# UNITED STATES TAX COURT > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3Aa7ba5187a321b2ee ## Record - **Collection:** Agency decision - **Document type:** Agency decision ## Text T.C. Memo. 1996-435 UNITED STATES TAX COURT BARRY B. BEALOR AND NANCY L. BEALOR, ET AL.,1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket Nos. 13364-89, 14112-89, 17236-89, 26434-89, 27614-90, 14819-91, 14820-91, 22407-91, 22496-91, 25519-91, 27125-91, 3453-92, 3456-92, 3457-92, 3461-92, 3462-92, 3551-92, 9950-92, 3221-93, 10897-93, 23719-93. 1 Filed September 25, 1996. Cases of the following petitioners are consolidated herewith: Frank A. Pettisani and Lucille M. Pettisani, docket No. 14112-89; James D. Cameron and Anita B. Cameron, docket No. 17236-89; Intercoastal Management Co. and Subsidiaries, docket No. 26434-89; Donald P. Crescenzo and Kathleen Crescenzo, docket No. 27614-90; MIT 82, Bryen & Bryen, P.A., Tax Matters Partner, docket No. 14819-91; MIT 83, Bryen & Bryen, P.A., Tax Matters Partner, docket No. 14820-91; MIT 83, Bryen & Bryen, P.A., Tax Matters Partner, docket No. 22407-91; MIT 84, Bryen & Bryen, P.A., Tax Matters Partner, docket No. 22496-91; MIT 85, Bryen & Bryen, P.A., Tax Matters Partner, docket No. 25519-91; Intercoastal Management Co. and Subsidiaries, docket No. 2712591; MIT 85, Bryen & Bryen, P.A., Tax Matters Partner, docket No. 3453-92; MIT 82, Bryen & Bryen, P.A., Tax Matters Partner, docket No. 3456-92; MIT 80, Bryen & Bryen, P.A., Tax Matters Partner, docket No. 3457-92; MIT 84, Bryen & Bryen, P.A., Tax Matters Partner, docket No. 3461-92; MIT 86, Bryen & Bryen, P.A., Tax Matters Partner, docket No. 3462-92; MIT 83, Bryen & Bryen, P.A., Tax Matters Partner, docket No. 3551-92; MIT 86, Bryen & Bryen, P.A., Tax Matters Partner, docket No. 9950-92; W & A Payroll Service, Bryen & Bryen, P.A., Tax Matters Partner, docket No. 3221-93; W & A Payroll Service, Bryen & Bryen, P.A., Tax Matters Partner, docket No. 10897-93; and Frank A. Pettisani and Lucille M. Pettisani, docket No. 23719-93. - 2 Stephen J. Jozwiak, for petitioners in docket Nos. 13364-89, 14112-89, 17236-89, 26434-89, 27614-90, 22407-91, 22496-91, 25519-91, 27125-91, 9950-92, 10897-93, and 23719-93. Fred Bryen (an officer), for petitioners in docket Nos. 14819-91, 14820-91, 3453-92, 3456-92, 3457-92, 3461-92, 3462-92, 3551-92, and 3221-93. John E. Becker, Jr., James C. Fee, Jr., and Joseph M. Abele, for respondent. CONTENTS Subject Page Issues.................................................. 7 FINDINGS OF FACT........................................ 8 Background.............................................. 9 MIT 80.................................................. 12 Formation of MIT 80................................ Investors in MIT 80................................ Organization and Management of MIT 80.............. MIT 80 Employee Leasing Arrangement................ Operation of MIT 80................................ Petitioner Crescenzo's Deduction of MIT 80 Partnership Loss................................. Post-1980 Transactions of MIT 80................... Illustration No. 1................................. Purported Transactions--MIT 80..................... Termination Agreement of MIT 80.................... Partnership Income of MIT 80....................... 12 13 13 14 17 MIT 82.................................................. 31 Formation of MIT 82................................ Investors in MIT 82................................ Organization and Management of MIT 82.............. MIT 82 Employee Leasing Agreement.................. Operation of MIT 82................................ Individual Petitioners’ Deductions of Partnership Loss................................. 31 31 33 35 36 21 21 24 25 26 28 39 - 3 Intercoastal’s Deduction of Compensation Fee....... Post-1982 Transactions of MIT 82................... The Pettisanis’ Deductions of Interest Payments......................................... Illustration No. 2................................. Purported Transactions--MIT 82..................... Termination Agreement of MIT 82.................... Partnership Income of MIT 82....................... 39 40 MIT 83.................................................. 46 MIT 83 Investors................................... Organization and Management of MIT 83.............. MIT 83 Employee Leasing Agreement.................. Operation of MIT 83................................ Tax Deductions..................................... Other Developments................................. Post-1983 Transactions of MIT 83................... Illustration No. 3................................. Investment Program--MIT 83......................... Termination Agreement of MIT 83.................... MIT 83 Income...................................... 46 46 50 51 54 55 56 57 57 60 60 MIT 84.................................................. 61 MIT 85.................................................. 68 MIT 86.................................................. 75 W & A Payroll Service................................... 82 The Investors........................................... 89 OPINION................................................. 92 I. Neither the Partners Nor the Partnerships Are Entitled to Loss Deductions Based Upon Payment of Machise's Payroll Costs ........... 41 42 42 43 44 93 A. The Requirement of Economic Substance...... 93 1. The Relationship of the Employees and Independent Contractors to Machise and to the Partnerships....... 95 2. Lack of Economic Substance of the Employee Leasing Agreements........... 103 a. Structure of the Financing....... 104 b. Termination Agreements........... 110 c. Arm's-Length Negotiations........ 115 d. Adherence to Contractual Terms............................ 119 e. Reasonableness of Income - 4 Projections...................... 123 f. Insertion of Other Entities...... 128 B. Lack of Profit Objective of the Employee Leasing Partnerships.............. 129 II. The Pettisanis Are Not Entitled to Deductions for Interest Claimed on Their Long-Term Notes............................... 138 III. Intercoastal Is Not Entitled To Deduct From Its Income the Accrued Interest, Management Fees, or Override Payments to the Leasing Partnerships.................................. 141 IV. The Transactions at Issue Are Not Recognized for Purposes of Claiming Deductions or Reporting Income................ 145 A. In Summary................................. 145 B. No Procedural Defense to Determined Deficiencies............................... 146 C. No Need To Address Other Issues............ 151 - 5 MEMORANDUM FINDINGS OF FACT AND OPINION BEGHE, Judge: In seven of these consolidated cases respondent determined deficiencies in Federal income taxes as follows: Taxable Year Deficiency Barry B. Bealor and Nancy L. Bealor 1982 $23,434 14112-89 Frank A. Pettisani and Lucille M. Pettisani 1982 12,344 17236-89 James D. Cameron and Anita B. Cameron 1982 33,749 26434-89 Intercoastal Management Co. and Subsidiaries 1982 1983 312,775 471,918 27614-90 Donald P. Crescenzo and Kathleen Crescenzo 1980 23,903 27125-91 Intercoastal Management Co. and Subsidiaries 1984 1985 1986 644,814 670,597 725,758 23719-93 Frank A. Pettisani1 and Lucille M. Pettisani 1983 1984 1985 1986 1987 270,425 606,481 1,014,702 1,304,694 293,682 Docket No. Petitioners 13364-89 1 In this case, respondent determined substantial deficiencies and additions to tax arising from petitioners' activities, including investments in various partnerships and S corporations. The only portions of the deficiencies at issue are those that arise from petitioners' claimed interest expense deductions with respect to their investment in MIT 82. In certain of the cases listed above, respondent also determined additions to tax under sections 6653(a)(1) and (2), - 6 and 6661, and additional interest under section 6621(c).2 By agreement of the parties, resolution of petitioners' liabilities for the additions to tax and additional interest has been reserved for other proceedings. In five other cases, respondent determined administrative adjustments to partnership returns, arising from disallowance of claimed partnership losses, as follows: Docket No. Partnership Taxable Year Adjustment 22407-91 22496-91 25519-91 9550-92 10897-93 MIT 83 MIT 84 MIT 85 MIT 86 W & A 1983 1984 1985 1986 1987 $3,066,626 3,035,000 2,700,000 3,850,000 3,586,269 In the nine remaining cases, petitioners have requested the following administrative adjustments reflecting the reduction of reported income to zero if we find that the transactions giving rise to that income are shams: Docket No. Partnership 14819-91 14820-91 3453-92 MIT 82 MIT 83 MIT 85 3456-92 MIT 82 3457-92 MIT 80 2 Taxable Year Adjustment 1986 1986 1986 1987 1988 1987 1988 1989 1986 $428,142 519,960 412,722 1,865,187 1,419,986 840,069 275,156 1,274,633 443,415 All section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. - 7 - 3461-92 MIT 84 3462-92 3551-92 MIT 86 MIT 83 3221-93 W & A 1987 1988 1989 1986 1987 1988 1989 1987 1987 1988 1989 1988 840,838 969,316 1,335,995 546,300 1,315,352 23,889 1,423,786 4,855,505 797,976 360,236 1,218,735 3,586,156 The cases in the foregoing dockets have been selected by the parties as test cases that will resolve common issues in more than 120 cases in a group identified by respondent as "Fred Bryen Promotions". Most petitioners in the nontest cases have executed "piggyback agreements" in which they agree with respondent to be bound by the outcomes in the test cases. Issues The global issue in these consolidated cases is the tax effect of the purported employee leasing transactions of seven partnerships. By agreement of the parties, the questions presented for decision are whether the transactions of the seven partnerships had (1) economic substance and (2) a profit objective. Because we answer those questions in the negative, we hold that neither the partners nor the partnerships are entitled to loss deductions for payroll costs, that the Pettisani petitioners are not entitled to deductions for interest on certain long-term notes, that petitioner Intercoastal Management - 8 Co. & Subsidiaries, the operator of the business for which worker services were provided, is not entitled to deduct from its income, ostensible accrued interest, management fees, or override payments to the partnerships, that none of the transactions at issue are recognized for the purpose of claiming deductions or reporting income, and that respondent is not estopped from asserting any of the deficiencies or proposed adjustments at issue. In view of these holdings, we need not answer any of a series of more particularized substantive tax questions that the parties posed: Whether the partnerships at issue are actually partnerships within the meaning of the Internal Revenue Code; whether the partnerships are employers under the Internal Revenue Code; whether the losses claimed by petitioner partners exceed their bases in the partnerships; whether the partners were at risk with respect to certain notes they issued; and whether the cash method of accounting selected by the partnerships clearly reflected their income. FINDINGS OF FACT The parties have stipulated some of the facts, and the eight sets of stipulations of fact and attached exhibits are incorporated in this opinion. - 9 Background The individual petitioners were residents of New Jersey when they filed their petitions. The principal place of business of the partnerships known as MIT 80, MIT 82, MIT 83, MIT 84, MIT 85, MIT 86, and W & A Payroll Service was Marlton, New Jersey, when their tax matters partner filed the petitions relating to the administrative adjustments or requests for adjustments at issue. When petitioner Intercoastal Management Co. filed its petitions, its principal place of business was Hammonton, New Jersey. Fred Bryen (Fred) has been a certified public accountant for approximately 40 years. From 1965 to 1978, he was a professor of accounting at Rutgers University. He is also one of the owners and employees of the accounting firm Bryen & Bryen, P.A. (BBPA). His son Bruce, also a certified public accountant, is also an employee-owner of BBPA. Marion Hunt, also a certified public accountant, is the third owner-employee of BBPA. BBPA provided business and tax advice to clients and prepared tax returns, but did not certify financial statements. In the mid-1970's, Fred and Bruce began to structure and promote tax shelters. These tax shelters were structured by Fred and primarily promoted by Bruce. One of BBPA's accounting clients was Machise Interstate Transportation Co., Inc. (Machise), a New Jersey corporation - 10 engaged in hauling gasoline and fuel oil. Machise was on the accrual method of accounting and employed a fiscal year ending June 30. Anthony Bucci (Bucci) and Joseph Ingemi (Ingemi) were clients of BBPA. In 1975, Bucci and Ingemi each purchased 50 percent of Machise's stock. At BBPA's suggestion, they transferred their Machise stock to their newly formed corporation, Intercoastal Management Co. (Intercoastal). Bucci and Ingemi were the only shareholders and employees of Intercoastal. The primary purpose for BBPA's recommending the formation of Intercoastal was to provide a means for Bucci and Ingemi to enjoy a generous pension plan without providing for the rank and file employees. During the years at issue, Intercoastal filed consolidated Federal income tax returns with Machise. For purposes of these findings and opinion, Intercoastal and Machise are essentially the same entity. Both corporations were dominated by Bucci and Ingemi, and, after Ingemi's death, by Bucci alone. Machise subsequently entered into an employee leasing agreement with MIT Personnel Co. (MIT Personnel), a corporation that was owned by Bruce Bryen. Bruce, at the time a young man, agreed to undertake the ownership of MIT Personnel as a favor to Bucci and Ingemi and in the hopes of attaining a promised $50,000 fee from them. Pursuant to this agreement, MIT Personnel was to provide Machise with the employees and independent contractors - 11 that Machise would need to carry on its business. Following execution of the agreement, the same employees and independent contractors who had worked previously for Machise continued to provide the same services for Machise. Fred recommended that MIT Personnel be formed to enable Bucci and Ingemi to set up a separate pension plan for the rank and file employees. BBPA also advised Bucci and Ingemi that the use of MIT Personnel would minimize their union problems, help reduce their exposure to personal liability arising from accidents to the Machise tank trucks, and minimize their exposure to payroll tax problems if the truck drivers were classified as employees rather than as independent contractors. On July 1, 1977, Bruce transferred ownership of MIT Personnel equally to Stella Bucci and Lena Ingemi, the mothers of Bucci and Ingemi. In 1980, the first of the tax years at issue, Bucci and Ingemi owned the stock of Intercoastal and were its only employees. Intercoastal owned the stock of Machise, the operating company. The employees and independent contractors who had worked for Machise continued to work for Machise, but now were ostensibly employed by MIT Personnel, a company owned by the mothers of Bucci and Ingemi. The following findings of fact describe the form of the transactions that give rise to the tax deductions at issue. - 12 These findings are necessary for an understanding of the issues presented. The descriptions of the transactions, however, are not meant to indicate that the events described actually happened, or that they had any economic effect. We reserve for the opinion below our discussion and conclusions on those matters. MIT 80 Formation of MIT 80 Fred decided to abandon the MIT Personnel/Machise leasing arrangement in order to promote annual tax-shelter partnerships that would utilize Machise. To this end, in 1980, Fred and Bruce organized and promoted a general partnership named MIT 80. MIT 80's business address was Allison Drive, Cherry Hill, New Jersey, the same address as BBPA’s. MIT 80 moved its business address to 100A Centre Boulevard, Marlton, New Jersey, when BBPA moved there. MIT 80 used the calendar year as it tax year. In order to carry out its tax-shelter objectives, MIT 80 employed the cash method of accounting until December 31, 1986, when it was required to change to the accrual method in accordance with a change in the accounting provisions of the Internal Revenue Code. MIT 80 obtained an employer identification number from the Internal Revenue Service and opened a payroll account at the Guarantee Bank. account. Bucci and Ingemi were signatories on this - 13 Investors in MIT 80 There were nine investors who became partners in MIT 80--six individuals, a trust, and two partnerships that BBPA had organized. One of the individual partners was Donald P. Crescenzo (Dr. Crescenzo), a dentist who practices in Hammonton, New Jersey. The Bryens were his accountants. that he invest in tax shelters. Bruce recommended He invested in MIT 80 because of the tax-sheltered nature of the investment. Dr. Crescenzo had a lot of faith in the Bryens and left the matter of his investment entirely up to Bruce. He was later surprised to discover that, in the course of becoming a partner in MIT 80, he had signed a note for $150,000. The MIT 80 investors were provided with a three-page document prepared by BBPA that set forth projections of income and expenses to the end of the partnership term. Organization and Management of MIT 80 Beginning in July 1980, the nine MIT 80 investors executed powers of attorney in favor of BBPA. Thereafter, at Fred's suggestion, Bruce signed the partnership agreement of MIT 80 on behalf of its investors, who thereby became partners in MIT 80. During July 1980, the investors, including petitioner Dr. Crescenzo, also executed promissory notes aggregating $2.4 million to Intercoastal. The notes bore interest at the annual rate of 10 percent on the unpaid principal. The notes specified - 14 that they would be repaid in 120 monthly installments of interest and principal. On July 17, 1980, Intercoastal drew checks on an account at the Bank of New Jersey totaling $2.4 million. The checks were payable to the MIT 80 investors in amounts equal to the face amounts of their notes. checks to MIT 80. The investors endorsed these These endorsed checks constituted the only capital investments in MIT 80 made by the nine investors.3 MIT 80 and BBPA also entered into a management agreement, drafted by Fred, dated "as of" January 1, 1980, whereby BBPA agreed to manage MIT 80. At Fred's behest, Bruce signed the management agreement on behalf of the MIT 80 partners pursuant to their powers of attorney. MIT 80 Employee Leasing Arrangement MIT 80 and Machise entered into an employee leasing agreement dated "as of" January 1, 1980. The agreement provided that MIT 80 would furnish all the employees and independent contractors needed by Machise to conduct its business for the 1980 calendar year. The agreement specified the duties of the partnership in some detail. 3 Thus, under the heading "Supply of Individuals", During 1980, the investors of MIT 80 actually made cash payments totaling $158,580.80 to Intercoastal, as payments of principal and interest on their notes. These payments went into a separate set of accounts called the MIT 80 ledger. They were deposited with the Merrill Lynch brokerage firm and with the Empire Savings & Loan Association. - 15 the agreement provided-(a) Within ten (10) days of the effective date of this Agreement, the Company shall provide the Partnership with an estimate of the job classifications and the number of individuals within each job classification that it will require during each month in 1980. In any month, the Partnership shall be obligated to provide only such number of individuals having only the qualification designated in such notice and estimate by the Company * * *. (b) Ten (10) days prior to the date that the Partnership is to provide an individual to the Company, the Partnership shall provide the Company biographical information of such individual, containing such information as may be mutually agreed between the Partnership and the Company. The amount of payroll costs to be incurred by the Partnership with respect to any such individual shall also be disclosed. * * * * * * * * * * (d) The Partnership shall have the exclusive right to determine which of its employees shall perform the job services designated by the Company according to the terms of this agreement. * * * The Partnership shall have the right to control and direct the performance of the services of the individuals, and shall instruct each individual as to his work hours and the nature of his duties. * * * Under the heading "Supply of Contractors" the Agreement provided-(a) The Company shall provide the Partnership at least three (3) days prior to the date needed, the number of contractors required for any particular day, the type of equipment required, the type of product to be hauled and the destination of such product. The Partnership shall be obligated to provide such number of contractors with the required equipment * * *. (b) One day prior to the date that the Partnership is to provide a contractor to the Company, the Partnership shall provide the Company such information concerning the contractor and his equipment - 16 as may be mutually agreed between the Partnership and the Company * * *. * * * * * * * (d) The Partnership shall have the exclusive right to determine the contractor to be used to fulfill the Partnership's obligations under this Agreement. Fred provided that the term of the employee leasing agreement between MIT 80 and Machise would be for 1 year so that, in each succeeding year, he could bring in more investors who would be able to deduct their shares of the first-year loss of a new and different tax shelter partnership. Bruce signed the employee leasing agreement on behalf of the partners in MIT 80, writing the words "by power of attorney" below each signature. Journal entries indicate that MIT 80 advanced 100 percent of its $2.4 million capital to Intercoastal on July 29, 1980, although MIT 80 was not specifically required to do so by the employee leasing agreement. The journal entries reflect that these advances took the form of MIT 80's further endorsement of $2.4 million in checks that originally had been drawn by Intercoastal, made payable to the MIT 80 investors, and deemed to have been used by them as their initial investment in MIT 80. However, the journal entries are the only documents indicating the endorsements; MIT 80 did not in fact endorse these checks to Intercoastal. None of the checks entered banking channels; instead, as Fred intended, they circled back to Intercoastal, their drawer. - 17 Thus, at the conclusion of this series of transactions, Intercoastal held, as an advance, the $2.4 million in checks that it had issued to the partners in exchange for their notes, and the partners owed Intercoastal $2.4 million on their notes. The above transactions are depicted in Illustration No. 1, infra p. 25. Operation of MIT 80 Following execution of the employee leasing agreement the same employees and independent contractors who had performed services for Machise continued to perform the same services for Machise. Neither Machise nor MIT Personnel--the prior employers--gave written notice of termination to the employees and independent contractors. The employees and independent contractors did not submit formal employment applications to MIT 80. Bucci and Ingemi were the individuals most knowledgeable about the detailed work assignments of Machise's employees. They actually directed and controlled the activities of those employees. However, there was no provision in the employee lease with MIT 80, purportedly the new employer, or any other document, under which Bucci and Ingemi were to provide such direction and control. Nor was there any provision in any agreement for remunerating Intercoastal, Bucci, or Ingemi for undertaking to manage the Machise personnel on behalf of MIT 80. Machise made - 18 weekly cash "advances" to the Guarantee Bank payroll account held by MIT 80, although it was not required to do so by the employee leasing agreement.4 These advances were equal to the actual weekly worker service compensation payments to employees and independent contractors. The advances were reflected on the books of MIT 80 and Machise. During 1980, Machise paid $2,243,495.73 into the MIT 80 payroll account so that MIT 80 could cover the weekly payroll costs for the employees and independent contractors. Hereafter, use of the term “payroll costs” includes amounts paid with respect to, or on behalf of, both employees and independent contractors. Bucci and Ingemi retained control of the MIT 80 ledger, although they were not partners in MIT 80. Either Bucci or Ingemi signed the MIT 80 checks that paid the employees and independent contractors from the weekly advances made by Machise. There was also a pension plan in effect for the rank and file employees. Bucci decided what investments were to be made for the pension plan, and the comptroller of Machise prepared the 4 Fred testified that there was an "oral agreement" that Machise would advance to MIT 80 the funds needed to pay Machise's employees and independent contractors for the first 6 months of 1980, until MIT 80 obtained funds from its incoming partnerinvestors. Thereafter MIT 80 would repay Machise and deposit with Machise the estimated amount needed by MIT 80 to pay the payroll expenses for the second 6 months. As a result, each week, Machise would pay into the MIT 80 account the amount needed to meet the Machise payroll. At the end of the year, Fred explained, "it was all washed out". - 19 quarterly financial statements for the pension plan.5 By or on behalf of MIT 80, payroll taxes were withheld from employees' wages and remitted to the appropriate State and Federal Government agencies under MIT 80's employer identification number. The employment tax returns that were filed showed MIT 80 as the employer. In 1983, the State of New Jersey made a claim against MIT 80 arising out of an alleged underpayment of unemployment tax contributions in the amount of $140.47. The employee leasing agreement required Machise to pay MIT 80 a "compensation fee" of 115 percent of the payroll costs paid by MIT 80 with respect to the erstwhile Machise employees and independent contractors. the "override". The 15-percent excess of such costs was The override was supposed to compensate MIT 80 for its services in providing and paying the employees and independent contractors to perform the services Machise required 5 The MIT Personnel Co. pension plan was in place for the Machise employees before and during the years in issue. The MIT 80 partnership and successor partnerships apparently were named parties to this plan by virtue of a "participation agreement". The evidence includes a "Valuation Report" of the "MIT 80 Money Purchase Pension Plan" prepared by an independent pension administration company. This report indicates that the plan had accrued assets and vesting schedules attributable to years before MIT 80 came into existence. Additionally, the report's terminology speaks of the MIT 80 "Board of Directors" and "Officers". These terms are consistent with the employer being a corporation, not a partnership. - 20 in order to carry on its business.6 Machise was not required to pay the compensation fee until April 30, 1981, 4 months after MIT 80's obligation to furnish employees and independent contractors had ceased. Additionally, the employee leasing agreement allowed Machise to defer payment of this fee for more than 10 years, until December 31, 1991, if it paid a 10-percent per year late charge on all deferred unpaid portions of the compensation fee. Thus, Machise was not required to, and did not, make any payment of the compensation fee to MIT 80 during 1980. MIT 80, under its cash method of accounting, accordingly reported a loss of $2,247,552. The loss consisted of the following: Salaries and wages Rent--independent contractors Payroll taxes Pension plan Insurance Professional fees Total 6 $456,618 1,673,742 35,877 37,109 41,823 2,383 2,247,552 Fred explained that, with respect to the employee leasing partnerships, all but 5 percent of the compensation fee constituted interest paid by Machise. It purportedly owed such interest because of the partnerships' advances of payroll costs during their first-year operations. This interest component is to be distinguished from the "late charges". The late charges represent interest imposed as a result of Machise's election not to pay compensation fees in years after completion of the respective partnerships' obligations to supply workers. - 21 Petitioner Crescenzo's Deduction of MIT 80 Partnership Loss On his individual income tax return for 1980, Dr. Crescenzo reported a Schedule E partnership loss from MIT 80 of $140,472, representing his 6.25-percent share of the loss purportedly incurred in 1980 by the MIT 80 partnership. Respondent has issued a statutory notice of deficiency to Dr. Crescenzo, disallowing this claimed loss deduction. Post-1980 Transactions of MIT 80 In 1981, Machise "advanced" $6,509 in cash to MIT 80. 80 then paid a net $2,109.97 in payroll taxes. MIT On its partnership return for 1981, MIT 80, under its cash method of accounting, reported a loss of $2,110, which is the net payroll tax payment, rounded off. In 1981, MIT 80's bank account, which had been used as the payroll account during 1980, was closed. MIT 80 billed Machise $2,587,110.96 as its compensation fee on April 30, 1981, the scheduled payment date. This amount represented the actual payroll costs of $2,247,551.73 plus the $2,109.97 net payroll tax paid in 1980, plus $337,449.26--which represented the 15-percent "override" of the payroll costs provided for in the employee leasing agreement.7 7 Machise did not There are often minor differences between the amount of cash paid into the payroll account during the years at issue, the cash paid out as payroll costs, and the amount of such costs that form the basis of Machise's compensation fee calculations. The parties have not always explained these relatively minor differences, and they are not relevant to our holdings herein. - 22 pay this amount to MIT 80 in 1981, or in 1982, or in 1983. It instead deferred payment of the compensation fee, thus becoming subject to the 10-percent annual "late charge". On its books for each of those years, Machise accrued and deducted for Federal income tax purposes the late charges payable to MIT 80. Throughout 1981 and 1982, investors in MIT 80 continued to make monthly cash payments of interest and principal on their notes to Intercoastal. By the end of March 1983, Dr. Crescenzo had made 32 payments on his note to Intercoastal in the total amount of $63,432. Of this amount, $26,727 was principal and $36,705 was interest.8 Ingemi died early in 1983 and Bucci became owner of 100 percent of the stock of Intercoastal/Machise. In the first few months of 1983, Dr. Crescenzo and the other MIT 80 investors executed new notes, prepared by Fred, in favor of Machise. These notes served as substitutes for the partners' original $2.4 million notes to Intercoastal, which were canceled. Some of the new notes were in reduced amounts, reflecting investors' intervening payments to Intercoastal. Other notes reflected increased amounts as a result of some investors' increased obligations to BBPA, which had occasionally made monthly payments to Intercoastal on behalf of those investors. 8 In the aggregate, all the investors in MIT 80 paid cash of $755,142, of which $310,672 was principal and $444,470 was interest. - 23 On June 3, 1983, Machise drew a check in the amount of $150,338 to MIT 80. This was the amount by which the "advances" from MIT 80 to Machise had exceeded the total weekly amounts paid in 1980 by Machise, through the MIT 80 payroll account, to the employees and independent contractors. In a memorandum to one of the partners, Bruce described this check as a nontaxable return of an advance. Bruce's memorandum stated that the $150,338 had been distributed to the partners pro rata and used by them to make partial payments on the interest due on their notes payable to Machise. Thus, the amount of Machise’s check circled back to Machise. On June 30, 1984, Fred prepared, and Machise issued to MIT 80, a demand note bearing no interest in the face amount of $285,952.34. This note was a partial payment of the 10-percent late charge on the compensation fee due under the employee leasing agreement. pay the note. Fred doubted that Machise had enough money to It was Fred's intention, however, that the note would be endorsed back to Machise in a circular movement and never presented for payment in cash. On the back of this note was typed: Pay to the order of: Machise Interstate Transportation Co. [Machise] MIT 80 The note also contains the following legend: By this endorsement, MIT 80 - 24 distributed $285,952.34 to its partners who used the proceeds to pay the annual installments on their notes payable to MIT [Machise] (See schedules) As a result of the endorsement on the $285,952.34 note, the investors did not make any cash payments on their notes to Machise in 1984. Machise issued similar notes, similarly endorsed, in June 1985 and 1986, although in those years the notes were each in the amount of $443,415. Each year, the note was issued to MIT 80, distributed to the partners, and then credited against their liabilities to Intercoastal. In 1986, an entity named Machise Personnel Co. (MPC) purchased all of the financial assets of Machise (subject to any related liabilities) that had been generated by the yearly employee leasing agreements to which Machise was a party. MPC was a partnership consisting of Bucci, who had a 99.999-percent interest, and Intercoastal, with a .001-percent interest. MPC was used to remove from the books of Machise the receivables and several million dollars of liabilities to MIT 80 and its successor partnerships. This was done in order to satisfy lenders and suppliers of Machise. The MIT 80 investors' notes to Machise were accordingly assigned to MPC. On June 30, 1987, MPC, like Machise in prior years, issued to MIT 80 a demand note, bearing no interest, in the face amount - 25 of $443,415. This note was a partial payment of the compensation fee and 10-percent late charges due under the employee leasing agreement. Like earlier similar notes from Machise, this note bore endorsements reflecting that it had been deemed distributed to the MIT 80 partners and then credited to their obligations on their notes to Intercoastal. The following illustration depicts the purported transactions and flows of funds to which MIT 80 was a party. Purported Transactions--MIT 80 A. B. C. Investment Phase 1. Partners execute 10-percent notes aggregating $2.4 million to Intercoastal. 2. Intercoastal draws checks aggregating $2.4 million to investors. 3. Investors endorse the checks to MIT 80 as capital investment in MIT 80. 4. Bookkeeping entries indicate the $2.4 million in Intercoastal checks endorsed to Intercoastal, although checks are neither endorsed nor otherwise enter banking channels. Payroll Phase 5. During 1980, Machise makes weekly transfers totaling $2,243,495.73 to MIT 80 payroll account. 6. Employees and independent contractors are paid from the amounts transferred to the MIT 80 payroll account with checks signed by officers of Machise. Repayment Phase 7. In 1984, repayment begins. Repayments take the form of Machise demand notes of $443,415 in compensation fees and late charges issued to MIT 80. (Although the 1984 - 26 note was for $285,942, Machise had earlier "advanced" $6,509 and issued a check for $150,338, for a total of $442,789.) After 1986, the notes were issued by MPC. 8. The demand notes (and the check for $150,338) are deemed distributed to the MIT 80 partners. 9. Endorsements reflect that the demand notes (and the check for $150,338) are used to pay partners' installments on their 10-percent notes to Machise, which had replaced the notes to Intercoastal. 10. MIT 80 employee leasing program terminated in 1988 with MPC's assignment of partners' notes to MIT 80 for credit against MPC's obligations to the partnership. MCP remained indebted to the partnership for $1,295,108, most of which was later claimed as bad debt loss by MIT 80 partners, on transfer of MIT Personnel Co. stock in 1992. See infra pp. 27-30. Termination Agreement of MIT 80 Fred prepared a Termination Agreement dated January 1, 1988, between MIT 80 and MPC with respect to the employee leasing agreement. Fred signed the Termination Agreement as vice president of BBPA on behalf of both MIT 80 and MPC. As stated in that agreement, MPC owed $2,401,416.25 to MIT 80, but it reduced that amount by $1,407,627 by assigning to MIT 80 the partners' notes to Machise (these notes were the substitutes for the notes originally issued by the partners to Intercoastal). MIT 80 was then to distribute these notes to its partners. No formal documents to effectuate the assignment of notes from MPC to MIT 80 were prepared, nor were any such documents prepared to carry out either the distribution of the notes to the partners or the assignment of those notes by the partners to Machise. - 27 Additionally, under the Termination Agreement, MIT 80 purportedly forgave MPC's unpaid late charges on the compensation fee in exchange for MPC's promise to pay $301,318.95 as a "Contract Renegotiation Fee". The purportedly scheduled date of payment of the amounts due under the agreement (including the "Contract Renegotiation fee") was January 1, 1992. This was 1 day past the date upon which the partnership, according to the partnership agreement, was to terminate. Fred testified that there was an oral amendment of the partnership agreement extending the life of the partnership. However, the provisions of the partnership agreement relating to amendments require that amendments be consented to in writing by all of the partners within 20 days of the notice thereunder. The Termination Agreement provided that, effective as of January 1, 1988, MIT 80 would issue an invoice to MPC in the amount of $301,318.95 for the Contract Renegotiation fee. No such invoice was issued. In the agreement, MPC agreed to pay to MIT 80 a balance due of $1,295,108. This amount included the $301,318.95 that MPC had agreed to pay in exchange for forgiveness of the late charges. The MIT 80 partners' notes were accordingly marked "Paid 1-1-88". The debt of $1,295,108 from MPC to MIT 80 remained outstanding for several years, and was ultimately dealt with as shown infra pp. 30-31. - 28 The operation of the MIT 80 Termination Agreement may be depicted as follows: Owed by MPC to MIT 80 as unpaid compensation fee Owed by MPC to MIT 80 as Contract Renegotiation fee Credited by MPC to MIT 80 as assignment of partners' notes to Machise Amount still owed MIT 80 by MPC $2,401,416 301,319 (1,407,627) 1,295,108 Partnership Income of MIT 80 In 1985 and 1986, MIT 80 reported net partnership taxable income of $443,415, reflecting the receipt of the notes (bearing no interest) from Machise, and treating them as the equivalent of cash. For the year 1987, MIT 80 changed its method of accounting from the cash method to the accrual method.9 On its partnership return for 1987, MIT 80 reported partnership taxable income of $840,838, consisting of $667,997 (one-fourth of the $2,671,990 deferred income that it was allocating over 4 years due to the change in accounting method), plus $241,590.43, shown as late fee 9 In a statement attached to the Form 3115 in which MIT 80 changed its method of accounting, BBPA explained that MIT 80 was a "tax shelter as defined in Section 461(i)(3)". As such, it was precluded from using the cash method after Dec. 31, 1986. BBPA further indicated that MIT 80's "accrued but not received" income was $2,671,990. Under the pertinent regulations, sec. 1.4481T(g)(2)(i), Temporary Income Tax Regs., 52 Fed. Reg. 22772 (June 16, 1987), it was required to take this amount into account ratably over the next 4 years. If it ceased business before the end of those 4 years, it was to take the entire balance into account for its last taxable year. Sec. 1.448-1T(g)(3)(iii), Temporary Income Tax Regs., 52 Fed. Reg. 22773 (June 16, 1987). - 29 income, less a $68,750 management fee expense to BBPA. On its partnership return for 1988, MIT 80 reported partnership taxable income of $969,315, consisting of $667,997 (one-fourth of the $2,671,990 deferred income that it was allocating over 4 years due to the change in accounting method), plus $301,319, the "Contract Renegotiation fee", less a $1 fee expense to BBPA. On its partnership return for 1989, MIT 80 reported partnership taxable income of $1,335,995, which was the remaining one-half of the $2,671,990 deferred income that it was allocating due to the change in accounting method, and no expenses. MIT 80 has pending claims in one of these consolidated cases to adjust its reported income to zero for the years 1985, 1986, 1987, 1988, and 1989, if we should determine that MIT 80 is a sham that is not entitled to deduct losses for its prior years. Respondent agrees that, if we should so find, the requested adjustments would be appropriate. During 1990, Dr. Crescenzo transferred his 6.25-percent interest in MIT 80 in approximately equal shares to Bruce, Bucci, and Richard Adamucci. Dr. Crescenzo received $63,300 for this interest, or $132 less than he had invested in MIT 80. MIT 80 had no activity in 1990 or in 1991, and its partnership returns reflect no income or loss for those years. The business of Machise was thereafter transferred to MIT Transportation Co., Inc., which was wholly owned by Bucci. On - 30 January 1, 1992, Bucci, MPC, MIT 80, and BBPA executed an agreement, prepared by Fred, whereby Bucci agreed to transfer 500 shares of his stock in MIT Transportation Co., Inc., to MPC. The agreement recited that MIT 80 agreed to accept the 500 shares from MPC in full payment of the $1,295,108 due to it from MPC. None of the parties to this transaction were represented by counsel. No one made a formal appraisal of the MIT Transportation Co. stock. Bruce nevertheless issued a memorandum to the MIT 80 partners explaining that since the value of the MIT Transportation stock was $250,000, MIT 80 could claim a bad debt deduction for 1992 in the amount of $1,045,108 ($1,295,108 - $250,000). The stock sale may be depicted as follows: Amount owed MIT 80 by MPC from 1988 to (1992) Claimed value of MIT Transportation Co., Inc. stock given to MPC, then to MIT 80 Amount BBPA advised MIT 80 partners to claim as a loss in 1992 $1,295,108 (250,000) 1,045,108 The partners were allocated pro rata amounts of this $1,045,108 loss in 1992. None of the investors in MIT 80 received more from the operation of the partnership than he had invested. - 31 MIT 82 Formation of MIT 82 On January 1, 1982, Fred and Bruce organized and promoted MIT 82, in the form of a general partnership.10 MIT 82's address was the same as BBPA's. As with MIT 80, MIT 82 used the calendar year as its tax year and the cash method of accounting from its inception through December 31, 1986. BBPA made the general journal entries for MIT 82 for the years 1982 through 1986 and adjusting journal entries for 1982 through 1987. Like MIT 80 before it, MIT 82 entered into an employee leasing agreement with Machise under which MIT 82 was to provide all the individual employees and independent contractors required by Machise for the period January 1 through December 31, 1982. The arrangement was essentially the same as that of MIT 80, but this time BBPA paid more attention to details. The employee leasing agreement again stated that the partnerships would provide Machise with employees, independent contractors, and equipment, plus biographical information about those workers. It also provided that the partnership would have the right to control and direct the employees and that the partnership would 10 Fred had also organized MIT 81 to lease employees and independent contractors to Machise for the period Jan. 1 through Dec. 31, 1981. There are no cases before this Court involving adjustments to the partnership returns of MIT 81 or to the tax returns of the individual participants in MIT 81 with respect to their interests in MIT 81. - 32 "instruct each individual as to his work hours and nature of his duties." As to the contractors, the partnership again had "the exclusive right to determine the contractor to be used" in Machise's business. MIT 82 and BBPA entered into a management agreement, prepared by Fred and dated January 1, 1982, whereby BBPA would manage MIT 82. The management agreement provided that BBPA would receive "such compensation as shall be mutually agreed upon by the parties", but no less than $45,000 per year. MIT 82 had several accounts at various banks. One of these accounts was a checking account at the Guarantee Bank, which was the payroll account. Pursuant to authorization of BBPA, Bucci and Ingemi were authorized signatories on the MIT 82 account at the Guarantee Bank. Investors in MIT 82 Fred prepared the MIT 82 partnership agreement. Petitioners Barry and Nancy Bealor, James Cameron, and Frank Pettisani were clients of BBPA who became investors and partners in MIT 82. There were 23 other individuals and three partnerships, also clients of BBPA, who were also investor partners in MIT 82. Some of the prospective investors in MIT 82 received a four-page document prepared by BBPA (or a later version of three pages). These documents made projections of income, expenses, and cashflow for MIT 82 to the end of the partnership term. - 33 Organization and Management of MIT 82 As the program was structured, the investors were required to execute notes to Machise representing ten-elevenths of their investment in MIT 82. Pursuant thereto, the Bealors executed a note to Machise on October 1, 1982, for $100,000; Cameron executed a note to Machise on September 9, 1982, for $100,000; and Pettisani executed a note to Machise on July 1, 1982, in the amount of $200,000. These notes bore interest at a rate of 10 percent per annum and were payable in level installments. The other partners executed similar notes; taken together, the partners' notes to Machise totaled $3,075,000. The first installments on these notes were not due until July 1, 1983. In 1982, in exchange for their notes to Machise, Machise lent $3,075,000 to the investors in MIT 82. This amount was equal to ten-elevenths of MIT 82's capital. Machise’s loans lacked physical form; they did not exist as checks, notes, or cash. They were recorded only by journal entries on Machise’s books. These amounts were then deemed to be contributed to the MIT 82 partnership with no supporting documentation other than journal entries on the books of MIT 82 maintained by BBPA. In addition to executing the notes, the investors were required to pay, in the aggregate, $307,500 in cash to MIT 82 as the other one-eleventh of their capital investment in MIT 82. Some of the investors in MIT 82 paid their share of the required - 34 cash in full in 1982. Others paid part, or none at all. Some of the amounts not paid were eliminated by offsetting journal entries, reflecting an apparent decision by BBPA not to attempt to collect the unpaid amounts. In order to obtain access to this cash, Bruce executed a "line-of-credit" note, dated January 1, 1982, from BBPA to MIT 82, whereby BBPA could borrow up to $300,000 from MIT 82 at a 15percent interest rate. If BBPA borrowed this amount, it would owe $45,000 annually to MIT 82 as interest. Fred intended that this interest would be offset by the $45,000 management fee that MIT 82 owed to BBPA. During the time the line-of-credit note was outstanding, the annual interest (owed to MIT 82) was $28,500, or 15 percent of the $190,000 borrowed by BBPA under the line-ofcredit note. BBPA accordingly lowered its management fee to $28,500, in order to offset exactly the interest owed by MIT 82. On the same date, Machise executed a separate line-of-credit note to BBPA, whereby it could borrow up to $180,000 of the partners’ cash investment from BBPA, at 7-1/2-percent interest. During 1982, some $190,00011 of the investors' cash passed from MIT 80 to BBPA. 11 BBPA retained 40 percent of this amount, some BBPA's note indicates that it borrowed $190,000 at the end of 1982, although the books maintained for MIT 82 reflect that only a total of $174,000 in cash was paid in during 1982. It was deposited into an account controlled by BBPA. The record also indicates, however, that some investors transferred other investment instruments or accounts receivable in lieu of cash for purposes of meeting their cash requirements. The $190,000 figure thus may reflect that some of these noncash assets were advanced to BBPA. - 35 $76,000, and the remaining 60 percent, $114,000, went to Machise. Machise's receipt of 60 percent of the cash put up by the investors was one of its incentives to participate in the deal. MIT 82 Employee Leasing Agreement The employee leasing agreement of MIT 82 and Machise, prepared by Fred, was dated as of January 1, 1982. Like the MIT 80 employee leasing agreement, the MIT 82 agreement provided that MIT 82 would furnish all the employees and independent contractors needed by Machise to conduct its business for the 1982 calendar year. It stated that Machise would provide the partnership with estimates of the number of employees or contractors Machise would need to carry on its business. It further stated that the partnership would provide Machise with the employees, independent contractors, and equipment, plus antecedent biographical information about the workers. It again provided that the partnership would have the right to control and direct the employees and that the partnership would "instruct each individual as to his work hours and nature of his duties." As to the contractors, the partnership again retained "the exclusive right to determine the contractor to be used" in Machise's business. Unlike the MIT 80 arrangement, the MIT 82 employee leasing agreement specifically required MIT 82 to advance the lesser of its invested capital or $3 million to Machise. As of December 31, 1982, the books of MIT 82 showed that it had - 36 advanced $3,075,000 to Machise. Fred explained that the parties had orally agreed to increase the amount that the partners could invest. Other than journal entries, however, there are no documents showing that this amount was ever paid. Illustration No. 2, infra p. 42, depicts the purported transactions and flows of funds of MIT 82. Operation of MIT 82 The employees and independent contractors were the same employees and independent contractors who provided their services to Machise before the employee leasing agreement was made. The employees and independent contractors were not consulted about the employee leasing agreement. They did not submit formal employment applications to MIT 82, nor did they explicitly consent to the execution of the employee leasing agreement. MIT 82 provided no work space or tools or equipment to the workers after the execution of the leasing agreement. In contrast to the situation of MIT 80, MIT 82, Intercoastal, and Machise entered into a management contract dated January 1, 1982. This agreement, prepared by Fred, provided that Intercoastal would manage Machise on behalf of MIT 82 for the period January 1 to December 31, 1982. The compensation to be paid by MIT 82 was to be the amount of Intercoastal's costs, plus a "supplemental management fee" to be determined by Machise's board of directors. Following the execution of this agreement, Bucci and Ingemi still directed and - 37 controlled the employees. In contrast to the situation of MIT 80, the employee leasing agreement specifically required Machise to make advances of cash to MIT 82. These cash advances were to be equal to the actual costs of meeting the Machise payroll. During 1982, Machise made these advances by transferring $2,550,150 into the MIT 82 payroll account so that MIT 82 could cover the payroll costs. These weekly cash advances took place by means of a transfer from a Machise bank account to the MIT 82 Guarantee Bank payroll account. The employees and independent contractors were paid from this account with MIT 82 checks signed by either Bucci or Ingemi.12 Payroll taxes were withheld from employees' wages and remitted to the appropriate State and Federal agencies under MIT 82's employer identification number. The name MIT 82 appeared on New Jersey unemployment compensation documents. MIT 82 also appeared as the employer on the employment tax returns that were 12 Although not spelled out in the MIT 82 employee leasing agreement, Fred testified that the payroll procedure was to be like that in MIT 80, whereby Machise would advance enough money to cover its payroll in the first 6 months. After July 1, 1982, when the partners' money came in, MIT 82 would pay over enough for the entire year's payroll. The resulting difference between the $3,075,000 allegedly advanced by MIT 82 to Machise and the $2,550,150 advanced to MIT 82 by Machise resulted in an asset called "Due from MIT 82-Advanced" in the amount of $524,850. (This amount was later increased, probably reflecting the difference between the amounts transferred to the payroll account and the amount paid from this account.) In subsequent years, Machise applied alleged payments of compensation fees toward these advances. - 38 filed. MIT 82 paid $1,947,852 to employees and independent contractors and taxing authorities. Some $51,908 was paid or accrued for workmen's compensation, health, and group life insurance premiums. MIT 82 paid an additional $461,092 for professional and management fees and $106 for bank charges. Of this amount, some $460,000 constituted fees paid to Intercoastal for the management of Machise. MIT 82 also accrued a pension contribution expense of $43,907.13 The total was $2,504,865. As with MIT 80, the employee leasing agreement required Machise to pay to MIT 82 a "compensation fee" of 115 percent of the payroll costs paid by MIT 82, plus 115 percent of the amount MIT 82 paid to Intercoastal for management services. Under the employee leasing agreement, no part of this compensation fee was due and payable until June 30, 1983, 6 months after MIT 82's obligation to furnish employees and independent contractors had ceased. Machise could also defer payment of the compensation fee for more than 10 years, until July 1, 1993, if it paid a 10percent per year late charge from June 30, 1983, on all deferred 13 The exhibits include a "Valuation Report" of the "M.I.T. 82 Money Purchase Pension Plan" prepared by an independent pension-administration company. This report contains, as an attachment, a Form 5500-R "Registration Statement of Employee Benefit Plan". That form indicates that the plan sponsor was MIT Personnel Co. and that the plan was instituted on Dec. 31, 1973. The form, which bears the date 1982, also indicates that the plan was not "terminated during this plan year or any prior plan year." As with the other partnerships, MIT 82 was a party apparently only by virtue of a "participation agreement" with the MIT Personnel Co. plan. See supra note 5. - 39 unpaid portions of the compensation fee. Thus, Machise was not required to, and did not, make any payment of the "compensation fee" to MIT 82 during 1982. MIT 82, under its cash method of accounting, accordingly reported a net loss of $2,488,164. This loss was the excess of the $2,504,865 payroll costs and other expenses over reported partnership interest income of $16,701. Individual Petitioners' Deductions of Partnership Loss On their individual income tax return for 1982, the Bealors reported a loss of $80,915, representing their 3.252-percent share of MIT 82's partnership loss. James Cameron reported the same amount as his 3.252-percent share of those losses in his 1982 Federal income tax return. Frank Pettisani, in his 1983 return, reported a Schedule E loss of $161,830, representing his 6.504-percent share of MIT 82 losses. The other investors in MIT 82 also reported Schedule E partnership losses from MIT 82, in proportion to their interests. Respondent issued statutory notices of deficiency to the named investors and the other investors, disallowing the claimed MIT 82 losses for 1982. Intercoastal's Deduction of Compensation Fee For the 6-month period January 1, 1982, to the end of its fiscal year on June 30, 1982, Machise/Intercoastal accrued and deducted, as "rents" for Federal income tax purposes, $1,389,950 with respect to payroll costs. For the next 6-month period of - 40 the following fiscal year--July 1 to December 31, 1982-Machise/Intercoastal accrued, and deducted as rents, another $1,490,645. For the combined 12-month period, these amounts totaled $2,880,595, or 115 percent of the payroll costs allegedly paid by MIT 82. Respondent issued a statutory notice of deficiency to Intercoastal disallowing Intercoastal's claimed deduction, for the fiscal years ended June 30, 1982 and 1983, of those parts of its "rents" expense that represent 15 percent of the compensation fee under the employee leasing agreement, for the management fee expense, and for the interest expense. Post-1982 Transactions of MIT 82 On July 1, 1983, some 6 months after MIT 82's obligation to provide Machise with employees and independent contractors had ended, MIT 82 billed Machise for 115 percent of the payroll costs, as the compensation fee pursuant to the employee leasing agreement. Under the employee leasing agreement, Machise was not required to pay this amount until July 1, 1993, if it paid the 10-percent annual late charges. MIT 82 closed its bank accounts in 1983. The journal entries for 1983 indicate that Machise issued to MIT 82 a check for $473,458, which was circled from MIT 82 through the partners and back to Machise, without being deposited. of any such check appears in the record. However, no copy All of MIT 82’s subsequent years’ financial operations were effected through - 41 noncash transactions, made by issuing, endorsing, or canceling notes, and recorded only by journal entries. These were Machise's payments, in 1984, 1985, and 1986, of $473,458 as deferred payments of the compensation fee, plus interest (the 10percent late charge). The payments took the form of demand notes executed by Machise. These payments were recorded as passing through MIT 82, as compensation fee income or as a return of advances under the employee leasing agreement. exited as capital distributions to the partners. The payments The payments, which took the form only of endorsements to the Machise demand notes, then passed from the partners as payments on their notes to Machise, which reported them as income. For the year 1987, MPC, which had succeeded to the interests of Machise, assumed the responsibility of making its payments. The books of MIT 82 reflect that, in 1987, MPC transferred $473,458 to MIT 82. The Pettisanis' Deductions of Interest Payments Each year, Fred treated as deductible interest some part of the $473,458 amount that was applied against the partners' note obligations to Machise. The partners in MIT 82, following instructions from BBPA, accordingly filed individual income tax returns (Forms 1040) on which they claimed their pro rata shares of the resulting deductions. Frank and Lucille Pettisani claimed Schedule E interest deductions of $20,000, $18,921, $17,733, $16,427, and $21,697 on - 42 Frank Pettisani's note obligations incurred to finance his participation in MIT 82 for the years 1983 through 1987, respectively. Respondent has disallowed these deductions. MIT 82 journal entries indicate that, on December 31, 1987, MIT 82 distributed its $190,000 line-of-credit note from BBPA to the partners, who in turn endorsed it to MPC for credit against their notes, originally made to Machise. The following illustration depicts the purported transactions and flows of funds to which MIT 82 was a party. Purported Transactions--MIT 82 A. B. Investment Phase 1. Partners issue $3,075,000 in 10-percent notes to Machise, representing ten-elevenths of MIT 82's capital. 2. Machise lends $3,075,000 to investors in MIT 82, represented only by journal entries. 3. The MIT 82 partners advance $3,075,000 to MIT 82, represented by their subscription agreements. 4. Pursuant to the employee leasing agreement, MIT 82 advances $3,075,000 to Machise, represented only by journal entries. 5. In addition to long-term notes, during 1982 partners invest cash of $174,000 plus other assets. 6. During 1982, BBPA takes $190,000 from the partners' cash investment account pursuant to a line-of-credit note with MIT 82. 7. During 1982, BBPA advances $114,000 of this cash to Machise. Payroll Phase 8. During 1982, Machise makes weekly transfers totaling - 43 $2,550,150 to MIT 82 payroll account. 9. C. Employees and independent contractors are paid $2,504,865 from the amounts transferred to the MIT 82 payroll account on a weekly basis with checks signed by officers of Machise. Repayment Phase. 10. In 1983, annual repayment begins with an alleged Machise check and then its demand notes to MIT 82 of $473,458 in compensation fees and late charges. After 1986, the repayment is made by MPC. 11. The demand notes are deemed to pass through the MIT 82 partners. Also on December 31, 1987, MIT 82 distributes the $190,000 line-of-credit note from BBPA to its partners. 12. The demand notes, and the BBPA line-of-credit note, are used to pay partners' installments on their 10-percent notes to Machise. Termination Agreement of MIT 82 On January 1, 1988, Fred drafted a Termination Agreement to end the obligations of MIT 82 and MPC under the employee leasing agreement. As recited in the agreement, MPC owed $2,307,059 to MIT 82, and it offered to pay $1,974,901 by means of a 10-percent note to MIT 82. MIT 82 accepted the offer as full payment and agreed to terminate the employee leasing agreement. Under the termination agreement, MIT 82 gave up rights to collect the difference, some $332,158, from MPC. The Termination Agreement required MIT 82 to distribute MPC's note for $1,974,901, executed pursuant to the Termination Agreement, to its partners. Under the Termination Agreement, the partners were to direct MIT 82 to assign that note in payment of amounts they owed MPC on their notes originally payable to - 44 Machise but subsequently assigned to MPC. There is no evidence that MPC issued any note for $1,974,901. A summary of the effect of the MIT 82 Termination Agreement shows the following: Owed by MPC to MIT 82 as unpaid compensation fee Accepted by MIT 80 in full satisfaction of amounts owed by MPC; this amount to be used to offset Partners' notes to Machise Amount forgone by MIT 82 in unpaid compensation fees $2,307,059 (1,974,901) 332,158 Fred designed the Termination Agreement so that everything would "zero out". He signed it under the heading "Bryen & Bryen, P.A." on behalf of both MIT 82 and MPC. Fred explained "the whole reason they [the MIT 82 partners] did it is to get rid of the risk. They owed $2 million and if Machise [sic, read "MPC"] did not pay the compensation fee, these partners would be after me with guns." Partnership Income of MIT 82 For the year 1986, MIT 82 reported partnership taxable income of $428,142. This amount included the $473,458 payment, in the form of a Machise demand note, of compensation fee income, plus interest from BBPA of $30,669, less $75,985 in accounting fees and management expenses to BBPA. For the year 1987, MIT 82, like MIT 80, changed its method of accounting from the cash method to the accrual method, reflecting the new requirements of the Tax Reform Act of 1986. MIT 82 accordingly reported partnership taxable income of $840,069 for 1987. This consisted of $637,316, one-fourth of the - 45 $2,549,264 deferred income that it was allocating over 4 years, plus $231,253 in accrued interest payable from MPC, less $28,500--a management fee expense to BBPA. On its partnership return for 1988, MIT 82 reported partnership taxable income of $275,156. This amount consisted of $637,316, again one-fourth of the $2,549,264 deferred income that MIT 82 was allocating over 4 years, less $332,159--the amount, rounded off, that MIT 82 had agreed to forgo in exchange for early payment to terminate the employee leasing agreement--less professional fees of $30,001. On its partnership return for 1989, MIT 82 reported gross income of $1,274,633. This was the remaining one-half of the $2,549,264 deferred income that MIT 82 allocated over 4 years due to the change in accounting method. MIT 82 reported no expenses. MIT 82 thus reported substantial amounts of income for the years 1986, 1987, 1988, and 1989. In two of these consolidated cases (docket Nos. 14819-91 and 3456-92) MIT 82 has claims pending that the amounts of income it reported for those years should be reduced to zero if we determine that MIT 82 is a sham that is not entitled to deduct losses for its prior years. Respondent agrees that, if we should so determine, the requested adjustments would be appropriate. None of the investors in MIT 82 ever received any cash return from his investment. - 46 MIT 83 The organization and operation of MIT 83 resembled those of MIT 82. However, the program was further complicated by the addition of other entities. On January 1, 1983, Fred and Bruce organized and promoted MIT 83 as a general partnership. Like MIT 80 and MIT 82, MIT 83 used the calendar year as its tax year and the cash method of accounting from its inception until December 31, 1986. As with MIT 80 and MIT 82, its address was the same as BBPA's. BBPA made the journal entries of MIT 83 for 1983 and 1984 and its adjusting journal entries for 1984, 1985, 1987, and 1988. As with MIT 80 and MIT 82, MIT 83 had a bank account at the Guarantee Bank, which was the payroll account. Pursuant to authorization by BBPA, Bucci was an authorized signatory on the MIT 83 account. MIT 83 Investors Fred prepared the MIT 83 partnership agreement. 25 partners, 23 individuals and 2 partnerships. There were Some of the prospective investors in MIT 83 received a three-page document prepared by BBPA. It set forth projections of financial income, expense, and cash-flow to the end of the partnership term. Organization and Management of MIT 83 A corporation named Qulart, Inc. (Qulart), had been formed on December 4, 1979, with Bruce as its sole shareholder. Qulart used a fiscal year ending June 30 as its tax year and employed - 47 the accrual method of accounting. Qulart was inactive through its fiscal year ending June 30, 1983. On July 1, 1983, Bruce transferred all of the stock of Qulart to Marion Hunt, the third owner-employee of BBPA. BBPA. Qulart had the same business address as Qulart did not, however, have a bank account, nor did it prepare financial statements for credit purposes. Fred intended Qulart to be a conduit between Machise and the MIT 83 partners. As with MIT 82 and MIT 80, Machise was the funding source of the noncash portion of the partners' investments, but the loans from Machise to the partners and their notes to Machise in return were both to pass through Qulart. Qulart's borrowings and lendings, like its reported income and expenses for tax purposes, were a wash. During the years in issue, the stated purpose of Qulart was to prevent Machise from assigning to third parties the investors' notes used to finance the employee leasing operations. Other than the change made by inserting Qulart, the funding of MIT 83 was the same as that of MIT 82. Thus, the plan was that MIT 83 would advance ten-elevenths of its capital to Machise. Accordingly, 23 of the MIT 83 partners executed notes to Qulart, dated July 1, 1983, in amounts aggregating $2,623,666. The notes required annual payments of interest only, at a rate of 12 percent per annum, and did not provide for repayment of the principal until July 1, 1994, 11 years after their dates of execution. Fred and Bruce were partners in MIT 83 and executed - 48 similar notes totaling, in the aggregate, $265,000. Fred's and Bruce's notes, however, were made out to Machise, and not to Qulart, apparently because of an error. The total of the investor notes was therefore $2,888,666, an amount equal to tenelevenths of MIT 83's capital. On July 1, 1983, Qulart issued to Machise a 12-percent promissory note in the amount of $2,888,666, whose provisions tracked the provisions of the partners' notes to Qulart. Machise then lent $2,888,666 to Qulart by means of a demand note, providing for no interest. Qulart then lent $2,888,666 to the 25 investors in MIT 83, including Fred and Bruce. Instead of taking the proceeds from Qulart, however, the MIT 83 partners purportedly directed Qulart to provide directly to MIT 83 the $2,888,666 that the partners had borrowed from Qulart. Qulart therefore endorsed to MIT 83 the $2,888,666 demand note that Qulart had received from Machise. In addition to their notes, the investors were required to put up, in the aggregate, $288,866 in cash as the other oneeleventh of their capital investment in MIT 83. Seventeen of the 25 investors in MIT 83 paid their share of the required cash in full in 1983, in the amount of $118,868, plus $13,902 in interest. BBPA issued a note receivable to MIT 83 representing payment in respect of the cash required of the other eight investors in MIT 83, who issued short-term promissory notes to MIT 83. The - 49 notes, aggregating $170,000, were dated January 1, 1983. were payable January 1, 1984. They Some of the investors paid these notes with cash, while others paid by means of offsets. Some portions of these notes remain unpaid. As with MIT 82, Bruce executed a "line-of-credit" note, dated January 1, 1983, from BBPA to MIT 83, whereby BBPA could borrow up to $300,000 in investor cash from MIT 83 at a 15percent interest rate. Of the investors' cash paid in, BBPA retained $46,500, a draw on the line-of-credit note. Pursuant to the line-of-credit note, MIT 83 also endorsed, or otherwise transferred to BBPA, the $170,000 in short-term partner notes. Machise executed a second line-of-credit note to BBPA, also dated January 1, 1983, whereby Machise could borrow up to $180,000 of the investors' cash from BBPA. Some $69,800 in investor cash was originally disbursed to Machise. Machise became obligated to BBPA in this amount. As a result, MIT 83 had a corresponding "receivable" account from BBPA for $284,300, represented by its line-of-credit note from BBPA.14 14 Another $13,669 of investors' cash went to BBPA as This amount consisted of the $46,500 of investor cash BBPA retained, plus the $69,800 given to Machise, plus $168,000 in short-term investor notes owed by BBPA in lieu of the unpaid cash required of the eight investors. The difference between the $170,000 figure for the short-term notes and $168,000 reflects a correction with respect to deposits. The cash paid out exceeds the amounts of cash stipulated as having been paid in during 1983. The difference of $2,559 is not explained; it may have come from interest payments or from additional payments on the (continued...) - 50 professional fees, and $5,330 went to BBPA as an "exchange account". MIT 83 Employee Leasing Agreement As with MIT 80 and MIT 82, MIT 83 and Machise entered into an employee leasing agreement, dated January 1, 1983. Therein MIT 83 agreed to provide all the individual employees and independent contractors required by Machise to conduct its business for the period January 1 through December 31, 1983. Like the prior agreements, the MIT 83 agreement stated that Machise would provide the partnerships with estimates of the number of employees or contractors it would need to carry on its business. It further stated that the partnerships would provide Machise with employees, independent contractors, and equipment, plus biographical information about those workers. It again provided that the partnership would have the right to control and direct the employees and that the partnership would "instruct each individual as to his work hours and nature of his duties." As to the contractors, the partnership again had "the exclusive right to determine the contractor to be used" in Machise's business. The employee leasing agreement specifically required MIT 83 to advance ten-elevenths of its invested capital--or $2,888,666-to Machise. MIT 83 accomplished this advance by endorsing to (...continued) partners' short-term obligations. - 51 Machise the $2,888,666 non-interest-bearing demand note originally made by Machise in favor of Qulart (which Qulart, at the MIT 83 partners' behest, had endorsed to MIT 83). Because Machise received back its own note, that note was retired. Operation of MIT 83 Another new entity, a partnership named MIT Associates (MITA), was formed on January 1, 1983, with Bucci and Intercoastal as its two partners. Bucci had a 99-percent interest in MITA, and Intercoastal had the 1-percent interest. MITA employed the calendar year as its tax year and used the cash method of accounting. The address of MITA was the same as that of Machise--500 North Egg Harbor Road, Hammonton, New Jersey. Ingemi's widow had instituted a lawsuit against Bucci and his companies, and MITA was formed to prevent that litigation from affecting the MIT partnerships. MIT 83, MITA, and Machise entered into a management agreement dated January 1, 1983. This agreement, prepared by Fred, provided that MITA would manage Machise on behalf of MIT 83 for the period January 1 through December 31, 1983, for a "fee to be determined by mutual agreement". After execution of the management agreement, Bucci still controlled and directed the employees and independent contractors. The employees and independent contractors were the same employees and independent contractors who had provided their services to Machise prior to the MIT 83 employee leasing - 52 agreement. They did not receive written notice of termination either by Machise or by MIT 82. They did not submit formal employment applications to MIT 83. The employee leasing agreement required Machise to make advances of cash to MIT 83. These cash advances were equal to the actual costs of meeting the Machise payroll. During 1983, Machise advanced $3,061,723 to MIT 83 to cover the payroll costs.15 These weekly cash advances were transferred from a Machise bank account to the MIT 83 Guarantee Bank payroll account. The employees and independent contractors were paid by checks drawn on this account and signed by Bucci. Payroll taxes were withheld from employees' wages and remitted to the appropriate State and Federal agencies under MIT 83's employer identification number. MIT 83 appeared as the employer on the employment tax returns that were filed. On February 26, 1983, the New Jersey Department of Labor wrote to "William Bryen and Bruce Bryen, t/a MIT 83". The letter stated that "our records indicated that you were not registered under the New Jersey Unemployment Compensation Law". Machise, not MIT 83, was listed as the insured on the Standard Workmen's Compensation and Employer's Liability Insurance policy for the 15 Machise ultimately advanced $189,908.85 more to MIT 83 than MIT 83 had advanced, as ten-elevenths of its capital, to Machise. Therefore, Fred prepared a demand note without interest in order to pay off the unpaid balance of this excess. - 53 period July 1, 1983, through July 1, 1984. Additionally, in 1983, Bucci, as president of "MIT" (which we are calling "Machise") verified the employment of one of its drivers to a mortgage company. MIT 83 was, however, listed as the employer on workmen's compensation claim forms. Machise's controller did not remove Machise from the workmen's compensation policy; he just added the name of the new lessor partnerships to the policy. He did not, however, remove the previous partnership names for several years, “just to be sure”. MIT 83 paid $2,528,416 to employees and independent contractors and taxing authorities. It paid out additional professional and bank fees, pension expenses and workmen's compensation, health, and group life insurance premiums. In addition, on December 22, 1983, MIT 83 issued a check to MITA, in the amount of $363,000, as the total management fee due under the management contract.16 The total paid by MIT 83 during 1983 was $3,080,528. Under its cash method of accounting, MIT 83 claimed a net loss of $3,066,626, which was the excess of the $3,080,528 16 The check was drawn on the Guaranty Bank account and signed by Bucci. The amount was recommended by Fred. The balance in the MIT 83 account when this check was written was $86,327.79. Fred intended this check to circle back into the MIT 83 account. On the day this check was issued, MITA endorsed it to Machise as payment of an alleged guaranty fee and the advance by Bucci to Machise to reduce his account. Machise endorsed the check back to MIT 83 as part of the advances required under the employee leasing agreement. On the day the check was drawn, it was deposited into the account upon which it was drawn. The check, in effect, funded itself. - 54 payroll costs over reported partnership income of $13,902. The reported partnership income was interest income that came from BBPA. The interest was based upon BBPA's borrowing of the investors' cash on the line-of-credit note. This income was offset by a claimed deductible payment to BBPA of professional fees of $14,366. Tax Deductions On their individual income tax return for 1983, the 25 participants in MIT 83 reported Schedule E partnership losses from MIT 83 in proportion to their interests in the partnership. Respondent issued a notice of final partnership administrative adjustment to MIT 83, in which respondent disallowed the entire claimed MIT 83 partnership loss of $3,066,626 for the year 1983. For the period January 1 through June 30, 1983, Machise accrued and deducted, for Federal income tax purposes, "rents" of $1,468,830. For the period July 1 through December 31, 1983, Machise/Intercoastal accrued, and deducted for Federal income tax purposes, "rents" of $2,061,962. For the two periods, these amounts totaled $3,530,792, which is 115 percent of the $3,070,25317 paid by MIT 83 for payroll and independent contractor costs. 17 There is a relatively minor difference between the preoverride amount that Machise used as a basis for computing its “rents” for the two 6-month periods in question and the amount claimed as a loss by MIT 83. The difference reflects an amount spent by MIT 83 in 1984. - 55 Respondent has issued statutory notices of deficiency to Intercoastal for its fiscal years ended June 30, 1983 and 1984. In those deficiency notices, respondent has disallowed the deduction of the portions of the "rents" paid to MIT 83 that represent 15 percent of the compensation fee under the employee leasing agreement, the management fee expense, and the interest expense attributable to Machise's accrued late fees. Other Developments William Crescenzo, a nephew of Dr. Crescenzo, a petitioner in docket No. 27614-90, had been hired as the controller of Machise during 1982. Machise. He considered himself an employee of He knew, however, that there were companies, which he called "payrolls", whose name appeared on paychecks. He was unaware of the existence of Qulart, and of the fact that large amounts of money were being lent at zero percent interest. He did not understand the purpose of checks coming in and going back to the maker, but at Bucci's direction, he followed written instruction from BBPA. Frank Peretti succeeded Ingemi as Machise's operations manager after Ingemi's death and later became the company controller. Peretti understood that the various partnerships were his employers, because "every year our payroll company changed." Ingemi had explained to Peretti that the details were complicated, and that Ingemi did not fully understand them himself, but to trust him and "you still have a job." Among - 56 Peretti's responsibilities were changing truck leases and insurance forms to reflect the name of the new employers. Post-1983 Transactions of MIT 83 MIT 83 closed its bank accounts early in 1984. Machise owed MIT 83 a compensation fee of 115 percent of the payroll costs. However, under the terms of the employee leasing agreement, this payment could be deferred until July 1, 1994, for a 10-percent-per-year late charge. The MIT 83 agreement differed from the MIT 82 agreement in a minor respect: Machise had no obligation to make any payment whatsoever to MIT 82 for 10 years; however, Machise was obligated to pay interest annually to MIT 83 on the unpaid compensation fee. On July 1, 1984, MIT 83 billed Machise for 115 percent of the payroll costs. In 1984, 1985, and 1986, Machise made annual payments of $519,960 as deferred payment of the compensation fee plus interest (the 10-percent late charge). the payments were made by MPC. transactions. After July 1, 1986, No cash changed hands in these All the payments consisted of the issuance of non- interest-bearing notes by Machise, and were recorded by journal entries. The purported payments were recorded as passing through MIT 83, coming in as compensation fee income, and exiting as capital distributions to its partners. The payments to MIT 83 then passed through the partners, going from them as payments on their notes to Qulart. The payments then passed from Qulart to Machise as payment on - 57 Qulart's 12-percent note to Machise. For the year 1987, MIT 83, like the other partnerships, changed its method of accounting from the cash method to the accrual method. At the end of 1987, the cash paid and short-term notes issued by the partners in 1983 were still reflected by BBPA's line-of-credit note for $284,300 in favor of MIT 83. On December 31, 1987, Fred applied this note as a deemed distribution to the partners and the further use by them as partial payment of their notes to Qulart. The following illustration depicts the purported transactions and flows of funds to which MIT 83 was a party. Investment Program--MIT 83 A. Investment Phase 1. Partners issue 12-percent notes to Qulart in the amount of $2,888,666, representing ten elevenths of MIT 83's capital. (Fred and Bruce themselves execute $265,000 of such notes by mistake to Machise). 2. Qulart issues a 12-percent note to Machise for $2,888,666. 3. Machise issues a zero-percent demand note to Qulart for $2,888,666. 4. Qulart endorses the $2,888,666 note directly to MIT 83, allegedly at partners' request. 5. By virtue of the endorsement in No. 4, above, the partners are deemed to have invested $2,888,666 in the capital of MIT 83. 6. Pursuant to the employee leasing agreement, MIT 83 advances $2,888,666 to Machise by endorsing the zeropercent demand note to Machise. - 58 - B. D. 7. In addition to long-term notes, during 1982, partners invest cash of $118,868, and pay $13,902 interest, plus $168,000 in short-term notes. 8. BBPA retains $46,500 from the partner cash account pursuant to a line-of-credit note with MIT 83, plus $13,699 as professional fees and $5,330 as an "exchange account". 9. Machise receives $69,800 of partner cash for which it becomes obligated to BBPA under its line-of-credit note. 10. BBPA becomes obligated to MIT 83 for "receivable" account of $284,300. Payroll Phase 11. During 1983, Machise makes weekly transfers totaling $3,061,723 to the MIT 83 payroll account. 12. Employees and independent contractors are paid by MIT 83 from the amounts transferred to the MIT 83 payroll account by Machise. Repayment Phase 13. In 1984, repayment begins with Machise notes of $519,960 to MIT 83 as compensation fee and late charges. 14. Notes for $519,960 pass through MIT 83 to its partners. 15. Partners transfer the notes for $519,960 to Qulart as payments on the partners' 12-percent notes. At the end of 1987, the BBPA line-of-credit note with a balance of $284,300 is also assigned to Qulart to be applied as payment on the MIT 83 partners' notes to Qulart. 16. The notes for $519,960 then exit to Machise as payments on Qulart's 12-percent note to Machise. - 59 Termination Agreement of MIT 83 On January 1, 1988, Fred prepared a handwritten Termination Agreement to terminate the obligations of MIT 83 and MPC under the employee leasing agreement. The Termination Agreement stated that MPC owed $2,148,764 to MIT 83 under the leasing agreement (the $2,148,764 amount is an error; the amount that should have appeared in the Termination Agreement was $2,135,260), and that MPC offered to pay $1,899,633. MPC proposed to do so by transferring to MIT 83 the note made by Qulart on July 1, 1983, in favor of Machise in the amount of $2,888,666. The balance on the note as of January 1, 1988, was $1,899,633. MIT 83 accepted the offer as full payment and agreed to terminate the agreement. It thus agreed to forego, as a “Contact Renegotiation Fee”, some $231,253. No formal assignment of the note was ever made. Under the Termination Agreement, MIT 83 was required to distribute the note to its partners, who in turn were to direct MIT 83 to assign the note to Qulart in payment of amounts they owed Qulart on their investor notes. No formal distribution of this note was ever made. Fred signed the Termination Agreement under the heading "Bryen & Bryen, P.A." on behalf of both MIT 83 and MPC. Fred caused MPC to enter into the Termination Agreement with MIT 83 in 1988 in order to remove from its books the "huge note liabilities"--presumably the accrued and unpaid compensation fee. Fred caused the partners of MIT 83 to enter into the termination - 60 agreement with MPC so as to avoid the risk of being required to pay their notes without MPC paying the partners themselves. Fred intended that all the parties to the MIT 83 employee leasing transactions would be "zeroed out" (with no further liabilities) following the purported termination. In addition, Fred never considered having Bucci obtain any legal representation or independent advice other than Fred himself concerning the alleged termination. MIT 83 Income On its partnership returns for 1985 and 1986, MIT 83 reported partnership taxable income of $519,960. On its partnership return for 1987, MIT 83 reported partnership taxable income of $797,976. This amount included one-fourth of the $2,437,470 deferred income that MIT 83 allocated over 4 years due to the change in accounting method imposed by section 448. this amount was added “fee income” of $231,253. To This fee income included accrued interest payable from MPC and an item of “portfolio income” in the amount of $42,645. The partnership’s taxable income further reflects a deduction of management fees payable to BBPA in the amount of $42,645--the same amount as the “portfolio income”. On its partnership return for 1988, MIT 83 reported partnership taxable income of $360,236; this amount included onefourth of the $2,437,470 deferred income that it allocated over 4 years due to the change in accounting method, less $235,627, - 61 which was the "Contract Renegotiation Fee" and other expenses. On its partnership return for 1989, MIT 83 reported partnership taxable income of $1,218,735, which was the remaining one-half of the $2,437,470 deferred income that it had allocated due to the change in accounting method. For the years 1986, 1987, 1988, and 1989, MIT 83 has filed administrative adjustment requests to reduce its reported taxable income to zero if we determine that MIT 83 is a sham that is not entitled to deduct losses for the prior years. These requests are pending in two of these consolidated cases, docket Nos. 14820-91 and 3551-92. Respondent has agreed that, if we so determine, the requested adjustments would be appropriate. None of the investors in MIT 83 received any cash return on his or her investment. MIT 84 On January 1, 1984, Fred and Bruce organized and promoted MIT 84 as a general partnership. In almost all particulars, the organization and operation of MIT 84 were the same as those of MIT 83. BBPA made the general ledger entries of MIT 84 for 1984, and its adjusting journal entries for 1984, 1985, 1987, and 1988. The 18 individuals and 3 partnerships who participated in MIT 84 were clients of BBPA. There were no prospectuses or offering memoranda or terms sheets for MIT 84. Like the previous partnerships, MIT 84 agreed to provide all the individual employees and independent contractors required by - 62 Machise to conduct business for the period January 1 through December 31, 1984. Machise and the partnership assumed duties similar to those set forth in the earlier partnership agreements. The employees and independent contractors were the same employees and independent contractors who had provided their services to Machise before the MIT 84 employee leasing agreement was made. Bucci continued to direct and control the employees. He determined the amount of wages to be paid, did the hiring and firing, took any necessary disciplinary action, and set the hours to be worked. New independent contractor agreements were made containing the name "MIT 84" as one of the parties and signed by Fred Bryen as "partner" of MIT 84. These agreements imposed rights and responsibilities upon the contractor, the partnership, and the "carrier", which was Machise. For example, under the agreement, both the carrier and the contractor agreed to carry liability insurance. When the lease began, Bucci himself signed as "partnership agent". The investment program followed a familiar pattern. The 21 partners executed 12-percent notes, in amounts aggregating $3,035,000, to Qulart. The notes required annual payments of interest, with the principal and remaining interest due 11 years after the notes’ dates of execution. note to Machise. 84's capital. Qulart executed a similar This amount was equal to ten-elevenths of MIT Machise then lent Qulart $3,035,000 in a zero - 63 percent demand note dated July 1, 1984. Qulart then lent $3,035,000 to the 21 investors in MIT 84. The MIT 84 partners then allegedly directed Qulart to pay the $3,035,000 that they had borrowed from Qulart directly to MIT 84. MIT 84 completed the investment circle by endorsing the $3,035,000 Machise zeropercent demand note back to Machise. Because Machise had its own note back, that note was retired. In addition to the notes, the investors were required to put up, in the aggregate, $303,500 in cash as the other one-eleventh of their capital investment in MIT 84. None of the investors in MIT 84 initially paid this one-eleventh in cash to MIT 84. Instead, they issued short-term notes to BBPA, which had set up a line-of-credit arrangement with MIT 84. The investors’ short- term notes to BBPA were dated January 1, 1984, and were payable July 1, 1984, with interest at the annual rate of 15 percent. The investors fully paid these notes to BBPA in 1984. During 1984, BBPA advanced $182,100 of this amount to Machise, pursuant to a second line-of-credit note, executed by Machise in favor of BBPA. During 1984, Machise made transfers totaling $4,183,049 to the MIT 84 payroll account. The employees and independent contractors were paid with checks on this account that were signed by Bucci. In addition to the payroll costs, on December 21, 1984, MIT 84 issued a check to MITA, in the amount of $400,000, as the - 64 total management fee due under the management contract. amount was recommended by Fred. This As with the MIT 83 check for $363,000, the MIT 84 check passed around in a circle to MIT 84, its maker. Under its cash method of accounting, MIT 84 claimed a net loss of $3,035,000. This was the excess of the $4,194,361 payroll costs over reported partnership income of $1,159,361.18 On their individual income tax returns for 1984, the 21 investors in MIT 84 reported Schedule E partnership losses from MIT 84 in proportion to their interests in the partnership. Respondent issued to MIT 84 a notice of final partnership administrative adjustment in which respondent disallowed the entire claimed MIT 84 partnership loss of $3,035,000 for the year 1984. The employee leasing agreement required Machise to pay a compensation fee to MIT 84 of 120 percent of the payroll costs. This was a 5-percent increase in the compensation fees charged by earlier partnerships. Once again, however, this payment could be deferred for 11 years, until July 1, 1995, for a 10-percent annual late charge. 18 MIT 84 took into income, as compensation fees, $1,112,394 to reflect that it had received more in advances from Machise than it had lent to Machise. The other income reported by MIT 84 for 1984 consisted of interest income of $46,967. Some $45,525 of the latter amount represented interest paid by BBPA based upon its use of the investors' cash under the line-of-credit note. This interest income was exactly offset by MIT 84's claimed payment of a $45,525 professional fee to BBPA. - 65 For the period January 1 through June 30, 1984, Machise accrued and deducted, for Federal income tax purposes, "rents", of $2,425,881. For the period July 1 through December 31, 1984, Machise/Intercoastal accrued, and deducted for Federal income tax purposes, rents of $2,556,722. Respondent issued a statutory notice of deficiency to Intercoastal disallowing Intercoastal's claimed deduction for its fiscal year ended June 30, 1984 and 1985, of those parts of its "rents" expense paid to MIT 84 that represent 20 percent of the compensation fee under the employee leasing agreement, the management fee expense, and the interest expense. MIT 84 closed its bank accounts early in 1985. All its subsequent years’ financial operations were effected through noncash transactions, made by issuing, endorsing, or canceling noninterest-bearing notes, and recorded only by journal entries. These included Machise's payments, in 1985 and 1986, of $546,300, in the form of demand notes, as deferred compensation fee plus interest (the 10-percent late charge). In 1987, MPC made the payment of this amount; it was recorded only by journal entries. These payments took the form of endorsements to the Machise notes; after July 1, 1986, they existed only as bookkeeping entries. They were recorded as passing through MIT 84, coming in as compensation fee income and exiting as capital distributions to its partners, going from them as payments on their notes to - 66 Qulart and then exiting as payments on Qulart's 12-percent note to Machise. The $303,500 line-of-credit note from BBPA, representing the partners' cash investment, remained unchanged until December 31, 1987, when it was assigned to Qulart to be applied as a payment on the MIT 84 partners' notes to Qulart. That amount passed from Qulart as payment to MPC on Qulart's 12-percent note for $3,035,000 originally issued by Qulart to Machise, now held by MPC. MPC offset the Qulart note against liabilities to BBPA, and the note was canceled. This line-of-credit note receivable was thus treated in the same manner as BBPA's corresponding line-ofcredit obligations to MIT 83 for $284,300 and to MIT 82 for $190,000. The net effect was that, as of December 31, 1987, the MIT 82, MIT 83, and MIT 84 partnerships could no longer collect BBPA's $777,800 line-of-credit obligations, which had represented the cash that the partners had paid in and which BBPA and Machise had divided between themselves. For the year 1987, MIT 84, like the other partnerships, changed its method of accounting from the cash method to the accrual method. On January 1, 1988, Fred prepared a Termination Agreement to end the obligations of MIT 84 and MPC under the employee leasing agreement. Fred signed the Termination Agreement under the heading "Bryen & Bryen, P.A." on behalf of both MIT 84 and MPC. - 67 The Termination Agreement recited that MPC owed $2,950,256 to MIT 84, and it offered to pay $2,262,253 by transferring to MIT 84 the $3,035,000-note made by Qulart to Machise, now held by MPC, with a current unpaid balance of $2,262,253. MIT 84 thus settled its receivable for MPC for $688,003 less than it was owed. This amount was again termed a "Contract Renegotiation fee." No formal assignment of the note, however, was ever made. The Termination Agreement also required MIT 84 to distribute the Qulart note for $3,035,000 to its partners, who were to direct MIT 84 to assign that note to Qulart in payment of amounts they owed Qulart on their investor notes. of that note was ever made. No formal assignment The partners' investor notes, however, were marked "Paid 1-1-88". MIT 84 reported partnership taxable income of $546,300 for 1986 and, by virtue of having changed its accounting method, $1,360,877 for 1987, $23,899 for 1988 (reflecting a deduction of the $688,003 Contract Renegotiation fee), and $1,423,786 for 1989. MIT 84 has filed one of the petitions in this consolidated proceeding (docket No. 3461-92) seeking to have its reported taxable income for those years reduced to zero should we determine that MIT 84 was a sham. In the event we make such a determination, respondent has agreed that such adjustments would be appropriate. None of the investors in MIT 84 ever received any cash return on his or her investment in MIT 84. - 68 MIT 85 On January 1, 1985, Fred and Bruce organized and promoted MIT 85 as a general partnership. Its organization and operation are similar to those of the partnerships previously described. The four individuals and six partnerships who were investors in MIT 85 were clients of BBPA. BBPA made the adjusting journal entries of MIT 85 for 1985, 1987, and 1988. There were no prospectuses or offering memoranda or terms sheets for MIT 85. Some of the prospective investors in MIT 85, however, were given a four-page document, prepared by BBPA, which described the tax advantages of investing in MIT 85 and made projections to the end of the partnership term. The document stated, in part: In 1985, each unit investor will report a loss of $100,000. During the next 10 years, each unit investor will report taxable income ranging from $3,286 in 1986 to $11,560 in 1995. In 1996, each unit investor will report taxable income of $41,263. MIT 85 and Machise, and MPC, newly inserted as a "subcontractor",19 entered into an employee leasing agreement, dated January 1, 1985, under which MIT 85 would provide all of the individual employees and independent contractors required by Machise to conduct its business for the period January 1 through December 31, 1985. 19 Fred testified that he inserted MPC as a subcontractor in order to deter questions by the creditors of Machise about Machise's large liabilities to the partnerships. Additionally, inserting MPC, in which Bucci was the principal partner, exposed Bucci's assets to possible claims of MIT 85 in the event of Machise's inability to pay its liabilities. - 69 The MIT 85 agreement was similar to those of the earlier partnerships. The employees and independent contractors were the same employees and independent contractors who had earlier provided their services to Machise before the MIT 85 employee leasing agreement was made. After this agreement, Bucci still directed and controlled the employees. The 10 partners executed notes to Qulart in face amounts aggregating $2,160,000. This aggregate amount was equal to 80 percent of MIT 85's capital. annual rate of 15 percent. annual payments. The notes bore interest at the They were to be repaid in 10 level Qulart issued a similar note to Machise, which then issued a $2,160,000 demand note dated July 1, 1985, to Qulart. This note circled from Qulart to the 10 investors who allegedly directed Qulart to endorse the note directly to MIT 85. In addition to issuing the notes, the investors were required to put up, in the aggregate, $540,000 in cash as the other 20 percent of their capital investment in MIT 85.20 The investors paid substantial amounts of this cash to BBPA during 1985. BBPA was supposed to advance to MIT 85 the cash required of the investors in MIT 85. BBPA issued neither cash, nor a check, nor notes to accomplish this advance. 20 The advance, The employee leasing agreement for the previous partnership, MIT 84, had required MIT 84 to advance ten-elevenths of its invested capital to Machise. The MIT 85 employee leasing agreement, however, required MIT 85 to advance all its invested capital to Machise. This totaled $2,700,000--$2,160,000 in notes from its partners and $540,000 in cash. - 70 however, was recorded by a journal entry. The total cash paid by the investors under the subscription agreements in 1985 was $334,096.80, plus $16,255 interest. Of this amount, BBPA was to retain some 20 percent as a promoter's fee from Machise. The balance apparently went to Machise, although some amounts that BBPA credited to Machise were in the form of setoffs.21 This "promoter's fee" arrangement for BBPA was new; it replaced the line-of-credit arrangement whereby BBPA--and, through it, Machise--had divided the cash invested by the partners in the earlier partnerships. Machise again made weekly transfers to the payroll accounts to cover the Machise payroll. amount of $3,508,786. During 1985, these totaled a net The employees and independent contractors were paid with MIT 85 checks drawn on this account and signed by Bucci. In addition to the payroll costs, on December 24, 1985, MIT 85 issued a check to MITA, in the amount of $400,000, as the total management fee due under the management contract. amount was recommended by Fred. This As with the MIT 84 check for the same amount, the MIT 85 check passed around in a circle to MIT 85, its maker. 21 Fred testified that, because all the investors’ cash was to go from MIT 85 to Machise it was not necessary for BBPA to forward all of the investors’ cash to Machise. Fred recalled that BBPA merely reduced an obligation that Machise had to BBPA in lieu of forwarding some of the investors’ cash to Machise. - 71 Under its cash method of accounting, MIT 85 claimed a net loss of $2,700,000, which was the excess of the $3,512,527 payroll costs over reported partnership income of $812,527, an amount that includes compensation fee income and a relatively small amount of interest earned.22 On their individual income tax returns for 1985, the 10 investors in MIT 85 reported Schedule E partnership losses totaling $2,700,000 from MIT 85 in proportion to their interests. Respondent issued a notice of final partnership administrative adjustment to MIT 85, wherein respondent disallowed the entire claimed MIT 85 partnership loss of $2,700,000 for the year 1985. For the period January 1 through June 30, 1985, Machise/ Intercoastal accrued and deducted, on its consolidated income tax return, "Rents" of $2,110,835. For the period July 1 through December 31, 1985, Machise/Intercoastal accrued, and deducted for Federal income tax purposes, an additional $2,104,042.23 For the 22 The $3,512,399 amount "advanced" by Machise to the MIT 85 payroll account exceeds the $2,700,000 amount "advanced" by MIT 85 to Machise under the employee leasing agreement. See supra note 20. Some $808,786 of the difference between the amounts allegedly advanced by MIT 85 and those advanced to MIT 85 was recorded as a prepayment of the compensation fee on Dec. 31, 1985, and is reflected in MIT 85's income for that year. Additionally, the payroll figure includes some $3,741 in interest. 23 Intercoastal/Machise filed an amended Form 1120 for the fiscal year ended June 30, 1986, in order to reflect a change in its net operating loss carryover from a prior year. - 72 two periods, these amounts totaled $4,214,877, or 120 percent of the amounts paid by MIT 85 for payroll costs. Respondent issued a statutory notice of deficiency to Intercoastal. Therein respondent disallowed Intercoastal's claimed deductions for the fiscal years ended June 30, 1985 and 1986, of those parts of its "rents" expense paid to MIT 85 that represent 20 percent of the compensation fee under the employee leasing agreement. Respondent also disallowed the management fee expense and the interest expense. MIT 85 closed its bank accounts early in 1986. On July 1, 1986, after the payroll costs were paid, MIT 85 billed Machise for 120 percent of their total amount, as the compensation fee. By that time, however, MIT 85 should have billed MPC, which, the day before, had purchased all of the financial paper assets of Machise that had been generated in the yearly employee leasing agreements to which Machise was a party. In subsequent years, MIT 85 engaged in noncash transactions, made by issuing, endorsing, and canceling notes, and recorded by journal entries. These included Machise's execution of demand notes without interest to MIT 85 in the amount of $412,722 as deferred payment of the compensation fee plus interest (the 10percent late charge). As with MIT 84, the payments went from Machise to MIT 85, then to its partners, then to Qulart, and finally back to Machise. Thus, on its partnership return for 1986, MIT 85 reported partnership taxable income of $412,722, - 73 which it called compensation fee income, and no expenses. In 1987, MPC issued a similar note, which circled through the partners, the partnership, and Qulart, and back to MPC. MIT 85 reported partnership taxable income of $1,865,187 on its partnership return for 1987. This amount consisted of $1,571,520 (one-half of the $3,143,039 deferred income that it was allocating over 2 years due to the change in accounting method), plus $293,667, which it called fee income, and which represented the accrual of interest payable from MPC, and no expenses. On January 1, 1988, Fred prepared a Termination Agreement to end the obligations of MIT 85 and MPC under the employee leasing agreement. Under the terms of the employee leasing agreement, MPC owed $3,023,984 to MIT 85. MPC offered to pay $2,116,938 by transferring to MIT 85 the $2,160,000 note made by Qulart to Machise, now held by MPC, with a balance, including accrued interest, of $2,116,938. The Termination Agreement recited that, after assignment of the note, the balance due to MIT 85 was $907,045.98, but that MIT 85 had agreed to reduce that amount by $151,531.98 and to cancel the 10-percent annual late charge. Fred calculated the net amount due to MIT 85, some $755,514, so that it would equal the amount that he had projected as the aggregate income to the MIT 85 investors. Additionally, under the Termination Agreement, MIT 85 was required to distribute the note to its partners who were to - 74 direct MIT 85 to assign the note to Qulart in payment of amounts they owed Qulart on their investor notes. of this note, however, was ever made. No formal assignment The partners' notes were nevertheless marked "Paid 1-1-88". Fred signed the Termination Agreement under the heading "Bryen & Bryen, P.A." on behalf of both MIT 85 and MPC. On its partnership return for 1988, MIT 85 reported partnership taxable income of $1,419,986, consisting of $1,571,520 (the remaining one-half of the $3,143,039 deferred income that was originally allocated over 2 years due to the change in accounting method), less $151,532, which it called a "Contract Renegotiation fee". This amount corresponds to the amount that MIT 85 agreed to forgo in exchange for early payment to terminate the employee leasing agreement, less an accounting fee to BBPA of $1. For the years 1986, 1987, and 1988, Fred, as vice president of BBPA, the tax matters partner of MIT 85, has filed an amended Form 1065 as a protective administrative adjustment request. Therein he seeks to have the income reported by MIT 85 for those years reduced to zero, in the event that we determine MIT 85 to be a sham, not entitled to deduct the losses for 1985. claims are pending in docket No. 3453-92. Those As with the other partnerships, respondent has agreed that such adjustments would be appropriate if we so determine. After the termination, MPC still owed MIT 85 some $755,514. - 75 Fred recommended that the partnership distribute this $755,514 receivable to its partners. The partners were thereafter listed as creditors against the estate in bankruptcy of Anthony S. and Miriam A. Bucci (Bucci was the 99.999-percent partner of MPC; Intercoastal held the other .001-percent interest). The Notice of Commencement of the Bucci bankruptcy case stated: "At this time there appear to be no assets available from which payment may be made to unsecured creditors." No representative of BBPA attended the Creditors' Meeting in the Bucci bankruptcy proceeding held on July 20, 1994. Fred explained that it is "an absolute waste of time to attend * * * these creditors' meeting when we know that there are no assets available to be distributed." BBPA recommended that the partners claim the amounts owed to them as bad debt deductions for the year 1994. None of the investors in MIT 85 ever received any cash return on his or her investment in MIT 85. MIT 86 Fred and Bruce organized and promoted MIT 86 as a general partnership at the beginning of 1986. to the previous partnerships. It also was very similar BBPA prepared financial statements for MIT 86 as of December 31, 1986, and made adjusting journal entries for 1987 and 1988. MIT 86 had nine partners--six individuals, two partnerships and one corporation. All were clients of BBPA. There were no - 76 prospectuses or formal offering memoranda or terms sheets for MIT 86. Some of the prospective investors in MIT 86, however, received a four-page document prepared by BBPA. The document described the provisions for investing in MIT 86 and made taxable income and cash-flow projections to the end of the partnership term. The arrangements for MIT 86 followed the familiar pattern. MIT 86, Machise, and MPC entered into an employee leasing agreement, dated January 1, 1986, under which MIT 86 would provide all the individual employees and independent contractors required by Machise to carry on business for the period January 1 through December 31, 1986. The employees and independent contractors were the same employees and independent contractors who had earlier provided their services to Machise before the employee leasing agreement was made. After this agreement, Bucci still directed and controlled the employees. The nine partners executed notes to Qulart in amounts aggregating $3,080,000. This amount was equal to 80 percent of the capital of MIT 86. The notes bore interest at a rate of 15 percent per annum and were to be repaid in annual level installments. Qulart issued a similar note to Machise, which issued a $3,080,000 demand note dated July 1, 1986. Backed by a series of reciprocal obligations, this note circled from Qulart back to the nine investors, who allegedly directed Qulart to endorse the note directly to MIT 86. - 77 In addition to the notes, the investors were required to put up, in the aggregate, $770,000 in cash as the other 20 percent of their capital investment in MIT 86. BBPA was supposed to advance to MIT 86 the cash required of its investors in MIT 86. BBPA issued neither cash, nor a check, nor notes to accomplish this advance, which was, however, recorded by a journal entries on the books of BBPA and MIT 86. The nine investors signed General Partnership Subscription Agreements by which they agreed to pay the 20 percent cash part of their investment in 10 monthly installments at 15 percent interest, commencing on January 1, 1986. The MIT 86 investors paid the $770,000 to BBPA in cash or by offsets in 1986. Machise made weekly transfers to the MIT 86 First Jersey payroll accounts to cover the Machise payroll costs. During 1986, these transfers totaled a net amount of $3,983,476. The employees and independent contractors were paid with MIT 86 checks signed by Bucci. Although the books and records of MIT 86 and MITA reflect payment of a management fee of $400,000 by MIT 86 to MITA, no check for that amount appears in the record. Under its cash method of accounting, MIT 86 claimed a net loss of $3,850,000. This was the excess of the payroll costs over reported partnership income.24 24 The employee leasing agreement required MIT 85 to advance (continued...) - 78 On their individual income tax returns for 1986, the nine investors in MIT 86 reported Schedule E partnership losses from MIT 86 in proportion to their interests. Respondent issued a notice of final partnership administrative adjustment to MIT 86, in which respondent disallowed the entire claimed MIT 86 partnership loss of $3,850,000 for the year 1986. For the period January 1 through June 30, 1986, Machise/ Intercoastal accrued and deducted, on its consolidated income tax return, "rents" of $1,925,000. Respondent issued a statutory notice of deficiency to Intercoastal disallowing Intercoastal's claimed deduction for fiscal year June 30, 1986, of those parts of its rents paid to MIT 86 that represent 20 percent of the compensation fee under the employee leasing agreement, the management fee expense, and the interest expense. MIT 86 closed its bank accounts early in 1986. Like the other partnerships, in its subsequent years MIT 86 engaged in noncash transactions, made by issuing, endorsing, and canceling notes, and recorded by journal entries. Thus, MPC issued MIT 86 (...continued) all its invested capital, notes of $3,080,000 plus cash of $770,000, to Machise. The $133,476 excess of the amounts allegedly advanced to MIT 86 over the $3,850,000 advanced by MIT 86 was recorded as a prepayment of the compensation fee on Dec. 31, 1986. - 79 a demand note in the amount of $585,511,25 without interest, dated July 1, 1987. The demand note bore endorsements that were recorded by journal entries as capital distributions from MIT 86 to its partners and then as payments on their notes to Qulart. As a result of these endorsements, the notes were credited against the partners' notes to Qulart, then applied as Qulart's payment of its note to Machise. The partners in MIT 86 made no cash payments in 1987 on their notes to Qulart. For the year 1987, MIT 86 changed its method of accounting from the cash method to the accrual method. On its partnership return for 1987, MIT 86 reported partnership taxable income of $4,855,505, which consisted of $4,652,314 (the deferred income that it reported due to the change in accounting method), plus $203,191, which it called fee income and which represented the accrual of interest payable from MPC, and no expenses. For the year 1987 Fred, as vice president of BBPA, the tax matters partner of MIT 86, has filed an amended Form 1065 as a protective administrative adjustment request. Therein he seeks to have the income reported by MIT 86 for the year 1987 reduced to zero, in the event that we determine MIT 86 to be a sham, not entitled to deduct the losses claimed for 1986. 25 The claim is The amount of $585,511 appearing on the note was incorrect and should have been $588,511. The transaction was recorded on the books of MIT 86 and MPC in the amount of $588,511. - 80 pending in docket No. 3462-92. Respondent has agreed that such an adjustment would be appropriate if we so determine. On January 1, 1988, Fred prepared a Termination Agreement to end the obligations of MIT 86 and MPC under the employee leasing agreement. MPC owed $4,266,993.53 to MIT 86 pursuant to the employee leasing agreement. Under the Termination Agreement, MPC offered to pay $3,175,000 to MIT 86 by transferring to MIT 86 the $3,080,000 note made by Qulart to Machise, now held by MPC, with a balance, including accrued interest, of $3,175,000.67. No formal assignment of this amount took place, however. The Termination Agreement also recited that, after MPC assigned the Qulart note to MIT 86, the balance due to MIT 86 would be $1,091,992.86. The Termination Agreement further provided that MIT 86 had agreed to reduce that balance by $14,685.86 and to cancel the 10-percent annual late charge. Fred computed the net amount due to MIT 86, some $1,077,307, so that it would equal the amount that he had projected as the aggregate income to the MIT 86 investors. Additionally, under the Termination Agreement, MIT 86 was required to distribute the Qulart note to its partners. They were to direct MIT 86 to assign that note back to Qulart, the note's maker, in payment of amounts they owed Qulart on their investor notes. ever made. No formal assignment of this note, however, was - 81 Fred signed the Termination Agreement under the heading "Bryen & Bryen, P.A." on behalf of both MIT 86 and MPC. None of the investors in MIT 86 received a return on his or her investment. Fred caused MPC to enter into the Termination Agreement with MIT 86 in 1988 in order to relieve it of its liabilities to MIT 86. Fred caused the partners of MIT 86 to enter into the Termination Agreement with MPC in 1988 so as to minimize their exposure to risk on their notes. On its partnership return for 1988, MIT 86 reported a loss of $14,687; this is the amount that MIT 86 agreed to forgo in exchange for early payment to terminate the employee leasing agreement), plus an accounting fee to BBPA of $1. After the termination, MPC still owed MIT 86 some $1,077,307. Fred recommended that the partnership distribute this $1,077,307 obligation to its partners. The partners were thereafter listed as creditors against the estate in bankruptcy of Anthony S. and Miriam A. Bucci.26 26 While the $1,077,307 allegedly owed by MPC to the investors in MIT 86 was still on the books at the time of the trial herein, Fred conceded that he will probably recommend that the debt be written off as an uncollectible loss by the investors. - 82 W & A Payroll Service On July 1, 1986, Fred and Bruce organized and promoted W & A Payroll Service (W & A) as a general partnership. BBPA prepared a schedule for cash receipts of W & A through March 31, 1988, and a schedule of W & A's cash disbursements through June 30, 1988. BBPA made adjusting journal entries as of January 1, 1987, and January 1, 1988. W & A was in substance similar to the earlier partnerships. There were, however, some notable differences, chiefly the absence of any checks or notes in the partnership's financial transactions. As with the previous partnerships, W & A used the calendar year as its tax year and the cash method of accounting from its inception until December 31, 1987. It also had the same address as BBPA. W & A had a bank account at the First [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3Aa7ba5187a321b2ee. Public record. Not legal advice.