusions relating to petitioner Rina would remain the same. * * *[19] During the summer of 1992, respondent’s Acting Chief Counsel David Jordan (Jordan) directed two senior attorneys in the Tax Litigation Division in the National Office, Thomas J. Kane (Kane) and Steven M. Miller (Miller), to investigate the Thompson settlement on behalf of the National Office. Kane and Miller conducted in-house depositions and interviewed various individuals who had participated in the test case trial and the Thompson settlement. Bakutes assigned Dombrowski to help Kane and Miller in their investigation. Dombrowski’s immediate problem was how to respond to this Court’s order of June 22, 1992, that the parties file agreed decisions with the Court or otherwise move within 30 days. Dombrowski learned that McWade and Sims had denied that the purpose of the new agreement to reduce the Thompsons’ deficiencies was to pay DeCastro’s fees; instead, they claimed, the lowered deficiencies had something to do with the Thompsons’ 19 Rina appealed from this denial. Unlike the Thompsons, Rina had no settlement agreement with Sims and McWade. On June 13, 1995, Rina agreed to the entry of a stipulated decision in the amounts originally determined in his statutory notice of deficiency. - 46 investment in Bauspar.20 To see whether Bauspar figured in the Thompson settlement, Dombrowski sought the Thompsons’ post-1981 tax returns. By July 13, 1992, he had received the Thompsons’ 1983-89 returns and a memo that the Thompsons’ 1982 tax return and administrative file had been destroyed. Dombrowski analyzed the returns to see if they shed light on the Bauspar question raised by McWade’s and Sims’s contentions. Although the 1982 tax return was not available, Dombrowski believed it likely that Kersting deductions had been claimed on that return because of the disparity between adjusted gross income and taxable income, and because Kersting deductions were claimed on the Thompsons’ 1983 and 1984 returns. Dombrowski’s “Analysis of Subsequent Year Returns” noted the mortgage interest deductions claimed on the Thompsons’ 1983-85 returns and further noted “(Bauspar?).” He also noted that entries that may have reflected the Bauspar deductions had not been audited. Dombrowski’s reason for putting a question mark after Bauspar was that he could not tell from the entries on the returns whether they actually related to Bauspar. 20 In a memorandum dated Sept. 11, 1992, Kane had written: “Sims claimed that McWade had initiated the recommendation to allow Bauspar losses so that both Thompson and DeCastro would remain in the case. * * * Thus, Sims told McWade to work with the Bauspar numbers in order to give Thompson relief and keep him as a test case.” (Fn. ref. omitted.) Additionally, in 1992, McWade testified that he reduced the Thompsons’ deficiencies on his own to make up for the Thompsons’ $80,000 “loss” in the Bauspar program. We found this testimony not credible. - 47 Dombrowski also noted that the Thompsons appeared to have defaulted on a statutory notice issued to the Thompsons for 1983 disallowing claimed Kersting deductions of $67,620, but that the IRS had failed to assess the resulting deficiency of $980. Dombrowski also noted the May 8, 1987, entry in the Thompsons’ file for 1983 that stated: refiling case.” “No reason to change determination – Dombrowski believed this entry indicated that someone contacted the Fresno Service Center after receiving and questioning the notice of deficiency for 1983. Because the 3- year period of limitations with respect to the returns he was examining had expired several years earlier, Dombrowski did not attempt to determine why the assessment for 1983 had not been made. He instead focused on preparing a timely response to the Court’s June 22, 1992, order in the Thompsons’ cases. On June 24, 1992, Marlene Gross (Gross), an official in the National Office of Chief Counsel, called Bakutes and informed him that, despite the disclosure of Sims’s and McWade’s misconduct, the Department of Justice (DOJ) would not seek to remand the test cases that had been appealed. The DOJ’s decision was based on the Tax Court’s refusal to vacate the decision in the Rina case. That refusal indicated to the DOJ officials that the Tax Court probably would not vacate its decisions in the other test cases if asked to do so. Gross also reported to Bakutes that the DOJ, and specifically, the Tax Division, Appellate Section Chief Gary - 48 Allen, wished to offer the same settlement to the test case petitioners on appeal that the Thompsons had received: A 65- percent reduction in deficiencies (an approximation of the reduction of the Thompsons’ originally determined deficiencies from $79,294 to the $30,000 figure finally agreed upon). Bakutes was opposed to settling the appealed cases on that basis. There is no evidence that the DOJ made any such settlement offer to the test case petitioners on appeal. On July 16, 1992, DeCastro filed a motion for entry of decision in the Thompsons’ cases, on the terms of his settlement agreement with McWade; i.e., deficiencies of zero, $15,000, and $15,000 for 1979-1981, respectively. On August 20, 1992, respondent filed objections to DeCastro’s motion for entry of decision, together with respondent’s own motion for entry of decision. Respondent’s motion sought a decision that reflected the original 18.8-percent reduction settlement agreed to by McWade and DeCastro in December 1986.21 21 Respondent’s motion stated that the December 1986 agreement between DeCastro, Sims, and McWade to reduce the Thompsons’ deficiencies by 18.8 percent exceeded the terms of the standard 7-percent reduction settlement offer. Nevertheless, respondent conceded: “Respondent’s counsel possessed the authority to make such an offer, and such offer was accepted by petitioners herein as well as others.” Respondent also noted the “approximately 20 percent” reduction settlement offers previously made to other participants. Respondent’s motion further (continued...) - 49 Respondent’s 11-page motion for entry of decision, with a 15-page supporting memorandum, disclosed to the Court the facts that had been discovered in respondent’s investigation. Respondent informed the Court that, before the test case trial, Sims and McWade had agreed to settle the Thompson cases by reducing the Thompsons’ deficiencies in amounts sufficient to compensate the Thompsons for their projected attorney’s fees. As respondent explained to the Court, Sims and McWade had agreed with DeCastro that All settlement refunds in excess of the amounts provided by the December 1986 agreement would go ultimately to the benefit of Mr. DeCastro for payment of his legal fees and costs. Mr. DeCastro would be paid solely from amounts refunded by the Service to Thompson. * * * This “New Agreement”, in sum and substance, if not explicitly, was designed, and constituted an agreement by Messrs. Sims and McWade to pay Mr. DeCastro’s legal fees and expenses.22 21 (...continued) indicates that Chicoine and Hallet’s motion to suppress evidence was pending when McWade offered the 20-percent reduction settlement to DeCastro in December 1986. Although McWade may have known of Chicoine and Hallet’s intent to file such a motion, the motion, in the form of a motion for leave to amend petition, was not filed until Jan. 12, 1987, after Chicoine and Hallett had entered their appearances. Any error in this regard, however, is immaterial, in view of our disposition of this matter. 22 On brief, petitioners question the assertions in respondent’s motion that all settlement refunds “in excess of the amounts provided in the December 1986 agreement” would go to DeCastro. This assertion, however, appears to have reflected respondent’s understanding at the time. Once again, in view of our disposition of this matter, any error in this respect is irrelevant. - 50 Respondent asserted that the new agreement was unauthorized and had no legal basis. If respondent’s motion had been granted, the Thompsons’ deficiencies would have been zero for taxable year 1979, $34,425 for 1980, and $30,000 for 1981. On August 26, 1992, this Court granted DeCastro’s motions for entry of decision in the Thompson cases, thus holding respondent to the pretrial concessions made by Sims and McWade in the new agreement: Year Deficiency Additions to Tax 1979 1980 1981 --$15,000 15,000 ------- The Tax Court’s decision for 1981 also relieved the Thompsons of the non-Kersting late filing addition of $4,934.32 under section 6651(a). That addition was the only non-Kersting issue in the Thompsons’ docketed cases. Respondent did not appeal the decisions entered by the Court with respect to the cases of the Thompsons and the Cravenses.23 23 The Cravenses, who were not represented by counsel after Seery’s withdrawal, had agreed with McWade to deficiencies of $9,782.16 for their taxable years 1979 and 1980, a reduction of only about 6 percent from the originally determined deficiencies of $10,401.45. This settlement was less favorable to them percentagewise than the generally available modified 7-percent reduction settlement offer and did not include the “burnout” feature. On Aug. 25, 1992, this Court entered a decision reflecting the Cravens settlement amounts, but the decision included the stipulation that certain advance payments made by the Cravenses had not yet been taken into account. Late in (continued...) - 51 The Office of Chief Counsel's rationale for not appealing the Tax Court's entry of the decisions giving effect to the Thompson settlement was set forth in a memorandum dated September 8, 1992, and signed by Kane: The Chief Counsel and Deputy Chief Counsel have concluded that, under the circumstances, we have completely fulfilled all applicable ethical and legal obligations with respect to this issue and this litigation. They have also concluded that given the fact that the conduct on the part of our attorneys is significantly less than exemplary, there is nothing to be gained by further prolonging this aspect of the Kersting litigation. On September 30, 1992, Judge Goffe terminated his recall status as a Senior Judge and retired from the bench. The Chief Judge of the Tax Court reassigned the Kersting project cases to Judge Renato Beghe. After this Court entered its decisions in the Thompson cases, Izen, who had represented the test case petitioners (other than the Thompsons and Cravenses) at the trial and who was representing them on their appeals, and Robert Patrick Sticht (Sticht), who represents a number of nontest case petitioners, filed separate motions with the Court to intervene in the Thompson and Cravens cases. 23 On November 6, 1992, the Court (...continued) October 1992, officials in respondent’s Western Region proposed closing the Cravenses’ cases in such a way as “to cause the taxpayers’ 1979 and 1980 accounts to zero out with no further amounts due.” - 52 denied their motions to intervene, and Izen and Sticht filed notices of appeal. I. Implementation and Effects of the Final Thompson Settlement This Court’s August 1992 decisions enforcing the final Thompson settlement had a number of financial consequences. The Court’s decisions not only reduced the Thompsons’ deficiencies; it also reduced the interest that had accrued on those deficiencies. In December 1986 and in January 1987, the Thompsons had paid $59,545 of interest on their originally settled deficiencies of $34,425 for 1980 and $30,000 for 1981. Because the Court’s decisions giving effect to the new settlement agreement resulted in deficiencies of only $15,000 for each of 1980 and 1981, the interest that had accrued on those deficiencies before the Thompsons made their interest payments was much less than $59,545. Instead, as of December 31, 1986, the interest accruals on the $15,000 deficiencies for 1980 and for 1981 amounted to only $15,370.73 and $12,135.31, respectively. As a result, the Thompsons’ aggregate payments of $59,545 in December 1986-February 1987 were more than sufficient to cover their total deficiencies and interest as eventually reduced by the final Thompson settlement. In January 1993, respondent made new assessments against the Thompsons for 1980 and 1981 that were based upon the decisions - 53 entered by the Tax Court on August 26, 1992. The total assessments for 1980 and 1981 amounted to $57,506.04 (tax and interest for 1980 of $15,000 and $15,370.73, respectively, plus tax and interest for 1981 of $15,000 and $12,135.31, respectively). Respondent applied the $59,545 credit balance resulting from the Thompsons’ payments of $59,545 in interest to satisfy their $57,506.04 liability for 1980 and 1981, leaving a small credit balance. The Thompsons’ having remitted $63,000 in June 1987, in respect of their previously settled deficiencies, respondent credited $62,225 of that amount to their 1979 account as an advance payment of tax. Because the Thompsons had no deficiency for 1979 under both the earlier settlements and the Tax Court’s decision giving effect to the new settlement, the $30,000 refund issued in July 1989 left a credit balance of $32,225. Accordingly, in February 1993, respondent issued a refund check for $32,225 to the Thompsons. As they had done with their earlier refund, the Thompsons endorsed this refund check to DeCastro, as payment of additional legal fees, without depositing the check in their own checking account. DeCastro thereafter complained to Dombrowski that the Thompsons were entitled to receive even more from respondent. DeCastro argued that the Thompsons were entitled to receive interest on the $63,000 advance payment (albeit as successively - 54 reduced to $62,225 and then $32,225). Dombrowski requested “audit assistance”, which he received from George Guzzardo (Guzzardo), an appeals auditor in respondent’s San Diego office, in determining whether the Thompsons were entitled to the requested interest. Guzzardo determined that the Thompsons’ $63,000 remittance on June 17, 1987, was an advance payment rather than a cash bond. The distinction is important: An advance payment resulting in an overpayment entitles the taxpayer to interest on the overpayment; conversely, a cash bond does not earn interest. Having concluded that the previously refunded $62,225 was an advance payment, Guzzardo determined that the Thompsons were entitled to additional interest of $31,511.17 as of July 31, 1993. Dombrowski did his own computations, and then asked Jean Samuels (Samuels), an experienced appeals auditor, to check his and Guzzardo’s figures. Samuels advised that in the main she agreed with both Guzzardo’s and Dombrowski’s calculations. Relatively small differences in their results were attributable to their use of different dates for the accrual of interest.24 On September 17, 1993, Dombrowski sent Bakutes a memorandum requesting approval to refund the interest on the Thompsons’ 24 Samuels saw that the refund included some previously deducted interest, thus producing tax benefit income, but stated in her memorandum to Dombrowski, “Most taxpayers would probably either not know or not remember to include this [tax benefit income] in income, since they won’t get a Form 1099 for it.” - 55 overpayments, with a copy to the National Office. Bakutes approved the refund in an e-mail message to Dombrowski. In October 1993, respondent issued a refund check to the Thompsons in the amount of $32,116.68. Finally, in December 1993, respondent issued a refund check of $4,107.93 to the Thompsons for 1980. The check represented an overpayment credit of $2,257.54 (the amount by which their $59,545 interest payment exceeded their deficiencies and interest for 1980 and 1981 after minor adjustments), plus accrued interest of $1,850.39 on the overpayment credit. The Thompsons deposited these last two refund checks in their checking account. The following table summarizes the payments by the Thompsons to respondent as well as the subsequent payments, as refunds and interest on refunds, by respondent to the Thompsons: Paid by Thompsons: $59,545 December 31, 1986 and February 17, 1987 payments of interest on deficiencies under original settlement. 62,225 June 1987 advance payment of deficiencies for 1979-1981 (net of $775 credited to tax year 1988). 121,770 Total amount paid for years in issue. - 56 Received by Thompsons: $30,000.00 Refunded July 11, 1989, pursuant to request of McWade, endorsed to DeCastro. 32,225.00 Refunded February 19, 1993, pursuant to request of DeCastro and endorsed to DeCastro. 32,116.68 Third refund check, dated October 22, 1993, for $32,116.68, representing interest on overpayment resulting from advance payment of deficiencies. 4,107.93 Refund, with interest, of overpayment resulting from application of $59,545 interest payment against 1980-81 deficiencies and interest. 98,449.61 Total amount refunded by IRS for years in issue. In sum, the Thompsons were refunded $98,449.61 of the $121,770 they had paid in deficiencies and interest for 19791981. Of the $98,449.61 refunded, $81,225 was paid to DeCastro as legal fees. Of this amount, $62,225 was paid to DeCastro by the Thompsons’ endorsement to him of the first two refund checks they received in 1989 and 1993. The Thompsons apparently paid DeCastro an additional $19,000 after receiving the third refund check later in 1993. On their 1993 tax return, the Thompsons reported both the $32,116 interest income received from the IRS in October and the smaller interest payment of $1,850 received in December. Their return did not reflect the tax benefit arising from the fact that, while they deducted $44,165 of deficiency interest on their - 57 1986 and 1987 returns ($16,251 for 1986 and $27,914 for 1987), the interest on the reduced deficiencies that were ultimately assessed in 1993 amounted to only $27,506 ($15,371 for 1980 and $12,135 for 1981). Pursuant to written advice from DeCastro, the Thompsons deducted the fees paid to him in 1993 totaling $51,225 ($32,225 + $19,000) in computing their taxable income. The description accompanying the deduction claim on the Thompsons’ 1993 return was “LEGAL FEES FOR INCLUDABLE INC.”25 J. Respondent’s Disciplinary Action Against Sims and McWade On July 29, 1993, Sanchez sent notices of proposed disciplinary action to Sims and McWade. that Sims and McWade had violated: The notices asserted (1) Department of the Treasury Minimum Standards of Conduct, section 0.735-30(a)(2) (an employee shall avoid any action which might result in or create the appearance of giving preferential treatment to any person); (2) Department of the Treasury Minimum Standards of Conduct, section 0.735-30(a)(6) (an employee shall avoid any action that might adversely affect the confidence of the public in the integrity of the Government); and (3) IRS Rule of Conduct 214.5 25 The reference to “INCLUDABLE INC.” has not been satisfactorily explained, even by Poltash, whose office prepared the return. Petitioners urge that the reference is to “an entity that never existed.” The Court doubts the reference is to an entity at all, but the Court’s question to Poltash, whether the reference was a shorthand reference to “includable income”, as a justification for deductibility under sec. 212, met with a protestation of ignorance. - 58 (an employee will not intentionally make false or misleading verbal or written statements in matters of official interest). The notices proposed to suspend both Sims and McWade for 14 calendar days without pay. McWade retired from the IRS effective October 2, 1993. On November 2, 1993, Acting Chief Counsel Jordan approved Sanchez’s proposed disciplinary action. Sims was suspended from duty without pay for 14 days and was transferred to the San Francisco Regional Counsel’s Office, where he was assigned nonsupervisory duties as a Special Litigation Assistant in the General Litigation area. IV. Ninth Circuit Remand and Subsequent Proceedings A. Ninth Circuit Orders in the DuFresne Case On June 14, 1994, the Court of Appeals for the Ninth Circuit filed a per curiam opinion, vacating and remanding this Court’s decisions in the remaining test cases, on the ground that the misconduct of Sims and McWade required further inquiry. v. Commissioner, 26 F.3d at 107. DuFresne Citing Arizona v. Fulminante, 499 U.S. 279, 309 (1991), the Court of Appeals observed: We cannot determine from this record whether the extent of misconduct rises to the level of a structural defect voiding the judgment as fundamentally unfair, or whether, despite the government’s misconduct, the judgment can be upheld as harmless error. * * * Accordingly, the Court of Appeals remanded the remaining test cases to this Court with directions “to conduct an evidentiary - 59 hearing to determine the full extent of the admitted wrong done by the government trial lawyers.” Id. It further directed this Court to “consider on the merits all motions of intervention filed by parties affected by this case.” Id. Finally, the Court indicated that “All subsequent appeals will be scheduled before this panel.” Id. Notwithstanding its general endorsement of allowing parties in related cases to intervene, the Court of Appeals for the Ninth Circuit dismissed attorneys Izen’s and Sticht’s appeals from this Court’s denial of their motions to intervene in the Thompson and Cravens cases. In an unpublished opinion filed the same day as the DuFresne opinion, the panel of the Court of Appeals that had decided DuFresne explained: The Tax Court’s August 25 and 26, 1992 decisions entering settlement in the Cravens and Thompson cases, respectively, are final. 26 U.S.C. § 7481(a)(1); Fed. R. App. P. 13. The Tax Court lacks jurisdiction to vacate those decisions. Billingsley v. CIR, 868 F.2d 1081, 1084 (9th Cir. 1989). Because there is no case remaining in which the taxpayers can intervene, this appeal is moot. [Adair v. Commissioner, 26 F.3d 129 (9th Cir. 1994).] On September 29, 1994, the District Court for the District of Hawaii entered an order in favor of the United States that approved the assessment of penalties of $1,545,201 and $2,230,000 under sections 6700 and 6701 against Kersting for the promotion of abusive tax shelters. Kersting timely appealed. - 60 In December 1994, the Tax Court received the mandate of the Court of Appeals in DuFresne, and the test cases were assigned to Judge Beghe for further proceedings under the mandate. B. Evidentiary Hearing and Opinions After the Remand in DuFresne In response to respondent’s motion for the evidentiary hearing required by the mandate, this Court, following receipt of the record from the Court of Appeals, set the test cases for a pretrial hearing to be held July 17, 1995. In furtherance of the Court of Appeals’ directive regarding intervention, the Court ordered that notice of the hearing be served on all attorneys who had entered appearances on behalf of nontest case petitioners in the Kersting project. Ultimately, the Court ordered that 10 cases of nontest case petitioners, each represented by either Izen, Sticht, or attorney Robert Alan Jones (Jones), be consolidated with the remaining test cases for purposes of the evidentiary hearing. As a result, three groups of petitioners participated in all subsequent phases of the evidentiary hearing: Test case and nontest case petitioners represented by Izen; nontest case petitioners represented by Sticht; and nontest case petitioners represented by Jones.26 26 The group of cases that were consolidated for purposes of the evidentiary hearing initially included the case of William D. and Karen S. Booth, docket No. 28950-88, in which Declan J. O'Donnell (O'Donnell) had entered his appearance. However, at the start of the evidentiary hearing, the Court granted (continued...) - 61 As directed by the Court of Appeals in DuFresne, Judge Beghe conducted the evidentiary hearing at special trial sessions of the Court in Los Angeles, California, from May 13-30 and June 10-26, 1996, and August 18, 1997. On March 30, 1999, on the basis of the record developed at the evidentiary hearing, the Court issued its supplemental opinion in Dixon v. Commissioner, T.C. Memo. 1999-101 (Dixon III). The Court held that the misconduct of the Government attorneys in the trial of the test cases did not, in the words of the Court of Appeals for the Ninth Circuit in DuFresne, constitute a “structural defect” in the trial, but rather resulted in “harmless error”. However, the Court imposed sanctions against respondent, holding that Kersting program participants who had not had final decisions entered in their cases would be relieved of liability for (1) the interest component of the addition to tax for negligence under section 6653(a)(1)(B) and (2), and (2) the incremental interest attributable to the increased rate prescribed in section 6621(c). 26 (...continued) O’Donnell's motion to sever the Booth case from the cases consolidated for the evidentiary hearing. O’Donnell argued that, in light of the theory underlying a motion for summary judgment that he had filed on behalf of the Booths, they had no need to participate in the evidentiary hearing. In Gridley v. Commissioner, T.C. Memo. 1997-210, the Court denied O’Donnell’s motions for entry of decision consistent with the final Thompson settlement. - 62 On March 13, 2000, the Court of Appeals for the Ninth Circuit affirmed the order of the Hawaii District Court that had imposed almost $3 million in penalties against Kersting for the promotion of abusive tax shelters. The opinion of the Court of Appeals states: The district court did not err in finding that Kersting knew or had reason to know that his statements concerning the allowability of interest were false or fraudulent. See 26 U.S.C. § 6700(a)(2); * * *. The record indicates that Kersting knew that his tax shelters were sham transactions in which participants could write off approximately twelve dollars for every dollar of actual out-of pocket expenses. Kersting himself indicated in a 1977 “comfort letter" to one of the “nervous nellies” investing in his scheme that these deductions were not legitimate - Kersting warned the individual to “be sure this letter does not get into the wrong hands. If IRS would become aware of the offsetting character of your note you would likely lose your interest deduction”. Kersting also knew that these fraudulent interest deductions originating in a prior version of his tax shelter had been previously disallowed by this Court. See Pike v. Commissioner, 78 T.C. 822 (1982) (denying interest deductions to taxpayers participating in Kersting’s tax shelters because the transactions conducted by Kersting’s corporations were shams lacking economic substance), affd., 732 F.2d 164 (9th Cir. 1984). After Pike, Kersting made merely cosmetic changes to his tax shelter scheme. * * * Kersting v. United States, 206 F.3d 817, 819 (9th Cir. 2000). On March 31, 2000, this Court issued a supplemental opinion, Dixon v. Commissioner, T.C. Memo. 2000-116 (Dixon IV), awarding petitioners some of the attorney’s fees they sought for services performed in the evidentiary hearing mandated by the Court of Appeals in DuFresne and denying their motions for additional - 63 sanctions. In so doing, the Court denied petitioners’ requests for the award of attorney’s fees under section 7430, on the ground that Dixon III had held that none of them was a “prevailing party” as defined in section 7430(c)(4). Instead, the Court awarded fees under section 6673(a)(2), which authorizes the Tax Court to require the United States to pay excess costs, expenses, and attorney’s fees whenever the Commissioner’s attorneys have “multiplied the proceedings in any case unreasonably and vexatiously”. On the same date, the Court entered decisions in the test cases, and the test case petitioners appealed. The Court also certified for interlocutory appeal the cases of nontest case petitioners represented by Izen, Jones, and Sticht who had also participated in the evidentiary hearing and nontest case petitioners represented by O’Donnell whose cases were the subject of the Court’s opinion in Gridley v. Commissioner, T.C. memo. 1997-210. C. These nontest case petitioners also appealed. The Ninth Circuit’s Opinion and Mandates in These Cases On November 21, 2001, following extensive motion practice on jurisdiction and other issues, the Court of Appeals set a briefing schedule and confirmed that the cases on appeal would be scheduled before the panel that issued the DuFresne opinion. Following receipt of opening and reply briefs from test case - 64 petitioners,27 now represented by three sets of attorneys,28 the DuFresne panel filed an order indicating that, upon reconsideration, it would not retain jurisdiction, and directing the Clerk to schedule the appeal in the normal course of events. On October 10, 2002, the panel that ultimately issued the opinion in Dixon V heard oral argument in the test cases. On January 17, 2003, the Court of Appeals issued its opinion in the test cases in Dixon v. Commissioner, 316 F.3d 1041 (9th Cir. 2003), amended on March 18, 2003 (Dixon V), vacating and remanding the Court’s decisions in the test cases, and directing the further proceedings that have resulted in this opinion. Citing Hazel-Atlas Glass Co. v. Hartford-Empire Co., 322 U.S. 238, 247 (1944), overruled on other grounds Standard Oil v. United States, 429 U.S. 17, 18 (1976), the Court of Appeals stated: “There can be no question here but that the actions of McWade and Sims amounted to a fraud on both the taxpayers and the Tax Court.” Dixon v. Commissioner, 316 F.3d at 1046. The Court 27 On Nov. 20, 2001, the DuFresne panel had filed an order directing that the appeals of nontest case petitioners represented by Izen, Sticht, Jones, and O’Donnell “shall be held in abeyance pending resolution of the appeal in No. 00-70858” (i.e., the test cases). 28 The three sets of attorneys are Izen, Michael L. Minns, and John A. Irvine and Henry G. Binder. - 65 of Appeals held that “fraud on the court” occurs regardless of whether the opposing party is prejudiced. Id.29 The Court of Appeals further stated: We have the inherent power to vacate the judgment of the Tax Court, fashion an appropriate remedy, and sanction a party or its lawyers for willful abuse of the judicial process, particularly when the party or its lawyers have intentionally practiced a fraud upon the Court. * * * * * * The taxpayers should not be forced to endure another trial and the IRS should be sanctioned for this extreme misconduct. Conversely, we will not enter judgment eradicating all tax liability of these taxpayers. Such an extreme sanction, while within the court’s power, is not warranted under these facts. * * * Id. at 1047 (citations omitted). The Court of Appeals instead reversed the decisions of this Court in the test cases and directed this Court to “enter judgment in favor of Appellants and all other taxpayers properly before this Court on terms equivalent to those provided in the settlement agreement with Thompson and the IRS.” Id. It left “to the Tax Court’s discretion the fashioning of such judgments which, to the extent possible and practicable, should put these taxpayers in the same position as provided for in the Thompson settlement.” 29 Id. n.11. The Court of Appeals acknowledged the contrary holding of the Court of Appeals for the Seventh Circuit in Drobny v. Commissioner, 113 F.3d 670 (7th Cir. 1997), affg. T.C. Memo. 1995-209. In Drobny, the Seventh Circuit held that proof of fraud on the court requires a showing that the alleged misconduct actually affected the outcome of the case to the taxpayer’s detriment. Id. at 678-679. - 66 On January 21, 2003, respondent’s then Chief Counsel, referring to Dixon V, publicly announced: “We will * * * assure that no interest is charged on deficiencies for the period of the appeals to the Ninth Circuit.”30 On February 3, 2003, Deborah Butler, respondent’s Associate Chief Counsel for Procedure and Administration, issued a Chief Counsel notice (CC-2003-008), reminding all Chief Counsel attorneys, in light of the opinion of the Court of Appeals in Dixon V, “to adhere to the highest ethical standards when performing their duties, including when representing the IRS before the Tax Court.” On March 14, 2003, the Court of Appeals issued orders remanding to the Tax Court for further proceedings consistent with the opinion in Dixon V the nontest cases that had been appealed pursuant to their certification for interlocutory appeal. On April 23, 2003, the Court of Appeals issued its mandates with respect to the test cases in accordance with Dixon V. D. Proceedings Following Remand On April 30, 2003, respondent filed a motion for a status conference regarding disposition on remand of the test cases and a group of related nontest cases. 30 On May 1, 2003, this Court The original decisions in Dixon II were entered Mar. 13, 1992; the notices of appeal were filed May 14, 1992; the 90-day appeal period would have expired June 11, 1992. - 67 ordered the parties to file status reports regarding subsequent disposition of the cases. The responses displayed various disagreements between respondent and petitioners concerning not only the scope of the remedy, but the manner of its implementation. For example, the status report of petitioners’ counsel Henry Binder states: “Respondent does not come to this Court’s fashioning of the equitable remedy ordered by the Ninth Circuit with clean hands and, therefore, has no standing to argue the terms or scope of that remedy.”31 The Court conducted status conferences in Houston, Texas, in August 2003 and in Los Angeles, California, in September 2003 to address petitioners’ attempts to settle the cases. The conferences resulted in no settlement. The parties then engaged in protracted motions practice regarding assertions of privilege by respondent as to some matters sought in discovery and regarding the award of attorney’s fees claimed by counsel for petitioners. On April 5, 2004, petitioners filed motions for an evidentiary hearing. Thereafter, at the behest of the parties, the Court directed further discovery and conducted further hearings. 31 The first hearing took place at Las Vegas, Nevada, in Having considered certain issues raised in the status reports, this Court issued an order dated June 12, 2003, indicating it was “not inclined to consider attempts to disqualify counsel” in any of the cases at issue. We additionally stated: “This Court is not inclined to seek appointment of counsel from the United States Department of Justice to represent respondent in these cases”. - 68 September 2004, the second hearing at Los Angeles, California, in November 2004, and the final hearing at Washington, D.C., in March 2005. By the end of September 2005, the parties had filed their briefs regarding the scope and application of the Thompson settlement. E. Further Disciplinary Proceedings On April 1, 1999, the day immediately following the issuance of the Dixon III opinion, Judge Beghe referred the misconduct of Sims, McWade, and DeCastro to the Committee on Admissions, Ethics, and Discipline of the Tax Court for disciplinary action.32 In accordance with the Court’s practice in such matters, the referrals were not mentioned in the Dixon III opinion or otherwise publicized when that opinion was issued. On April 22, 2003, the Court, through the Committee on Admissions, Ethics, and Discipline, issued orders to Sims, McWade, and DeCastro to show cause why they should not be suspended or disbarred from practice before the Court or otherwise further disciplined. On July 1, 2003, DeCastro resigned from practice before the Court. 32 On June 26, 1996, at what then seemed to be the close of the evidentiary hearing, Izen had filed a motion requesting this Court to refer the Thompson and Cravens settlements and McWade’s settlement with Denis Alexander to the DOJ (Public Integrity Section) for criminal prosecution. Izen identified approximately 17 alleged crimes associated with these settlements. By order dated June 26, 1996, the Court denied Izen's motion. - 69 Following complaints filed by petitioners’ counsel Minns in response to inquiries by the Dixon V panel at oral argument, the Arkansas State Bar suspended Sims’s license to practice for 1 year in February 2004, and the Oregon State Bar suspended McWade’s license to practice for 2 years in August 2004. This Court, acting on the orders to show cause and the recommendations of the Committee on Admissions, Ethics, and Discipline, suspended McWade and Sims from practice for 2 years, commencing February 20, 2004.33 The Director of the IRS Office of Professional Responsibility suspended McWade and Sims indefinitely from practice before the IRS, effective June 9, 2004. Under Rule 202(c)(1), a practitioner who has been suspended for more than 60 days or disbarred from practice before this Court may not resume practice until reinstated by order of the Court. Under Rule 202(c)(2), if the disciplinary proceeding giving rise to a suspension or disbarment was predicated upon the complaint of a Judge of this Court, a hearing on the petition for reinstatement is to be held before a panel of three other Judges appointed by the Chief Judge. At the hearing on the petition: the practitioner shall have the burden of demonstrating by clear and convincing evidence that the practitioner 33 The first announcement by the Court with respect to the referrals was the Court’s issuance, on Feb. 20, 2004, of a press release that disciplinary action had been taken against McWade and Sims. DeCastro’s resignation was not publicized by the Court until issuance of the opinion herein. - 70 has the moral qualifications, competency, and learning in the law required for admission to practice before this Court and that the practitioner’s resumption of such practice will not be detrimental to the integrity and standing of the Bar or to the administration of justice, or subversive of the public interest. [Id.] OPINION Preliminary Comments The Court of Appeals has directed that the remaining test case petitioners “and all other taxpayers properly before this Court” receive judgments in their favor “on terms equivalent to those provided in the settlement agreement with Thompson and the IRS.” Dixon v. Commissioner, 316 F.3d at 1047. The Court of Appeals has left to this Court’s discretion “the fashioning of such judgments which, to the extent possible and practicable, should put these taxpayers in the same position as provided in the Thompson settlement.” Id. n.11. Throughout the proceedings required to implement the mandates of the Court of Appeals, petitioners, impelled by outrage and indignation at the fraud on the Court committed by respondent’s attorneys, seem to view the mandates as an invitation to award damages against respondent. Without in any way minimizing the seriousness of the misconduct of respondent’s attorneys, we decline any such invitation.34 The mandates do not call for the recovery of damages by the taxpayers; they call for 34 In any event, we lack jurisdiction to award damages. Chocallo v. Commissioner, T.C. Memo. 2004-152. - 71 sanctions against respondent, to be determined in accordance with the ascertainable standard provided by the Dixon V opinion. We now broach how, in light of the different circumstances of the Thompsons and the various groups of affected taxpayers, we can follow and apply the directive of the mandates. Interpreting the term “same position” used in footnote 11 of Dixon V to mean “same financial position”, it might seem, at first blush, that the test case and nontest petitioners cannot be put in the financial position the Thompsons found themselves in as a result of the Thompson settlement. The Thompson settlement was embodied in a sequence of payments and refunds that occurred more than 15 to 20 years ago, when personal interest was fully or partially deductible for income tax purposes, in a different interest rate environment, and in temporal relationships that are not now reproducible with respect to any of the other petitioner participants in the Kersting project. Also, the bulk of those refunds was used to pay legal fees the other test case petitioners were not required to pay for representation in the test case trial. It should be borne in mind that the Thompson settlement occurred in two distinct phases: In December 1986 into early 1987, McWade and DeCastro arranged to provide the Thompsons a reduction of approximately 20 percent in the originally determined deficiencies; this version of the settlement took - 72 account of respondent’s increased litigation risk resulting from Chicoine and Hallett’s efforts to suppress the evidence discovered in the IRS raid on Kersting’s office. Other Kersting petitioner clients of DeCastro and Chicoine and Hallett obtained 20-percent reduction settlements from McWade prior to the Court’s 1988 opinion in Dixon I, and some other nontest case petitioners thereafter obtained such settlements. The Thompsons’ payments to the IRS in late 1986 and in 1987 were made to satisfy their obligations under the approximately 20-percent reduction settlement arranged by McWade and DeCastro. DeCastro thereafter played on the fears of Sims and McWade that he would walk away from the test case trial to extort the additional reduction agreed to in late 1988 and early 1989 that would generate the refunds that were to be used to pay his fees for providing legal representation to the Thompsons at the trial. The new Thompson settlement had no rationale quantifiably related to the hazards of litigation or the merits of the case; it was based on the opportunistic estimates of McWade and Decastro of what was needed to bring about a particular financial result that has little or no congruence with the situation in which the petitioners before the Court now find themselves. The fact that the Thompsons had already made the payments required by the earlier 20-percent reduction settlement provided the fund that was ripening for the taking under the new settlement. As it - 73 turned out, the overall reduction of approximately 62 percent in the Thompson deficiencies provided by the new settlement was more than enough to produce the approximately $60,000 of refunds McWade and DeCastro thought would be needed to pay DeCastro’s original estimate of what his fees would be. As it further turned out, the additional interest on the Thompsons’ payments under the original settlement was sufficient to provide DeCastro with an additional fee that he (and perhaps Mr. Thompson) probably felt was justified by his success in keeping the new settlement in effect, as well as leave a surplus to be retained by the Thompsons.35 Test case and nontest case petitioners in the main fall into two groups, both of which are now in different situations from the situation of the Thompsons 15-20 years ago. It is the Court’s impression that a substantial majority of nontest case petitioners are in the unhappy situation of having followed Kersting’s advice to stand pat. They neither settled their cases nor made any remittances in respect of the deficiencies determined against them. With the passage of years and the operation against them of the force of compound interest, they claim that they have been facing financial ruin, with all its 35 The lack of legal rationale and the opportunistic character of the new settlement are emphasized by the fact that it was entered into after the litigation risk that supported the original 20-percent reduction settlement had evaporated with the publication of this Court’s opinion in Dixon I. - 74 attendant anxieties; this is because they did not have the foresight or the discipline to invest the chimerical tax savings they had appropriated by using the Kersting shelters to support their original return positions.36 On the other hand, there are a minority of petitioners who, without conceding their liabilities, have stopped the running of interest against themselves by prepaying the Kersting deficiencies the IRS had determined against them.37 With the passage of time and the operation in their favor of the force of compound interest, this minority of petitioners are entitled, under the Dixon V opinion and mandates, to substantial refunds, and properly so. A further comment: The financial burden of petitioners who did not prepay has been substantially ameliorated--but not completely eliminated--by respondent’s concession that no interest will be charged on deficiencies for the period of the 36 The bulk of petitioners in the Kersting project appear to have been commercial airline pilots. There is no evidence in the record of their financial sophistication or lack thereof, either individually or as a group. 37 The Court understands that this group includes the remaining test case petitioners, with the exception of the Dixons, who received a discharge in bankruptcy. By collecting the deficiencies from the test case petitioners because of their failure to file appeal bonds, cf. Estate of Kanter v. Commissioner, T.C. Memo. 2006-46, respondent has put those petitioners in the advantageous position of being entitled to collect substantial refunds, on which interest has been accruing and compounding over the years without attracting current annual tax liabilities. Of course, the interest component of those refunds will be includable in gross income of the recipients when finally paid. - 75 appeals to the Ninth Circuit. That concession, prompted by respondent’s recognition of responsibility for the delay in resolving the Kersting project cases caused by the need to investigate the misconduct of respondent’s attorneys, seems appropriate, but also generous. Even if there had been no misconduct by respondent’s attorneys, the appeals filed by test case petitioners, before the misconduct was discovered, would have taken some substantial time beyond June 1992 to resolve. The amelioration is substantial because it has stopped the further accrual and compounding of interest on the deficiencies for more than 13 years. The amelioration is not complete because many petitioners have deficiencies going back to the late 1970s and early 1980s. The bottom line is that, in the absence of the misconduct, petitioners who did not prepay would have been required to pay substantially more than they will be required to pay under the mandates. Moreover, they will be entitled to pay these reduced amounts many years later than would have been necessary if there had been no misconduct. As a result of respondent’s concession, they have had the use of the money due for their reduced deficiencies for more than 13 additional years. Stated differently, they have enjoyed for more than 13 years the equivalent of an interest-free loan of the reduced deficiencies and interest they will now have to pay. - 76 In sum, this Court has determined the terms of the Thompson settlement. Our decisions in these cases will apply those terms to test case and nontest case petitioners alike. Subject to the review of the Court of Appeals, our opinion and decisions will provide the template for the disposition of the more than 1,300 pending cases in the Kersting project. The thoughts underlying the foregoing comments have informed our effort not only to determine and apply the terms of the Thompson settlement, but also our effort to put petitioners, to the extent possible and practicable, in positions similar to that provided by the Thompson settlement. Although it may be impossible to put petitioners in the same position, financial or otherwise, the Thompsons were in 15 to 20 years ago, we observe that the Code provisions for interest on deficiencies and overpayments,38 in which are embedded the time value of money principles that underlie all financial planning,39 provide the only available appropriate means of approximating the desired equivalence.40 38 Secs. 6601, 6611. 39 See generally, e.g., Brealey & Myers, Principles of Corporate Finance (7th ed. 2003). 40 Gokhale & Smetters, “Measuring Social Security’s Financial Outlook within an Aging Society”, Daedalus 91-92 n.2 (Winter 2006), comment that discounting to present value, an operation integral to giving effect to the time value of money, makes it possible “to place dollars accruing at different points in time (continued...) - 77 For two reasons, those petitioners who prepaid will receive refunds many times greater than the Thompsons received: Most of those petitioners probably made payments equal to their originally determined deficiencies, not just 80 percent thereof, like the Thompsons, and their refunds will be exponentially increased by interest accruals because they have had to wait much longer than the Thompsons did to receive their refunds. On the other hand, those petitioners who, unlike the Thompsons, did not prepay will have deficiencies that will be reduced in the same proportion as the Thompsons’ deficiencies were finally reduced under the settlement. Although they will still have to pay those reduced deficiencies with interest accruing until mid-1992, their interest obligation will have been substantially reduced by respondent’s concession. We conclude these comments by again observing that these petitioners will still be substantially better off financially than they would have been in the absence of respondent’s misconduct. And so should it be, in accord with the sanction the Court of Appeals has fixed as the appropriate judicial response to the misconduct of respondent’s attorneys. 40 (...continued) on an equal valuation scale”. - 78 I. Procedural Issues Following Remand A. Procedural Posture These cases are before the Court pursuant to the DuFresne and Dixon V opinions and mandates of the Court of Appeals for the Ninth Circuit. They therefore present issues in a procedural posture diametrically different from the standpoint from which we usually redetermine income tax deficiencies or overpayments arising from notices of deficiency or refund claims. Here, the traditional roles of petitioner and respondent are reversed. In this phase of the proceedings, it is respondent, not petitioner, whose activities are being questioned. It is respondent, not petitioners, who is charged with having the necessary records and the personnel who have recollections regarding the matters at issue.41 Because of the unique posture of this case, it is respondent, not petitioner, who often argues that a deduction has been properly claimed and allowed (and thus should not be included as one of the taxpayer benefits of the Thompson settlement), while petitioners argue the contrary. 41 It should be noted that, following the remand in Dixon V, neither side called DeCastro, Mcwade, or Sims as a witness. We understand that DeCastro is seriously ill, so he was not available. We have no such information about McWade or Sims; perhaps their previous failures to persuade this Court of their credibility discouraged both sides from calling them. - 79 B. Law of the Case The Court of Appeals for the Ninth Circuit recently explained the law of the case doctrine as follows: “The law of the case doctrine requires a district court to follow the appellate court’s resolution of an issue of law in all subsequent proceedings in the same case.” United States ex rel. Lujan v. Hughes Aircraft Co., 243 F.3d 1181, 1186 (9th Cir. 2001). The doctrine applies to both the appellate court’s “explicit decisions as well as those issues decided by necessary implication.” United States v. Cote, 51 F.3d 178, 181 (9th Cir. 1995) (quoting Eichman v. Fotomat Corp., 880 F.2d 149, 157 (9th Cir. 1989)). * * * [Al-Safin v. Circuit City Stores, Inc., 394 F.3d 1254, 1258 (9th Cir. 2005).] In relying upon its inherent authority to sanction the IRS by extending the benefit of the Thompson settlement to all interested parties, the Court of Appeals by necessary implication concluded that the doctrine of inherent authority trumps the doctrine of sovereign immunity (the latter generally prohibiting the imposition of monetary sanctions against the United States absent the express consent of Congress).42 We therefore are not concerned with that issue. 42 The principle that a court has inherent power to impose sanctions is well established. “It has long been understood that ‘[c]ertain implied powers must necessarily result to our Courts of justice from the nature of their institution,’ powers ‘which cannot be dispensed with in a Court, because they are necessary to the exercise of all others.’” Chambers v. NASCO, 501 U.S. 32, 43 (1991) (quoting United States v. Hudson, 11 U.S. (7 Cranch) 32, 34 (1812)). - 80 C. Parties Before the Court The opinion of the Court of Appeals directs this Court “to enter judgment in favor of Appellants and all other taxpayers properly before this Court”. 1047. Dixon v. Commissioner, 316 F.3d at In a technical sense, the Dixon V opinion and the implementing mandates might be deemed to extend only to those parties who filed notices of appeal. 859 F.2d 115, 120 (9th Cir. 1988). See Abatti v. Commissioner, We believe, however, that the Court of Appeals did not intend a technical, restricted application of its opinion and mandates, nor, apparently, do the parties. Following the hearings in these cases, the parties filed a stipulation of settled issues. Among other things, that stipulation recites: 1. The Kersting deficiencies of any petitioner who has filed a piggyback agreement with the Tax Court shall be determined in accord with the Ninth Circuit’s mandates as implemented by the Tax Court on remand in this proceeding * * *. 2. The Kersting deficiencies of any petitioner in a case docketed before the Tax Court who has not filed a piggyback agreement will, absent a showing of cause, be determined in accord with the Ninth Circuit’s mandates as implemented by the Tax Court on remand in this proceeding * * *. We read these stipulations to apply to all open cases of petitioner participants in the Kersting tax shelter programs. other words, the parties have agreed--and properly so--that the In sanction applies to benefit not only to test case petitioners, but also to nontest case petitioners in all remaining docketed - 81 cases in the Kersting project, whether or not they signed piggyback agreements. D. Burden of Proof In our Dixon III opinion, we noted several factors that impelled us to impose the burden of proof on respondent with respect to whether the misconduct of respondent’s [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/documents/agency%3Atax-court%3A5c45f4473c548ff0. Public record. Not legal advice.