# UNITED STATES TAX COURT > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A8165409c89cff241 ## Record - **Collection:** Agency decision - **Document type:** Agency decision ## Text T.C. Memo. 1999-101 UNITED STATES TAX COURT JERRY AND PATRICIA A. DIXON, ET AL. , Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent* Docket Nos. 9382-83, 4201-84, 15907-84, 40159-84, 30010-85, 29643-86, 19464-92, 7205-94, 17992-95, 17646-83, 73;23-84, 20119-84, 22783-85, 30979-85, 35608-86, 621-94, 9532-94, 17993-95. Filed March 30, 1999. Cases of the followins petitioilers are consolidated herewithi Ronald L. Alverson and Matt'ie L. Alverson, docket No. 17646-83; Hoyt W. and Barbara D. Young, docket Nos. 4201-84, 22783-85, 30010-85; Anthony E. ancPCarol A. Eggers, docket No. 7323-84; Robert L. and Carolyn S. DuFresne, docket Nos. 15907-84, 30979-85; John L. and Terry E. Huber, docket No. 20119-84; Terry D. and Gloria K. Owens, docket No. 40159-84; Richard and Fidella Hongsermeier, docket No. ·29643-86;'Norman -W. and Barbara L. Adair, docket No. 35608-86; Willis F. McComas, II and Marie D. McComas, docket No. 19464-92; Wésley Arniand 'and Sherry Lynn Cacia Baughman, docket No. 6 1-94; Joe Ai and JoAnne Rinaldi, docket No. 7205-94; Normen A. and Irene Cerasoli, docket No. 9532-94; Stanley C. and Sharor Ä. Titcomb, do^cket No. 1799295; Richard B. and Donna G. Rogerc, docket No. 17993-95. * This opinion suppleinents 02r previously filed Memorandum Findings of Fact and Opinion in Dixon v Commissioneí-, T.C. Memo. 1991-614, vacated and remanded per curiam sub nom. DuFresne v. Commissioner, 26 F.3d 105 (9th Cir. 1994) . ÈERVED MAR 3 0 - In Dixon v. Commissioner, T.C. Memo. 1991-614, vacated and remanded per curi m sub nom. DuFresne v. Com issioner, 26 F.3d 105 (9t Cir. 1994), following a triallof 14 docketed test cas s of eight Ps, the Court sustained R's disallowance of interest deductions claimed by Ps in various tax helter programs promoted by.K.i After the Court enter decisions against the test case Ps in accordance w' h its opinion, R moved to vacate the decisions entered 'n three test cases (T, C, and X). R alleged that,;befo e the trial of the test cases! R's trial attorney and District Counsel had entered into contingent settl ment agreements with T änd b that had not been disclþsed to the Court or to the other test case Ps or th r counsel. R asked the Court to conduct an evidenti hearing to determine whether the undisclosed agree ents with T and C had affected the trial of the tes cases or the opinion of the Court . TheoCourt granted R's mo ions to vacate the decisions entered in the T a C cases, entered revised decisions in the T and C cas s consistent with R's prior agreements with T and , denied R's motion to vacate'the decision in the X case, and.denied R's request for an evidentiarysh aring on the ground that the testimony, stipulated fa ts, and exhibits relating to the T and C cases.had no terial effect on the Court's opinion as it relate to the remaining test case Ps. On appeal, the Court o peals for the Ninth Circuit vacated the decision in the remaining test cases and remanded them to t 's Court with directions "to conduct an evidentiary h ring to determine the full extent. of the admitted ong done by the government trial lawyers . " Fresne v . Commissioner , supra at 107. The Court of ppeals, citing Arizona v. Fulminante, 499 U.S. 279, 30 (1991), directed the Court.to consider "whether t e extent of misconduct rises to the level of a structural defect voiding the judgment as fundamentally unfair, or whether, despite the government's,misconduct, the judgment can be upheld as harmless error." Id. Further, the Court of Appeals directed this Court to consicer on the merits all motions of intervention filec by affected parties. See id. This Court ordered that lthe cases of 10 nontest case Ps, the majority of whon had previously signed piggyback -agreements, be ,contolidated with the remaining test cases for purposes of the evidentiary hearing. Three groups of Ps participated in all subsequent phases of the evicentiary hearing. . Ps .argue (under various theories) that the Court's decisions in the remaining tE st cases should not be reinstated, or, in the alterrative, that the piggyback . .agreements .are not enforceab]e. R counters that the decisions in the remaining te st cases should be . reinstated on the ground that Ps were not prejudiced by the Government misconduct in the trial of the test cases and that the piggyback agreements remain in force. . Held: The Government misconduct in the trial of the test cases did not result in a structural defect in the trial. Held further: The Government misconduct in the trial of the test cases resulted in harmless error. Held further: The Government misconduct in the trial of the test cases does not provide any other basis for invalidating the Court's decisions in the remaining test cases or for setting aside the piggyback agreements. Held further: As a sanction against R, program participants who have not been the subject of a final determination are not liable for time-sensitive additions to tax for negligence iinder secs. 6653 (a) (2) and 6653 (a) (1) (B) , I . R . C. , or increased interest under sec. 6621(c), I.R.C. Joe .Alfred Izen, Jr., counsel for petitioners in docket Nos. 9382-83, 4201-84, 15907-84, 40159-84, 22783-85, 30010-85, 3097985, 29643-86, and 35608-86. . . - Robert Alan Jones, counsel for petitioners in docket× Nos. 17646-83, 19464-92, 621-94, .and 9532-94. Robert Patrick Sticht, counsel for petitioners in docket Nos. 7323-84, 20119-84, 7205-94, 17992-95, and 17993-95. Mary Elizabeth Wynne, Steven A. Wilson, Andrew J. Gottlieb, Milton J. Carter, .Jr. , Robert E. Casey, .and Richard S. Goldstein, for respondent. . - 4 CONTEl(TS Page Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . , , , . . . . . . . . . . . . . . . . . 9 FINDINGS OF FACT. . . . . . . . . . . . . . . . . . . . . . ... . . . . . . . . . .; . . . . . . . . . . . .15 I. Kersting Tax Shelter Programs and Related Matters . . . . . . . .15 A. The Pike Case . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15 B. Kersting Criminal Investigat Lon. . . . . . . . . . . . . . . . . . . . . . . . . .16 C. Assessments of Kersting PromOter Penalties*. . . . . . . . . . . . . . .18 D. Kersting Notice of Deficienc . . . . . . . . . . . . . . . . . . . . . . . . . . .19 II. Notices of .Deficiency Issued to Kersting Program V. Kersting.Disputes With Program Participants..............55 Participants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20 A. Form of Notices of Deficienc . . . . . . . . . . . . . . . . . . . . . . . . . . . .20 B. Thompson Notices of Deficien y. . . . . . . . . . . . . . . . . . . . . . . . . . .21 C. Cravens Notices of Deficienc . . . . . . . . . . . . . . . . . . . . . . . . . . . .23 D. Alexander Notices of Deficie lcy. . . . . . . . . . . . . . . . . . . . . . . . . .24 1. 1974 and 1975. .......................................25 2. 1976 and 1977 ... ............................. .......26 E. Validity of Notices of Deficiency. . . . . . . . . . . . . . . . . . . . . . . .27 F. Errors in Notices of Deficielcy. . . . . . . . . . . . . . . . . . . . . . . . . .27 III. Commencement of Kersting Pro ject . . . . . . . . . . . . . . . . . . . . . . . .28 A. Tax Shelter Projects and Tes : Case Procedures . . . . . . . . . . . . 28 1. Overview. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .28 2 .. National Of f ice Tax Shelt 3r Branch Functions . . . . . . . . . . 30 B. Petitions for Redeterminatio 1. . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 C. Brian J. Seery. . . . . . . . .s . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 D. Respondent ' s Counsel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 1. Kenneth W. McWade . . . . . . . . . . . . . . . . .'. . . . . . . . . . . . . . . . . . . . 33 2. William A. Sims.......................................34 E. Adoption of Test Case Procedares in Kersting Project . . . . . 34 1. The Honolulu Session (Jun3 1985) . . . . . . . . . . . . . . . . . . . . . . 34 2. Test Case Procedure . . . . ... . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 3. Test Case Array.......................................38 IV. The Maui Session (February 1987) . . . . . . . . . . . . . . . . . . . . . . . . . 42 A. Trial Notices . . . . . . ..:. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 B. Piggyback Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44 C. Mr. Seery' s Withdrawals .as Counsel. . . . . . . . . . . . . . . . . . . . . . . 48 1. The Thompsons.........................................49 2 . The Test Cases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 D. Entries of Appearance by Chicoine and Hallett . . . . . . . . . . . . 51 E . Evidentiary Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . : . . . . . . . . . . 54 1. The Maui Session......................................54 2. Dixon I Opinion.......................................55 A. The Thompsons . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56 1. The Bauspar Program... . . . . . . ". . . . . . .-. . . . . . . . . . . . . . . . . . . . 56 B. The Alexander Dispute . . . . . . . . . . . . . . . . . . . . . ... . . . . . . . . . . . . . 67 C. Collection Actions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1. . . . . . . . 72 1. Steve Hane. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .72 2. Deterioration . of Thompsor /Kersting Relationship. . . . . . . 57 2. Carl Mott, -George Vermef , and Robert Peterson. . 1; . . . . . 73 VI. A. Settlements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .74 Internal Revenue Service Policy. . . . . . ... . . . . . . . . . . . . . . ; . . .74 1. National Office. Position. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .74 2. Regional Counsel. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .76 B. Official Kersting Project Settlement Offer (7-Percent Reduction of Def iciency or Cut -of -Pocket Expenses) . . . . . . . 77 C. Deviations From Of ficial Prc ject .Settlement Of fer. . . . . . . . 78 1. Modified 7-Percent Settlement Offer. . . . . . . ... . . . . . . . . . 78 2 . 20 -Percent Settlement Offer. . . . .:. . . . . . . . . . . . . . . . . . . . . . 80 3 . Negotiations for 50-Percent Settlement Offer. . . . . . . . . . 82 4 . Revival of 20-Percent Settlement Of fer. . . . . . . . . . . . . . . . 84 The Thompson Settlement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92 2 . First Revision of Thompscn Settlement . . . . . ; .? . . . . . . . . 94 3 . Second Revision of Thompson Settlement . . . . . . . . . . . . . . 98 E. The Cravens Settlement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .100 F. The Alexander Understanding. . . :n . . . . . . . : . . . . . . . . : . . . . . . 106 G. The Kozak Decision. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . : . . 115 VI I . Pretrial Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 116 D. 1. Initial Thompson Settlement Agreement . . ; . . . . . . . . . . . . . . 92 A. The Kersting Deposition--Postponed (January 1987) . : . . . . . 116 B. John Doe Summons/Assessments of Promoter Penalties . . . . . . 118 C. Chicoine and Hallett' s Withdrawal as Counsel. . . . . . . . . . . .120 D. Mr . Izen' s Entry of Appearance . . . . . . . . . . . . . . . . . . . . . . . .120 E . The Kersting Deposition (October 1988) . . . . . . . . . . . . . . . . . .121 VIII. Trial of Test Cases (January 1989) . . . . . . . . . . . . . . . . . . . . . .123 A. Mr. Cravens. . . . . . . . ... . . . . . . . . :. . . . . . :. . . . . . . . . . . . . . . . . .124 B. Mr. Thompson. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ... . . . . . . .126 C. Mr. Kersting. . . . ... . ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .129 D. Mr. Alexander. . . . . . . . . . . . . . . . ... .·. . . . . . . . . . . . . ... . .». . . . . .130 E. Mr. DeCastro............................................133 F. Comfort Letters. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .133 G. Mr. Izen's Introduction of Evidence of Collection. Litigation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ... . . . . . . .135 IX. Posttrial Developments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .137 A. First Thompson Refund. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .137 B. Mr. Izen' s Motion To Reopen Record. . . . . . . . .:. . . . . . . . . . . . .141 C. Dixon II Opinion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .142 D. Disclosure of Thompson Settlement . . . .:. . . . . . . . . . . . . . . . . . . 143 . E . Disclosure of Cravens Settlement . . . . . . . . . . . . . . . . . . . . . . . . 152 F . Respondent ' s Motions To Vacate . . . . . . . . . . . . . . . . . . . . . . . . . .155 G. Attempted Discovery by Counsel for Nontest Case Petitioners.............................................156 I. Closing of Cravens Cases..-..............................160 H. Closing of Thompson Cases/Further Refunds...............156 PROCEDURAL HISTORY OF EVIDENTIARY HEARING. . . . . . . . . . . . . . . . . . . . .162 I. Developments Before Evidentiary Hearing.................162 of Inspector General....................................162 B. Revival.of 7-Percent Settlement Offer...................165 C. Disciplinary Actions......!.............................165 D. Indictment of Mr. Izen..................................166 E. Pretrial Conference- (July 1995).........................167 F. Pretrial Conference (January 1996)......................168 G. Denial of Respondent's Moticln To Disqualify Mr. Izen....168 H. Mr. DeCastro's Withdrawal. . . . . . . . . .~. . . . . . . . . . . . . . . . . . . .170 I. Discovery of Alexander Decisions and Referral to Office of Inspector General.............................170 J. Mr. Izen's Motion To Compel Production of Documents and Issuance of Protective Crders.......................171 K. Burden of Proof and Rule 145 Order......................173 II. The Evidentiary Hearing...'..............................175 A. Testimony. . . . ... . . . . . . . . . . . . . . . . . . . . ; . ... . . . . . . . . . . . . . . . . .176 1. Mr. Cravens......................................... 176 2. Mr. Thompson.................5..............r!^........178 3. Mr. Alexander. . . . . . . :. . . .~. . . . . . . . . . . . . . . . . . . . . . . . . . . .179 4. Mr. McWade.c......:...................................180 5. Mr. Sims..............................................182 6. Mr..DeCastro.........................................183 . . . 7. Mr. Izen. . . . . . . . . . . . . . . . . . . . . . . .?. . . . . . . . . . . . . . . . . . . .184 B. Mr. Sticht's Allegations of Potential Witness . . Intimidation............................................186 A. Referral of Thompson and Cravens Settlements to Office C. Mr. Bradt's June 12, 1996, -letter to Mr. Kersting.......187 D. Denial of Mr. Izen's Motion To Refer Thompson and Cravens Settlements and Alexander Agreement to Department of Justice (Public Integrity Section)........189 III. Developments Following Initial Evidentiary Hearing......189 A. Denial of Respondent's Moticn for Further Hearing .Regarding Potential Witness Intimidation................189 B. Supplemental Evidentiary Hesring (August 18, 1997)......192 C. Denial of Mr. Izen's.Motion To Compel Production of Documents...............................................194 D. Denial of Mr. Sticht's Moticn To Reopen Record..........195 E. Denial of Mr. Izen's Motion To Take Judicial Notice.....196 F. Denial of Mr. Sticht's Motiens for Release From Piggyback Agreements....................................198 G. Reports Regarding -the Court's Protective Orders..........199 - 7 - ULTIMATE FINDINGS OF FACT . . . . . . . . . . ... . . . . . . . . . . . . . . . . . . . . . . . . . 200 OPINION.......................................................202 1. Burden of Proof.........................................203 I I . Structural Defect . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..... . . . . . . . 211 A. Case Law................................................211 B. Arguments...............................................215 C. Summary of Government Miscor,duct........................218 D. Discussion..............................................225 III. Harmless Error Analysis.................................233 . A. Review of Dixon II.......................................236 1. Mr. Kersting's Lack of Credibility...................237 2. Sham Analysis........................................238 3.. Lack of Genuine Debt/Walt z of Funds..................240 i. Subscription Interect............................241 ii. . . Primary Loans . ... . . . . . . . .'. . . . . . . . ... . . . . . . . . . . . . . . 242 iii. Leverage Loans..................................244 4. Collection Litigation.................................244 5. CAT-FIT Plan.........................................245 6. Additions to Tax.......................................247 i. Negligence......................................247 ii. Late Filing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 247 iii. Substantial Understatement......................247 iv. Increased Interest........................... ...248 B. Discussion..............................................249 1. Mr. Cravens.........................................249 i. Sham Analysis...................................251 ii. Lack of Genuine Debt /Waltz of Funds . . . . . . . . . . . . . 254 2. Mr. Thompson.........................................255 i . Sham Analysis . . . . . . . . . . . . . . . . . . . . . ..... . . . . . ... . . . ..257 ii. Lack of Genuine Debt/Waltz of Funds.............258 iii. Additions to'Tax................................262 3. Mr. Alexander........................................264 4. Summary. . . . . . . . . ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .266 IV. Fraud, Misrepresentation, ar.d Misconduct................267 V. Fraud on the Court...................-...................271 A. Case Law Survey.........................................271 B. Discussion..............................................281 VI. Mr. Izen's Allegations That Mr. DeCastro Was a "Mole"...283 VII. Enforceability of Piggyback Agreements...................284 A. Principles of Contract Law..............................285 B. Discussion.................-............................290 1. Benefit of the Bargain.. ............................290 2. Mr. Seery's Purported Conflict of Interest...........294 - 8 3. Rejection of Mr. Izen's »rgument for Entry of Decision On the Basis of Thompson Decisions..........296 VIII. Mary Carter Agreements..................................296 IX. Mr. Sticht's Motion To Sever Case and for Entry of Decision or Alternatively Tc Sever Case and Set for Trial . . . . . . . . . . . . . . . . . . . . . . . . . . . ... . . . . . . . . . . . . ... . . . . . . .300 X.. Protective Orders........................................302 XI. Sanctions...............................................305 Conclusion.....................................................307 SUPPLEMENTAL MEMORANDUM FINDINGS OF FACT AND OPINION BEGHE, Judge: Eight of these consolidated cases--with five petitioners represented by Joe Alfred Izen, Jr. (Mr. Izen),--are test cases before the Court on remand from the Court of Appeals for the Ninth Circuit in DuFresne v. Commissioner, 26 F.3d 105 (9th Cir. 1994), vacating and remanding per curiam Dixon v. Commissioner, T.C. Memo. 1991-614 The other 10 consolidated cases--with petitioners in one case represented by.Mr. Izen and the other petitioners represented by Robert Alan Jones Mr. Jones) and Robert Patrick Sticht (Mr..Sticht)--are nontest cases that have been added to the consolidated group in order to effectuate the direction of the Court of Appeals "to consider on the merits all motions of intervention filed by parties aff cted by this case." Id. at 107. Unless otherwise indicated,- aection references are to the Internal Revenue Code, as amended, and Rule references are to the Tax Court Rules of Practice and P-ocedure. Introduction These consolidated cases are part of a group of more- than 1,300 remaining cases--more than 500 cases have settled--arising from respondent'stdisallowance of interest deductions claimed by participants in varlous tax shelter programs promoted by Hen ý F.K. Kersting (Mr. Kersting) . Tha Kersting group of cases (hereinafter the Kersting project) was assigned to Judge William A. Goffe (Judge Goffe) for disposition. By agreement of the parties and the Court, the·merits of the Kersting programs were to be litigated in a consolidated trial of '14 docketed cases of eight petitioners that had. been designated as "test cases". The vast majority of the remainins Kersting project ·petitioners signed stipulations to be bound . (bometimes referred to herein as piggyback agreements) in which they agreed with respondent that their cases would be resolved in Lccordance with the Court's opinion in the test cases. Before the trial of the test cases, some test case petitioners argued that a 1981 setrch of Mr. Kersting's office had been illegal,. that materials rieized during the search should be suppressed in the test case proceedings, and that the burden of proof and burden of going forwerd with evidence should be shifted to respondent. (1988) In Dixon v. Commissioner, 90 T.C. 237 (Dixon I), the Court held, in an opinion by Judge Goffe, that the petitioners had failed to establish standing to contest the Kersting search and seizure. - 10 - Judge Goffe held the trial of the test cases in Honolulu, Hawaii, during January 1989. The najority of the test case petitioners were represented at trial by Mr. Izen. However, test case petitioners John R. and Maydea L. Thompson (docket Nos. 19321-83, 31236-84, and 3Ó965-85) were represented at trial by Luis C. DeCastro (Mr. DeCastro), and test case petitioners John R. and E. Maria Cravens (docket Nos. 16900-83 and 15135-84) appeared - pro sese . Following the trial of the test cases, the Court issued its 042 memorandum opinion in Dixon v. Comnissioner, T. C. Memo. 1991-614, 62 T..C.M. (CCH) 1440, 1991 T.C.M. (RIA) par. 91,614 (Dixon II), sustaining,virtually all of respondent's determinations in each of the test cases, and entered decisions against the test case petitioners in accordance with its opinion. On March 13, 1992 the Court entered the following decisions in the Thompson and Cravens cases: John R. and Maydee L. Thompson Sec. Additions to Tax Sec. Sec. Y_e.gr Def iciency 6651 (a) 6653 (a) 6653 (a) (1) 1979 $18,161.00 --- $908 --- 1981 36, 294 . 52 $4, 934 . 32 --- $1, 958 . 28 1980 24,838.00 --- --- --- Sec. 6653 (a) (2) --- --- 50 percent of the interest due on the deficiency John R. and E. Maria Cravens Year Deficiency Additions to Tax Sec. 6653(a) 1979 1980 $4,508.00 5,893.45 $225.40 294.67 - 11 - On June 9, (1992, respondent filed motions for leave to file motions to .vacate: the decisions eittered against the Thompsons, the Cravenses, and another, test case petitioner,. Ralph J. Rina (Mr. Rina), docket No. 17640-83. Respondent's motions. to vacate alleged that,· before the trial of, the. test cases, respondent's trial attorney, Kenneth W. McWade (Mr. «McWade), and his supervisor, Honolulu District Courtsel William A.~.Sims (Mr. Sims), had entered into contingent settlement agreements with the Thompsons and the Cravenses that hadi not been disclosed to the Court or to the other test case petitioners or their counsel. Respondent asked the Court to conduct an evidentiary hearing to determine whether the undisclosed agreements with the Thompsons and the Cravenses had affected the trial of the test cases or the opinion of the Court. On June 22, 1992, Judge Goffe granted respondent's motions to vacate filed in the Thompson arid Cravens cases, vacated the decisions entered in those cases, ordered the parties to file agreed decisions with the Court, or otherwise move as appropriate, and denied respondent's request for an evidentiary hearing. By order dated June 22, 1992, Judge Goffe also denied respondent's motion to vacate the decision entered against Mr. Rina, on the ground that the testimony, stipulated facts, and exhibits relating to the Thompson and Cravens cases had no material effect on the Court's Di::on II op1nlon as it related to Mr. Rina. . - 12 - On July 22, 1992, the test case petitioners represented by Mr. Izen filed a motion for reconsideration of the Court's order denying respondent':s motion to vacate the decision in the Rina case. By order dated August 4, 1992, Judge Goffe denied petitioners' motion for reconsideration. - In August 1992, the Court entered révised decisions in the Thompson and Cravens cases -consistent with Mr. McWade's prior agreements with the taxpayers in those cases. Specifically, the Court entered the following decisions in the Thompson. and Cravens cases: John R . and Maydee L . Thompson v Year 1979 1980 1981 Deficiency --- $15,000 15, 000 . Additions to Tax --- ----- John R . and E . Maria Cravens Year Deficiency Additions to Tax 1979 1980 $3,606.40 6,175.76 ---' --- The decisions entered in the Thompson and. Cravens cases are now final.2 2 Mr. Izen and Mr. Sticht filed separate motions with the Court to intervene in the Thompsor and Cravens cases. The Court denied these motions to intervene Although Mr. Izen and Mr. Sticht filed separate appeals in the Thompson and Cravens cases with various courts, including the Courts of Appeals for the Second, Ninth, and Tenth Circuits, all appeals in the Thompson and Cravens cases eventually were dismissed. In an unpublished opinion filed June 15, 1994, the Court of Appeals for the Ninth Circuit stated: (continued. . . ) . Because of Judge:Goffe's ternination, mon September 30, 1992, of his recallastatus as a Senior udge of the Court, all cases in the Kersting project group were re asigned to Judge Renató Beghe . The other test case petitioners,1 including .Mr. Rina, appealed the decisions entiered in their casess to the Court of Appeals for the.Ninth Circuit'. Or appeal, those petitioners argued that the trial of the test cases had been tainted by the Thompson.and Cravens settlement acreements. The response of the Court of Appeals was toevacate the .decisions in the remaining test cases and remand them to this Court with directions "to conduct an evidentiary hearing to determine the full extent of the admitted wrong done by the government trial lawyers."· DuFresne v. Commissioner, 26 F.3d at 107. The Court of Appeals, citing Arizona . v. Fulminante , 499 U. S . 279, 309 (1991) , directed the . Court to consider "whether the extent of misconduct rises to the level of. a structural defect voiding the judgment as fundamentally unfair, or whether, despite' the government's misconduct, the judgment can be ul;held as harmless error. " DuFresne v. Commissioner, supra at 107. Further, the Court of 2(...continued) . The Tax Court's August 25 and 26, 1992 decisions entering settlement in the Cravens and Thompson cases, respectively, are finalx 26 U.S.C. § 7481(a) (1); Fed. R. App. P. 13. The Tax Cour lacks jurisdiction to vacate those decisions. Bil ingsley v. CIR, 868 F.2d 1081, 1084 (9th Cir. 1989) . Because there is no case remaining in which the taxpayers can intervene this appeal is moot . , [Adair v. Commissioner, No. 92,70812, 26 F.3d 129 (9th Cir. 1994) .] 14 - Appeals directed this Court to corsider on the merits all motions of intervention filed by parties affected by Dixon II. ·See id.3 On February 2, 1995, respond 254nt filed a Motion for an Evidentiary Hearing. On September 14, 1995, the Court granted respondent's motion. To effectuate the« direction of the Court of Appeals regarding intervention, the Court ordered that the cases of 10 nontest case petitioners, the majority of whom had previously signed piggyback agreen.ents, be consolidated with the remaining test cases for purposes of the evidentiary hearing.' As a result, three groups of petitioners have participated in all subsequent phases of the evidentiary hearing: Test case and nontest case petitioners represented by Mr: Izen; nontest case petitioners represented by Mr. Joïes; and.nontest case petitioners represented by Mr..Sticht.5 The positions taken by 3 The appellate panel in DuFresne v. Commissioner, 26 F.3d 105, 107' (9th Cir. 1994), vacatinc and remanding per curiam Dixon v. Commissioner, T.C. Memo. 1991-£14, 62 T.C.M. (CCH) 1440, 1991 T.C.M. (RIA) par. 91,614 (Dixon I)), issued an order stating that the panel would retain jurisdiction over any subsequent appeal. * On June 13, 1995, test case petitioner Mr. Rina conceded his case in full, resulting in ent ry of a stipulated decision in docket No. 17640-83 that was ident ical with the decision originally entered in that case oï the basis of the Court's opinion in Dixon II. s The group of cases that were consolidated for purposes of the evidentiary hearing initially included the case of William D. and Karen S. Booth, docket No. 28950-88, in which Declan J. O'Donnell (Mr. O'Donnell) had ent red his appearance. However, at the start of the evidentiary hearing, the Court granted Mr. O'Donnell's motion to sever the Booth case from the cases consolidated for the evidentiary hearing. Mr. O'Donnell argued that, in light of the theory underlying a Motion for Summary Judgment that he had filed on behalf-of the Booths, they had no (continued...) - - 15 - the various groups . of petitioners dtiring . thesel proceedings have not been consist;ent in call respect s andv in2some arespects the positions of counsel--primarily Messrs. Izen 'and Sticht--have become adversarial. . Following pretrial conferences on the record in Los Angeles on July 17, 1995, nând January 16 1996, the evidentiary hearing was held at special trial sessione of the Court conducted in Los Angeles on May 13 to 30 and June ] O ,to 26, 71996, and August 18, 1997. In the interest öf chronology and as arí aid to understanding this opiniori, the procedural history of the evidentiary hearing comes after the Court'.s detailed findings> of fact and before the ultimate findings of fact. FINDINGS F FACT I. Kersting Tax Shelter Programe and Related Matters A. The Pike Case Mr . Kersting began promoting tax shelter programs in Hawaii in the early 1970 ' s . Mr . 042 Kerst ing ' s early tãx sheltei programs included an "Auto-Leasing Plan" ar.d an "Acceptance Corporation Plan. " Those plans generally r~egtired participants to purchase s ( . . . continued) need to participate in the evident.iary hearing. In Gridley v. Commissioner, T.C. Memo. 1997-210, the·Court rejected the argument, raised in the Booths' Motion for Summary Judgment, that Kersting petitioners who sigtred stipulations to be bound to Dixon II were entitled to entry of decisions in their cases consistent with the decision entered by the Court in the Thompson case at docket No. 19321-83. See infra pp. 168-169, 171-172, and 187-188. -- 16 - stock in a subchapter S leasing corporation or an acceptance corporation and/or enter into a stbscription agreement.to purchase stock, all in connection with loans to the participants by various entities created by Mr.. Kersting. The plans were primarily designed to generate income tax deductions for interest that the participants purportedly paid to the Kersting entities on the loans. 042 The Commissioner determined that participants in Mr. Kersting's auto-leasing and acceptance corporation plans were not entitled to deduct: (1) "Interest" that participants claimed to have paid on eithet the Auto-L(asing stock purchase or leverage loans; (2). thesparticipal ts' pro rata shares of losses or investment credits from the auto leasing companies; and (3) "interest" that participants claimed to have paid either on the acceptance corporation stock purchase or stock subscription loans. In.Pike v. Commissioner, 78 U.C. 822 (1982), affd. without published opinion 732 F.2d 164 (9th Cir. 1984), this Court sustained the Commissioner's disa _lowances of all deductions for interest, losses, and credits claimed by participants in Mr. Kersting's early programs. B. Kersting Criminal Investigation While the Pike litigation waã underway, Mr. Kersting continued to promote additional tax shelter programs, which came to be known as the stock purchase plan, the stock subscription plan, the leasing company plan, and the CAT-FIT plan. The - 17 - Court'Eopinion iirï Dixon II desch.bes the tnechanics oft these programà in detail. On January 22, 1981, following an undercover criminal investigation, the Internal Revenue Service searched Mr. Kersting's offices in Hawaii pursuant to a -search warrant issued by the U.S. District Court for the .District of Hawaii. Seventy-seven boxes and two filing cabinets of irecords were seized from Mr. Kersting's office including lists identifying, by name and addres s , approximatel 1, 80 0 , part icipant s in Mr. Kersting's programs, and schedules of the interest purportedly paid by each participant to _one .or more Kersting companles during the taxable years 1977, 1978, and' 1979. On January 24, 1981, Mr. Ker ting wrote a. form letter to the participants of his programs, one of his many "Dear Friend" letters, stating that he had been entrapped by an undercover Internal Revenue Service special agent into creating a backdated "tax deduction" of $21,600.a By Jetter dated February 15, 1981, Mr. Kersting provided participanta in his programs. with "tax reporting notices",. presumably fo: the 19.80 tax year, and encouraged them to "take full advantage of the .deductions 7 The Kersting. programs involved a number of corporations (hereinafter Kersting corporations) . Mr. Kersting served as both a director and president of most af these corporations and also sometimes owned stock. For those corporations in which he served as president during the years in issue, he had exclusive management authority. . . 8 The record in these cases contains no fewer than 38 "Dear Friend" letters. - 18 - reported to you. " Mr. Kersting f rther informed participants that the Internal Revenue Service had "accomplished only a temporary disruption of our opera ions" and that his office was "back to almost normal workings". All records seized in thè January 22, 1981, search were rettrned to Mr. Kersting by 1987. In .January 1983, Mr. Kerstinç filed suit in the U.S. District Court for the District of Hawaii (docket - No . CV-83-0018MP) against the United States, th 254 Internal Revenue Service, and certain Internal Revenue Service igents alleging, inter alia, that the January 1981 search was i llegal and that the defendants had abused the. grand jury process by shopping for a favorable grand jury, by violating grand ju y secrecy, and by using the grand jury as a civil investigati n tool. Through a number of unpublished orders, the District ourt and the Court of Appeals for the Ninth Circuit rejected Mr 'Kersting's claims. See - Kersting v. United States, 865 F. Supp. 669, 674-675 (D. Haw. 1994) . C. Assessments of Kersting Prom ter Penalties Mr. Kersting's tax shelter a tivities did not lead to an indictment . However, in October 989, the Commissioner assessed promoter penalties of $1, 545, 201 nd $2, 330 , 000 against Mr. Kersting, pursuant to section 6700 and 6701," respectively, for the years'1982 through 1988. The District Court for the Sec. 6700 provides for im osition of a penalty of a percentage of the gross income de ived from promoting an abusive tax shelter, and sec. 6701 provid s for imposition of a penalty (dontinued...) District of Hawaii sustained the Cþmmissioner' s assessments . See Kersting v. United States, Civil N s. 90-00304, 91-00747, 92- 00593 (D. Haw., Sept. 30, 1994) . Mr. Kersting's appeal of that decision to the Court of Appeals r the Ninth Circuit, docket No. 94-16942, was argued and subm ted on May 8, 1996, but subsequently withdrawn from submi ion (with an opportunity for supplemental briefing) until afte this Court issues its opinion in these consolidated cases. D. Kersting Notice of Deficienc The Commissioner sent Mr. Ke sting a notice of deficiency determining deficiencies in and a ditions to his Federal income taxes for the taxable years .982 hrough 1988. The deficiencies were based upon the Commissioner' determination that cash payments of so-called leverage lo n interest received by Kersting corporations, which were characte ized by the District Court in the promoter penalty cases as "al er egos" of Mr. Kersting, and which the Court's Dixon II opinio characterized as fees paid to Mr. Kersting by program participa ts in- exchange for= tax deductions, were includable in Mr Kersting' s gross income . Mr. Kersting filed a timely petit on for redetermination with this Court (assigned docke No. 7 48 96), -and the case was tried at a Honolulu special trial sessi n that commenced January 27, 1999. 9 ( . . . COntinue of $1,000 (per incident) upon a p rson who knowingly aids or assists another in understating h a tax liability. - 20 - II. Notices of Deficiency Issued to Kersting.Program Participants In 1982, respondent began to issue notices of deficiency to Kersting program participants, diEallOwing interest deduCtions claimed with respect to the stock purchase plan, the stock subscription plan, the leasing conipany plan, and the CAT-FIT plan for a number of taxable years. A. Form of Notices of Deficiency The notices of deficiency istued by respondent to many Kersting program participants usec a common format, stating in pertinent part as follows: EXPLANATION OF ADJUSTMENTS 1. It is determined that the following amounts claimed on your income tax return as interest deductions are.not allowable: Amount $--------- Purported Payee U°l Any entity owned, associated witl, or controlled, either dir$ctly or indirectly, by Henry Kersting. This.disallowance is based oli the determination that the transactions giving rise to the claimed interest deduction are shams. This d:.sallowance is further based upon your failure to entablish that the above amounts were paid or properly accrued, or that, the transactions purportedly generating the claimed amounts resulted either in any bona :!ide indebtedness or in any enforceable and bona fide ob:.igation to pay compensation for use or forboarance of money on indebtedness within the mean _ng of I.R.C. Section 163. Furthermore, if it is eatablished that any portion of the above disallowed "intorest" is a properly 1° In some instances, respondent's notices of deficiency listed specific Kersting corporations under "Purported Payee". - 21 - allowable deduction,7it is ftrther determined that such interest constitutes interest in investment indebtedhess and deduction of .such amounts is limited under the provisions of I.R.C. 163(d). Further, and in -support of a portion-of the determined deficiency, if yot establish that you are entitled to the above-mentiored interest deduction, it is determined that you improperly failed to report the income resulting from the sane.transaction. 2. It is determined that part of the underpayment of tax for the taxable year is due to your negligent of [sic] intentional disregard of the rules and regulations. Consequently, the 5 percent addition to the tax is charged for ss provided by Section 6653(a) of the Internal Reverue Code. B. - Thompson Notices nof Deficiency John R. Thompson (Mr. Thompscn) was a pilot with Continental Airlines from 1946 until his retirement in October 1982. Mr. Thompson became aware of Mr. Kersting's programs through a conversation with another pilot, Fichael Provan (Mr. Provan), who had solicited other pilots to participate in Mr. Kersting's programs." The Thompsons began participating in Mr. Kersting's programs in 1977." In addition to their participation in Mr. Provan, who was at one time the president of one of the Kersting companies, eventually became an adversary of Mr. Kersting. See infra p. 66. Although the Thompsons participated in one of Mr . Kers ting ' s programs during 19 , 7, the Thompsons did not claim,any Kersting-related intereEt deductions on their 1977 return because their accountant-return preparer refused to include them on the return. The record suggests that the Thompsons' 1978 tax return was prepared by Phil Scheff (an ancountant recommended by Mr. Kersting).and that the Thompsons claimed Kersting program interest deductions on their return for that year. The Thompsons experienced audit problems with.tbeir 1978 tax return that were (continued...) - 22 - certain programs that were the subject of this Court's opinion in Dixon I-I, the Thompsons, along with some 40 other investors, including Mr. Provan, participated in a transaction arranged by Mr. Kersting in early 1978.to acquire First Savings and Loan Association of Hawaii ~(First Savings) . The Thompsons filed joint Federal income tax returns for 1979, ·1980, and.1981 in which they claimed interest deductions attributable to their participation in certain Kersting programs. On May 5, 1983, June 13, 1984,. and May 31, 1985, respondent mailed notices of deficiency to the "Thompsons determining deficiencies in and additions to their Federal income taxes for the taxable years 1979, 1980., and 1981, as follows: . 1 Year..Deficiency Sec. 6651(a) Additions to Tax Sec. Sec. 6653(a) 6653(a) (1) 1979 $18,161.00 ; --- $908 --- --- $4,934.32 --- $1,958.28 50 percent of 1980 1981 24,838.00 36,294..52 --- --- --- Sec. 6653(a) (2) --- the interest due on the deficiency Respondent further determined that the Thompsons were liable for increased interest for 1981 pursuaat to section 6621(d)." The (...continued) . due, in part, to their failure to attach to.the return a Form W-2 showing the amount of tax.that Continental Airlines had withheld from Mr. Thompson's wages. In early to mid-1986, the Thompsons' counsel, Samuel M. Huestis, negotiated a.settlement of their tax liability for 1978. The record does not disclose the terms of the -settlement. Sec. 6621(d) was redesignated sec.r6621(c) by sec. 1511(c) (1) (A)-(C) of the Tax Reforn Act of 1986 99-514, 100 Stat. 2744. (TRA), Pub. L.. We will hereinafter refer to the (continued...) - 23 - Thompsons filed titnely7 joint petitions for redetermination ·of the above-described deficieñcies. C. Cravens Notices of Deficiency John R. Cravens was a pilot with American Airlines during 1979 and 198.0. Mr. Cravens became aware of Mr. Kersting's programs through conversations with other pilots. The Cravenses filed joint Fec.eral income. tax returns .for 1979 and.1980 in which they.claimed interest deductions attributable to their participaticn in certain'Kersting programs. On April 15, 1983, and March 20, 1984, respondent mailed notices of deficiency to the Cravenses determining deficiencies in and additions to their Federal- income taxes for the taxable years 1979 and 1980; as follows: Year Deficiency Acditions to Tax Sec. 6653(a) 1979 1980 $4,508.00 19,251.70 $225.40 962.59 The notice of.deficiency issued tc the Cravenses for 1979, while disallowing interest deductions oi $9,810, included a credit for personal exemptionsvof.$4,000, reculting in a net adjustment of $5,810. The notice of deficiency issued to the cravenses for 1980 included disallowed interest deductions of $19,620 and, as an alternative to the disallowanco of such interest.,; the inclusion of $18,000 in.unreportec. dividend income from a Kersting controlled entity known cs Candace'Acceptance Corp. (...continued) provision as sec. 6621(c). - 24 - (Candace) . The _notice of deficiency issued 2to the Cravenses for 1980 also included the disallowance of two personal exemptions claimed for the Cravenses' children. The Cravenses filed timely oint petitions for tedetermination contesting the abovedescribed notices of deficiency. The Cravenses' reporting position was unique among the test case petitioners insofar as: the Cravenses had adjusted (reduced) their tax basis in their Candace stock by the amount of a "non- taxable distribution" from Candace in 1980. Having reduced the basis of their Candace stock, the Cravenses reported a capital gain of $7.,200 on their 1980 tax return after surrendering the stock to Mr. Kersting in exchange for cancellation and return of the note evidencing their primary toan. D. Alexander Notices of Deficiency Denis Alexander (Mr. Alexandec) is a broker and investor who first met Mr. Kersting in Los Angeles in the early 1960's. Mr. Alexander lent money to Mr. Kecsting's -subchapter S leasing corporations in the 19'70's, participated in the acquisition of First Savinc)s, and participated in some of the Kersting programs at issue in Dixon II. . " Although the Cravenses' reporting position was unique insofar as they had reported a capi.tal gain in a taxable year ·in dispute before the Court, we note chat test case petitioners Robert L. and Carolyn S. DuFresne 2ad also reported a capital gain (albeit in a year subsequent :o the years in dispute) upon the surrender of stock in Chacter Financial Corp. to Mr. Kersting. Like the Cravenses', the DuFresnes' capital gain was attributable to their reductio2 of the tax basis of their stock as opposed to an increase in its value. -. 25 1. 1974 and 1975 . Mr. Alexander and his wife, Freida, filed.joint Federal income tax returns for the taxable years 1974, 1975, 1976, and. 1977. Following an examination of their -returns for 1974 and 1975, the Alexanders conceded certain adjustments proposed by respondent, resulting in agreed" assessments of $2,133 and $811 for 1974 and 1975, respectively.15 However, because the - Alexanders declined to agree to other proposed adjustments, respondent, on November 29, 1979, issued a notice of deficiency determining deficiencies of $4,891.83 and $40,760.38, respectively, in their Federal income taxes for 1974 and 1975. Respondent's deficiency determinations against the Alexanders for 1974 and 1975 were based, in partfon disallowance of interest deductions of $2,917 and $46,500, respectively, attributable to their participaticn in Kersting programs for those taxable years. Additional adjustments included e disallowance.of an.$183500 capital loss_ claimed by the Alexanders for 1974 on_a sale of stock in Mendocino Financial Corp. and respondent's determination that they had failed to report a $59,080 capital gain for 1975 froa·a sale of real estate to the Cadillac Drive Apartments partnership. is The Alexanders were represented during the audit by their accountant,.Gilbert Matsumoto (Mr. Matsumoto).. Mr. Matsumoto had served as the accountant for some of Mr. Kersting's subchapter S leasing corporations, and Mr. Kersting had recommended that program participants use Mr. Matsumoto, among others, to prepare their tax returns. - 26 - On February L28, 1980, the Alexanders filed a timely petition with the Court·, assigned docket No. 2758-80, contesting the notice of deficiency for. 1974 and 1975. 2. 1976 and 1977 Respondent also.examined the Alexanders' joint income tax returns for 1976 and 1977. On. April 17, 1986, respondent issued the Alexanders _a notice of deficiency determining deficiencies in and additions to their 1976 and 1977 Federal income taxes, as follows: Year Deficiency 1976 1977 $3,596 876 Additions to Tax Sec.. 6653(a) . $180 44 Respondent also determined that the Alexanders. were liable for increased interest for 1976 pursuLnt to section 6621(c) . The deficiencies that responcient determined against the Alexanders for 1976 and 1977 resulted,. in part, from respondent's disallowance of interest deductiorss of $8, 665 and $12, 993, respectively, attributable to their participation in Kersting programs for those years. Respondent also disallowed a $5,149 partnership loss claimed by the Alexanders for 1976 on their investment in the Avista Epsilon and Sarbonne partnership. On July 21, 1986, the Alexanclers filed a petition through Mr. Kersting's office, assigned docket No. 30413-86, contesting the notice of deficiency for 1976 and 1977. - 27 - E. Validity of Notices of Deficiency 042 In Dixon II, the Court considered and rejected arguments by the test case petitioners represer.ted,by Mr. Izen that the notices of deficiency-issued to them were invalid under Scar v. Commissioner, 814 F.. 2d 1363 (1983). (9th Cir . 1987) , revg . 81 . T . C. 855 After the evidentiary hesring in these proceedings, the Court rejected the Scar argument sdvanced by Mr. Jones on behalf of a Kersting participant who had2 settledihis case before the trial of the test cases - in Dixon J I . See Richards v. Commissioner, T;C. Memo. 1997-149, supplemented by T.C. Memo. 1997-299., affd. without.published opinion 165 F.3d 917 (9th Cir. 1998)." F. Errors in Notices of Deficiency Although this.Court.rejected.the argument that notices of- deficiency issued to Kersting program participants were invalid, it is evident that some-notices. of deficiencylissued to Kersting program participants did contain errors: For instance, in Richards v. Commissioner, supra, it appears that respondent. overstated the deficiency using an excessive tax rate of 70 percent. In addition, the petition.filed in the Richards case included an allegation thatirespondent disallowed interest Although Luis C. DeCastro had negotiated the settlement on behalf of Mr. and. Mrs. Richards, he did not participate in the filing or prosecution of Mr. Jones' motion to vacate the decision entered in their case. - 28 - deductions in excess of Kersting interest deductions that the Richardses actually claimed." Similarly, as observed in the Court's Dixon II opinion, respondent's alternative determinations in the notice of deficiency issued to the Cravenses overstated their deficiency for 1980. The Court ordered-that the Cravenses' deficiency for 1980.be reduced to account for: (1) The,elimination of respondent's alternative.determination that the Cravenses failed to report $18,000 in dividends paid by.Candace; and (2) respondent's failure.to eliminate the capital gain of $7,200 reported by the Cravenses for 198C on the disposition of their Candace stock. .. .... III. Commencement of Kersting Project A. Tax Shelter Projects and Test Case Procedures 1. Overview :r The large volume of cases gererated by the Commissioner's disallowances of deductions claimcd by taxpayers participating in large tax shelter programs during the late 1970's and early 1980's created the largest inventcry the Tax Court. 042of cases ever docketed in Among the responses of the Internal Revenue Service and the Tax Court were the development of procedures that Test case petitioners Terry D. and Gloria K. Owens alleged in their petition that respondent disallowed legitimate interest deductions in their notice of deficiency. However, it appears that the allegation was nc-t pursued by or on behalf of the Owenses, inasmuch as the decision entered by the Court in their case, following the issuance of the Court's opinion in Dixon II, was consistent with the deficiency determined by respondent. I - 29 were intended to streamline the .1:.tigatiron process, economize on the use of administrative and jud:.cial resources, and reduce the costs incurred by taxpayers in renolving disputes over tax shelter adjustments. The Interna.1 Revenue Service, Office of Chief Counsel, created the Tax Shelter Branch in the National Office to oversee tax shelter lit:.gation across the country. and to organize individual tax shelter projects. Concurrently, the Tax Court began working with the ::nternal Revenue Service' and private parties in tax shelter canes to create what became known as the, test case procedure; i.e., the selection of representative or test cases from a particular tax shelter project for a single trial on the merits. See, e.g., Drobny v. Commissioner, T.C. Memo. 1995-209 (citing H. Conf. Rept. 98-861, at 985-986 1984-3 C.B. (Vol. 2) .1, 239-240), affd. 113 F.3d 670 (1984), (7th Cir. 1997) . The test case procedure is intended to streamline the litigation process. To thise end, taxpayers who are not sel·ected . as testo cases are encouraged to e2:ecute a piggyback agreement; i.e., a stipulation to be bound by the outcome of the test cases. As a practical matter, . the effectiveness of the .test. Case procedure depends in large part upon the agreement of the taxpayers not selected as test cases to be bound by the outcome of the test cases. Normally, taxpayers in a tax shelter project who decline orgotherwise fail to nign a piggyback agreement will either have their cases set for trial with the test cases or, after the trial of the test cases, will be. ordered to show cause 30 - why their case should not be decided the same way as the test cases . See, e . g . , Krause v. Comm:.ssioner, 99 T . C: .132 (1992 ) , affd. sub nom. Hildebrand v. Comm:.ssioner, 28 F.3d 1024 Cir. 1994); Acierno v. Commissioner, T.C. Memo. Karlsson v. Commissioner,: T.C. Meno. .1997-432. (10th 1997-441; Using the order to show cause procedure to dispose of nontest cases in a tax shelter project .is more cumbersome and consumes more time .and judicial, administrative, and private party resources than using piggyback agreements . As: discussed in greater detail below, the Court used the test case procedura in the Kersting project; the vast majority of the Kersting pro:ect participants signed piggyback agreements. 2. See infra pp. 34-41. . National Office Tax Shelter Branch Functions The Tax Shelter Branch, established by the Office of Chief Counsel in the National Office, wus given the responsibilities of coordinating the examination, appeals, and litigation functions and of overseeing tax shelter projects from the National Office perspective . The Tax Shelter Branch provided advice and prepared material for use by the field in tax shelter cases, reviewed legal briefs, .monitored the statu of tax shelter case inventory, and prepared reports for Internal Revenue Service executives. The. Tax Shelter Branch monitored tax shelter projects by reviewing and extracting informat:.on .from quarterly tax shelter reports that were required to be nubniitted by the project attorney; i.e., the District Counnel trial attorney with primary responsibility for the project . ach project attorney was - 31 - required to submit a quarterly ta: shelter report providing an update on the status of the projec t, including a summary of the current project settlement offer and any fecent court action affecting the project. One of the goals of the tax 13heltef'program was consistent treatment of similarly situated taxpayers. The Táx Shelter Branch monitored settlement offers in similar tax shelter projects for disparities and tried to determine whèther the project settlement offers should be similar. .However, actual supervisory responsibility in a tax shelter project was left primarily in the Regional' Counsel and District' Counsel offices to which the project was assigned. B. -Petitions for Redetermination In or around June 1982, Mr. Kersting facilitated the filing of petitions with the Tax Court bv Kersting program participants. In letters issued in June and Jul 1982, Mr. Kersting informed Kersting program participants that a joint petition was being prepared on behalf of a large gfouþ of taxpayers. On July 12, 1982, Lu N. Nevels, Jr., filed a consolidated Tax Court petition, assigned docket No. 17445-82, on behalf of 60 Kersting þrogram participants.18 18 Lu N. Nevels, Jr., had represented the test case taxpayers in Pike v. Commissioner. 78 T.C.'822 (1982), affd. without published opinion 732 F.2ci 164 (9th Cir. 1984). For an example of the problems created by using oné petition on behalf of so many different petitioners, see Aaronson v. Commissioner, T.C. Memo. 1985-131, involving the Hongsermeier petitioners in what is now docket No. 29643-86. See infra p. 38. . C. - 32 - Brian J. Seery In early 1982, Brian J. Seery (Mr. 'Seery) began assisting Kersting program participants with issues arising from the audit of their income tax returns. On April 14, 1982,3 Mr. Kersting issued a . letter to Kersting program participants informing them . that they soon would receive sa letter from the Commissioner proposing to disallow their Kerstung program interest. deductions. Mr. Kersting advised program part;.cipants that they should not remit any amount to the Internal Itevenue Service until their liability was determined in 3pourt 042On February:15, 1983, Mr. Kersting issued a letter to Kerst:.ng program participants stating in pertinent part: "I trust that you have placed the tax retrievals which we have accomplished for you over the years into profitable investments and that you are receiving a reasonable rate of return. You will .not losm any ground if your funds earn at least a return equal to ;the ini erest charges imposed by the IRS from time to time." On March 1, 1985, Mr. Kersting issued a -letter to Kersting program part:icipants stating: that he had retained Mr. Seery to represent them in the Tax Court at no charge to the individual petitioners." The letter requestod that each Kersting program participant provide written autho"ization for Mr. Seery's Initia'lly, Mr. Kersting oc the entities that he controlled paid the legal . fees asaociated with the Tax Court litigation. Later, however, some Kersting program participants began paying $100 per month to a .egal defense fund managed by Mr. Kersting. representation. In a letter to program participahts dated August 11, 1986, Mr. Kersting; recommendect that program 'participants not attempt to resolve their cases on their own and instead rely on counsel that he had hired. Mr.. Seery subsequently entered his appearance in the Tax Court on behalf of several hundrect Kersting petitioners, including the Thompsons and the Cravenses. 'Mr. Seery's compensation for legal services rendered to Kersting program participants was always paid by one of the corporations controlled by Mr. Kersting. . D. Respondent's Counsel 1. Kenneth W.. . McWade In 1970, Mr. McWade began hi career as a trial attorney with. the Office of Chief Counsel. Mr. McWade's. duties with the Of·fice of Chief Counsel.included litigating tax cases. In January 1982/ Mr. McWade transferred from respondent's~ District Counsel office .in Seattle , Washington, to respondent's District Counsel office in Honolulu, Hawaii... initially assisted with the Pike Mr. McWade roup of cases. On or about July 1, 1984, the Kersting project was officially established in the Honolulu Appeals Office, and Nr;. McWade was appoiñted'to serve as the project -attorney. W2 lly Kobayashi was appointed to serve as the .key Appeals officer f or the Kersting project. By late 1986, Mr. McWade had litigated 40 to 50 Tax Court . cases. However, Mr. McWade-had never litigated any cases that were part of a tax shelter project . - 34 - 2. William A.. Sims In 1972, Mr. Sims began his. career with the. Office of Chief Counsel, General Litigation Division, National Office. Except for a 6-month assignment doing Ta>: Court work, Mr. 'Sims handled general litigation matters concerr.ing collection, bankruptcy, and tax liens. Mr. Sims eventually became Assistant Director of the General Litigation Division in the National Office. In February 1986, Mr. Sims w2 s appointed District Counsel for Honolulu, Hawaii. Before his. appointment as District Counsel, Mr. Sims had never workec on a tax shelter project in any capacity. E. Adoption of Test Case Procedures in Kersting Project 1. The Honolulu Session (J ne 1985) The Court set for. trial the c ases of approximately 375 Kersting program participants at Tax Court session scheduled to commence on June 10, 1985, in -Honc lulu, ~Hawaii (the June 1985 session) . Before the June 1985 . session, Mr. McWade and Mr. Seery agreed to use the . test case procecure in the Kersting project . During the -June 1985 session, Mr. McWade and Mr. Seery discussed the use of the test case procedurc with Judge Goffe during a chambers conference. Judge Gof fe, that During the conference, Mr.' Seery informed although he was representing petitioners who were Kersting program participante , he was beiñg paid by Mr. Kersting. Judge Goffe indicated that-he saw. no conflict of interest as long as Mr. Seery had not participated in the - 35 planning or promotion of the Kersting programs . See Rule 24 (f) .2o Consistent with :counsels' agreement to use the test case procedure . in athe Kersting project Judge Goffe granted the parties' joint motions to continue the cases called at the June 1985 session. . At the same time, the parties began filing piggyback agreements (discussed in greater detail below) , which they did in the vast majority of the Kersting project cases. Mr. Seery reported the results of- the June 1985 proceedings to Mr. Kersting and 'kept him abreast of developments. Mr. Seery relied upon' Mr. Kersting to distr::bute correspondence from Mr. Seery to .petitioners in:the Kursting project. 2. Test Case Procedure Mr. McWade and Mr.. Seery agreed to select test cases that would be representative of all the Kersting programs for all years in dispute, including the taxable years 1975 through 1983 . At the time that Mr. Seery selectod his test 'cases, he assumed that the test case petitioners would bear the burden of proof,at trial. In selecting test· cases, Mr. Seery was not concerned with whether a case involved other tax issues.^ Mr. Seery was simply looking for cases ,"where someone did everything right . " . 2° Rule 24 (f), which became effective n dufy 1, 1990, see 93 T.C. 857, addresses conflicts of interest in Tax Court litigation. Rule 24 (f) was redes .gnated Rule 24 (g) veffective Aug. 1, 1998. See 109 T.C. 542. _ 36 - Mr. Seery selected two or three test cases, including the Cravenses and the Hongsermeiers . In an effort to find the best; cases for trial from petitioners' point of view, Mr.·.Seery selected test cases by reference to the manner in which t,he taxpayers had reported the transactions. Mr. Seery selected test cases that he thought he could win, but, as he testified at; the evidentiary hearing, he had difficulty identifying such cases in addition to the Cravenses and the Hongsermeiers ." Mr. Kersting and Mr.' Cravens discussed having Mr. Cravens' case serve as a test case. . Mr. Kersting told Mr. Cravens that Mr. Seery wanted to use him as a t est case because, unlike other Kersting program participants, the Cravenses had reported a capital gain when they surrendered their stock in the Kersting holding company in conjunction wit h the annual termination of the Kersting program! The Cravenses' reporting position was consistent with Mr. Kersting's advice to program participants that distributions. by Kersting ho]ding companies used by program participants to pay the principal amount of leverage loans were tax-free returns of capital rather than taxable dividends. Mr.. Seery. viewed the Cravens cases. as "unique" in this respect. Mr. Cravens believed that he had a choice whether his case would serve as a test case. When Mr. Cravens agreed to have his Mr. Seery's testimony: ":: was having trouble selecting cases beyond those two that I thotght would be good vehicles for that." - 37 case serve as a test case, he did.so without condition. He believed that he would win his case because he had correctly reported his tax liabilities, as reduced by reason of his participation in the Kersting pro rams. Mr. Seery selected the Hongs rmeier case because it was his impression that the Hongsermeiers had used their own funds to pay the principal of a Kersting levertige loan, rather than using a "nontaxable distribution" from a Eersting holding company 22 Mr. Seery also selected the Hongsermeiers because they had participated in the CAT-FIT progr2.m, which Mr. Seery viewed as the strongest Kersting program from the standpoint of sustaining the interest deductions claimed. Mr. McWade analyzed between 400 and 500 project cases; he selected test cases thatuhe thought would be representative of all Kersting programs for all years in dispute. Mr. McWade selected "clean" cases; i.e., cases that did not include issues other than Kersting interest deductions. Mr. McWade tried to avoid cases that were unique or at pical of the Kersting programs. Although Mr. McWade selected at least five of the test cases, he could not recall the sp(cific cases that he selected. In June 1986, Mr. McWade and Mr. Seery agreed on the dockets that were to serve as the test cases. By letter dated June 10, 22 Mr. Seery's impression wan not quite :right. The Court found in Dixon II that the Hongsermeiers were unique insofar as they paid $250 per month out-of-pocket (rather than use the proceeds.from a leverage loan) to satisfy the interest due on a CAT-FIT primary loan. See Dixon II, 62 T.C.M. 1991 T.C.M. (RIA), at 91-3023. (CCH) at 1480, - 38 1986, Mr. McWade notified Judge Goffe that he and Mr. Seery had selected the following 14 dockets to serve as test cases with respect to the Kersting project: Case Name Docket No. Dixon v. Commissioner 9382-83 Cravens v.. Commissioner 16900-83 Rina v. Commissioner Thompson v. Commissioner Young v. Commissioner Cravens v. Commissioner DuFresne v. Commissioner Thompson v. Commissioner 17640-83 19321-83 4201-84 15135-84 15907-84 31236-84 . Owens v. Commissioner 40159-84 Young v. Commissioner Young v. Commissioner Thompson v. Commissioner DuFresne v. Commissioner Hongsermeier v. Commissioner 22783-85 30010-85 30965-85 10979-85 129643-86 1 By order dated Aug. 13, 1986, the Court severed the Hongsermeiers from docket No. 17405-82 (the Aaronson consolidated petition filed by Mr. Nevels) and assigned them new docket No. 29643-86. See supra note 18 and accompanying text. With the exception of the Cravens case assigned docket No. 16900-83, and the Hongsermeier case assigned docket No. 17445-82, each of the test case petitioners had filed pro se petitions. By August 1986, Mr. Seery had entered his appearance in each of the test cases with the exception of t.he Young cases assigned docket Nos. 4201-84, 22783-85, and 30010- 85, the DuFresne case assigned docket No. 30979-85, and the Thompson case assigned docket No. 30965-85. 3. Test Case Array The test case petitioners had participated in Kersting programs during the taxable years 1975 through 1983 as follows: - 39 - Taxable Year 1975 Program Petitioner (s) CAT-FIT MAURIER LEASING NORWICK 20/20 Owens Owens Owens Taxable Year 1976 Program Petitioner (s) UNIVERSAL LEASING FORBES 30/30 Owens Owens . . Taxable Year 1977 Program Petit ioner (s) CAT-FIT ESCON LEASING FARGO 30/30 NORWICK 20/20 Dixon Dixon Dixon Owens Taxable Year 1978 Program Petitioner (s) CAT-FIT CAT-FIT UNIVERSAL LEASING ESCON LEASING ESCON LEASING MAHALO 30/30 MAHALO 60/60 Hongsermeiere Dixon Hongsermeier Dixon Hongsermeier Owens Dixon Taxable Year 1979 Program Petitioner (s) CAT-FIT CAT-FIT UNIVERSAL LEASING ANSETH LEASING ANSETH LEASING ESCON LEASING ESCON LEASING ESCON LEASING CANDACE 60/60 CANDACE 60/60 CANDACE 60/60 Hongsermeier Dixon Hongsermeier Rina Young Hongsermeier Dixon Thompson Dixon Cravens Rina - 40 Thompson Young CANDACE 60/60 CANDACE 60/60 CHARTER 80 , 000 CHARTER 120 , 000 INVESTORS 80 , 000 INVESTORS 12ò, 000 Rina Young Rina Young Taxable Year 1980 Program Petitioner(s) CAT-FIT CAT-FIT Dixon DuFresne CAT-FIT Hongsermeier ANSETH LEASING ANSETH LEASING ANSETH LEASING ESCON LEASING Hongsermeier Rina Young Dixon . ESCON LEASING . ESCON LEASING CANDACE 60/60 CANDACE 60/60 DELTA 40/40 DELTA 60/60 DELTA 60/60 DELTA 60/60 DELTA 60/60 DELTA 60/60 DELTA 60/60 CHARTER 40 , 000 CHARTER 80 , 000 CHARTER 120 , 000 CHARTER 120 , 000 CHARTER 120 , 000 CHARTER 120 , 00 0 INVESTORS 80 , 000 INVESTORS 80, 000 INVESTORS 80 , 000 INVESTORS 120 , 000 INVESTORS 120 , 000 . Hongsermeier Thompson Cravens Rina Hongsermeier Cravens Dixon DuFresne Rina Thompson Young Rina Rina Dixon DuFresne Thompson Young DuFresne Rina Thompson Dixon Young Taxable Year 1981 Program Petitioner(s) ANSETH LEASING ESCON LEASING DELTA 60/60 CHARTER 120 , 0 0 0 CHARTER 120, 000 CHARTER 120 , 00 0 Young Dixon Young Dixon DuFresne Young - 41 INVESTORS 80, 000 INVESTORS 120 , 0 0 0 INVESTORS 120 , 0 0 0 DuFresne Dixon Young Taxable Year.1982 Program . Petitioner (s) ANSETH LEASING CHARTER 120 , 000 CHARTER 120 , 0 00 INVESTORS 80 , 00 0 INVESTORS 120 , 0 00 Taxable . Year 1983 Program Young DuFresne Young DuFresne Young . . ANSETH LEASING . CHARTER^120 , 000 INVESTORS 80 , 000 Petitioner (s ) Young DuFresne DuFresne . 1 Maurier Leasing, a subch. S leasing program, was considered by the Court in Pike v. Commissioner, 78 T.C. 822 (1982) . The notice of deficiency issued to the Thompsons for the taxable year 1981 states in pertin nt part: "Based on · t examination information from the 1978, 1979, and 1980 returns, the investment interest is .generated from the interest deduction tax shelter. The purported payees cannot be identified from the 1981 income tax return filed by the taipayers." Respondent has not been able to identify specifically the Kersting programs that the Thompsons participated ;in during 1981. ' However, the record suggests that, in addition to the ^I:ersting programs that the Thompsons participated in during 1979 and 1980, the'Thompsons participated in the Anseth Leasing Program during 1981. If the Thompson and Cravens cases had been removed from the test case array, there would have been no reduction in coverage - 42 - of the test cases. In other words, each program in which the Thompsons and Cravenses participated during the years in issue was also a program before the Cour; in which one or more of the other test case petitioners had pacticipated. IV. The Maui Session (February 1937) After Messrs. Seery and McWad3 had selected the test cases, they initiated settlement negotiations and began to prepare the test cases for trial.23 Their trial preparations included work on a proposed stipulation of facts and an attempt to take Mr. Kersting's deposition. During this period (June 1986 or thereabout), Mr. Seery and Mr. Kerating's attorney, L.T. Bradt (Mr. Bradt), discussed using the.1381 search of Mr. Kersting's office as a basis for filing a motion to shift the burden of proof to respondent in the test cases A. Trial Notices . By letter dated July 30, 1986, Judge Goffe informed Messrs. Seery and McWade that.the est cases would be set for trial during a special session of :he Court commencing on February 9, 1987, in.Wailuku, Maui Hawaii (the Maui session). Judge Goffe's letter also informed Messrs. Seery and McWade that he intended to notify each Kersting petitioner who had not filed a piggyback agreement that his or her case would be set for trial during the Maui session. 042 23 Settlement negotiations between Mr. McWade and Mr. Seery are discussed in greater detail inEra pp. 78-80. O - 43 In August 1986, the Court issued orders setting the 14 test cases for trial during the Maui seusion. By letter dated August 5, 1986, Judge Goffe informnd all Kersting petitioners who had not already executed piggyback agreements that their cases would be set for trial at 'the Maui session unless they executed piggyback agreements by September ±9, 1986. Judge Goffe's letter states as follows: hugust 5, 1986 Dear Dkt # Your case involves matters concerning promotions by Henry Kersting. Cases with issues identical to the issues in your case haVë been set for trial on February 9, 1987, at the courtroom of the Circuit Court for the Second Circuit .in Wailuku, Maui, Hawaii. In order to conserve the time and expense of the taxpayers, the government and the Court, all of the cases with identical issues w:.ll be tried at one time unless the parties agree in advance, in writing, to be bound by the outcome of the cases set for trial. In most of the pending cases, thÅ parties have so agreed to be bound. You should contact atiyour earliest: convenience the lawyer for the government in the Kersting cases if you decide to agree to be bound. He is Mr. Kenneth McWade, PJKK Federal Building, Room 3304, Box 50089, 300 Ala Moana Boulevard, Honolulu, Hagaii 96850 His telephone number is (808) 546-7333. r If however, you do not wish to be bound, you should advise my office promptly, in writing at the above address, in order that your case may be set for trial on February 9, 1987. In either event, you must advise Mr. McHade or me by September 29, 1986. If you fail to advise Mr McWade by September 29, 1986, that you wish to be bound and have executed a stipulation to be bound by that time and if you fail to advise me by September 29,- 1936, that you wish to have your case set for trial, it wull automatically be set for trial on February 9, 1987 If-your case is set for trial and you do not appear f or trial,p your case will likely be dismissed and you will be required to pay all of the -income tax which. the government contends you owe) plus interest thereon as provided by law. William A. Goffe Judge In November 1986,. the Court issued orders notifying Kersting petitioners who had not filed pigcyback agreements that their cases were set for trial at the Maui session. As additional Kersting project cases were docketed and identified, the Court issued orders setting them for trial at the Maui session, subject to being stricken if the parties executed a piggyback agreement . B. Piqqyback Agreements As early as June 1985, Kersting program participants had begun executing piggyback agreements (1985 piggyback agreements);2' drafted by Messrs. McWade and. Seery, that stated as follows: Stipulation of Settlement for Tax Shelter Ad-justments With respect to all adjustments in respondent's notice of deficiency relating to the Kersting interest deduction tax shelter (s) , thel parties stipulate to the following terms of settlement: 1. The term Kersting programs refers to interest expense deductions or other related deductions associated with various programs promoted by Henry Kersting. 2. The Kersting program deduction.adjustments shall be redetermined on the same basis that the same program adjustments are resolved with respect to taxpayers trying the same program adjustments at the 24 Before 1987, there was no uniform format for piggyback agreements. In.1987 or early 1988, respondent's Tax shelter Branch issued a standard form of piggyback agreement . June 10, 1985 session of the . Court granted Mr. Seery's motions. By letter dated December 12, L986, Mr. Kersting informed Kersting program participants that Judge Goffe.had "inferred" that Mr. Seery might have a conflict of interest. Although Mr. Kersting denied that he was represented by Mr. Seery, he, stated that he and Mr. Seery had d3cided that it would be prudent for-Mr. Seery to withdraw as couns 1. Mr. Kersting further stated that substitute counsel -had been retained to represent · test case and nontest case petitioners alike. D.. Entries of Appearance by Chicaine and Hallett Following Mr. Seery's withdrasal, Mrd Bradt.recommended.that Mr. Kersting hire Mr. Izen to serv3 as counsel.for the testn, - 52 - cases.3° ·However, Mr. Kersting, w:.th his son-in-law, an attorney, Roger Moseley (Mr. Mose]ey), contacted Robert J. Chicoine (Mr. Chicoine) and Darre)1 D. Hallett (Mr. Hallett) (collectively Chicoine and Hallett), to determine whether they would ;represent the test case petitioners at the Maui session. On November 22, 1986, Mr. Kersting sent Mr. Hallett a letter describing the Kersting programs. Shortly thereafter, Mr. Kersting interviewed Mr. HallEtt in Hawaii. On December 9, 1986, Chicoine and Hallett reachec an agreement with Mr. Kersting to represent. the.test case petitioners (other than the Thompsons). On.December 12, 1986, Mr. Kersting wrote to Kersting program participants informing them that Mr. Seery had withdrawn as counsel and that Chicoine and Eallett had been retained. At the same time, either Mr. Kerstinc or Chicoine and Hallett informed the.test case petitioners that they would have to provide Chicoine and Hallett with written authorization to enter appearances in their cases. Although Mr. Seery sent Chicoine and Hallett his files for the test cases, most of the documents that Mr. Seery had intended to use at trial remained in Mr. Kersting's possession. By letter dated December 19, 1986, Chicoine and Hallett reminded Mr. Kersting that they needed all documents in the possession of Mr. Kersting and Mr. Seery that pE:rtained to the Kersting programs in dispute in the Tax Court. 3° to 1981. Mr. Bradt and Mr. Izen had been law partners from 1978 - 53 By letter dated January 7, 19 7, Chicoine and Hallett outlined the conditions underlying their agreement with Mr. Kersting to represent the test case petitioners*in the Tax Court. Chicoine and Hallett's let;er states in pertinent part: Our representation is conditioned upon the following however: 1. We will represent only the individuals selected as test cases and who request us to do so. We are not representing or acting on behalf of any other taxpayers or litigants who have invested in various companies in which you are afEiliated and who have stipulated to be bound by the outcome of the litigation or desire legal advice with r±spect to whether they should accept the Internal Rezenue Service's settlement proposal. 2. All parties underst d and agree that under the _circumstances, the Petiti ners involved in the test cases who have expressly aut rized us to represent them will be our clients. and hat we do not represent you individually, although y have agreed with those Petitioners that you will pay the legal fees to defer [sic] the costs of their defeþse. We will discuss the fee arrangement with each of he Petitioners.in the test cases and their perceptibn of any possible conflict of interest which we would require that they waive. 3. It is understood that there will be no restrictions on the advice which we may provide to,our clients and after review of t e relevant facts and documents, we are free to pro ose such settlements as we may deem appropriate. We eed not proceed with trial in any situation if which we consider our position to be indefensible r frivolous. In early January 1987, Messr . Chicoine and Hallett filed entries of appearance as counsel each of the test cases other than the Thompson and Cravens cas s. As discussed in greater deta 1 infra pp. 100-106, at the time of Mr. Seery's withdrawal fr the Cravens cases, - 54 - Mr. Cravens and Mr. McWade had agreed to a settlement of the Cravens cases. After reaching an agreement with Mr. McWade, Mr. Cravens did not authorize Chicoine and Hallett to enter an appearance in his cases. E. Evidentiary Issues After undertaking to represent the test case petitioners, Chicoine and Hallett decided to challenge their'deficiency notices on the ground that the search of Mr. Kersting's office in January 1981 had been illegal. Chicoine and Hallett- thereupon filed motions for leave to file amendments to the petitions and lodged the amendments with the Cotrt. The amendments included arguments that the materials seized by the Internal Revenue Service during the.search of Mr. Eersting's office should be suppressed at trial of the test cLses and that the burden of proof and burden of going forward with evidence should be shifted to respondent. On January 14, 19E7, the Court granted Chicoine and Hallett's motions for.leave tc- file amendments to the petitions and subsequently directed respondent to file answers to the petitions as amended. 1. The Maui Session - Although the test cases were originally scheduled for trial at the Maui session, the trial was delayed by the need to use the Maui session to receive testimony and evidence on the evidentiary issues raised by Chicoine and Hal]ett. Mr. McWade and Henry E. O'Nejll (Mr. O'Neill), another trial attorney assigned to the Honolulu District Counsel Office, - 55 - appeared on behalf of respondent a the Maui session. Mr. DeCastro appeared at the Maui ession on behalf of the Thompsons. ppear at the Maui session. The Cravenses did not Following the .Maui session, t e Court ordered respondent and petitioners, by May 18 and June 17, 1987, respectively, to file opening and reply briefs addressing the evidentiary issues raised by Chicoine and Hallett. On motions by the parties, the Court extended the dates for the filing of openirig and reply briefs to June 8 and August 10, 1987, respectively. 2-. Dixon I Opinion On February 11, 1988, the Co t issued its Dixon I opinion rejecting Chicoine and Hallett's identiary arguments. Specifically, the. Court held that etitioners had failed to establish standing to contest the ersting search. Commissioner, 90 T.C. 237 Dixon v. (1988) . By order dated July 1, 1988 he Court set the test cases for trial in San Diego, California on January 9, 1989. By order dated October 24, 1988, the Court ranted Mr. Izen's motion to reconsider and set the test cases for trial in Honolulu, Hawaii, on January 9, 1989. V. Kersting Disputes With Progra Participants, Before the trial of the test cases, Mr. Kersting had disputes, summarized below, with the Thompsons and the Alexanders . . .- 56 - A. The Thompsons 1. The Bauspar Program On August 13, 1979, the Thompsons purchased a condominium unit in Wahiawa, Hawaii (the.Wahitwa property), from'Pacific Universal Corp. (not a Kersting company). On April 24; 1981, sthe Thompsons entered a Kersting program known as Bauspar--not one of the Kersting programs -in dispute Lt the trial of the test cases-to effect the payoff of seller-provided financing on the Wahiawa property. The Thompsons executed a first mortgage and promissory note reflecting a loan from Bauspär, Inc. principal.amount of $80,000. (Bauspar), in the The Thompsons agreed to·repay the $80,000.Bauspar loan, with interest at 7 percent per year, through monthly- payments of principal and interest of $532.24 for a 10-year period, followed by a bëlloon payment of $69,182.47.31 In conjunction with the Bauspar lc·an, the Thompsons agreed to purchase $80,000 worth of Bauspar stock. The Thompsons borrowed $80,000 to purchase the Bauspar stock from another Kersting company., Paragon Investments, .Inc. interest rate of 18 percent. (Paragon), at an annual The Thompsons further agreed to participate in a "savings program'' by depositing $1,200 per month into an account with Citizen's^Fir.ancial, Inc. (Citizen's Financial), another Kersting'compäny. On August 12, 1982, the Thompsons agreed to sell the Wahiawa property to Kevin and Ada Shea for $122,500 by an "Agreement of 31 It appears that the Thompnons actually made monthly payments of $535 to Bauspar. O -.. 57 - Sale" :under which the Thompsons apparently took back a purchase money mortgage on the property. The Thompsons continued to participate in the Bauspar program until 1986 when the Sheas decided to sell the Wahiawa proper:y to a third party. On January 30, 1985, Mr. -Kers;ing sent Mr. Thompson a schedule listing the interest. payments that Mr_. Thompson had made during 1984 as follows: Payee Bauspar, Inc . Amount . $6., 420 ..0 0 Paragon Investment s , Inc . 9, 611. 04 Citizens Financial, Inc. 14,400.00 . Upon sale of the-Wahiawa prop rty by the Sheas in 1986, Bauspar received a .check in the am unt of $75, 511. 74 in satisfaction of the principal amou t remaining due on the Thomps ons ' loan f rom Bauspar . 042 2. Deterioration of Thompsob/Kersting Relationship While working ron the,Thompso s' estate plan, ,Mr. Huestis asked 2Mr. Kersting for an accounting of the Thompsons' investments in Kersting programs. By»letter dated March;3, 1986, Mr. Kersting responded by providi g Mr. Huestis a summary list sof the Kersting programs that the Th mpsons had participated in during 1977, 1978, 1979, 1980, an 1981. By letter dated March 12, 1986, Mr. Huestis. info ed Mr.. Kersting that the Thompsons wished to terminate the r participation insall Kersting programs and obtain a complete ac ounting of their investments.. Mr. Huestis also requested that a 1 future communications - 58 - regarding the matter be directed to Mr. Huestis rather than to the Thompsons. By letter dated March 17, 19E6, Mr. Kersting complained to Mr. Huestis about his "assertive approach" and said he'would continue to communicate directly with the Thompsons. By letter dated March 17, 1986, Mr. Kerstinc wrote to Mr. Thompson, confirmed that he would terminate Mr. Thompson's programs, and inquired whether Mr. Thompson still had any stock certificates issued in connection with his participation in Kersting programs. Mr. Kersting's letter also states that Mr. Thompson would incur tax liability for capital gains that would be realized upon the termination of his accounts in the Kersting programs. On March 21, 1986, Mr. Huestis again wrote to Mr. Kersting, stating that the Thompsons were disappointed with Mr. Kersting's failure to respond to their requests or to assist them with the tax problems arising from their participation in his programs. By letter.to the Thompsons dated March 25, 1986, Mr. Kersting confirmed that.he would liquidate their investments, as discussed with Mr. Thompson in a recënt telephone conversation. Mr. Kersting requested that Mr. Thompson endorse all relevant stock certificates and return them to Mr: Kersting so that the proceeds from the sale of stock represented by'such certificates could be used to retire Mr. Thompson's debts to Kersting: companies. By letter dated March 31, 1986, Mr. Kersting wrote to Mr. Thompson and admitted that he was having difficulty reconciling Mr. Thompson's Bauspar account because Earl LeMond, Mr. Kersting's son-in-law and the did not keep reliable records. anager- of the Bauspar program, No Étheless, Mr. Kersting prepared an accounting of Mr. Thom son's Bauspar account indicating that Mr. Thompson had p id $90, 769. 72 under the program and had received nontaxabl dividends of $27, 000 and Federal tax and State income tax vings (presumably from interest deductions) of $36 307.79 a d $9,000, respectively. Mr. Kersting further indicated th , in light of Mr. Thompson's apparent dissatisfaction, he woul waive the normal requirement that the Bauspar program. run for 10-year period, allow Mr. Thompson to terminate the pro ram prematurely, . and pay Mr. Thompson $27,000 reflecting 3 years of. "equity build-up" in the program: On the basis of his accounting, Mr. Kersting concluded that Mr. Thompson would from the Bauspar program. ealize a net gain of $8,538.07 Mr. Ke sting advised Mr. Thompson -to check his .accounting carefully, ar d that, if necessary, Mr. Kersting would make adjustments i Mr. Thompson s favor to avoid a legal dispute. . On March 31, 1986, Mr. Kerst ng wrote a second letter to Mr . Thompson stating that the Tho sons owed a total of $11, 844 to Avalon Acceptancee Corp . , Aztec Acceptance . Corp. , Mahalo Acceptance +Corp. , Lombard Accept a ce Corp. , and . Candace, for interest due on leverage notes du ing 1983 and 1984 . Mr. Kersting's letter states in p rtinent part: . - 60 - I will assume that you vill take the position that you should not be payinc: interest on notes which produced deductions which yot might not have used. While this, of course, would not go well with a bank or Credit Union (they would cha¶ge you interest whether you use the deductions or not) I am willing to make adjustments to your advantage. To get that underway I suggest that you tell us which of the deductions were ·claimed by you in 1983 and 1584. * * * ·* * * * To keep the spirit of accommcdation alive and to remove all elements of dissatisfaction we are quite willing to lean over into your directior. It has troubled me considerably that of all people you would be displeased with our services. On May 6, 1986, Mr. Thompson wrote to Mr. Kersting requesting a full accounting for=bis participation in the Bauspar program. Mr. Thompson informed Mr. Kersting that the property subject to the Bauspar mortgage had been sold. Mr. Thompson also said that he was.reminding Mr. Kersting that, upon his retirement in 1982, he had asked to terminate his participation in the programs for which Mr.. Kersting-was now seeking interest payments for leverage loans. , Beginning in June 1986, Mr. Thompson stopped making the $1,200 monthly deposits to Citizens Financial as required under the Bauspar program. At the same time, Mr. Thompson ignored Mr. Kersting's. written requests to explain his failure to make the deposits. Further, on June 23, 1986, 'at the suggestion of Mr. Huestis, the Thompsons retained John A. Chanin-(Mr. Chanin), an attorney practicing in Honolulu, to assist them in their dispute with Mr. Kersting. Mr.. Chanin assigned the matter to his associate, Keith Y. Yamada (Mr. Yamada). On August 1, 1986,.Mr. Yamada, spoke with Mr. Kersting by telephone and- requested a detailed accounting of the amounts that the Thompsons had paid to Bauspar And Citizen's Financial, as well as a status report.on the promissory notes executed by the Thompsons in favor of Bauspar, Sig:1et, Financial, Inc., and Paragon. Following. the telephone kall from Mr. Yamada, Mr. Kersting called Mr. Thompson. During this conversation, Mr. Thompson reminded Mr. Kersting that the Wahiawa property had been sold. Mr. Kersting stated that he would provide Mr. Chanin with copies of the documents relat:.ng to Mr. Thompson's participation in the Bauspar program as soon as Mr. Thompson provided be:. Kersting with a writtén authorization to release them. By letter dated August 23, 19f6, Mr. Kersting notified the Thompsons.that he had turned their file over to Mr. Moseley for collection and that he sensed that litigation·'was imminent. Mr. Kersting's letter states in pertinent part: Since the odds, however, are inifavor of imminent litigation I consider it to be my obligation to point out to you the consequences: a The day after.you have allowec your attorneys to file suit I will declare all notes which you have executed to our companies in default and begin collection proceedings. We will make an effort to collect from you not only the n$11,844.00 of interest on.promissory notes of which we have sent ycu billings several times we will also file suit to collect the principal of all notes which we hold. The aggregate sum is well in excess of $250,000.00, as you know. I will also ask you to return to us the $40,000.00 we advanced to you after the First Savings debacle. We will start collection proceedings on the $75,000.00 note which you executed in fa or"of.-FEDERATED FINANCE COMPANY to facilitate the ac isition of your stock in First Savings & Loan Ass. We will ask you to-pay a pre-payment penalty on your m rtgage on the house in Wahiawa. We will NOT arrange for-you a capital gain in your BAUSPAR HOLDINGS INC. stock which I had considered-- even though not dué you becauue of premature withdrawal from the Plan--and we will NO'' render assistance in saving you capital gains taxem on the re-capture of basis in your stock holdings. We will NOT provide legal ass«.stance 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, 19 6, Mr. Kersting notified Mr. Seery that he expected to be i litigation with the Thompsons and directed Db:. Seery not to ?ren er any services, at our expense,'ï to the Thompsons. By "letter dated August 28, 19 6,.Mr. Huestis notified Mr. Moseley that he represented th Thompsons in connection with their Kersting transactions and th pending Tax Court litigation. Mr. Huestis advised Mr. Moseley.to direct all future communications regardingr the Tho p ons to Mr: Chanin. By letter dated September 5, 1986, Mr. Kersting again notified Mr. Seery of.his dispute the likelihood of litigation. ith the Thompsons and Mr. Kersting included a copy of Mr. Huestis' August 28, 1986, 1 tter to Mr. Moseley. As previously mentioned, his was around the time that Mr. Seery began the process of wi hdrawing as counsel for the Thompsons, following Mr. Huestis' notification to Mr. Seery that the Thompsons were in the process of retaining substitute - 63 Mr. Kersting told Mr..Seery that he.considered it "mandatory" that the Thompsons be removed as test case petitioners. On September 24, 1986, Mr. Kersting again wrote to*Mr. Seery, reminding him of the need to remove the Thompsons from the list of test cases. During this period, Mr. Thompson began talking with other Kersting program participants about filing a class action lawsuit against Mr. Kersting. On January 1rF1987, Mr. Kersting wrote to Bill Witthorne, a Kersting program participant, requesting help in dealing with Mr. Thompson. Mr. Kersting's letter states in pertinent part: Yet, I consider it important that someone would bring home to Jack the dangers of the action he has in mind. He has been hoodwinked by the attorneys.out in California and I think he is blind to the ramifications. Can you think of anyone in California who is close to Jack and willing to talk to him? That same day Mr. Kersting wrote to Benness M. Richards, another Kersting program.participant, stating in pertinent part: We have been unsuccessful over the last six months or so to convince Jack that he will be better off with the legal representation provided by us. Neither has anyone be [sic] able.to bring home to him that the IRS does NOT make him a better deal than offered to all the other Petitioners. On March 10, 1987,;Mr. DeCastro and Mr. Huestis informed Mr. Thompson that Mr. Kersting would not'return the Thompsons' promissory notes. Mr; DeCastro indicated that he wanted to ' discuss the possible involvement of his firm in bringing legal action against Mr. Kersting. On April 10, 1987, Mr. Thompson wrote a letter to other Kersting program participants, saying that Mr. Kersting had deceived him. In his letter, Mr. Thompson said that he had gone to Mr. Kersting to reduce his tax liabilities but that he now believed the cost to him would be great because the Internal Revenue Service was challenging Mr. Kersting's programs. Mr. Thompson suggested that the biggest worry for Kersting program participants was Mr. Kersting's "ultimate weapon", the promissory notes. Mr. Thompson enclosed a copy of a letter that he had, received from Mri Kersting as an example of what the others might face.33 Mr. Thompson informed the other participants that, although Mr. Keesting had promised to cancel all promissory notes in exchange f 3r the surrender of the Kersting company stock that was purchased with the proceeds of the primary loan, Mr. Thompson had tried to surrender his Kersting company stock but Mr. Ker sting had refused to cancel Mr. Thompson's promissory notes. Mr. Thompson indicated that he no longer trusted Mr. Kersting, and that he had retained Mr. DeCastro. By letter dated May 5, 1987, Mr. Yamada advised Mr. Thompson that a lawsuit against Mr. Kersting would have merit, and that a class action law suit should be considered. Around this time, Mr. DeCastro had proposed. to. file :3uit on behalf of the Thompsons against Mr. Kersting in Federal Di:3trict Court. 33 Although the Court's copy of Mr. Thompson's Apr. 10, 1987, letter does not include a copy of a letter from Mr. Kersting, we assume that Mr. Thompson circulated Mr. Kersting's letter of Aug. 23, :.986. - 65 On May 26, 1987, Mr. Huestis called 'Mr. DeCastro and learned that, after Mr. Kersting had obtained a copy of Mr. Thompson's April 10, 1987 letter, Mr. Moseley had written to Mr. DeCastro on behalf of Mr. Kersting and proposed a settlement of the Kersting/Thompson dispute. Durinc a later meeting. that day with Mr. Thompson, Mr. Huestis agreed to contact another lawyer in Honolulu, Charles R. Kozak (Mr.vKczak), to discuss whether Mr . Kozak might represent the Thonpsons in a lawsuit against " Mr. Kersting. On May 27, 1987, Mr. Huestis contacted Mr. Kozak on behalf of the Thompsons. Mr. Kozak informed Mr. Huestis that he had represented two other Kersting participants (David L. Bigelow" David L. Bigelow and Patricia L. Bigelow had. participated in the CAT-FIT- program during the taxable years 1975 and 1976. In Bigelow v. Comnissioner, T.C. Summary 1983-6 (docket No. 3147-.78S) , the Court teld that the Bigelows were entitled to interest deductions that they had claimed under the CAT-FIT program, partly on the basis of evidence that the Bigelows had successfully sued a related Kersting finance company in State court . Because the Bigelows' case was tried under the small tax case procedure, the case was not subject to appeal and is not treated as precedent for ary other case. See sec. 7463 (b) . Mr. Kozak had represented Mr. Bigelow in a lawsuit against Mr. Kersting for payment of the "equity build-up" in. a mortgage funding program (presumably Bauspar) following Mr Bigelow's termination of the program. Mr. Eigelow won- the suit and . collected damage s . Accòrding to . IV r . Kozak, Mr . Bigelow had prevailed by virtue of Mr. Kerstirg's promise not to enforce notes that Mr. Bigelow had signed in connection with his - fficial project settlement 39 Respondent's position represented a concession insofar as the allowance as a deduction of a theft loss of payments induced by misrepresentation is postponed until the year of discovery. See sec. 165(e); Bellis v. Commissioner, 61 T.C. 354, 357 (1973), affd. 540 F.2d 448 (9th Cir. 1976) . offer-in one significant respect. Specifically, by September - 1986, Mr; McWade and Mr. Seery had agreed to modify the^7-percent settlement offer to incorporate a new featurerthey called the "shelter burnout" that, would apply in cases involving more than 1 taxable year. The shelter burnout feature*grew out of Mr. Seery's contention that Mr. Kersting's programs could be viewed as a tax deferral mechanism.'° Mr. McWade agreed with Mr. Seery, for settlement purposes, to allow a shifting of the initial year's deficiency to a later year as a "shelter burnout". For example, in a case involving 2 taxable years, the taxpayer's liability for statutory interest under section 6601 was computed under the modified 7-percent settlement offer by treating the taxpayer's tax liability for the earlier of the 2 years as having been incurred.on.the due date for paymeht of tax for the later year. Under this approach, the tctal amount of the taxpayer's underlying tax deficiencies remained the same; but the taxpayer's liability for interest on the deficiencies was reduced by the amount of such interest that otherwise would have accrued on the deficiency for the earlier year of the 2-year period. -Variations of this approach were used in cases involving more than 2 taxable years. .The modified 7-percent settlement offer negotiated by 4° In Dixon II, the Court considered and rejected the argument that Mr. Kersting's programs resulted in mere tax deferral. The Court arrived at.tris conclusion through a detailed analysis of the Cravensee' tax returns for 1979 and 1980. See Dixon II, (RIA), at 91-3026. 62 T.C.M. (CC:H) at 1483-1484, 1991 T.C.M. . - 80 Mr.- Seery and Mr. McWade provided that the Ccimmissioner would settle any additions to. tax for fraud on a case-by-case basis. By letter .dated September 29; 1986, Mr. Seery informed Kersting program participants of . the~terms öf. the modified 7percent - settlement of fer and sugge sted that they give serious consideration to the proposal. Mr . McWade informed Mri Seery that, because the trial of the teet. cases had been set for February 1987, the modified 7-percent settlement offer would be withdrawn on December 31, 1986, 'ard that Kersting program participants interested in accepting the settlement should contact Mr. McWade by November 10, :1986, in o der to allow time to complete thegnecessary computations before the withdrawal of the offer. On October'10, 1986, Mri Kereting issued"a letter to Kersting program participants in which he characterized the modified 7-percent settlement offer as "grossly inadequate." Messrs: Sims and McWade did rot notify- the National Office, Regional:.Counsel, or the Appeals Cffice that they had incorporated the ,burnout feature in their offer to-settle Kersting project cases. 2. ' . 20-Percent Settlement O fer Between September and December 1986, Mr. McWade and Mr. Sims began to offer 20-percent settlements that were based on the same general-approach as their modifiec 7-percent settlement offer t;hat included thecburnout feature. The 20 percent settlement approach originated in late 1986 in separate negotiations bêtween . - 81 - Mr. Sims.and Mr. Chicoine .and betw en Mr. McWade and Mr. DeCastro. The. enhanced 20-per ent settlement offer reflected the perceptions of Messrs. Sims an McWade that the evidentiary issues raised by Chicoine and Hall tt increased respondent's risks of litigation. r The 20-percent settlement off r was not disseminated in writing by either Mr. Sims or Mr. cWade. The existence of the 20-percent settlement offer became known, if at all, through a combination of Mr. Kersting's lett rs to þrogram participants and calls that Mr. .McWade receive participants. from Kersting program Messrs. Sims and Mc ade did not request approval from or otherwise inform the Nat.io al Office, Regional Counsel, or the Appeals Office before makin the 20-percent settlement offer. Following the February 1987 aui session, the Honolulu Appeal s Of f ice once again began t o f fer Kerst ing program participants a deduction for thei cash out-of-pocket expenses, or if substantiation was not avai able, a reduction of the deficiency by 7 percent, with a w iver of the additions under section 6653 (a) (1) and (2) . The onolulu Appeals Office did not learn that Mr. McWade had negotia ed 20-percent settlement offers until mid-1988, following issuanc Dixon I. of the Court's opinion in At that time, the Honol lu Appeals Office determined not to extend such offers because it saw no reason to deviate from the official 7-percent proje t settlement offer. . - 82 - 3. Negotiations . for 50-Percent Settlement Of fer In January 1987, Messrs. .Sims and Chicoine continued their efforts to negotiate a ssettlement of the Kersting project cases. Initially, their discussions conceened a higher percentage settlement if Mr. Kersting would agree to quit the tax.shelter business. They eventually abandoned their discussions to link the settlement offer with Mr. Kers;ing's future conduct. By letter dated January 16, 1387, Mr. Chicoine; notified Mr. Kersting that he believed he had arrived at an agreement with Mr. Sims to settle all the Kersting cases docketed in the Tax Court by allowing 50 percent of the claimed interest deductions. Mr. Chicoine's letter further states that Chicoine and Hallett would agree to represent Kersting program participants desiring to settle their cases on these terns for a flat fee of $550 per case. On January 19, 1987, Mr. Kersting wrote a letter to- program participants stating that a 50'percent settlement had been . negotiated. . Mr. Kersting recommended that the 50-percent settlement be accepted; he included with his letter a form for program participants to use to authorize Chicoine and Hallett to represent them for purposes of sett:lement . ., .As a result of Mr. Kersting's letter, approximate:.y 300 Kersting program participants . contacted Chicoine .and Hallett seeking representation. - 83 In the meantime, Mr. Sims con ulted Barbara Leonard, Deputy Regional Counsel for the Western Region. She directed him to terminate negotiations based upon a 50-percent settlement. Upon learning of Mr. Kersting's letter, Mr.. DeCastro called Mr. Chicoine to inquire about the ;erms of the purported 50percent settlement. Mr. DeCastro stated (that. the. terms of the purported settlement were better t 1an the terms he had received for his clients and that le intended to attempt to obtain the same terms for his clie its. During his conversation with Mr. Chicoine, Mr. DeCastro th eatiened to "make trouble" for Mr. Chicoine unless he referred c ents residing in California to Mr. DeCastro for further represen tion. Mr. Chicoine flatly rejected Mr. DeCastro's proposal. Following the release ofi Mr. ersting's January 19,. 1987, letter, ·Mr. Sims .received numerous telephone calls from Kersting program participants and attorneys seeking to accept the 50- percent settlement. Following his conversation with Mr. Chicoine, Mr. DeCastro called Mr. Sims to express concern that Mr. Chicoine's clients might obtain more favprable settlements than the settlements ffered to Mr. DeCastro's clients. By letter to Mr. Chicoine da ed February 4, 1987, during the week immediately preceding the Ma i session, Mr. Sims denied that he had agreed to a 50-percent set lement of the Kersting project cases. Mr. Sims' letter states i pertinent part: - 84 - 1. I have not settled any of the Kersting cases with you. 2. The government has rot made any new, blanket offer to settle these cases (other than our old 7% offer); nor has the governmert made any offer to wholly or partially concede any of the issues presented by these cases. To the extent dhat you may disagree with this statement, any such offdr of concession that you believe has been made by me dr any other government official is hereby withdrawn. 3. We do not'have a wodkable basis for settlement of any case or any group of dases. If you should attempt to represent to..the dourt that you have süch a basis, either- in order to obtain a continuance of the trials in this matter or to ëttempt to force the government into unagreed-to settlements or concessions, I will dispute this firmly. Before the start of the Maui.session, Judge Goffe held a chambers conference with Messrs. Chicoine, Hallett, Sims, McWade, O'Neill, and DeCastro. Although Mr. Chicoine told Judge Goffe that the parties had reached a basis of set'tlement, Mr. Sims denied that there was a settlement. Mr. Sims said that he had "pulled- the plug" on a proposed 50-percent settlement because Mr. Kersting had interfered with the negotiations. 4. Revival of 20-Percent Settlement Offer During spring 1987, Mr. Chicoine continued to explore with Mr. McWade the possibility of a global settlement. By letter dated April 13, 1987, Mr. Chicoine provided Kersting program participants with a détailed statis report addressing developments at the Maui session Ls well as settlement negotiations. Mr. Chicoine's lett,ef also stated that the firm's representation of nontest case ta>:payers was not intended to extend to general representation in all matters but was limited - 85 - to the acceptance of an Internal R venue Service settlement offer. On April 16, 1987, Mr. Chicoi e wrote to Mr. Kersting and confirmed that he would be meeting Mr. McWade ·in Hawaii the following week to discuss the possuble settlement of six cases. . Mr. Chicoine warned Mr. Kersting not to address the subject of the status of settlement negotiations >in his letters to Kersting program participants, inasmuch as his comments could be detrimental to such negotiations. On or about April 27, 1987, Mr. Chicoine. informed Mr. Kersting that he would recommend that Kersting program participants acce t a.20-percent settlement offer. By letter dated May 22, 1987, Mr. Kerstingsprovided Mr. Hallett with information perta ning to è purported 30-percent settlement negotiated by Mr. DeCas ro on behalf of Benness M. and Jane Richards. Mr. Kersting stat d that"he'was*attempting to obtain information respecting addi ió~nal settlemeñts negotiated by Mr. DeCastro.. Between May 1987 and February 1988, Mr. Kersting wrote no fewer than s ven letters to Chicoine and Hallett strongly objecting to thei communication of a 20-percent settlement offer to Kersting progr m participants. In his In Richards v. Commissioner, T.C. Memo. 1997-149, supplemented by T.C. Memo. 1997-29 , affd. without published opinion 165 F.3d.917 (9th Cir. 199 ), we observed that the settlement may have been detriment 1 to Mrt and Mrs. Richards insofar as the original deficiency had been computed using an excessive tax rate (70 percent) an may hãve been based in part upon the disallowance of legitimat non-Kersting interest deductions. See supra p. 27. - 86 - May 22, 1987 letter, Mr. Kersting 'objected to Chicoine and Hallett's recommendation of a 20-gercent settlement in pertinent part as follows: . As I have done several times 'now I ask you again NOT to communicate to anyone of my friends a prospect of a 20% settlement. +The 50% flop hae, left a $40,000.00 to $50,000.00 scar with us. It was a lesson I will take with me ·to the other side 3 trust that you have reconsidered by now your position in the matter and that you will NOT go into an adverse stance to me and my enterprises. I assure you that the jolt of April 27th has not worn off yet.. On June 10, 1987, Mr. Kerstirg forwarded to Mr. Chicoine a letter that he had received from Fr. DeCastro pertaining to a settlement that Mr. DeCastro purpcrtedly negotiated on behalf of Boyd S. and Jeannette F. Proctor.. By letter dated June 16, 1987, Mr. Chicoine responded,to Mr. KerEting, stating that he was satisfied that the Proctors did nct receive a settlement in excess o:E 50 percent as Mr. Kersting had suggested because the figures in.question did not incluce the Proctors' liability for statutory interest. Mr. Chicoine concluded that the settlement was in the range.of a 14-percent reduction. of the Proctors' deficiency. On November 4, 1987,,Mr. Kerïting sent.Mr. Hallett a letter which states in pertinent·part: Here I asked you about L year ago to defend my friends, here I had high hopes and reasonable expectation that you.would wÅrk with us, that we would work on consensus and to the common benefit of my friends and here I find that you not only do not care to do that, you are actually moving into an adversary position. And this after I have paid you an enormous amount of legal fees and after I have disciplined myself over and over again to keep my temper as I - 87 - observe a widening rift between the attorneys who are supposed to work for us and who are, instead, looking after their strangly [sic] perceived protection from liability, My interest in these proceedings and what I consider to be the best interest óf my friends is arrogantly overlooked and we are, if your scheme of things would prevail, relegated to onlookers to a spectacle for which we are compelled to pay but in 'which we are not allówed to take part. It is simply absurd. - On January 12, 1988, Mr. Kersting issued a.letter encouraging nontest case Kersting program participants who had paid $550 to Chicoine and Hallett for representation in the settlement process to "recall your funds". By letter dated January 20, 1988, Mr. Chicoine notified the test case petitioners represented by his firm that Mr. McWade was offering a 20-percent settlement. Mr. Chicoine's letter states in pertinent part: Mr. McWade has stated that ycu may settle your case along the grounds set forth above. Since you are a test case, however, you will not be permitted to withdraw if you wish to enter into the settlement proposed. Accordingly, we wculd enter into an agreement with Mr. McWade that regardléss of the outcome of the trial, you would be allowed the settlement . Thus, if the case were lost in its entirety, your tax deficiency would be calculated in accordance with the settlemert. By letter dated.January 22, 1988, Mr. Hallett informed Mr. Kersting that Chicoine and-Ha]lett were seeking an opinion from an expert on legal ethics whether it would be appropriate for the firm to-accept new cliente seeking to settle Kersting project cases. However, Mr. Hallett stated that the firm would continue to inform its existing clients regarding the status of settlement discussions. - 88 - By letter dated January 29, 1988, Mr. Chicoine sent Mr. Kersting copies of proposed stipulated. decisions reflecting settlements that Mr. Chicoine had negotiated with Mr. McWade in three Kersting cases.42 Mr. Chico:.ne stated that Chicoine and Hallett were obliged to inform all Kersting program participants who had retained his firm that Mr. McWade was continuing to offer settlements despite Mr. Kersting's misrepresentations in his letters to Kersting program participants that no settlement was being offered. By letter dated F bruary 5, J988, John A. Strait, Associate Professor of Law at the University of Puget Sound School of Law (·Professor Strait), responded to Chicoine and Hallett's request for an expert opinion regarding their ethical obligations as counsel in the Kersting project. Professor Strait advised Chicoine and Hallett that the.firm did not have an attorney/ client relationship with, or owe Ettorney/client duties to, Mr. Kersting, but that Chicoine ard Hallett did have an attorney/client relationship with the test case petitioners as well as the nontest case Kersting program participants who had sent Chicoine and Hallett the $55C retainer and authorization forms. Concerning the nontest care clients, Professor Strait concluded that Chicoine and Hallett were obliged to "evaluate settlement proposals and to transmit to them your recommendation 42 Mr. Chicoine's letter identified the taxpayers as Muller, Lipsky, and Mellows. The record does not reflect the terms of the settlements in these cases. - 89 - with the explanation of what the options might be as to the desirability of accepting any sett Lement proposal. " On February 6, 1988, Mr. Kers;ing wrote to Mr. Hallett stating in pertinent part : I take it from our phone conversation yesterday that you are intent now to trigger the melt-down on me and our corporations with which you have threatened me now for months. And if I have absorbed all this correctly, you will do this mainly out o E concern that some of my friends might sue you at some time down the line if you do not advise them of a "setti.ement" which you perceive to be available. The bitter irony of all this is that there was only a remote possibility that anyons of my friends would sue you. If you.go through with your threat to cause a run on us you will have THE CERTAINTY that there will be litigation. .It will be hell after this. On February 8, 1988, Mr; Kersting wrote a letter to Kersting program participants warning them that Chicoine and Hallett soon would circulate the details of a 20-percent settlement offer. Mr. Kersting urged Kersting progra participants not to hire Chicoine and Hallett for purposes f settlement and instead to await the Court's decision regarding the evidentiary issues raised by Chicoine and Hallett on behalf of the test cases . During this period, Mr. Kersting threatened to sue Chicoine and Hallett if they reported the settlement offer. On February 9, 1988, Mr. Chicoine.issued two letters, one addressed to the firm's clients and one addressed to Kersting program participants who had contacted Chicoine and Hallett regarding representation. These letters served as status reports on the Tax Court case and settlement negotiations. Mr. Chicoine - 90 - reported that Mr. McWade had offered to settle docketed Tax Court cases in accordance with the previously described 20-percent settlement offer, recommended that program participants seriously consider the settlement, and sugge sted that those who desired to settle on these terms shoùld contact Chicoine and Hallett. On February 20, 1988, Mr. Kersting wrote to Chicoine and Hallett stating in pertinent part: "I hereby revoke your appointment as counsel= for the teEt Cases". On February 23, 1988, Mr. Chicoine wrote to Mr. McWade seeking a 20-percent settlement or behalf of test case petitioners Terry D. and Gloria K. Owens. Mr. Chicoine's letter states in pertinent part : Mr. Owens understands that nct all cases will settle and you wish to proceed to trial with some test cases. It is hoped that under the circumstances he may be withdrawn as a test case. If this is not possible, he still wishes to settle thc case and enter into an agreement which will permit 1 im to settle the case regardless of the outcome of the trial. Mr. and Mrs. Owens subsequently dccided that they would not continue efforts to settle their case. In early March 1988, Chicoinc and Hallett began receiving requests from Kersting program participants for return of the $550 retainer fee . Although Chicc ine and Hallett returned the full amount of the fee to all thoee who requested it, they were informed that they might be billed for a "minimal amount" reflecting the firm's costs associated with the opening-of files and issuance of status reports. - 91 - . On March .9, 1988, Mr. Kersting issued a letter to program participants characterizing Chicoine and Hallett as "scoundrels", and stating that he had fired them and retained Mr. Izen to represent the test cases (excluding the Thompsons and the Cravenses) . By letter dated April 22, 1988, Mr. Chicoine notified Kersting program participants that the Court had ruled in the Government's favor in Dixon I; he restated his support for the 20-percent settlement of fer described in his February 9, 1988-, letter and revealed that, because of a disagreement with Mr. Kersting, Chicoine and Hallett would withdraw as counsel for the test cases.43 Mr. Kersting later carried out his threat to sue Chicoine and Hallett for legal malpractice. Mr. Izen served as an expert witness for Mr. Kersting in his lawsuit against Chicoine and Hallett . By. letter dated April 8, 198E, Mr. .McWade notified Mr. DeCastro. that, after June 15, 1988, respondent would no 43 Coincidentally, on Apr. 20, 1988, Mr. DeCastro wrote a letter to a client, James Losey, Expressing similar sentiments in favor of settlement of the Kerstir.g cases. After outlining the deadlines that Mr. McWade had set for the acceptance of outstanding settlement offers, Mr. DeCastro's letter states in pertinent part : There is now an urgent r.eed for your friends and acquaintances to consult their legal counsel and seriously consider settling t heir case with the IRS. The evidence continues to build against the taxpayers in these cases and despite Mr.. Kersting'.s assurances, we feel the trial will be wor. by the IRS. The result would be very serious for the taxpayers. - 92 - longer consider settlements, other than on the basis of allowing out-of-pocket expenses, and that cut-of-pocket settlements would no longer be available after October 3,.1988. By memoran [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%3A8165409c89cff241. Public record. Not legal advice.