# T .C . Memo . 2009-13 0 > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A9113c1e18e4b5f61 ## Record - **Collection:** Agency decision - **Document type:** Agency decision ## Text T .C . Memo . 2009-13 0 UNITED STATES TAX COUR T HIE HOLDINGS,-INC ., HAWAIIAN ISLES KONA COFFEE CO ., LTD ., AND ROYAL HAWAIIAN WATER CO ., LTD ., ET AL .,1 Petitioners v . COMMISSIONER OF INTERNAL REVENUE, Responden t Docket Nos . 5045-05, 5047-05 . 5046-05 . Filed June 8, 2009 . William C . McCorriston , Cataldo , R . John Seibert , Brian R . Lynn , Jonathan H . Steiner , Paul B . K . Wong , Christopher S . Rizek , Lisa W . Christopher J . Cole , Lawrence Inouye , Richard W . .2 Craigo , and John Gaims , for petitioners 'Cases of the following petitioners are consolidated herewith : Hawaiian Isles Enterprises, Inc ., docket No . 5046-05 ; and Michael H . Boulware, docket No . 5047-05 . 2On Mar . 1 5, 2005, Sidney E . Boulware, Jr . (an .officer), filed the petitions with the Court in docket Nos . 5045-05 and (continued . . . ) SERVED Jun 08 2009 2 Kenneth C . Peterson , Paul K . Webb , Gordon L . Gidlund , and L . Katrine Shelton , for respondent . CONTENTS FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 I . Preliminaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 1 II . NODS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 2 A . NOD Issued to HIE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 1 . General,Information . . . . . . . . . . . . . . . . . . . . . . . . 22 . 2 . First Adjustment--Disallowance of Portio n of Deductions for NOLs . . . . . . . . . . . . . . . . . . . . . 22 a . . Overview . . . . . . . . . . . . . . . . . . . . . . . . . . 22 . .b . Primary Determination . . . . . . . . . . . . . . . . 2 2 ,c . Alternate Determination . . . . . . . . . . . . . . . 23 A . Overview . . . . . . . . . . . . . . . . . . . . . ii . Adjustments Related t o 23 Criminal Indictment . . . . . . . . . . iii . Adjustments Unrelated to Criminal Indictment . . . . . . . . . . iv . Some Specifics o f 24 Adjustments . . . . . . . . . 25 . . . . . . . . . 26 3 . Second Adjustment--Disallowance of Portion of Deductions for Professional Fees . . . . . . . a . Overview . . . . . . . . . . . . . . . 27 . . . . . . . 27 2( . . . continued) 5046 - 05, and Michael H . Boulware filed the petition with the Court in docket No . 5047 - 05 . Richard W . Craigo'and John Gaims entered their appearances in each of the three resulting cases on Dec . 9 and 21, 2005, respectively , and were allowed to withdraw from those cases on Nov . 15 and Sept . 22, 2006 , respectively . Lawrence = Inouye , Jonathan H . Steiner, William C . McCorriston, Lisa W . Cataldo, R . John Seibert , Paul B . K . Wong , Brian R . Lynn, Christopher S . Rizek, and Christopher J . Cole entered their appearances in each of the cases on Jan . 19, 2006 , July _10, 2006, July 14, 2006 , Sept . 8, 2006, Nov . 27, 2006, Dec . 1,,2006, Dec . 7, 2006, Dec . 7 ., 2006, and July 9, 2007 , respectively . b .` Personal Expenses of Michae l Boulware . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 'c : Unsubstantiated Expenses . . . . . . . . . : . . . 29 d . Capital Expenditures . . . . . . . . . . . . . . . . 29 e . Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 4 . Third Adjustment --Disallowance of ' Deduction for Bad Debt . . . . . . . . . . . . . . . . . . . . 31 B . NOD Issued to Holdings .. . . . : . . . . . . . . . . . . . . . . . . . . 31 1 . General Information . . . . . . . . . . . . . . . . . . . . . . . 31 2 . Sole Relevant Adjustment--Disallowance o f Portion'of Deductions for Professiona l Fees . . . .. . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . 3 1 C . NOD Issued to Michael Boulware . . . . . . . . . . . . . . . . . 32 1 . General Information . . . . . . . . . . . . . . . . . . . . . . . 32 2 . Sole Relevant Adjustment--Constructiv e . . . . . . . . . . . . 33 Dividends .' . . . . . . . . . . . . . . III . Background of Michael Boulware . . . . . . . . . . . . . . . . . . 3 3 IV . Relevant Corporations . . . . . . . . . . . . . . . . . . .. . . . . . . . . 3 4 . . . . . . . . . . . 34 A . HIE . . 1 . Formation of Business : . . . . . . . . . . . . . . . . . . . . .34 2 . --Officers and Directors . . . . . . . . . . . . . . . . . . . . 3 6 a . Initially . . ., . . . . . . . . . . . . . . . . . . . . . . 36 b .- August,31, 1982, to July 10, 1991 , or Thereabouts . . . . . . . . . . . . . . . . . . . . . 37 c . On or About July 10, 1991, Throug h an Effective Date of April 15, 2000 .38 d . Effective April 15, 2000 . . . . . . . . . . . . 39 e . Board Meetings . . . . . . . . . . . . . . . . . . . . . . 4 0 3 . Shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 4 . Michael Boulware's Control . . . . . . . . . . . . . . . . 4 2 B . Holdings . . . . . .' . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 2 C . Other Corporations Organized in 1994 . . . . . . . . . . . 4 3 Restructuring of HIE . . . . . . . . . . . . . . . . . . .x. . . . . . .4 3 E . Royal Hawaiian Water . . . . . . . . . . . . . . . . . . . . . . . . . 44 F . Holdings After the Restructuring . . . . . . . . . . . . . . . 44 G . Payment of Common Costs . . . . . . . . . . . . . . . . . . . . . . . . 4 5 H . Various Names Used by HIE To Conduct It s Business Duringtthe :Subject Years . . . .. . . . . . . . . . 4 5 I . No Payment . of Formal Dividends by HIE . . . . . . . . . . 46 J . E&P of HIE and Its Predecessor for 19820 6 Through 198806 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 1 . 198206 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 2 . 198306 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . 46 3 . 198406 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 4 . 198506 . . . . . . . . . . . . . . . . . . . . . . . 47 5 . 198606 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 6 . 198706 . . . . . . . . . . . . . . . . . . . . . 7 . 198806 . . . . . . . . . . . . . . . . . . . . . 48 . . . . . . . . . 49 K . E&P of Holdings for 199706 and 199806 . . . . .. . . . . 50 1 . 199706 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 a . Accumulated E&P . . . . . . . . . . . . . . . . . . . 50 b . Current E&P . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 2 . 199806 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 L . Number of Holdings and HIE Employees . . . . . . . . . . . 50 V . Officer Loan Account . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 A . Overview . . . . . . . . . . . . . . . 50 B . Mechanics of Account . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 0 C . Repayment of Officer Loans . . . . . . . . . . . . . . . . . . . . . 5 2 Michael Boulware's Claimed Coffe e Transactions . . . . . . . E . Promissory Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 F . Lack of Collection on Promissory Notes . . . . . . . . . VI . Personal Bank Accounts . . . . . . . : 55 . . . . . . . . . . . . . . . 55 A . Michael Boulware Individually . . . . . . . . . . . . . . . . . . 55 B . Michael Boulware and Mal Sun Boulware Jointly . . 56 - 5 C . Jin Sook Lee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56 . VII . Mal Sun'Boulware . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . 56 VIII . Jin Sook Lee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 7 A . Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 B . Jin Sook Lee Meets Michael Boulware . . . . . . . . . . . . 58 C . Paradise Roasting . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . 60 D . Video Consultant . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 2 - 1 . Overview . . . .. . . . . . . . . . . . . . . 2 . Formation . . . . . . . . . . . . . . . J . . . . . . . . . . . . . . 62 . . . . . . . . . . . . . . . . 62 3 . . Payments From HIE for False Invoices . . . . . . 63 E . Michael Boulware's Divorce From Mal Su n Boulware . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64 1 . Discussions Concerning Divorce . . . . . . . . . . . . 64 2 . Glenn Lee Boulware Trust . . . . . . . . . . . . . . . . . . . 65 3 . Divorce Proceeding . . . . . . . . . . . . . . . . . . . . . . . . 6 6 F . Transfers of HIE Assets to_Jin Sook Lee . . . . . . . . 1 .- Overview . . ; . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . 2 . Atkinson Condominium . . . . . . . . . . . . . . . . . . . . . . 68 68 69 70 3 . Makaiwa House . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 . Koloa House . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71 . . . . 73 5 . Punahou Condominium . . . . . . . . . . . . . . . . 6 . Understanding as to the Transferre d Assets . . 74 7 . Jin Sook Lee's Use of the Transferre d Funds . . . . . . . . . . . . . . . . . . . . . . . . 75 8 . Michael Boulware Takes Some of the Transferred Funds From Jin Sook Le e Without Her Knowledge . . . . . . . . . . . . . . . . . . . . . 7 6 IX . Off-Book Bank Accounts . . . . . . . . . X . . . . . . . . . . . . . 77 Off - Book Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 8 A. Overview . . . . . . . . . . . . 78 - 6 B . OTC Sales of Tobacco Products . . . . . . . . . . . . . . . . . . 7 9 C . Michael Boulware's Personal Sales of HIE Coffee Unknown at the Time to HIE . . . . . . . . . . . . . . . . . . . . . 8 1 1. 2 . 3 . 4 . Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81 Sales to Hawaii Misuzu . . . . . . . . . . . . . . . . . . . . 82 83 Sales to Pele Trading . . . . . . Referenced Coffee Sold by Michael Boulwar e Included in HIE's COGS . . . . . . . . . . . . . . . . . . 85 D . Bonded Construction . . . . . . . . . . 85 1 . Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85 2 . Michael Boulware Causes HIE To Pay t o Remodel Jin Sook Lee's Residence . . . . . . . . . . 85 3 . Paving of the Back Lot at HIE ., . . . . . . . . . . . 86 a . Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . 86 b . Automated-Equipment . . . . . . . . . . . . . . . . . 8 7 E . Michael Boulware's .Fictitious Leasing Transactions . . . . . . . . . . . . . . . 88 1 . Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88 2 . Michael Boulware's First Scheme . . . . . . . . . . . 89 3 . Michael Boulware's Second Scheme . . . . . . . . . . 90 a . Need for the Second Scheme . . . . . . . . . . 90 b . HIE's Relationship With GECC . . . . . . . . 91 c . Seven False Invoices . . . . . . . . . . . . . . . . 9 2 92 i . Overview . . . . . . . . . ii . Four False-Invoices Totaling $271,382 .80 . . . . . . . . . . . . . . . . . . 9 2 iii . Three False Invoice s Totaling $224,432 . . . 93 d . First . Four'Referenced False Invoices . 94 e .- Last Three . Referenced False Invoices . 9 5 4 . Funds Transferred to Lorin Kushiyama . . . . . . 96 F . Michael Boulware's International Circular Flo w of- Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 1 . Overview . . . . . . 96 2 . . Relevant Foreign Entities . . . . . . . . . . . . . . . . . 9 7 a . Forest Trading . . . . . . . . . . . . . . . . . . . . . . 97 b . Pacific Vendors . . . . . . . . . . . . . . . . . . . . . 98 c . Harvest International . . . . . . . . . . . . . . . 9 9 i . Roxca Limited . . . . . . . . . . . . . . . . . 99 ii . Reinvoicing Operation . . . . . . . . 99 iii . Bank Accounts . . . . . . . . . . . . . . . . .100 iv . Rationale Underlying Formation . . . . . . . . . . . . . . . . . . . . 101 v . Actual Operation . . . . . . . . . . . . . 101 vi . False Invoices From Harves t International . . . . . . . . . . . . . . . . . 101 1 . Overview . . . . . . . . . . . . . . . . .101 2 . Payments of Invoices . . . . . . . 102 3 . Transfers From Harves t International . . . . . . . . . . . . . . . 10 3 a . Overview . . . . . . . . . . . . . .103 b . Transfers to Personal Account of Michael Boulware . . . . . . . . . . . . . . 10 3 C . Transfers on Behalf of Michael Boulware to Paragon Coffee, Gloria Oh Young, ' an d Antoinette Hirai . . . . . .103 d . Transfer on Behalf of Michael Boulware to Briggs Cockerham . . . . . . 10 4 vii . Coffee Rebagging . . . . . . . . . . . . .105 3 . Role of Nathan Suzuki . . . . . . . . . . . . . . . . . . . . . 105 4 . Harold Okimoto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 6 a . Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106 b . Harold Okimoto's Employment . . . . . . . . . 106 c . Administration of Harold Okimoto' s d. Estate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .107 U .S . Attorney Contacts Okimot o Family . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109 e . Claim of an Approximately $1 . 7 Million Debt . . . . . . . . . . . . . . . . . . . . . .110 . After-the-Fact Creation o f f Promissory Notes . . . . . . . . . . . . . . . . . . . .11 0 XI . Michael Boulware's Removal of Funds From the Off-Book Bank,Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . il l A. Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .il l B . Michael Boulware Causes Checks To Be Cashed for Him by Employees and Friends . . . . . . . . . . . . . . . . . . . 11 2 1 . Stanley Hirai and Antoinette Hirai . . . . . . . . 112 2 . Morris Miyasota . . . . . . . . . . . . . . . . . . . . . . . . . . .113 3 . Thomas Okimoto . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114 - 8 4 . Milton Ikeda . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .115 5 . Sydney Murayama . . . . . . . . . . . . . . . . . . . . . . . . . .116 6 . .Neal Taira . . . . . . . : . . . . . . . . . . . . . . . . . . . . . .116 7 . Paul Takekawa . . . . . . . . . . . . . . . . . . . . . . . . . . . . .116 8 . John Torres . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117 9 . Other Check Cashers . . . . . . . . . . . . . . . . . . . . . . . 11 8 XII . Criminal Investigation of Michael Boulware . . . . . . 11 8 Jerry Yamachika Contacts .and Meets Wit h Michael Boulware . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 8 B . Michael Boulware Obtains Professional Representation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 0 C . Focus of Criminal Investigation . . . . . . . . . . . . . . . . 12 2 D, .- Applicability of HIE's Indemnification . Provision Relating to Certain Personal Lega l Fees Incurred by Its Directors and Officers . . . . 12 4 XIII . Civil Litigation Initiated by Jin Sook Lee : . . . . . 12 6 A . Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . : . .12 6 B . JSL Litigation . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127 1 . Complaint . . . . . 2 . Counterclaim . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 12 9 . . . . . . . . . . . . .127 C . Trust-Case . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131 D . Shareholder Derivative Case . . . . . . . . . . . . . . . . . . . . 132 E . HIE's Perception of Civil Litigation . . . . . . . . . . . 13 3 F . Actions Taken by HIE Board of Directors . . . . . . . . 133 1 . Resolution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .133 2 . Payment of Legal Expenses . . . . . . . . . . . . . . . . . 13 4 XIV . Referral of Michael Boulware for Prosecutio n and Michael Boulware's Grand Jury Indictment . . . . 13 4 A . Referral to DOJ for Prosecution . . . . B . Referral to Grand Jury . . . . . .. . . . . . . . . . . . . . . . . . . . .13 4 - 9 C . Grand Jury Indictment . . . 138 XV . Resolution of JSL Litigation . . . . . . . . . . . . . . . . . . . . 13 9 A . Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .139 B . Jury Verdict . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .140 C . Equitable Issues Decided by State Court . . . . . . . . 140 D . Final Judgment Entered . . . . . . . . . . . . . . . . . . . . . . . .142 E . HIE Records Receivable From Jin Sook Lee . . . . . . . 14 2 XVI . Bankruptcy Case of Jin Sook Lee . . . . . . . . . . . . . . . . .142 A . Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .142 B . Property Transfers and Claims . . . . . . . . . . . . . . . . . . .143 C . Adversary Proceedings Commenced in 1998 . . . . . . . . 14 5 D . Settlement of 1997 Adversary Proceeding . . . . . . . . 14 6 E . May 1998 Settlement Agreement . . . . . . . . . . . . . . . . . . 14 1 . Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .147 2 . Property Distributions . . . . . . . . . . . . . . . . . . . .14 7 a . Cash and Cash Equivalents . . . . . . . . . . . 147 b . Automobiles . . . . . . . . . . . . . . . . . . . . . . .147 c . Real Properties . . . . . . . . . . . . . . . . . . . . . 147 d . Jewelry and Furs . . . . . . . . . . . . . . . . . . . .148 e . Judgment Against Michael Boulware . . .148 f . Summary . . . . . . . . . . . . . . . . . . . . . . . . . . .14 8 3 . Disbursements by HIE . . . . . . . . . . . . . . . . . . . . . .14 9 F . Settlement of 1998 Adversary Proceedings . . . . . .. . 14 9 G . Claimed Bad Debt Deductions Related to Amounts Considered Due From Jin Sook Lee, Trustee . . . . . . 15 1 XVII . NOL Adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15 1 A . HIE's Filing of Its Federal Income . Tax Return s for 198906 Through 199906 . . . . . . . . . . . . . . . . . . . . .151 - 10 B . Pre-199806 Reported NOLs and Applications . . . . . . .15 2 C . HIE Claims .on Its Federal Income Tax Return for 199806 That Its NOL Carryover From Earlie r Years Is Larger .Than That Previously Reported . .15 3 D . Source of Larger NOL Carryover Reported Fo r 199806 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 4 2 E . HIE's 199906 Federal Income Tax Return . . . . . . . . . 155 1 . . Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155 2 . Exhibit 18-J . . . . . . . . . . . . . . . . . . . . . . . . . . . . .156 3 . Claim to Additional COGS . . . . . . . . . . . . . . . . . . . 15 8 F . HIE's Position as to-Its NOL Carryover s Reported for 199806 and Later Years . . . . . . . . . . . . 159 . .159 1 . Overview . 2 . HIE's Liability for Hawaii Tobacco Tax . . . . 160 3 . HIE's Purported Overpayment of Hawai i . . . .160 . . . . . . . . . . . . . . . . . . . . . . .Tobacco Tax . 4 . Tobacco Tax Liability Adjustment . . .. . . . . . . . . 162 5 . HIE's Monthly Book Adjustments . . . . . . . . . . . . 164 6 . HIE's AJEs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 165 7 . Tobacco Tax Refund Income Claimed Reporte d and Reportable by HIE . . . . . . . . . . . . . . . . . . . . .166 a . Income Claimed Reportable . . . . . . . . . . . . 166 b . Income Claimed Reported Throug h Monthly, Adjustments . . . . . . . . . . . . . . . . .167 c . Income .Claimed Reported Through AJEs .168 d . . Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..16 8 8 . HIE's Purported Income Shift . . . . . . . . . . . .16 9 XVIII . Michael Boulware's Criminal Trials . . . . . . . . . . . . . . 16 9 . . . . . . . . . . . . . . . . . . . .169 A . First Trial . . . . . . . . . . . . . . 1 . General Information : . . . . . . : . . . . . . . . . . . . . . . .169 2 . Relevant Evidence and Arguments . . . . . . . . . . . 169 3 . Jury Verdict . . 17 0 B . Sentencing Phase and First Appeal . . . . . . . . . . . . . . 171 1 . Positions as to Sentencing . . . . . . . . . . . . . . . .171 2 . Sentence Imposed . . . . . . . . . . . . . . . . . . . . . . . . 3 . Appeal of Conviction. . . . . . . . . . . . . . . . . . . . . . . . . 17 2 C . Michael Boulware ' s Retrial . . . . . . . . . . . . . . . . . . . . . 172 - 11 D . Criminal Case Heard by U .S . Supreme Court . . . . . . 173 E . Remand From U .S . Supreme Court . . . . . . . . . . . . . . . . .17 4 XIX . Civil Examinations and Requests fo r Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17 5 A . Start of Civil Examinations . . . . . . . . . . . . . . . . . . . . 17 5 B . Requests for Information . . . . . . . . . . . . . . . . . . . . . . .175 1 . HIE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .175 . .177 2 . Holdings . . . . . . . 3 . Actions During This Proceeding . . . . . . . . . . . . 18 0 XX . 'Professional Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 0 A . Overview . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . .18 0 B . Source of Professional Fees . . . . . . . . . . . . . . . . . . . . 181 1 . HIE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .181 2 ., Holdings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18 2 C . Categories of Disputed Professional Fees . . . . . . . 182 . . . . . . . .182 1 . Overview . . . . . . . . . . . . . . . . . . . . . . . . 2 . Specifics of Expenses in Each Category . . . . 18 3 a . Criminal Investigation . . . . . . . . . . . . . . 183 b . Grand Jury Proceedings . . . . . . . . . . . . . . 183 c . Michael Boulware's Criminal Trial . . .184 d . Fees .Involving Jin Sook Lee . . . . . . . . . 184 e . Fees Accepted as Ordinary an d Necessary . . . . . . . . . . . . . . . . . . . . . . . .185 f . Other Fees . . . . . . . . . . . . . . . . . . . . . . . . . . 185 3 . Amounts of Fees Attributable to Eac h Category . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18 5 D . Providers of the Professional Service s Underlying the Legal Costs . . . . . . . . . . . . . . . . . . . . . 186 186 1 . Criminal Investigation . . . . . . . . . . Representation of HIE Employees . . . . . 18 6 a i . Overview . . . . . . . . . . . . . . . . . . . . . 186 ii . Peter Wolff . . . . . . . . . . . . . . . . . . 186 iii . Benjamin Cassidy . . . . . . . . . . . . . 18 6 b . Damon Key . . . . . . . . . . . . . . . . . . . . . . . . . . . 187 . . .188 c . Irell Manella . . . . . . . . . . . . . . . . . . d . Shiotani Inouye . . . . . . . . . . . . . . . . . . . . . 188 - 12 - e . Wachi Watanabe . . . . . . . . . . . . . . . . . . . .189 2 . Grand Jury Proceedings . . . . . . . . . . . . . . . . . . . . 19 0 . a . Birney Bervar . .. . . . . . . . . . . . . . . . . . . . . . 190 b . Brook Hart . . . . . . . . . . . . . . . . . . . . . . . . . . 190 c . Chee Markham . . . . . . . . . . . . . . . . . . . . . . .191 d ., Damon Key . . . . . . . . . . . . . . . . . . . . . . . . .191 e . Graham James . . . . . . . . . . . . . . . . . . . . . . .192 f . Hochman Salkin . . . . . . . . . . . . . . . . . . . . .194 g . Howard Chang . . . . . . . . . . . . . . . . . . . . . . . . 194 h . Irell Manella . . . . . . . . . . . . . . . . . . . . . . .195 i . Lopeti Foliaki . . . . . . . . . . . . . . . . . . . .195 . . . . . . . . . . . . . . . . . . .195 j . Perkin Hosoda . . k . Reinwald O'Connor . . . . . . . . . . . . . . . . . . .196 1 . Shiotani Inouye . . . . . . . . . . . . . . . . . . . . . 198 Stephen Pingree . . . . . . . . . . . . . . . . . . . . .198 M. n . Wachi Watanabe . . . . . . . . . . . . . . . . . . .. . . .19 8 . . . . . . . . . . . . . . . . . . . . .199 3 . Criminal Trial . . . . . a . Accucopy . . . . . . . . . . . . . . . . . . . . . . . . . . . .199 b . . Ayabe Chong . .. . . . . . . . . . . . . . . . . . . . . . . . 1 c . Bird Marella . . . . . . . . . . . . . . . .. . . . . . . . . 200 d . Bowen Hunsaker . . . . . . . . . . . . . . . . . . . . . . 200 e . Brook Hart . . . . . . . . . . . . . . . . . . . . . . . . . .201 f . Candon Consulting/John-Landon . . . . . . . 201 g . Chicoine Hallett . . . . . . . . . . . . . . . . . . . . .203 . . . . . . . . .20 3 h . Corniel . . . . . . . . . . . . . . . . . . i . Overview . . . . . . . . . . . . . . . . . . . .203 ii . Specifics . . . . . . . . . . . . . . . . . . . .204 i . . Damon Key . . . . . . . . . . . . . . . . . . . . . . . . . . .204 j . Gaims Weil . . . . . . . . . . . . . . . . . . . . . . . . . .204 k . Goodenow . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205 1 . Graham James . . . . . . . . . . . . . . . . . . . . . . . .205 .205 M. Hawaii National Bank . . . . . . . . . . . . . n . Leonard Sharenow . . . . . . . . . . . . . . . . . . . . 20 6 .o . Lyle Hosoda Associates . . . . . . . . . . . . . .206 p . McCorriston Miller . . . . . . . . . . . . . . . .206 q . Michael McCarthy . . . . . . . . . . . . . . . r . Nathan Suzuki . . . . . . . . . . . . . . . . . . . . . .207 s . Perkin Hosoda . . . . . . . . . . . . . . . . . . . . . .207 . . . . . . . . . . . . .207 t . PWC . . u . Professional Image . . . . . . . . . . . . .. . . . . . 208 v . Reinwald,O'Connor . . . . . . . . . . . . . . . . . .208 w . Robert Waters . . . . . . . . . . . . . . . . . . . . . . . 209 X. Saranow Pagani . . . . . . . . . . . . . . . . . . . . . .210 y . Sherman Sherman . . . . . . . . . . . . . . . . . . . . . 210 Sheila Balkan . . . . . . . . . . . . . . . . . . . . .211 Z . 13 aa . Shiotan_i Inouye . . . . . . . . . . . . . . . . . . . . 211 i . 200006 . . . . . . . . . . . . . . . . . . . . . . . 211 ii . 200106 . . . . . . . . . . . . . . . . . . . . . . .211 iii . 200206 . . . . . . . . . . . . . . . . . . . . . . . 21 2 bb . Squire Sanders . . . . . . . . . . . . . . . . . . . . . . 212 cc . Stephen Platt . . . . . . . . . . . . . . . . . . . . . . . 213 dd . Wachi Watanabe . . . . . . . . . . . . . . . . . . . . .213 ee . Wilmington Institute . . . . . . . . . . . . . . . 21 3 4 . Fees Concerning Jin Sook Lee . . . . . . . . . . . . . .214 . . . . . . . . . . . .214 a . Chee Markham . . . . . . . . . b . Damon Key . . . . . . . . . . . . . . . . . . . . . . . . . . .214 c . Gaims Well . . . . . . . . . . . . . . . . . . . . . . . .215 d ." Glenn Lee Boulware Trust . . . . . . . . . . . . 216 . . . . . . . . .21 6 e . Reinwald O'Connor . . . . . . . 5 . Fees Accepted as Ordinary and Necessary . . . 217 . . . . .217 a . Carlsmith Ball . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .217 b . Damon Key . . . . . . . . . . . . . . . . . . . . . . . . . . . .218 c . Marr Hipp . . . . . d . Seyfarth Shaw . . . . . . . . . . . . . . . . . . . . . . .218 e . Other Legal . . . . . . . . . . . . . . . . . . . . . . . . . 21 9 . . . . . . . . . . . . . . . . . . . .219 6 . Other Fees . . . . . . . . . . a . Accucopy . . . . . .. . . . . . . . . . . . . . . . . . . . . . .219 b . Case Bigelow . . . . . . . . . . . . . . . . . . . . . . . .21 9 Damon Key . . . . . . . . . . . . . . . . . . . . . . . . . . . 220 C. d. Foley Jones . . . . . . . . . . . . . . . . . . . . . . . . .221 . GMK Consulting . . . . . . . . . . . . . . . . . . . . . . 221 e. . . . . . .222 f. King King . . . . . . . . . . . . . . . . . . . . 9h. i. . . . . . . .222 Laird Christianson . . . . . . . . . . . . . . . . . . . . .222 Louis Wai . . . . . . . . . . . . . Michael McCarthy . . . . . . . . . . . . . . . . . . . . 223 Nathan Suzuki . . . . . . . . . . . . . . . . . . . . . . . 223 Robert .Holland'. . . . . . . . . . . . . . . . . . . . . .22 3 1 . Yoshida, Inc . . . . . . . . . . . . . . . . . . . . . . .223 Other Legal . . . . . . . . . . . . . . . . . . . . . . . . .22 4 M. J• k. . . . . . . . . . . . . .224 E . Other Professional Fees . . . . . . . . . 1 . Fees Related-to Criminal Trial . . . . . . . . . . . . 224 2 . Fees Accepted as ordinary and Necessary . . . 22 4 a . Antoneita DeWang-Seo . . . . . . . . . . . . . . . .224 b . Applied Computer . . . . . . . . . . . . . . . . . . . . 224 ASI Food Safety . . . . . . . . . . . . . . . . . . . . . 225 Q. d . Back to Basics Plus . . . . . . . . . . . . . . . . . 225 e . Brewer Environmental . . . . . . . . . . . . . . . .225 f . Business Consulting . . . . . . . . . . . . . . . . . 225 g . Ceridian Employer . . . . . . . . . . . . . . . . . .225 h .' Charles Abraham . . . . . . . . . . . . . . . . . . . . .226 . - 14 i. k. 1 . M. n. 0. pq• r. S . t . .u v. w. X . . .y . Z . aa . . bb . cc . dd . ee . ff . Jg hh . ii . jj . kk . 11 . . - . . . . . . . . 22 6 COLIFORM . . . . . . . . . . . . . . . . 22 6 Commercial Plumbing . . Communications Pacific . . . . . . . . . . . . . 22 6 Datahouse . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 7 Dataprofit Corp . . . . . . . . . . . . . . . . . . . . .22 7 . . .22 7 Dunn Bradstreet . . . . . . . . . . . . . . . . . . . . . . . . . .22 7 Electra Form . . EMS Solutions . . . . . . . . . . . . . . . . . . . . . . . 22 7 Fidelity Investments ._. . . . . . . . . . . . . . .. 22 8 Foley Jones . . . . . . . . . . . . . . . . . . . . . . . . . 22 8 Food Products . . . . . . . . . . . . . . . . . . . . . . . . 22 8 . . . . . . . . . . . .22 9 GEM Communications . . . GT Service . . . . . . . . . . . . . . . . . . . Hawaiian Hard ware . . . . . . . . . . . . . . . . . . 22 9 Intrastate . . . . . . . . . . . . . . . . . . . . . .22 9 IW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .22 9 John Ching . . . . . . . . . . . . . . . . . . . . . . . . . 23 0 Kimura International . . . . . . . . . . . . . . . . 23 0 . . . . . . . . . . . . .23 0 . . . . . . . . . . . . . . . . . . . . . 23 0 Leung Pang . . . . . . . . . . . . . . . . . . . . . . . . . . 23 1 Melvin Kam . . . . . . . . . . . . . . . . . . . . . . . . . . .231 , Michael Toigo . . . . . . . . . . . . . . . . . . . . . . .23 1 KPMG . . . . . . L .C . Financial Pension Services . . . . . . . . . . . . . . . . . . . . 2 3 Procomm . . . . . . . . . . . . . . . . . . . . . . . . . . . .23 2 Professional Image . . . . . . . . . . . . . . . . .23 2 Profit Concepts . . . . . . . . . . . . . . . . . . . . .23 2 Quadrel Labeling . . . . . . . . . . . . . . . . . .23 2 . . . . . . . . . .23 2 Rhanda Kim . . . . . . . . . . . . . . mm . Richard Kitagawa . . . . . . .. . . . . . . . . . . . . . . 23 3 . . . . . . : . . . . . . .23 3 RJR Packaging . . . . . . nn . Servend of Hawaii . . . . oo . pp . Stewart Engineering . . . . . . . . . . . . . . . .23 3 Tricia Young . . . . . . . . . . . . . . . . . . . . . . . . . .23 3 Wayne Arakaki . . . . . . . . . . . . . . . . . . . . . . . 23 4 qq . Other a .. b. . Fees . . . . . . . 23 3 . . . . . . . . . . . . . . . . . . . . . Henry Yokogawa . . . . . . . . . . . . . . . . . . . . . . 23 4 Kobayashi Doi . . . . . . . . . . . . . . . . . . . . . . . 23 4 i . overview . . . . . . . . . . . . . . . . . . . . . . .234 . ii . 199806 . . . . . .. . . . . . . . . . . . . . . i-ii . 199906 . . . . . . . . . . . . . . . . . . . . . . .235 . . . . . . . . . . . . .236 . . . iv . 200006 . . . . v . 200106 . . . . . . . . . . . . . . . . . . . . . . . . vi . 200206 . . . . . . . . . . . . . . . . . . . . . . . . 23 6 c . Lorin Kushiyama . . . . . . . . . . . . . . . . . . . .236 - 15 d . -Richard Kitagawa . . . . . . . . . . . . . . . . . . . . . . 23 6 e. TRI Pac . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23 7 f . Vending-Consulting . . . . . . . . . . . . . . . . . .237 g . Watson Wyatt . . . . . . . . . . . . . . . . . . . . . . . . 23 7 h . Amortization . . . . . . . . . . . . . . . . . . . . . . . . . 23 7 XXI . Kona Coffee . . . . . . . . . . . . . . . . . . . . . . . . A. Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23 8 B. . Season for Kona'Coffee . .. . . . . . . . . . . . . . . . . . . . . C. Shelia David . . . . . . . . . . . . . . . . . . OPINION . . . . . . . . . . . . . . . . I . . . . . . . . . . . . .23 8 Perception of . . . . . . . . . . . . . . . . . . . . . . . . . . .23 9 . . . . . . . . . . . . . . . . . . . . .241 Witnesses . . . . . . . . 1 . . . . . . . . . . . . . . . . . . 24 1 II . Burden of Proof . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 244 A . Overview . . . . .. . . . . . . . . . : . . . . . . . . . . . . . .24 4 B . Applicability of Section 7491 . . . . . . . . . . . . . . . . . . 245 C . Claim That NODs Are Arbitrary . . . . . . . . . . . III . NOL Deduction . . . . . . 24 9 . . . . . . . . . . . . . . . . . . . . . . . . . . . .251 IV . Bad Debt Deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .263 V . Professional Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 9 A . Overview of Dispute . . . . . . . . . . . . . . . . . . . . . . . . . . . .26 9 B . Applicable Law in General . . . . . . . . . . . . . . . . . . . . . . 270 1 . Deduction of Ordinary and Necessary Business Expenses . . . . . . . . . . . . . . . . . . . . . . . . .270 2 . Corporate Taxpayer's Burdens Underlying Deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .27 1 3 . Payment of Another Taxpayer's Expense . . . . . 272 a . First Prong of Two-Prong Test . . . . . . . . 273 b . Second Prong of Two-Prong Test . . . . . . . 27 5 C . Whether HIE Incurred Any of the Disputed Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16 D . Whether All Expenses•Were Substantiated . . . . . . . . 28 0 E . "Fees Accepted as Ordinary and Necessary" and . . . . . . . . . . . . . . . . . .28 1 "Other Fees" . . . . . . . . . . . . . . . F . Expenses of Michael Boulware's Crimina l . . . . . . . . . . . . . .. . . . ._ . .282 Defense . . . . . . . Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .282 1 2 . Expenses Stemmed From Personal Pursuits . . .284 G . Professional Fees Related to Civil Litigatio n Initiated by Jin Sook Lee . . . . . . . . . . . . . . . . . . . . . . 288 . . . . . . . . . . . . . . . . . . . . .288 1 . Overview . . . . . . . 2 . Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 289 a . . Fees Determined To Be Capita l . Expenditures . . . . . . . . . . . . . . . . . . . . b . Fees Determined To Be Michae l Boulware's Personal Expenses . . . . . . . . . 29 0 H . Applicability of Indemnification Agreement . . . . . 292 . . . . . . . . . . . . . . . . . . . . .292 1 . Overview . . . . 2 . Arrangements Under Section 62(a)(2)(A) . . . . 293 . . . . . . . . . . .29 5 3 . Mandatory Indemnity . . . . . . a . Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . .295 b . Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . .296 4 . Permissive Indemnity . . . . . . . . . . . . . . . . . . . . . . 298 . . . . . . . . . . . . . . . .2 .9 9 5 . Repayment Obligation . . VI . Constructive Dividends . . . . . . . . . . .. . . . . . . . . . . . . . . A . Overview . . . . . . . . . .300 . . . . . . . . . . . .300 B . Rules Applicable to Distributions, . .. . . . . . . . . . . C . E&P . . . . .. . . . . . . . . . . 1 . • Background . . . . . . . . . . . . . . . . . . . . . . . . . . 2 . Lack of Comprehensive . Definition . . . . ., 3 ., Calculation ; . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 303 a . Overview . . . . . . . . . . . . . . . . . . . . . . . . . . .303 . . . . . . . . . . . . . . . . . . . . . . . .303 i . ATI . . . ii . Increases and Decreases to ATI . .30 4 . . . . . . . . . . . . . . . . .306 b . Current E&P . . . Accumulated E&P . . . . . . . . . . . . . . . . . . . . . .307 c . . . . .307 d . Summary of Calculation . . . . . 17 D . Adjustments Applicable to These Cases . . . . . . . .. . . 309 1 . Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .309 2 . . First Adjustment . . . . . . . . . . . . . . . . . . . . . . . . . .309 3 . Second Adjustment . . . . . . . . . . . . . . . . . . . . . . . . . 309 4 . Third Adjustment . . . . . . . . . . . . . . . . . . . . . . . . . .310 5 . Fourth Adjustment . . . . . . . . . . . . . . . . . . . . . . . . .310 6 . Fifth Adjustment . . . . . . . . . . . . . . . . . . . . . . . .31 1 E . Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .311 VII . Additions to Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .312 VIII . 'Epilog . .- . : . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 313 , Appendix A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 4 Appendix B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . : . . . . . . . . . . . . . . . . . . . . .32 1 Appendix C . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. MEMORANDUM FINDINGS OF FACT AND OPINIO N LARO, Judge : These cases are before the Court consolidated for purposes of trial, briefing, and opinion .3 In docket No . 5045-05,- .HIE Holdings, Inc . (Holdings), and 'two of it s subsidiaries, Hawaiian Isles Kona Coffee Co ., Ltd . (Hawaiian Isles Kona Coffee), and Royal Hawaiian Water Co ., Ltd . (Royal" Hawaiian Water), petitioned the Court to redetermine respondent's determination of deficiencies of $242,54 .6, $77,602, $470,461, $280,489, and $519,760 in the affiliated group's Federal income taxes for its taxable years ended June 30, 1997, 1999, 2000 , 3The cases were consolidated on Feb . 27, 2006, pursuant to the joint motion of the parties . ; Y I 2001, and 2002,, respectively : .' In docket No . 5046-05, Hawaiian Isles Enterprises , Inc . ,(HIE ), petitioned the, Court t o redetermine respondent' .s determination of deficiencies of $1,057,181, $125,317, .$175,524, and $799,433 in HIE's Federal income taxes .for 199806, 200006, 200106, and 200206, respectively, . and a $264,295 addition to .HIE's 199806 tax under section 6651 (a)(1) .5 In docket No . 5047-05, Michael Boulware petitioned the Court to redetermine respondent's determination of deficiencies of $497,926, $603,406, .$935,124, $1,339,019, and $874,551 in Michael Boulware's 1998 through 2002 Federal income taxes, respectively . 'We hereinafter refer to each relevant fiscal year by using a six-digit number . The first four digit's refer to the year in which the fiscal year ended . The last two digits refer to the month in which .the fiscal year ended . 'Unless otherwise indicated, section references are to the applicable versions of the Internal Revenue Code, Rule references are to the Tax Court Rules of Practice .and Procedure, and dollar amounts are rounded to the dollar . References to sections and chapters of the Bankruptcy Code are to tit . .11 of the United States Code after the effective date of amendments made thereto by the Bankruptcy Reform . Act of 1994, Pub . L . 103-394, 108 Stat . 4106, that were effective for bankruptcies filed'on and after Id . sec . 702, 108 Stat . 4150 . Throughout this Oct . 22, 1994 . Memorandum opinion, we reference various law, accounting, and other professional firms, many of which changed their names during the relevant period . We refer to each firm by one of its names and include within that,name each of the firm's relevant predecessors and successors . 19 Following a trial of these cases held primarily in Honolulu, Hawaii, we decide five issues .6 First, we decide whether to sustain respondent's disallowances of HIE's deductions of net . operating losses (NOLs), reported as arising from NOL carryovers from 198906 through 199606, to the . extent of $1,636,322 for 199806 and of $1,184,192, $324,767, and $145,145 for 200006 , 'These cases were originally scheduled to, be tried in Los Angeles, California, but the Court granted the parties' joint motion to change the situs of trial to Honolulu, Hawaii, where most of the witnesses resided . Because Michael Boulware would otherwise have been detained at a U .S . penitentiary in Californi a during the trial, the Court, pursuant to sec . 7456 and joint motions of the parties, issued writs of habeas corpus ad testificandum causing the U .S . Marshal for the District of Hawaii to move Michael Boulware to a prison in the vicinity of Honolulu and then to transport Michael Boulware (under the escort of Deputy U .S . Marshals) to and from the courtroom in Honolulu on each day that Michael Boulware wanted to attend his trial . For purposes of the trial, the parties generally made electronic copies of each document that was introduced into evidence, and petitioners caused five large electronic screens (including a 42-inch screen) to be present in the courtroom . . The parties generally used those screens to display to themselves, to the Court, and to each witness any exhibit that was the subject of the witness's testimony . The Court imposed a time limit . on each side's presentation of evidence . On Aug . 28, 2007, these cases were initially submitted to the Court for decision . On Mar . 3, 2008, the U .S . Supreme Court decided Boulware v . United States , 552 U .S . , 128 S . Ct . 1168 (2008), a case involving Michael Boulware and much of the . same evidence that is in the recor d here . In the light of that case, this Court granted petitioners' request to reopen the record in .these cases so that they could solicit additional testimony and present additional documents during a further trial in Honolulu . The issues tried at the further trial were limited to determinations of the earnings and profit (E&P) of HIE and Holdings and a determination of Michael Boulware's adjusted basis in each of those corporations . - 20 200106, and 200206, respectively .'. We shall . sustain those disallowances in,full . . Second, we decide whether to sustain respondent's disallowance of ,a $905,340 bad debt deduction HIE claimed for 199806 . We shall sustain none of that disallowance . Third, we decide whether to sustain respondent's disallowances of professional fees deducted by HIE to the extent of $1,241,995, $1,159,635, $1,156,364, and $2,208,588 for 199806, 200006, 200106, and 200206, respectively, and of professional fees deducted by Holdings to the extent of $228,240', $1,383,710, $794,404, and $2,253,652 for 199906 through 200206, respectively . We shall sustain those disallowances to the extent stated herein . Fourth, we'decide whether to sustain respondent's determinations that Michael Boulware received constructive dividends o f $1,406,343, $1,513,055, $2,332,643, $3,380,947, and $2,231,12 0 for 1998 through 2002, respectively, primarily because the just-referenced professional fees were paid by his constructive withdrawals of funds from HIE and Holdings (collectively, subjec t corporations) . We shall-sustain those determinations to the extent stated herein . Fifth, we decide whether to sustain respondent's determination that HIE is liable'for the addition t o ,'For 199806_, HIE claimed an NOL deduction of $2,086,891 . Respondent determined that the NOL deduction was $450,569 ; i .e ., $1,636,322 less than .claimed . 21 tax under section 6651 ( a) .- We shall sustain that determination in full .' FINDINGS OF FACT I . Preliminarie s Many facts were stipulated, and those facts are found accordingly . The approximately 2,000 stipulated facts and the thousands of exhibits submitted therewith are incorporated herein by this reference . The trial transcripts total 5,255 pages, and the number of pages in the exhibits total approximately 50,000 . The Court has recorded on the docket sheets of these cases over 900 index entries . The subject corporations are C corporations that during th e relevant years used accrual methods to report their income and expenses for Federal income tax purposes on the basis of fiscal years ended on June 30 .9 When the petitions commencing thes e 8In their posttrial briefs, petitioners attempt to raise certain issues that were not pleaded in their petitions . We decline to decide those issues as they are not properly before us . See Rules 34(b)(4), 41(a) and (b) ; see also' Bob Wondries Motors, Inc . v . Commissioner , 268 F .3d 1156, 1161 (9th Cir . 2001), affg . Toyota Town, Inc . v . Commissioner , T .C . Memo .,, 2000-40 ; Foil v . Commissioner , 92 T .C . 376, 418 (1989), affd . 920 F .2d 1196 (5th Cir . 1990) . . 9The'Federal income tax return . of a corporate taxpayer such as HIE or Holdings that uses a fiscal year ending on June 30 is generally due on Sept . 15 of the year in which its fiscal year ends, unless the corporation receives an extension to file its return 6 months later ; i .e ., by Mar . 15 of the following year . - 22 cases were filed, the principal place of business of each subject corporation was in Hawaii .lo Also at that time, the "legal residence" of Michael Boulware as stipulated by the parties was in Hawaii ; we understand him then to have been imprisoned at a U .S . penitentiary in California, specifically, the Lompoc Correctional Facility in Lompoc, California . II . NOD S A. NOD Issued to HI E 1. General Informatio n On December 15, 2004, respondent issued a notice of deficiency (NOD) to HIE for 199806 and 200006 through 200206 . The NOD contained three adjustments which are relevant herein . 2 . First Adjustment--Disallowance of Portion of Deductions for NOL s a. Overvie w Respondent disallowed HIE's claim of NOL deductions for eac h year, except for $450,569 that was allowed for 199806 . b . Primary Determinatio n Respondent determined primarily that HIE failed to establish that it was entitled to an NOL deduction for 199806 of more than $450,569 or that it had an NOL carryover to apply to any of th e loUnless otherwise-noted, all references to Hawaii are to the State of Hawaii . - 23 other subject years . As part of,this primary determination, respondent also determined that HIE was entitled to reduce its "miscellaneous income related'to HIE's tobacco tax `self correction'" (discussed infra ) by $1,927,648 for 200006 and $962,426 for 200106 .1 1 c. Alternate Determination i . Overvie w Respondent . determined alternatively that adjustments to HIE's income and deductions for 198906 through 199706, the years in which HIE claims its NOL carryover to 199806 originated, limited HIE's NOL carryover to 199806 (and hence HIE's NOL deduction for that year) to $450,569 and resulted in no NOL carryover to any of the other subject years . Many of those adjustments, as discussed infra , related to the criminal indictment of Michael Boulware in part with respect to his 198 9 through 1997 Federal income taxes .1 2 "During respondent's civil examination of HIE, respondent also verified that HIE had reported as taxable income for 199906 "miscellaneous income related to HIE's tobacco tax `selfcorrection'" . Respondent did not determine a deficiency-for that year . 12As discussed infra , MichaelBoulware's indictment also related in part to certain false invoicing schemes . - 24 ii . Adj ustments Related to Crimina l Indictmen t The adjustments for 198906 through 199706 that were related to the . criminal indictment reflected the following determinations by respondent : (1) For 199006 through 199306, HIE failed t o report $3,583,725 of income that was diverted to Michael Boulware from HIE's over-the-counter (OTC) sales of tobacco ; (2) for 198906 through 199206, HIE failed to report $1,335,132 of income that was diverted to Michael Boulware and/or his mistress, Ji n Sook Lee, from HIE's sales of coffee beans to Pele Trading, Inc . (Pele Trading) ; (3) for 199006 through 19930 6 , HIE failed to report $1,265,458 of income that was diverted to Michael Boulware and/or Jin Sook Lee from HIE's sales of coffee beans to Hawaiian Kona Coffee Co ., d .b .a . Hawaii Misuzu Coffee Co ., Ltd . (Hawaii Misuzu) ;13 (4) for 199006, HIE improperly deducted $50,785 that HIE paid to Bonded Construction Co ., Ltd . (Bonded Construction), . for work that HIE reported was performed at HIE's coffee plant but which actually was performed to renovate Jin Sook Lee's residence in Honolulu at 1017 Makaiwa Street (Makaiwa house) ; (5) for 199306, HIE improperly deducted $638,427~that was diverted from HIE to Michael Boulware through certain fictitiou s "Hawaii Misuzu and Hawaiian Isles Kona Coffee are different .entities and are unrelated . - 25 leasing arrangements ; (6) for 199506 through 199706, HIE improperly deducted $1,731,000_ that HIE paid to a foreign entity, Harvest International King Coffee, Ltd . (Harvest International), which was then transferred to .Michael Boulware through a second foreign entity, Forest Trading Corp . (Forest Trading) ; (7) for 199506, HIE improperly deducted $29,984 that HIE paid to Harvest International, which was then transferred on behalf of Michael Boulware to a domestic entity, Briggs Cockerham, L .L .C . (Briggs Cockerham) ; and (8) for 199506 and 199606, HIE improperly deducted $89,936 that .HIE paid to'Harvest International, which was then transferred on behalf of Michael Boulware to Anthony Oh Young and Gloria Oh Young through a foreign entity, Pacific Vendors Equipment, Ltd . (Pacific Vendors) . iii . Adjustments Unrelated to Criminal Indictmen t The adjustments for 198906 through 199706 that were unrelated to the criminal indictment of Michael Boulware reflected respondent's determinations that HIE was not entitle d to deduct : (1) Salaries . totaling $1,040,000 reportedly paid during 198906 through 199406 to Michael Boulware's then wife, Mal Sun Boulware ; (2) payments totaling $385,000 that HIE made during 198906 and 199006 to Paradise Roasting, Inc . (Paradise Roasting), a nonoperating entity that was the alter ego of Jin Sook Lee and 26 was established to hide the transfer of HIE funds to Jin Sook Lee ; (3) professional fees totaling $175,000 reportedly paid to Jin Sook~Lee's sole proprietorship, Video Consultant, durin g 199006 and 199106 ;14 (4) bad debts totaling $1,800,000 that were written off during 199306, 199406, 199506, and 199706 a s uncollectible but otherwise due HIE from Jin Sook Lee in her capacity as the sole trustee of the°Glenn Lee Boulware Trust, a trust established for the primary benefit of the oldest son of Jin Sook Lee and Michael Boulware ; and (5) certain other professional fees totaling $4,269,980 for 199406 through 199706 . ' iv . Some Specifics of Adjustment s Some specifics of the adjustments for 198906 through 199706 are as follows : 14The record sometimes lists this entity as "Video Consultant" and other times as "Video Consultants" . We consistently refer to this entity in the singular . - 27 198906 OTC sales - 0Pele Trading $ 264,790 Hawai i Misuzu - 0Bonde d Construction - 0Leasin g arrangement - 0Forest Trading - 0Briggs Cockerham - 0Anthony Oh Young and Gloria Oh Young 0Salaries 30,000 Paradise Roasting 185,000 Vide o Consultant -0Bad debts - 0Othe r professiona l fees - 0Total 479,790 3 . 199006 199106 $506,464 $1 , 337,213 1,029 , 963 21,175 199206 199306 199404 199506 199606 199706 Tota l $719 , 755 19,204 $1,020,293 - 0- -0-0- -0-0- -0-, -0- -0- 0- $3,583,72 5 1,335,13 2 116,832 382 , 403 347,866 418,357 -0- -0- -0- -0 - 1,265,45 8 50,785 - 0- -0- -0- -0 - - 0- -0- -0- 50,78 5 -0-0- -0-0- -0 -0 - 638,427 - 0- - 0-0- -0$837,000 -0$ 819,000 -0 $75 , 000 -0- -0- -0 - - 0- -0- 29,984 - 0- -0- 29,98 4 095,000 0275 , 000 4,986 - 0- 4 , 950 -0- 0-0- 9,93 6 1,040,00 0 200 , 000 0190,000 , -0 - - 0- -0- -0- -0- -0 - - 0- 385,00 0 84,000 -0- 91,000 -0- - 0-0 - -0300,000 -0100 , 000 -0700,000 - 0- 0- -0700,000 175,00 0 1 , 800,00 0 -02,083,044 -02,021,791 -02 , 677,077 521 , 690 771 , 690 903 , 695 2,505,665 -01,361,825 00300,000 $ 150,000 1,296,308 2,170,258 4 , 269,98 0 1,548 , 287 2 , 323,287 16,394,42 7 Second Adjustment--Disallowance of Portion of Deductions for Professional Fee s a. Overvie w For each subject year, respondent disallowed a portion of HIE's deduction for professional fees . The disallowed fees totaled $1,241,995, $1,159,635, $1,156,364, and $2,208,588 for 199806, 200006, 200106, and 200206, respectively . Respondent determined that some disallowed fees were the personal expenses of HIE's controlling shareholder, Michael Boulware . Respondent determined that other disallowed fees were unsubstantiated . Respondent determined that the remaining disallowed fees were capital expenditures incurred in connection with HIE's acquisition of property from the bankruptcy estate of Jin Sook Lee . 638,42 7 1,731,00 0 28 b. Personal-Expenses of Michael Boulwar e The disallowed fees determined to be personal expenses of Michael Boulware stemmed from professional representation that he received in his individual capacity . He received some of that representation while respondent's Criminal Investigation Division (CID) was conducting a criminal investigation of Michael Boulware and Jin Sook Lee as to their personal Federal income taxes (criminal investigation) ; while a grand jury was conducting its investigation of Michael Boulware, proceeding to his indictment (grand jury proceedings) ; and during Michael Boulware's first criminal trial and his appeal of his conviction resulting from that trial ." Michael Boulware received the remainder of that representation while he and HIE were involved in civil litigation initiated by Jin Sook Lee . Respondent determined that 50 percent of the expenses related to that civil litigation were the personal expenses of Michael Boulware and that the other 50 percent were the business expenses of HIE . "As discussed infra , the criminal investigation began onor about June 16, 1993 ; the grand jury proceedings began at or about the beginning of August 1997 ; Michael Boulware was indicted on May 19, 1999 (a superseding indictment and second superseding indictment occurred on Apr . 6, 2000, and Feb . 14, 2001, respectively) ; the jury in Michael Boulware's first criminal trial convicted him on Nov . 29, 2001 ; and Michael Boulware appealed that conviction in May 2002 . 29 In sum, the amounts of Michael Boulware's personal expenses determined to be attributable to the criminal and civil cases are as follows : 16 199806 199906 200006 200106 200206 Tota l $ 598,602 $810 , 688 $1,016,103 $ 1,156,364 -0- $3,581,75 7 11,678 1,'010,280 6,245 846,933 8,588 1,074,691 01,156,364 0-0- 06,51 1 4,088,26 8 Criminal investigation , grand jury proceedings , first criminal trial , and appeal 50 percent of expense s related to civi l litigation initiate d by Jin Sock Lee Total c. Unsubstantiated Expense s The disallowed fees determined to be unsubstantiated totaled $103,313 for 199806, $10,000 for 199906, $66,671 for 200006, and $2,208,588 for 200206 . . d. Capital Expenditure s Respondent determined that $157,979 of the total disallowed fees was capital expenditures attributable to various assets that HIE acquired from the bankruptcy estate of Jin Sook Lee . The specific amounts underlying the $157,979 were $128,402 for 199806, $11,304 for 199906, and $18,273 for 200006 ($128,402 + $11,304 + $18,273 = $157,979) . The acquired assets were the Makaiwa house, a condominium in Honolulu at 1117 Punahou Street (Punahou condominium), a condominium in Honolulu at'475 Atkinso n 16Although 199906 is not a year that was the subject of the NOD issued to HIE, we include that year in our findings because it relates to the constructive dividends determined in the NOD issued to Michael Boulware . 30 Drive (Atkinson condominium), a 1992 Rolls Royce, and jewelry and furs . Of the $157,979 ., respondent determined that $16,391, $60,134, $22,308, $19,398, and $39,747 were allocable to thos e Respondent determined the . allocable amount s respective assets . as f o ll ows : Applicable . Percent of Capitalize d Value Whole F ee s Makaiwa house Less : A life estat e retained by Jin Soo k Lee in the house Acquired interest Punahou condominium Atkinson condominium 1992 Rolls Royce Jewelry and furs Total $845,00 0 760,50 0 84,500 310,000 115,000 100,000 10 .38 38 .06 14 .12 12 .28 $16,39 1 60,13 4 22,30 8 19,39 8 204,900 25 .16 39,74 7 814,400 100 .00 157,97 9 For each of the taxable years 200006, 200106, and 200206, respondent determined that HIE was entitled to deduct $2,459 o f depreciation as to the capital expenditures . Respondent determined that depreciation as follows : Punahou condominium Atkinson . condominium Total e . Capitalized Fees Allocatio n to Building Depreciabl e Basis 200006 200106 20020 6 $60,134 22,308 85% $51,114 16,508 $1,859 600 2,459 $1,859 600 2,459 $1,85 9 74 60 0 2,45 9 Summary In sum, the disallowed professional fees are as follows : 199806 Personal expenses Unsubstantiated expenses Capital expenditures Total $1,010,280 103,313 128,402 1,241,995 199906 200006 $846,933 $1,074,691 10,000 . 66,671 11,304 18,273 868,237 1,159,635 200106 200206 Tota l $1,156,364 -0-01,156,364 .-0$2,208,588 -02,208,588 $4,088,26 8 2,388,57 2 157,97 9 6,634,819 - 31 4 . Third Adjustment--Disallowance of Deduction for Bad Deb t For 199806, respondent disallowed HIE's claimed bad debt deduction of $905,340 . That deduction was attributable to HIE's writeoff of a further portion of the debt reportedly due to HIE from Jin Sook Lee in her capacity as trustee of the Glenn Lee Boulware Trust . Respondent determined that the deduction was not allowed primarily because HIE had failed to establish a debtor/creditor relationship with Jin Sook Lee . Respondent determined alternatively that the deduction was not allowed because HIE had failed to establish the accuracy of the amount claimed as the deduction or its worthlessness . B. NOD Issued to Holdings 1 . General Information On December 15, 2004, respondent issued an NOD to Holding s for 199706 and 199906 through 200206 . The NOD related to Holdings and to its wholly owned subsidiaries, Hawaiian Isle s Kona Coffee and Royal Hawaiian Water . 2 . Sole Relevant Adjustment--Disallowance of Portion of Deductions for Professional Fee s The NOD contained one adjustment which is relevant herein ; i .e ., respondent disallowed a portion of Holdings' deduction of 32 professional fees for 199906 through 200206 .17 The disallowed fees totaled $22,8,240, $1,383,710, .$794,404, and $2,253,652 fo r 199906 through 200206, respectively . Respondent determined that some of the disallowed fees were the personal expenses of Michae l Boulware . Those personal expenses were determined to stem mainly from the professional representation Michael Boulware receive d during the criminal investigation ; during the grand jury proceedings ; and during Michael Boulware's first criminal trial and his appeal of his conviction resulting from that trial . Respondent determined that the remaining disallowed fees were unsubstantiated .' Respondent determined the specific amounts attributable to the two reasons for disallowance as follows : Personal expenses Unsubstantiated expenses Total C. 1999 06 200006 200106 20020 6 -0$228,240 228,240 $1,110,435 273,275 1,383,710 $575,114 219,290 794,404 $1,678,57 9 575,07 3 2,253,65 2 NOD Issued to Michael Boulware 1 . General Information On December 15, 2004, respondent issued an NOD to Michael Boulware for 1998 through 2002 . 17For 199706, Holdings had carried back and claimed a deduction for a $713,370 NOL from 200206 . Because respondent's disallowance of the amount of professional fees Holdings deducted for 200206 was greater than $713,370, respondent determined that Holdings did not have an NOL for 200206 and thus was not entitled to its claimed NOL deduction for 199706 . 33 2. Sole Relevant Adjustment--Constructive Dividends The NOD contained one adjustment which is relevant herein ; i .e ., respondent determined that most of the above-mentioned unsubstantiated expenses and personal expenses were personal withdrawals of funds by Michael Boulware from the subject' corporations and that the amounts of these funds were includable .in Michael Boulware's taxable income as constructive dividends . Respondent determined that the constructive dividends totaled $1,406,343, $1,513,055, $2,332,643, $3,380,947, and $2,231,120 for 1998 through 2002, respectively, Respondent determined these amounts as follows : It Distribution HIE 199806 HIE 199906 HIE 200006 HIE 200106 HIE 200206 Subtotal Holdings 19990 6 Unsubstantiated Holdings 20000 6 Personal expenses Unsubstantiated Holdings 20010 6 Personal expenses Unsubstantiated Holdings 20020 6 Personal expenses Unsubstantiated Subtotal Total III . 1999 2000 2001 2002 Tota l $ 891,242 400,981 -0$472 , 235 -0- 0-01,292,223 477,969 -0-0950 , 204 -0 -0$596 , 722 485,610 -01,082,332 - 0-0-0$670,754 1,104,294 1,775,048 -0-0-0-0$ 1,104,294 1 , 104,294 $891,24 2 873,21 6 1,074,69 1 1,156,36 4 2,208,58 8 6,204,10 1 114,120 114 , 120 -0- -0- -0- 228,24 0 - 0- 0- 312,094 136,637 798 , 341 136 , 638 -0-0- -0-0- 1,110,43 5 273,27 5 - 0- 0- -0-0- 205,687 109,645 369,428 109,645 - 0- 0- 575,11 5 219,29 0 -0-01,250,311 2,332,643 839,290 287,536 1,605,899 3 ; 380,947 1998 - 0-0114,120 1,406 , 343 -0-0562 , 851 1,513,055 839,290 287,536 1,678,58 0 1 , 126,826 2,231 , 120 4,660,00 7 10,864,10 8 575,07 2 Background of Michael Boulwar e Michael Boulware was born on the Island of Maui on March 14, 1948, and he was raised on the Island of Oahu in a lower-middleincome neighborhood . He attended college for approximately 2 34 - years and then served in the National Guard through 1970 . He later attended college for one more semester and then quit school to work for a telephone company . He subsequently stopped workin g for the telephone company and performed a variety of job s including driving a cab and working at a restaurant bar . IV . Relevant Corporation s A. HI E 1 . Formation of Busines s In the late 1970s, Michael Boulware started his own business, the operation of a pool hall, and he began working for that business . On the premises of the business were pool tables, video games, and vending machines . In or about 1980, Michael Boulware changed his business to one of video games . Shortly thereafter, on July 10, 1981, Michael Boulware transferred mos t if not all of the assets and liabilities of his video gam e business to a newly formed corporation, M&S Vending, Inc . (M&S Vending), in exchange for all of its stock . M&S Vending was initially a cash business that involved owning and maintaining coin-operated video games and jukebox, pinball, karaoke, and vending machines (including vending machines that sold cigarettes) and leasing those games and .machines to hotels, bars, restaurants, and other establishments for use on their premises . M&S Vending generally shared the cash 35 receipts of each of its games-,and machines' with the establishment in which the game or machine was located . The establishment generally received 50 percent of the cash receipts in each game or machine (other than a cigarette machine) located on its premises ; sometimes, the establishment received the first 10 percent of the cash receipts plus 50 percent of the remainin g cash-receipts (in other words, the establishment received 5 5 percent of the-cash receipts) . . As to the cigarette. machines, M&S Vending paid an establishment 10 percent'of the receipts fro m those machines on the premises of that 'establishment . addition to the remaining 90 percent-of the cigarette machine receipts that it kept as income, M&S Vending also earned income from cigarette manufacturers that paid M&S Vending to place their brands in'the cigarette machines . In or about the mid-1980s', M&S Vending expanded its business to include the purchase of cigarettes and the sale of those cigarettes through its leased cigarette machines . Initially, M&S Vending purchased its cigarette inventory from Island Tobacco, a local wholesaler owned-by Harold Okimoto and run by his brother Thomas Okimoto ."Because M&S Vending had a lot of cigarette machines, it was eventually able to (and did) purchase cigarettes directly from the manufacturers (e .g ., Philip Morris), rather than from the wholesalers . I 36 M&S Vending eventually changed its name to Hawaiian Isles Vending and later, on or about June 30, 1987, to HIE . Shortly thereafter, HIE expanded its business further to include the sale of coffee and candy,through its vending machines . HIE's coffee business involved selling coffee to business offices through machines that HIE lent to the businesses . In 1988 or 1989, HIE expanded its business even further to include the processing and distribution of a blend of Kona coffee . Kona coffee is grown and sold at approximately 600 small farms in a central region of Kona, a section of the Island of Hawaii, and Kona coffee is one of the most expensive coffees . in the world .18 In order to be labeled and sold as "Kona coffee", a blend of coffee must contain at least 10 percent Kona coffee . HIE's blend of Kona coffee was a mix of 10 percent Kona coffee beans and 90 percent coffee beans grown in places such as Brazil, Costa Rica_, or Sumatra . 2 . Officers and Directors a. Initiall y Initially, Michael Boulware was the president, treasurer, and secretary of M&S Vending, and he was one of two directors on its board . Through August 31, 1982, M&S Vending's vice president and only other director was Matthew S .K . Pyun, Jr . "The average size of each of the approximately 600 farms is less than 5 acres, and the owners of those farms are natives . I. - 37 b. August 31, 1982, to July 10,1991„ or Thereabout s From August 31, 1982,through July 10, 1991, or thereabouts, Michael Boulware was the only officer of HIE (inclusive of its predecessor), serving simultaneously as president, vice president, secretary, and treasurer .- During .that .time, Michael Boulware also was either the sole director on the corporation's board or one of its two directors . Stanley Hirai, was the other director of HIE (and its predecessor) during some of that time . Stanley Hirai helped Michael Boulware form the business that became the business of M&S Vending and was one of M&S Vending's original employees . Stanley Hirai's role as a director of HIE (and its predecessor) was limited and scripted by Michae l Boulware ; among other things, Stanley Hirai signed corporate documents as directed by Michael Boulware, without fully readin g the documents or understanding them . In or about 1991, Stanley Hirai contracted diabetes and was instructed by Michael Boulware not to come into the office but to remain at home-on full salary, . Afterwards, Stanley Hirai was paid approximately $50,000 per year through at least 1997, and he performed few services for HIE in return for that salary . i - 38 c . On or About July 10 , 1991, Through an Effective Date of April 15, 200 0 From July 10, 1991, or thereabouts, through an effective date of April 15, 2000, HIE-had two directors . in addition to Michael Boulware . One was Michael Boulware's,brother, Sidney E . Boulware, Jr . (Sidney Boulware) ., The other was Merwyn Manago, a friend of a friend .of Michael Boulware . Sidney Boulware began working for HIE in or about 1983 . Before that time, . Sidney Boulware had worked for the,Department of Education as a counselor at a high school . . Sidney Boulware worked part time for HIE through June 1987, at which time he began (and has continued) to work full time for HIE as a chief operations officer . As of July 10, 1991, Sidney .Boulware als o took over Michael Boulware's role as vice president of HIE . Merwyn Manago began working for HIE in or about Novembe r 1988 . His position at that time was chief financial officer under the title of controller . Merwyn Manago has continued , t date to work for HIE (and later also .Holdings) as : chief financial officer . Merwyn Manago also served as a board member of HIE (and Holdings) through 2006 . In 2006, Michael Boulware removed Merwy n Manago from the board and replaced him with Michael Boulware's daughter . I - 39 When Merwyn Manago began working for HIE,HIE's accountin g department was weak to inadequate, and its accounting records were not current . Merwyn Manago aimed .. to make that department stronger . Initially, Merwyn Manago caused HIE to hire a vending accountant and an .assistant controller . Later, in 1995 or 1996, Merwyn Manago caused HIE to hire another assistant controller . Scott Yoshida, an employee of HIE and then Holdings from December 1991 to date, was employed as .assistant controller through December 1995 . In December 1995, Scott Yoshida was promoted to controller of Hawaiian Isles Kona Coffee . d. Effective April 15, 200 0 Effective April 15, 2000, Michael Boulware resigned his position as president, secretary, and treasurer of HIE . HIE's board (Michael Boulware, Sidney Boulware, and Merwyn Manago) accepted that resignation and appointed Sidney Boulware,and Florence Boulware as HIE's sole officers for the next corporate year ." Sidney Boulware was appointed president, vice president, and treasurer . Florence Boulware was appointed secretary . Sidney Boulware has continued to date'to work for HIE as its president . 19While`we find in the record that Florence Boulware is related to Michael Boulware, we are unable to find the specific relationship between the two . - 40 e. Board Meeting s HIE's board of directors met frequently (either formally or informally) and memorialized those meetings in-minutes . The minutes were typically typed into .form by .an administrative secretary of HIE, who was not at the meeting but who would . receive from either Michael Boulware or . Sidney .Boul.ware the statements that she would type . The typed document would then b e circulated to the officers who were-present at the meeting for their signature . 3 . Shareholder s Initially, Michael Boulware was the sole shareholder of M&S . Vending . Through September 8, 1987`,' Michael Boulware also was the sole shareholder of HIE ., On'September 8, 1987, Michael Boulware transferred 50 percent of his stock in HIE to Jin Sook Lee as trustee'of the Glenn Lee Boulware Trust~ .2 0, , Jin Sook Lee was Michael Boulware's mistress from-1982 through 1994, and sh e is the mother of their two children . Their oldest child is GlennLeeBoulware . At the time of the'transfer, HIE did not issue a stock certificate to Jin Sook Lee, as trustee, or otherwise record-th e 20Immediately before this transfer, Michael Boulware's adjusted basis in his HIE stock was $1,,000 . Immediately after the transfer, Michael Boulware's .'adjusted basis in his HIE stock was $500 . - 41 transfer in its books . In 1995, Jin Sook Lee, as trustee, commenced a lawsuit in the Circuit Court of the First Circuit of Hawaii by filing with the court a "Petition of •Jin Sook tee to Enforce Trust and For An Accounting in Favor of Glenn Lee Boulware, A'Minor, Beneficiary" (trust case) . The court docketed the'trust case as No . 95-0029 . On June 14, 1996, while the lawsuit was pending, HIE issued a stock certificate to Jin Sook Lee, as trustee, reflecting the ownership of 47 .5 percent of the outstanding shares of HIE . Contemporaneously, HIE also issued stock to Sidney Boulware so that thereafter Sidney Boulware reportedly owned a 5-percent interest in HIE and Michael Boulware and Jin Sook Lee, as trustee, each reportedly owned a 47 .5percent interest in HIE . On or about March 15, 1998, Sidney Boulware rescinded his reported 5-percent interest in HIE so that thereafter Michael Boulware and Jin Sook Lee,` as trustee, each owned 50 percent of HIE's stock . Sidney Boulware's action of rescission was in response to a ruling made by the court in the trust case . Specifically, on July 31, 1997, the court ruled that the Glenn Lee Boulware Trust was entitled to own 50 percent of the stock of HIE as of September 8, 1987 . 1 - 42 4 . - Michael Boulware's Contro l Michael Boulware was viewed by the directors, officers, and employees of HIE as the "boss" . When he was a director on HIE's board, Michael Boulware always had the final say at boar d meetings, and he always had the final say with respect to the operation and the business of,HIE . . Michael Boulware controlled HIE during the relevant years, and its employees routinely followed his directions and instructions without questioning the propriety of his actions . , B. Holding s On April 4, 1994,_Holdings was formed by Michael Boulware .as a corporation with 1,00 1 0 outstanding shares all owned by HIE . Holdings began its operations in .and filed its initial Federal corporate income tax return for 199706 . As of the first day of that taxable year, i .e ., July 1, 199 .6, .Michael Boulware caused HIE to effect .a tax-free reorganization (spinoff) through which it transferred its shares in Holdings as follows : 475 shares to Michael Boulware, 475 shares to Jin Sook Lee, as trustee of the Glenn, Lee Boulware Trust, and 50 shares to Sidney Boulware . As of the first day of the following taxable year, i .e ., : July .1, 1997, Holdings reverse-split its stock tenfold so that thereafter Holdings had 100 outstanding shares and the numbers of shares - 43 owned by the three just-mentioned individuals were 47 .5, 47 .5, and 5, respectively . For each of the taxable years 199906 through 200206, Michael Boulware was Holdings' principal officer, principal employee, and controlling shareholder . At some point, Sidney Boulware als o served as a director of Holdings . From 199706 to date, Sidney Boulware worked for Holdings as an officer, including as its president from April 15, 2000, or thereabouts, to date . .C . Other Corporations Organized in 199 4 Three other relevant'corporations also were organized in 1994 : Hawaiian Isles Vending, Inc . ; Hawaiian Isles Distributors, Ltd . ; and Hawaiian Isles Kona Coffee . HIE owned all of the shares of each'of these corporations . D. Restructuring of HI E Effective June 30, 1995, Michael Boulware and HIE entered into an Agreement and Plan of Reorganization and Corporate Separation (restructuring). Pursuant to the restructuring, Hawaiian Isles Vending, Inc ., changed its name,to Holdings, an d all shares of Hawaiian Isles Kona Coffee owned by HIE were transferred to Holdings . Also pursuant to the restructuring, HIE reorganized its businesses so that thereafter HIE generally sold cigarettes and Holdings generally sold and leased vending machines and processed and sold coffee . - 44 E. Royal Hawaiian Wate r Royal Hawaiian Water bottles purified drinking water and sells that bottled water to retailers in Hawaii . Royal Hawaiian Water conducts its business under the name "Hawaiian Isles Water Company" . Royal'Hawaiian Water is presently .a subsidiary o f Holdings . In September 1995, Michael Boulware formed Royal Hawaiian Water as his wholly owned corporation and elected to .have that corporation taxed as an S corporation . As of July . 1, 1997 (but after the reverse split mentioned supra ), Michael .Boulware contributed the net assets of Royal Hawaiian Water to Holdings in exchange for 162 .5 newly issued shares of Holdings . This transaction increased Michael Boulware's ownership interest in Holdings to 210 shares (47 .5 + 162 .5 = 210) or in other words to 80 percent of its stock (210/(100-+ 162 .5) F. 800-.) . Holdings After the Restructurin g As now relevant, the primary business of Holdings and its subsidiaries is the wholesaling, distribution, leasing, and maintenance of vending machines (it was the largest vending company in Hawaii before its vending, operation was .sold on December 29, 2006) ; the bottling, wholesaling, and distributio n of purified drinking water (it has approximately 40 percent of the market in Hawaii) ; and the processing, wholesaling, and - 45 - distribution of coffee (it has' approximately 60 percent of the "gourmet end coffee" market in Hawaii) . Holdings conducts most of its business in Hawaii but also exports coffee to the continental United States and to some foreign countries . For 199706, 199906, 200006, 200106, and 200206, Holdings had the following compensated officers, each of whom received the indicated compensation : Taxable Year Officer Compensatio n 199706 Michael Boulware Sidney Boulware Michael Boulware Sidney Boulware Michael Boulware Sidney Boulware Michael Boulware Sidney Boulware Michael Boulware Sidney Boulware $T-,372,00 8 126,32 2 199906 200006 200106 200206 G. .375,70 0 177,76 9 1,496,00 6 192,20 0 396,00 6 142,00 0 396,00 6 142,00 0 Payment of Common Cost s At all relevant times, Holdings shared certain common costs with HIE, d .b .a . Hawaiian Isles Distributors . At one point, Holdings began paying HIE's overhead and other expenses . H. Various Names Used by HIE To Conduct During the Subject Year s During the subject years, Its Business . HIE sometimes did business as Hawaiian Isles Distributors , sometimes as Hawaiian or sometimes as Kona Coffee Service . Isles Vending, 46 I . No Payment of Formal Dividends by HI E From in or about November 1988 until the end of 2005, HIE paid no formal dividends . J. E&P ofHIE and Its Predecessor for 198206 Through 198806 1. 19820 6 As of June 30, 1982, the accumulated E&P of HIE's predecessor, M&S Vending, was $189,252 . 2 . 19830 6 For 198306,'the current E&P ..of M&S Vending was $234,989 . The current E&P reflected M&S Vending's taxable income a s reported on its Federal income tax return for 198306 ($339,960), less negative adjustments totaling $104,971 for Federal income taxes ($103,324) and political contributions and penalties ($1,647) . As of June 30, 1983, the accumulated E&P of M&S Vending was $424,241 ($189,252 + $234,989) . 3. 19840 6 For 198406, the current E&P of M&S Vending was $341,224 . The current E&P reflected M&S Vending's taxable income .as reported on its Federal income tax return for 198406 ($424,392), less negative adjustments totaling $83,168 for Federal income taxes ($77,319) and political contributions and . penalties ($5, .849) . As of June 30, 1984, the accumulated E&P of M&S Vending was $765,465 ($424,241 + $341,224) . - 47 - 4 . 19850 6 For 198506, the current E&P of M&S Vending was $126,955 . The current E&P reflected M&S Vending's taxable income as reported on its Federal income tax return for 198506 ($151,550), plus a $34,779 positive adjustment to-reflect an error on that return, less negative adjustments totaling $59,374 for Federa l income taxes ($45,589), political contributions and penaltie s ($8,649), prior period income included in the return ($136), and a bad debt .($5,000) . In addition to that year's current E&P, the calculation of the accumulated E&P of M&S Vending as of June 30, 1985, included a $10,110 positive adjustment to reflect a n overaccrual of prior years' taxes .- As of June 30, 1985, the accumulated E&P of M&S Vending was $902,530 ($765,465 + $126,955 + $10,110) . 5 . 19860 6 For 198606, the current .E&P of M&S Vending was $252,942 . The current E&P reflected M&S Vending's taxable income as . reported on its Federal income tax return for 198606 ($271,420), less the sum of various positive and negative adjustments totaling negative $18,478 . The positive adjustments totaled $133,981 and were attributable to a prior year adjustment for "FA" ($120,000), bad debt reversals ($4,000), depreciation ($3,733), an NOL carryover ($5,798), and a recording of the - 48 correct book value of "FA" ($450) . The negative adjustments totaled $152,459 and were attributable to Federal income taxes ($70,001), depreciation adjustments ($11,094), an overaccrual of tax ($60,871), and penalties ($10,493) . In addition to that year's current E&P, the calculation of the accumulated E&P of M&S Vending as of June 30, 1986, included two positive adjustments . The first positive adjustment, $17,132, was made to reflect an adjustment to HIE's net income for 198506 as reported in its .. books . The second positive adjustment, $16,283, was made to reflect an adjustment to HIE's net income as reported in its books for years before 198506 : As of June 30, 1986, the accumulated E&P of M&S Vending was $1,188,887 ($902,530 + $252,942 + $17,132 + $16,283) . 6 . 19870 6 For 198706, the current E&P of M&S Vending was negative $329,574 . The current E&P .reflected M&S Vending's taxable loss as reported on its Federal income tax return for 198706 ($367,487), less the sum of various positive and negative adjustments totaling negative $37,913 . The positive adjustments totaled $68,912 and were attributable to a Federal income taxrefund ($39,377) and depreciation ($29,535) . The negative adjustments totaled $30 .,999 and were . attributable to Federal income taxes ($1,193), goodwill ($4,065), depreciation on capital - 49 leases ($10,815), contribution carryovers ($2,473), bad debt expenses ($5,955), and book depreciation greater than tax depreciation ($6,498) . As of June'30, 1987, the accumulated E&P of M&S Vending was $859,313 ($1,188,887 + (-$329,574)) . 7 . 19880 6 For 198806, the current E&P, of HIE was negative $859,431 . The current E&P reflected HIE's taxable loss as reported on its Federal income tax return for 198806 ($813,106), less the sum of various positive and negative adjustments totaling negativ e $46,325 . The positive adjustments totaled $930,937 and were attributable town income tax benefit ($273,200), depreciation ($21,393), and a lease rental expense ($636,343) . The negative adjustments totaled $977,262 and were attributable to Federal income taxes ($107), an adjustment to a bad debt reserve ($2,250), gain on investment property ($132,978), inventory capitalization ($18,000), pension contribution adjustments ($96,858), goodwill ($6,093), interest on leases ($103,942), further depreciation ($5,500), contribution carryover ($1,425), depreciation on leases ($436,761), penalties ($172,877), and meals ($471) . As of June 30, 1988, the accumulated E&P .of HIE was negative $118 ($859,313 + (-$859,431)) . - 50 K. E&P of Holdings for 199706 and 19980 6 1 . 19970 6 a . Accumulated E& P As a result of. HIE's spinoff of Holdings on July 1, 1996, 45 .9206 percent of HIE's accumulated E&P is allocated to Holdings as of that date . Current E& P For 199706, the current E&P of Holdings was $722,937 . 2 . 19980 6 For 199806, the current E&P of Holdings was $346,579 . L. Number of Holdings and HIE Employee s At all relevant times, HIE and Holdings each had fewer than 500 employees . V. Officer Loan Account A. Overvie w Before the restructuring, an officer loan account was kept on the books of HIE . After the restructuring, that account was kept on the books of Holdings . B. . Mechanics of Accoun t Michael Boulware routinely . requested that checks be .written to him from HIE's checking accounts . Those checks were written as requested . HIE did not always know how Michael Boulware would use the funds reflected in those checks . Merwyn Manago 11 1 - 51 - anticipated that the dollar-amounts of the checks written to Michael Boulware would be charged to Michael Boulware's officer loan account (officer loan account) as borrowings by him and that the officer loan account would be reduced by any amount,repaid by or on behalf of Michael Boulware . Merwyn Manago kept a running balance of the amounts that .he knew that Michael Boulware borrowed (including by way of checks written to him) and that Michael Boulware repaid . Merwyn Manago generally caused those transactions to be recorded in the officer loan account contemporaneously with the transactions . As discussed infra , Michael Boulware participated in certain transactions that were not reported on the books of either subject corporation (off-book activities), and he caused deposits and withdrawals to be made to and from two bank accounts (offbook bank accounts) that were neither reported on the books of either subject corporation nor known about by Merwyn Manago or . the other independent (of Michael Boulware) managers of ..the subject corporations (collectively, independent managers) . Merwyn Manago did not know about the funds that were deposited into or withdrawn from the off-book bank accounts, and he did not reflect those funds in the officer loan account . Merwyn Manago did not know about or cause HIE to record contemporaneously in - 52 the officer loan account transactions related to the off-book activities . C. Repayment of Officer Loan s Bonuses were declared to Michael Boulware at the end of each year to repay some of the balance in the officer loan account . Merwyn Manago caused to be recorded as reductions of the officer loan account any portion of a loan to Michael Boulware that was repaid . Michael Boulware's repayments were not always made in cash . D. Michael Boulware's Claimed Coffee Transactions Michael Boulware told Merwyn Manago that-Michael Boulwar e was using HIE funds in his individual capacity to purchase coffee for resale to HIE . Merwyn Manago caused the balance of the officer loan account to be increased-by the amount of HIE funds that Merwyn Manago~believed that Michael Boulware was using for that purpose . Michael Boulware told Merwyn Manago when Michael, Boulware purportedly sold and delivered coffee to HIE, and Merwyn Manago recorded those sales and alleged deliveries as reductions to the balance in the officer loan account . Merwyn Manago told Michael Boulware that HIE needed invoices to document . any coffee transaction between him and HIE . Afterwards, Michael'Boulware gave Merwyn Manago invoices stating that Michael Boulware had sold Kona coffee to Hawaiian Isles Kona - 53 Coffee or to HIE and that he had delivered that coffee to'the purchasing corporation . Michael Boulware did not always give those invoices to HIE contemporaneously with the dates that Michael Boulware said he had delivered coffee to HIE . Other than through Merwyn Manago's receipt of the invoices from Michae l Boulware and Merwyn Manago's related discussions with Michael Boulware, Merwyn Manago did not attempt to verify that HIE received the coffee Michael Boulware said he sold to HIE ; Merwyn Manago relied primarily upon the representations and actions, of Michael Boulware . From November 1988 through June 1994, Michael Boulware gave HIE various invoices for coffee that he purportedly sold to HIE or one of its subsidiaries . These invoices for the most part are consecutively numbered . One invoice stated that Michael Boulware sold and delivered to Hawaiian Isles Kona Coffee 80,00.0 pounds of Kona coffee . Merwyn Manago did not see this coffee but credited Michael Boulware's loan account for the $500,000 sales price listed on the invoice . Nor did Merwyn Manago verify that Hawaiian Isles Kona Coffee had received 40,000 pounds of Kona coffee that a second invoice stated that Michael Boulware had sold and delivered to Hawaiian Isles Kona Coffee for $250,000 . Merwyn Manago also did not verify that Hawaiian Isles Kona Coffee received 200,000 pounds of Kona coffee that a third invoice 54 - stated that Michael Boulware had sold and delivered to .Hawaiian . Isles Kona Coffee for $800,000 . Michael Boulware did not actually deliver this 320,000 pounds of coffee (200,000 + 40,000 + 80,000 320,000) but through the officer loan account was credited with doing so .2 1 E. : Promissory Note s Before 1993, the year in which the CID investigation began, Michael Boulware was . not required to sign promissory notes for checks written to him from an HIE account . Afterwards, at the end of each year, Merwyn Manago generally took the total amount of checks written to Michael Boulware in each month of that year and drafted promissory notes for-each of those months . None of the funds that were deposited into the off-book bank accounts were reflected in the promissory notes . Payment of the promissory notes was not secured . The promissory, notes set forth a repayment date within 24 months after their making and . stated that a holder of a note in default could declare that the entire unpaid balance was, immediately due and payable . 21In addition to these amounts credited to the officer loan account as coffee repayments, we are unable to verify other items for which Merwyn Manago credited the officer loan account . - 55 F. Lack of Collection on Promissory Note s Some of the loans recorded as made to Michael Boulware were not repaid, and defaults occurred on the related and some of the other promissory notes . Merwyn Manago never declared that any amount due under a promissory note related to Michael Boulware was immediately due and payable . Nor did Merwyn Manago ever attempt to collect repayment of an obligation of Michael Boulware that was in default ; Merwyn Manago viewed Michael Boulware as the owner of the subject corporations and, hence, as the boss of Merwyn Manago and every other employee of one or both of the subject corporations . When the period of limitations expired on the enforcement of a promissory note related to Michael Boulware, Merwyn Manago never recorded on the books of either subject corporation that those amounts were uncollectible . The board of directors never took any action with respect to collection on the promissory notes . VI . Personal Bank Account s A. Michael Boulware Individuall y As relevant herein, Michael Boulware had three personal bank accounts listed .in his name . These accounts were checking account No . 05-389054 at First Interstate Bank of Hawaii, checking account No . 49-507151 at First Hawaiian Bank, .checking account No . 09-365508 .and at First Hawaiian Bank . Michael - 56 Boulware also maintained a checking account at the Bank of Hawaii in his reported capacity as president, treasurer, and secretary of his wholly owned corporation, Automated Equipment, Ltd . (Automated Equipment) . - That account number was 17-134698 . B. Michael Boulware and Mal Sun Boulware Jointly Michael Boulware and Mal Sun Boulware had a joint savings account, account No . 17-00 .9762 at Liberty Bank . They also had a joint checking account, account No . 37-251410 at First Hawaiian Bank . C. Jin Sook Le e Jin Sook Lee had a personal checking account, account .,No . 65-56 .5579-'at First Hawaiian Bank . Jin Sook Lee also maintained a savings account at First National Bank in her capacity as trustee of the Glenn Lee Boulware Trust . That account number wa s 65-570109 . VII . Mal Sun Boulwar e Mal Sun Boulware was born in Korea in 1944, and she moved to the United States in 1963 . She was .married to Michael Boulware from 1975-through May 5, 1994 . She and-Michael Boulware have one child, Karen Min Boulware, a Korean girl whom they adopted . Karen Min Boulware was born on'May 2, 1979 . .M&S Vending reportedly paid Mal Sun Boulware wages of $16,560 and $21,210 during 1981 and 1982, respectively, and 57 $24,000 during each of the years 1983 through 1986 . HIE reportedly paid Mal Sun Boulware wages of $47,000, $59,000, $60,000, $130,000, $250,000, $300,000,- $300,000, and $75,000 during 1987 through 1994, respectively . Mal Sun Boulware generally received her reported wages in equal installments throughout the corresponding year . For 198906 through 199406, . HIE deducted wages paid to Mal Sun Boulware of $30,000, $95,000, $190,000, $275,000, $300,000, and $150,000, respectively . Respondent disallowed the deductions for 198906 through 199 .406 in the total amount of $1,040,000 . Mal Sun Boulware has just a few years of education, all in Korea, and she reads little English . She did not have either an office or a desk at HIE (or at any related entity) . Mal Su n -Boulware performed no meaningful work for HIE (or M&S Vending) that would support characterizing the disputed payments to her as compensation . VIII . Jin Sook Lee A. Background Jin Sook Lee was born in . Seoul, Korea, in 1955, and she moved to the United States in 1980 . When she moved, Jin Sook Lee had a high school education and had been married for approximately 2 years to a man who lived in Hawaii . Shortl y after her move, Jin Sook Lee divorced her husband because he was - 58 jobless and, she believed, incapable of supporting her desired lifestyle . After her divorce, Jin Sook Lee started working at a Korean hostess bar in Hawaii as a hostess retained by the bar owners to socialize with their patrons and to allure the patrons to buy a lot of drinks from the bar . Such bars usually involv e prostitution and are generally staffed with young women from .Korea who speak little English, have few job skills, and are looking for someone to take care .of them . Jin Sook Lee and th e .other hostesses were paid for their services at the Korean hostess bar through commissions earned on the drinks they caused to be sold and through their receipt of . tips left for them by the patrons . B : Jin'Sook Lee Meets Michael Boulwar e In or about 1981, Jin Sook Lee met Michael Boulware at the Korean hostess bar where and while she was working . Shortly thereafter, Michael Boulware and Jin Sook Lee began an intimate relationship which Michael Boulware endeavored to keep hidde n from Mal Sun Boulware and others . .22 Throughout their relationship,' Michael Boulware provided Jin Sook Lee with housing and supported her. financially . 22Merwyn Manago, for example, did not know of Jin Sook Lee until June 1993 or thereafter . . 59 Jin Sook Lee stopped working at the Korean hostess bar soon after she met Michael Boulware, and she moved from her studio apartment to what she considered to be Michael Boulware's Atkinson condominium . Jin Sook Lee lived at the Atkinson condominium rent free . Later, Jin . Sook Lee moved from the Atkinson condominium to what she considered to be Michael Boulware's house in Honolulu at Hawaii Kai, 3 Lumahai Street . She lived at that house rent free . Later, after Mal Sun Boulware learned that Jin Sook Lee was living at the house at 3 Lumahai Street, Jin Sook Lee moved from that house to the Punahou condominium, which Jin Sook Lee bought with money given to her by Michael Boulware . Jin Sook Lee has not worked since she stopped working at the Korean . hostess bdr . During her relationship with Michael Boulware, Jin Sook Lee attended business college, and she received a diploma and certificate in 1994 . Jin Sook Lee currently receives $10,000 a year from HIE as a "settlement" . Jin Sook Lee began her relationship with Michael Boulware because she thought she would be better off financially, and she almost daily told him during their relationship that they should get married to each other .' Michael Boulware eventually told Jin Sook Lee that they would marry but that he first had to divorce Mal Sun Boulware . Jin Sook Lee repeatedly fought with Michael Boulware about his not getting a divorce, and Jin Sook Lee . I 60 repeatedly told Michael Boulware that she would leave him unless he got a divorce . Michael .Boulware informed Jin Sook Lee that he would divorce Mal Sun Boulware,in due time . Jin Sook Lee did not believe that Michael Boulware actually wanted to or would divorce Mal Sun Boulware . During, their relationship, Jin Sook Lee and, Michael Boulware had two children together . Both of those children were planned . The older child, Glenn Lee Boulware, was born on September-15, 1985 . The younger child, Steven Boulware, was born on, .October 13, 1988 . Currently, Michael Boulware's relationship with each of .his .sans is .good . C. Paradise Roasting Beginning at least in 1986, Michael Boulware caused M&S Vending to pay Jin Sook Lee wages_although she did not perform any work for .M&S Vending in return for the wages . After M&S Vending was renamed HIE, HIE continued to pay Jin Sook Lee wages although . she performed no work for HIE in return for the wages . In or about 1987, Mal Sun Boulware learned that Michael Boulware was having an affair with Jin Sook Lee and that Michael Boulware and Jin Sook Lee had a son, Glenn Boulware . Because Michael .Boulware believed he could no longer cause HIE to pay . wages to Jin .S .ook Lee, he sought an indirect, surreptitious way to give her money . Michael Boulware helped Jin Sook Lee form 61 Paradise Roasting as her wholly owned corporation and instructed her to open a bank account for Paradise Roasting in part so that he could give her'money in the form of checks . Jin Sook ;Lee was named president of Paradise Roasting, and her sister, Hong Sun Hirai, was named vice president . During 198906 and 199006, Paradise Roasting had no employees . Paradise Roasting sent invoices to HIE indicating it-ha d sold coffee to HIE, and Michael Boulware caused HIE to pay those invoices . During 198906, HIE generally sent Paradise Roasting one check every month . The first four checks were each in the amount of $10,000 . The next three checks were each in the amount of $15,000 . The last five checks were each in the amount of $20,000 . During 199006, HIE generally sent to Paradise Roasting one check in the amount of $20,000 for each of the first 10 months . In total, . HIE paid Paradise Roasting $185,000 and $200,000 during 198906 and 199006, respectively . HIE deducted those payments for Federal income tax purposes . Paradise Roasting never sold or delivered any coffee to HIE . Nor did Paradise Roasting ever have a business, ever"have an y customers, or ever sell any goods (e .g ., coffee) or perform an y services . Jin Sook Lee used the money that HIE transferred to Paradise Roasting as she pleased, including to pay her living expenses, to travel, and to purchase expensive jewelry for 62 herself . When HIE wrote the above-referenced checks to Paradis e Roasting,HIE,did not reflect those checks as loans on its books . Except by means of the adjusting journal entries (AJEs) discussed infra , HIE did not ever record, those payments as loans on it s books . D . Video Consultant 1 . Overvie w HIE also paid Jin Sook Lee at least $175,000 during the 2-year period beginning in July 1988 purportedly for work as a video consultant . Jin Sook Lee received those funds through Video Consultant, an entity that was formed as her sole proprietorship . Jin Sook Lee was not,a video consultant, and she has never worked as such . Nor did Video Consultant ever have any employees or any customers . Michael-Boulware caused that money to be paid to Jin .Sook Lee for her living expenses and for her other desires . 2 . Formatio n Michael Boulware helped Jin Sook Lee form Video Consultant as another way to,get money to her indirectly and surreptiously . Michael Boulware filled in a form application for a general excise license for Video Consultant, and he had Jin Sook Lee sign the application . Michael Boulware caused Jin Sook Lee to open an account at First Interstate Bank of Hawaii in the name of Jin 63 Sook Lee d .b .a . Video Consultant . That account, No . 24-100804, was a market interest investment account, with check writing privileges . 3 . Payments From HIE for False Invoice s During 198906 and 199006, Video Consultant invoiced HIE for goods or services totaling $84,000 and $91,000, respectively, and Michael Boulware caused HIE to pay Video Consultant the amount of the invoices and to deduct those payments on HIE's Federal income tax returns . HIE paid those amounts to Video Consultant through 22 checks . During 198906, 12 of those checks were writte n monthly in the amount of $7,000 . During 199006, the first three monthly payments were in the amount of $7,000 and the next seven monthly payments were in the amount of $10,000 . All 22 payment s were received by Video Consultant and deposited into Firs t Interstate bank account No . 24-100804 . Neither Jin Sook Lee nor Video Consultant performed any service for or provided any good to HIE in exchange for any of the 22 payments . Jin Sook Lee spent the money that HIE transferred to Video761% 55~-- -77w---~ -O -, Carlsmith Bal l -0- 14,258 .83 8,401 .97 -0 -0 -0 -0 - -0 - Case Bigelo w 200006 -0- -0- 736 .3 1 -0- -0 - -0-0- -0 -0- Chee Markha m 199806 199906 200006 -0-0- 2,806 .88 -0-0- -0- 2,207 .94 2,046 .86 -0- - 323 - Total Fees. Re : Fees Accepte d Criminal Grand Jury Criminal Jin Sock As Ordinary Investigation Proceedings Trial Lee and Necessary Other Fee s Chicoine Halle t 200206 34 , 784.24 -0- -0- 34 , 784 .24 -0- -0- -0 - Cornie l 199806 18 , 559 .93 -0- -0- 18 , 559 .93 -0- -0- -0 - Damon Key 199806 199906 200006 378 , 261 .40 312,735 .35 423 , 692 .50 200106 200206 63 , 890 .75 23 , 062 .32 -0- 0- -0-0- Foley Jone s 200006 1,459 . 5.0 -0- 7 0- -0- Gaims Wei l 199806 199906 65 , 234 .68 11 , 558 .00 -0-0- -0- 0- -0 -0- 200006 36,927 .34 -0- -0- 36 , 927 .34 200106 548 . 64 200206 Glenn tee Trus t 395 .00 -0-0- -0-0- 548 . 64 395 .00 35 , 000 .00 -0'- - 0- -0- 18 , 854 .05 -0- -0- -0 - 199806 Graham Jame s 35 , 351 .94 -0- -0- 199806 199906 56,,848 . 50 65 , 403 .96 -0 - 53 , 977 .76 -0- 31 , 227 .39 29 , 146 .04 199806 199906 48 , 590 .23 -0- 48 , 590 .23 3,475 .70 200006 ( 10,000 .00 ) -0 - 0- 3,475 . 70 (10,000 .00 ) 2 42,853 . 42 20 , 638 .78 16 , 837 .64 -0-0-0- 20,638 .78 16 , 837 .64 13,874 . 12 -0-0- 122,706 . 28 173 , 275 .20 -0- -025,864 . 59 373 , 737 .84 227,005 . 66 55,025 .96 5,762 .90 2,831 .89 11,843 .4 5 - 040,913 .91 58,569 .6 0 3,277 .8 5 47,055 .32 4,486 .71 438 . 25 - 0- 6,792 .73 1,977 .36 9,604 .4 5 16 , 598 .2 5 -0- -0- 1,459 .5 0 65,234 . 68 -0- -0 - 11,558 .00 -0- -0 - -0- -0- -0 - -0- -0- -0 - - 0- -0- -0 - -0- -0 - Boulware 199906 GMK Consultin g 200206 35,000 .00 - 0- -0- 18,854 .0 5 -0 -0- -0 - -024 , 032 .37 -0-0- -0-0- -0 -0 - -0- 53 , 977 .76 -0- -0- -0 - -0- -0- -0- -0- 31 , 227 .39 29 , 146 .04 -0-0- -0-0- -0 -0 - - 0- -0-0-0- -0-0-0- -0 -0 -0 - -0-0- -0-0- -0- -0- -0-0-0- -0 -0 -0 - -0- -0- -0- -0- Goodeno w 200006 Hawaii National Ban k 200106 200206 56,848 . 50 41,371 .59 35 , 351 .94 Hochman Salki n -0-0- Howard Chan g 199806 199906 200006 42,853 . 42 Irell Manell a 199806 44 , 401 .14 15,279 .94 29,121 . 20 - 324 .- Total Fees Re : Fees Accepte d Criminal Grand Jury Criminal Jin Sock As Ordinary Other Investigation Proceedings Trial Lee and Necessary Fee s King King 200006 Laird Christianso n 2,500 .00 200006 200106 Leonard Sharenow 200006 200206 McCorriston Mille r 200106 200206 Michael McCarthy 199806 199906 200006 -0- -0- 2,500 .0 0 -0-0- -0-0- -0-0- -0-0 .- 252 .2 0 252 .2 0 -0- -0- -0 - -0- -0- -0- -0 - -0- -0- -0- 5 , 000 . 0 0 -0- -0-0- -0 - 825 .26 293 .39 -0 - -0-0- 758 ,111 .97 -0- -0- 13,579 .50 -0- 13,579 .50 5,000 .00 -0- -0- 665 .29 15,667 .22 -0- -0-0- 825 .26 293 .39 771 .14 -0- 200006 Lyle Hosoda Associates 200106 199806 199906 200006 200106 -0- 252 .20 252 .20 Lopeti Foliak i 200006 Louis Wa i 200206 Marr Hip p -0- -0- - 758,111 . 97 665 . 29 15,667 .22 - 0- -0 - -0-0- -0-0-0-0- -0- -0-0-0- -0-0-0-0- -0- -0- 771 .14 465 .10 469 .79 25,154 .47 9,343 .61 -0- -0- 25,154 .47 - 0- -0- -0 - -0- -0- 9,343 .61 -0- -0- -0 - 21,747 .02 18,193 .49 -0-0-0- -0-0- -0-0- -0- 21,747 .0 2 -0-0-0- 18,193 .4 9 14,914 .5 9 465 .10 469 .79 14 , 914 .59 200106 2,019 .44 200206 15,266 .02 -0-0-0- -0-0- -0-0-0- -0-0= -0-03,646 .54 -0-0-0- -0 -0 -0 -0 - -0- 2,019 .4 4 11,619 .4 8 -0- 0 -0- 1,118 .0 0 -0 - Nathan Suzuk i ~_.0~__ - l-, 118 .-00'- -- 17,500 .00 _0= - _r -- 0 -0- -0- 200006 200106 PW C 44,480 .01 136 .55 -0- 44,480 .01 -0- -0- -0- -0 - -0- -0- 136 .55 -0 - - 0- -0 - 200006 200106 60 , 225 .24 -0- 56 , 023 .89 -0-0- 60,225 . 24 56,023 .89 -0 -0 - -0- 69,436 .14 -0-0-0- -0-0- 69,436 .14 -0-0- -0- -0 - 5,763 .36 -0- -0- 5,763 . 36 -0- -0- -0- -T-2-00006 = 200106 17,500 .00 0-` Perkin Hosod a 200206 Professional 200006 Image - 325 Fees Re : Total Fees Accepte d Criminal Grand Jury Criminal Jin Sock Investigation Proceedings Trial Lee As Ordinary Other and Necessary Fee s Reinwald O'Connor 199806 199906 200006 200206 Robert Waters 200206 Robert Holland 199806 Saranow,Pagan i 200006 200106 200206 Seyfarth Sha w 199806 533,491 .70 -0- 321,845 .65 260,264 .45 23,543 .49 -0-0-0- 353,348 .98 307,988 .61 -0-0- 259,730 .35 23,090 .85 158,073 .00 158,073 .00 -0- -0- 925 .00 -0- -0- 31,345 .34 292,282 .61 192,644 .18 -0-0-0- -0- -0- -0- 122 .50 Sherman Sherman -0-0- -0-0- 180,142 .72 13,857 .04 534 .10 -0-0- -0 -0 -0 - 452 .64 -0-0- -0- -0- -0 - -0- -0- 925 .0 0 31,345 .34 292,282 .61 -0-0- -0-0- -0 -0 - 192,644 .18 -0- -0- -0 - =0- 122 .50 -0 - -0- -0- -0 - ' 200206 Sheila Balka n 91,179 .04 -0- -0- 91,179 .04 -0- -0- -0 - 200206 Shiotani Inouy e 32,430 .00 -0- -0- 3 2,430 .00 -0- -0- -0 - 356,826 .59 285,228 .94 199,130 .37 124,213 .60 356,826 .59 -0-0-0- 285,228 .94 -0-0- -0-0-0- -0-0-0- -0 -0 -0 - -0- 200206 Squire Sander s 56,266 .17 -0- -0- -0199,130 .37 124,213 .60 56,266 .17 -0- -0-0- -0 -0 - 200106 Stephen Plat t 200206 3,888 .10 -0- -0- 3,888 .10 -0- -0- -0 - 13,102 .18 -0- -0- 13,102 .18 -0- -0- -0 - Stephen Pingre e 199806 199906 15,117 .06 8,111 .50 -0-0-0- -0-0-0- -0- -0- -0-0- -0-0- -0 -0 - -0-0-0- -0-0-0- -0- -0- -0- -0 -0- -0- 199806 199906 200006 200106 200006 Wachi Watanab e 199806 199906 200006 200206 Wilmington Institut e 200106 200206 24,749 .15 -0- 15,117 .06 8,111 .50 24,749 .15 21,473 .82 10,000 .00 7,298 .13 3,776 .02 3,986 . 9 5 -0-0-0- -0-0-0- 67,225 .00 -0-0- -0-0- 26,853 .00 17,486 .87 -0- -010,000 .00 7,298 .13 3,776 .02 67,225 .00 26,853 .00 -0 -0 -0 -0 -0 -0 -0- - 326 - Total Criminal Investigation Grand Jury Criminal Proceedings Trial Fees Re : Fees Accepte d Jin Sock As Ordinary Other Lee and Necessary Fee s Yoshida, Inc . -0199906 1,894 .04 Other Lega l 199806 .23 -0199906 ( .16) -0200006 200106 290 .34 298 .77 -0-0- 270 .51 -0- 200206 Total Legal Fee s 199806 1,675,146 .42 394,967 .60 199906 1,112,540 .32 -0.200006 2,397,682 .43 -0-0200106 1,783,518 .22 200206 2,107,919 .42 -0- -0- -0- -0- -0-0-0- -0-0-0- -0- .23 -0 - ( .16) -0-0- -0- -0-0-0- -0- -0 290 .3 4 298 .7 7 -0- -0- -0- 270 .5 1 699,121 .77 847,803 .17 53,911 .87 59,896 .96 474,591 .00 117,487 .86 96,985 .95 5,000 .00 2,207,999 .62 1,756,169 .06 2,052,651 .31 6,297 .00 438 .25 452 .64 -0- -0- -0- 18,038 .71 8,695 .20 55,957 .82 9,736 .05 7,473 .18 1,894 .0 4 34,515 .4 7 78,657 .1 3 30,442 .0 4 12,174 .8 6 47,342 .2 9 Other Professional Fee s Antoneita DeWang-Se o 199806 Applied Compute r 199806 200206 ASI Food Safet y 199906 Back to Basics Plus 200206 Brewer Environmenta l 199806 199906 .` -200006" 200106 200206 Business Consultin g 199806 199906 7,000 .00 -0- -0- -0- -0-' 7 .000 .00 -0 - 405 .00 1,025 .00 -0-0- -0-0- -0-0- -0-0- 405 .00 1,025 .00 -0 -0 - 150 .00 -0- -0- -0- -0- 150 .00 -0 - 1,074 .00 -0- -0- -0- -0- 1,074 .00 -0 - 145 .83 2,004 .15 -0-0- -0-0- -0-0- -0-0- 145 .83 -0 - 2,004 .15 -0 - -0- 1,899 .98 -0 - 89-9 .98-2,158 .32 -0-0- -0-0- -0- 2,158 .32 -0 - 1,999 .98 -0-0- -0- 1,999 .98 -0 - 19 , 999 .93 -0- 4,999 .98 -0- -0-0- -0-0- -0-0- 19,999 .93 4,999 .98 -0 -0 - 520 .00 -0- -0- -0- -0- 520 .00 -0 - 675 .00 -0- -0- -0- -0- 675 .00 -0- Ceridian Employe r 200006 Charles Abraha m 200206 - 327 Fees Re : Fees Accepte d Total Criminal Grand Jury Criminal Jin Sock Investigation Proceedings Trial Lee As Ordinary Other and Necessary Fee s Commercial Plumbin g 200006 125 . 00 -0- Communications -- Pacifi c 200206 979 . 16 COLIFORM -0- 199906 145 . 83 Datahous e 199806 1,588 . 53 199906 200106 53 , 532 .46 200106 5,400 . 00 Dunn Bradstree t 199806 158 . 22 Electra Form 199906 EMS Solution s 10 , 302 .58 -0- -0- -0- 8,234 . 22 6,054 . 64 Dataprofit Corp . 200006 -0- -0- -0- -0- - 0- -0-0- 125 .00 -0- 979 .16 -0- 145 .83 -0- -0- -0- 1,588 .53 -0- -0-0- -0 - 0-08,234 .22 -0-0-06,054 .64 -0-0- -0-0-0 - 0- 53,532 .46 -0 -0-0-05,400 .00 -0-0- -0- 158 .22 -0- 10,302 .58 -0= -0- -0- -0- -0- -0- -0- -0 - -0- 0- -0-0-0(90 .00) -0(90.00) -0 2,045 . 00 -0-0-0-02,045 .00 -0-0-0- 0-021,970 .00 -0200006 21 , 970 .00 199806 199906 Fidelity Investment s 200006 7,017 .53 Foley Jone s 199906 Food Product s 741 . 00 -0- -0 - -0- -0- - 0-0- -0- 7,017 .53 -0- 741 .00 -0- -0- 199806 199906 200006 2,345 . 00 2,860 . 00 2,860 . 00 -0- -0- -0- -0- 2,345 .00 -0- -0-0- =0-0- -0-0- -0-0- 2,860 .00 2,860 .00 -0-0- 200106 GEM Comm 2,660 .. 00 -0- -0- -0- -0- 2,660 .00 -0- 200006 GT Servic e 200006 5,841 . 12 -0- -0- -0- -0- 5,841 .12 -0- 1,080 . 00 -0- -0- -0- -0- 1,080 .00 -0- Hawaiian Hardwar e 200006 324 . 76 -0-0-0-0 Henry Yokogawa -0-0-0 - 0200106 26 , 500 .00 200206 63,600 .00 -0-0-0'- 0Intrastate Comm 200006 IW dba Italia Wan g 199906 86 . 46 32,000 .00 -0-0- -0- 0- -0-0- -0- -0- 324 .76 -0-026,500 .00 -063,600 .00 86 .46 -0- 32,000 .00 -0- 328 - Total Crimina l Investigation Grand Jur y Proceedings 1,075 .00 -0- -0- 19,428 .68 11 , 562 .42 -0-0- -0-0- -0-0- Crimina l Trial Fees Re : Fees Accepted Jin Sock Lee As . Ordinary and Necessary -0- 1,075 .00 0- -0- 19,428 .68 -0 - .-0- 11,562 .42 -0 - Othe r Fee s John Ching 200006 Kimura Internationa l 200106 200206 Kobayashi Do i 199806 65 , 837 .29 -0- -0- -0- -0- "-0- 65,837 .2 9 199906 200006 61 , 140 .22 57 , 966 .64 -0- -0- 200106 67 , 758 .54 -0- -0-0-0- -0-0-0- -0-0-0- 200206 KPM G 76 , 116 .85 -0 -0- 61,140 .2 2 57,966 .6 4 67,758 .5 4 73,921 .5 7 199806 200006 17,291 .00 8,854 .11 -0- -0- -0- -0- -0- -0- -0- -0- 17,291 .00 8,854 .11 -0 -0- . 451 .00 -0- -0- -0 -0- 451 .00 -0 - 1,800 .00 -0- -0- -0- -0- 1,800 .00 -0 - 20,000 .00 -0- -0- -0- -0- 760 .50 0 -0- -0- -0- 246 .75 1,291 .60 -0-0- -0-0- -0-0- 200006 Procomm 200006 781 .20 -0- -0- 751 .60 200106 1,734 .92 -0-0- 125 .68 - -360 .00 L .C .-Financia l 199806 Leung Pang 200006 -0- -02,195 .28 -0- Lorin Kushiyama 199906 Melvin Ka m 199806 20,000 .0 0 760 .50' -0 - -0- 246 .75 -0- 1,291 .60 -0 -0 - -0- -0- 781 .2 0 -0-0- -0- -0- 751 .60 -0 - -0- -0- 1,734 .92 -0 - -0- -0 -0- -0- 125 .68 -0 - Michael Toig o 199806 200006 Pension Service s Professional Imag e 200206 Pro fit=C once pt s-200006 200106 -0- -0- -0- -0- 360 .00 -0 - 7,400 .00 -0- -0- -0- -0- 7,400 .00 -0 - 14 ,142 .33 -0- -0- -0- 14,142 .33 -0 - 7,127 .56 -0- -0- -0- -0- 7,127 .56 -0 - 7,658 .81 -0- -0- -0- -0- 7,658 .81 -0 - 4,500 .00 500 .00 ( 1,000 .00) -0 -0- -0- -0- -0-0- -0-0- -0-0- -0-0- Quadrel Labeling 199806 Rhanda Kim 200106 200206 Richard Kitagawa 200006 200106 200206 4,500 .0 0 500 .00 (1,000 . 00) -0 -0- 329 Fees Re : Fees Accepte d Total Criminal Grand Jury Investigation Proceedings Criminal Trial Jin Sook Lee As Ordinary and Other Necessary Fee s RJR Packaging 745 .00 -0- -0- -0- -0- 745 .00 -0 - Servend of Hawai i 199906 2,500 .00 -0- -0- -0- -0- 2,500 .00 , -0 - Stewart Engineerin g 199906 8,853 .60 200206 -0- -0- 200006 Tricia Young 200006 TRI Pa c 2,197 .78 -0- -0- -0- -0-0- 8,853 .60 2,197 .78 -0 -0 - 613 .60 -0- -0- -0- - -0- 613 .60 -0 - 199906 10,000 .00 -0- -0- -0- -0- -0- 10,000 .0 0 Vending Consulting 200006 60,000 .00 -0- -0- -0- 60,000 .0 0 15,000 .00 -0- -0-0- -0- 200106 Watson Wyat t -0- -0- -0- 15,000 .0 0 199906 15 , 857 .00 -0- -0- -0- -0- -0- 15,857 .0 0 353 .60 -0- -0- -0- -0- 353 .60 199806 30 , 643 .54 -0- -0- -0- -0- 199906 116,176 .10 38 ,387 .03 -0-0-0- -0-0-0- -0- -0- -0-0- 30,643 .5 4 116,176 .1 0 -0- -0- -0- 38,387 .0 3 -0- -0- -0- -0- -0- -0- -0-0- 45,080 .1 3 40,570 .6 7 Wayne Arakak i 200106 -0 - Amortization 200006 200106 200206 45 ,080 .13 40 ,570 .67 Total Othe r Professiona l Fee s 199806 60 , 924 .92 0- 0- 0- 199906 298 , 009 .68 -0- -0- -0- 4,444 .09 6,480 .8 3 74,836 .36 223,173 .3 2 -0- 0-0-0- 200006 273, 835 .87 -0- -0- 200106 200206 207,156 .39 205 ,132 .57 -0- -0- 112,982 . 20 160,853 .6 7 -0- -0- 52,817 .72 -0- 2,195 .28 154,338 .6 7 -0- -0- 24,845 .05 178,092 .2 4 2,482 .80 83,531 .56 168,940 .02 62,553 .77 30 , 996 .3 0 301,830 .4 5 191,295 .7 1 Total Legal and Othe r Professiona l Fee s 199806 199906 200006 200106 200206 ,836 ,071 .34 1,410, 550 .00 2,671 ,518 .30 1,990,674 .61 2,313 ,051 .99 94,967 .60 -0-0-0-0 99,081 .77 847,803 .17 96,985 .95 5,000 .00 2,195 .28 3,911 .87 59,896 .96 2,2.07,999 .62 74,591 .00 117,487 . 86 6,297 .00 1,756,169 .06 2 ,052,651 .31 438 .25 452 .64 32,318 . 23 166,513 .5 3 225,434 .53 - 330 - 'In at least one of petitioners' submissions to the Court, petitioners erroneously include this amount a second time in other professional fees paid by Carlsmith Ball for 200206 . 'In at least one of their submissions to the Court, petitioners erroneously list Howard Chang's total charges for 199806 as $39,027 .63 . . The correct total charges is $42,853 .42, or in other words $3,825 .79 greater than that reported by petitioners ($42,853 .42 - $ 39,027 .63 = $3,825 .79) . --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A9113c1e18e4b5f61. Public record. Not legal advice.