# UNITED STATES TAX COURT

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## Record

- **Collection:** Agency decision
- **Document type:** Agency decision

## Text

T.C. Memo. 2008-124
UNITED STATES TAX COURT

LARRY L. HARTMAN, ET AL.,¹ Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent*

Docket Nos.

1371-85,
4116-87r
16761-87,
29429-88.

48690-86,
15673-87,
18551-88,

diled May 1, 2008.

Ps' cases were part of the Kersting tax shelter
project, which the parties and the Tax Court tried to
resolve by using a test case procedure that resulted in
Dixon v. Commissioner, T.C. Memo. 1991-614 (Dixon II),
vacated and remanded sub nom. DuFresne v. Commissioner,
26 F.3d 105 (9th Cir. 1994), on remand Dixon v.

¹Cases of the following petitioners are consolidated
herewith: Wilbert L. F. and Valarie W. Liu, docket No. 48690-86;
and Jesse M. and Lura L. Lewis, docket Nos. 15673-87, 18551-88,
and 29429-88.
*This opinion reconsiders and supersedes our previously
filed Memorandum Opinion Lewis v. Commissioner, T.C. Memo. 2005205.

SERVED MAY - / 2008

- 2 Commissioner, T.C. Memo. 1999-101 (Dixon III),
supplemented by T.C. Memo. 2000-116 (Dixon IV), revd.
and remanded 316 F.3d 1041, -1047 (9th Cir. 2003) (Dixon
V), on remand T.C. Memo. 2006-90 (Dixon VI),
supplemented by T.C. Memo. 2006-190 (Dixon VIII) (on
appeal).
In Dixon V, the Court of Appeals for the Ninth
Circuit held that the misconduct of M (R's trial
attorney) and S (M's supervising attorney) in arranging
secret settlements with test case petitioners the Ts
and the Cs was a fraud on the Tax Court. The Court of
Appeals observed that the fraud not only violated the
rights of the other test case petitioners and
petitioners in more than 1,300 cases bound by the
outcome of the test cases but also defiled the sanctity
of the Court and the confidence of all future
litigants. The Court of Appeals ordered the Tax Court
to sanction R by entering judgments in favor of the
remaining test case petitioners and other petitioners
in the Kersting tax shelter group before the Court of
Appeals, on terms equivalent to those provided in the
Ts' secret settlement agreement. The Court of Appeals
left the fashioning of such judgments to the discretion
of the Tax Court.
Shortly before the trial of the test cases that
resulted in the Tax Court's opinion in Dixon II, P1
settled his cases on terms more favorable to him than
R's project settlement offer but less favorable to him
than the Ts' settlement, and stipulated decisions were
entered in P1's cases.
After the trial, Dixon II opinion, and entry of
decisions in the test cases, R's management discovered
the misconduct of M and S when M attempted to have R
assess deficiencies in the Ts' and the Cs' cases in
accordance with the secret settlements rather than with
the Court's decisions in those cases.
In motions to
vacate the decisions entered in the cases of the Ts,
the Cs, and a third test case petitioner, R disclosed
to the Court the misconduct of M and S.
R concedes
that stipulated decisions in Kersting project nontest
cases entered after the Court filed its Dixon II
opinion and before R disclosed the misconduct of M and
S to the Court should be vacated.

- 3 While the remaining test cases were on appeal, R
reinstated R's Kersting project settlement offer by
means of an offer letter that contained material
omissions. The offer letter stated:
"Acceptance of
this settlement offer will preclude any further
challenge or appeal with respect to the Kersting
programs or the merits of the Dixon opinion. Any other
issues involved in this case will be resolved
separately." P2s (proceeding pro- sese at the time) and
P3s (represented by counsel) accepted R's offer, and
stipulated decisions were entered in their cases.
Other Kersting project petitioners accepted the
reinstated project settlement offer; as a result,
stipulated decisions were entered in more than 400
cases.
The stipulated decisions entered in Ps' cases were
not appealable and became final many years ago.
Ps now
seek to have their decisions vacated so that the
sanctions mandated by the Court of Appeals in Dixon V
can be imposed on R in their cases. Ps argue that,
because they were bound by the decisions in the test
cases, the fraud committed by M and S in the test cases
necessarily adversely affected their cases.
They ask
this Court to impose on R the same sanctions mandated
by the Court of Appeals in Dixon V for the fraud on the
Court of M and S in the test cases which, they assert,
is imputed to their cases.
In Lewis v. Commissioner, T.C. Memo. 2005-205, we
denied the motions of P3s for leave to file motions to
vacate their stipulated decisions on the grounds they
and their counsel had become aware of the misconduct of
R's attorneys and of the pending appeals by test case
petitioners when they agreed to the decisions.
P3S
filed a motion for reconsideration asking us to
reconsider our Lewis opinion on the ground that their
settlement agreements did not encompass or foreclose
imposing sanctions on R for the fraud M and S committed
on the Court. We granted the motion for
reconsideration, granted the motions for leave filed by
P1, P2s, and P3s, and consolidated the three sets of
cases for purposes of this opinion. Upon
reconsideration, we hold that the law of the case set
forth in Dixon V requires that Ps' motions to vacate
stipulated decisions be granted and that all Kersting
project petitioners whose cases were bound by the test

- 4 -

cases and who suffered entry of stipulated decisions
are entitled to the benefit of the T settlement.
1. Held: The fraud on the Court committed by R's
attorneys in the test case proceedings constituted
fraud on the Court in every case bound by the outcome
of the test cases and harmed the integrity of the
judicial process, not only as the test case procedure
was employed in the Kersting project cases, but also as
it might be employed in the future.
2. Held, further, imposing the sanctions against
R in every case that was part of the Kersting tax
shelter project is the appropriate sanction for the
fraud committed in the test case proceedings because it
serves to remedy the harm done to the judicial process,
restore public confidence in the test case procedure,
and rectify the violation of the rights of every
petitioner bound by the outcome of the test cases.
3.
Held, further, once R discovered the
misconduct of R's attorneys, R had an obligation to
fully disclose the misconduct, not only to the Court
and the test case petitioners, but also to all
petitioners who had been bound by the outcome of the
Kersting project test cases.
4.
Held, further, R's posttrial settlement offer
did not adequately disclose R's attorneys' misconduct
to the offerees and did not remedy or purge the fraud
from the Kersting project cases.
5.
Held, further, P2s' and P3s' requests that
sanctions be imposed on R for the fraud committed on
the Court are not a "challenge or appeal with respect
to the Kersting programs or the merits of the Dixon
opinion" encompassed by R's posttrial settlement offer,
but rather encompass another issue in their cases that
is to "be resolved separately" under the specific terms
of that offer.
6.
Held, further, the posttrial and other
settlements and stipulated decisions entered in the
cases at hand and in other Kersting project cases do
not divest the Tax Court of its inherent power to
impose sanctions against R for the fraud committed on
the Court in those cases.
See, e.g., Bader.v. Itel
Corp. (In re Itel Secs. Litig.), 791 F.2d 672 (9th Cir.

- 5 1986) (party cannot avoid sanctions for committing
fraud on the court by settlement or withdrawing from
the case).
7. Held, further, the Tax Court has inherent
power to impose sanctions against R for the fraud
committed on the Court in every case that was part of
the Kersting tax shelter project and may impose such
sanctions either by vacating the decision in each such
case and entering a new decision or by separate order
imposing an equivalent monetary sanction. In the cases
at hand, we are vacating the decisions.
8. Held, further, once the new decisions in these
cases become final, the Court will issue an
implementation order to allow R reasonable time to
notify all remaining Kersting project petitioners
against whom stipulated decisions were entered and to
adjust their accounts administratively in accordance
with the terms of the Ts' settlement. The Court will
not accept for filing motions for leave to file motions
to vacate the decisions in the cases of other such
Kersting project petitioners unless R fails to adjust
their accounts administratively within 9 months after
the date of entry of the implementation order.

Robert Alan Jònes and Declan J. O'Donnell, for petitioner
Larry L. Hartman in docket Nos. 1371-85, 4116-87, and 16761-87
and for petitioners Jesse M. and Lura L. Lewis in docket Nos.

15673-87, 18551-88, and 29429-88.
Matthew K. Chung, for petitioners Wilbert L. F. and Valarie
W. Liu in docket No. 48690-86.
Henry E. O'Neill, for respondent.

- 6 CONTENTS

Page

Introduction . . . . . . . . . . . . . . . . . . . . . . . , . 8
Background . . . . . . . . . . . . . . . . . . . . . . . . . 14
I.

The Kersting Project Test Case Proceedings

.

.

.

.

15

II.

Respondent's Discovery and Disclosure of the
Thompson and Cravens Settlements . . . . . .

.

.

.

32

III. Kersting's Responses to Dixon II and Discovery and
Disclosure of the Secret Settlements: Letters to
Kersting Program Participants and Formation of the
Kersting Defense Group . . . . . . . . . . . . . .

41

IV.

Respondent's Posttrial Settlement Offer

V.

The Lewis and Liu Settlements .

VI.

Disciplinary Actions Against McWade and Sims

.

.

.

.

.

44

.

.

.

.

.

49

.

.

.

50

VII. Appeals to the Court of Appeals for the Ninth
Circuit and Proceedings on Remand . . . . . . .

.

.

52

.

.

53

A.

.

.

.

.

.

Ninth Circuit Remand: DuFresne v.
Commissioner and Adair v. Commissioner .

.

B.

Evidentiary Hearing and Opinions on DuFresne

Remand: Dixon III and IV . . . . . . . . . .

55

C.

Gridley v. Commissioner

.

62

Remands . . . . . . . . . . . . . . . . . . .

63

D.

Dixon V:

.

.

.

.

.

.

.

.

.

.

Court of Appeals Again Reverses and

E.

Responses to Dixon V by the Office of Chief

Counsel . . . . . . . . . . . . . . . . . . .

66

F.

Determination on Remand of Terms of the
Thompson Settlement by Dixon VI and VIII

.

.

68

.

.

72

Discussion . . . . . . . . . . . . . . . . . . . . . . . . .

74

VIII.

Motions To Vacate

.

.

.

.

.

.

.

.

.

.

.

.

.

I.

Preliminary Comments

.

74

II. Analysis . . . . . . . . . . . . . . . . . . . . .

83

A.

.

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.

.

.

.

.

.

.

.

.

.

.

The Fraud on the Court Committed by
Respondent's Attorneys, the Harm Done
Thereby, and the Sanction Mandated by the
Court of Appeals . . . . . . . . . . . . .

.

.

.

84

B.

Lewis v. Commissioner Reconsidered and

Superseded . . . . . . . . . . . . . . . . . .

94

C.

Subsequent Voluntary Disclosure of the Fraud
on the Court Does Not Purge the Fraud . . . .

99

Respondent's Posttrial Settlement Offer Did
Not Satisfy Respondent's Obligations to the
Nontest Case Petitioners . . . . . . . . . .

.

101

Respondent's Posttrial Settlement Offer Did
Not Rectify the Harm and Does Not Preclude
Additional Sanctions . . . . . . . . . . . .

.

110

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . .
Implementation of Sanction . . . . . . . . . . . . . . . . .
APPENDIX A . . . . . . . . . . . . . . . . . . . . . . . . .
APPENDIX B . . . . . . . . . . . . . .. . . . . . . . . . . .

127
130
134
136

D.

E.

- 8 MEMORANDUM OPINION

BEGHE, Judoe:

These consolidated cases are before the Court

on petitioners' motions under Rule 1622 to vacate stipulated
decisions entered many years ago.

Petitioners' cases are broadly

representative of hundreds of cases in which stipulated decisions
were entered and of dozens of such cases in which motions for

leave to file motions to vacate stipulated decisions have been
filed.

Introduction
Petitioners' motions arise from the misconduct of
respondent's attorneys in implementing the Court's test case
procedure used by the Court in the Kersting tax shelter project

to try and decide Dixon v. Commissioner, T.C. Memo. 1991-614
(Dixon II), vacated and remanded sub nom. DuFresne v.

Commissioner, 26 F.3d 105 (9th Cir. 1994), on remand Dixon v.
Commissioner, T.C. Memo. 1999-101 (Dixon III), supplemented by
T.C. Memo. 2000-116 (Dixon IV), revd. and remanded 316 F.3d 1041
(9th Cir. 2003)

(Dixon V), culminating with our disposition of

the second remand in Dixon v. Commissioner, T.C. Memo. 2006-90
(Dixon VI), supplemented by T.C. Memo. 2006-190 (Dixon VIII).3

We

2Unless otherwise indicated, all Rule references are to the
Tax Court Rules of Practice and Procedure, and all section
references are to the Internal Revenue Code.
3In Dixon v. Commissioner, T.C. Memo. 2006-97 (Dixon VII)
and Youno v. Commissioner, T.C. Memo. 2006-189, we responded to
(continued...)

_ 9 _
have entered decisions in the 27 docketed cases that participated
in the second remand; 13 of those cases are on appeal to the
Court of Appeals for the Ninth Circuit,4 where, we assume, they
will be considered by the panel that decided Dixon V.S
In Dixon V, the Court of Appeals held that the misconduct of
respondent's trial attorney and his supervisor was a fraud on the
Court that violated the rights of all Kersting project
petitioners who had agreed to be bound by the outcome of the Tax
Court proceeding.

The Court of Appeals ordered this Court to

sanction respondent by entering decisions in the cases of the
remaining test case petitioners and other Kersting project

3(...continued)
the supplemental mandate of the Court of Appeals for the Ninth
Circuit in Dixon v. Commissioner, 316 F.3d 1041 (9th Cir. 2003)
(Dixon V), revg. T.C. Memo. 1999-101 (Dixon III), to determine
the appellate legal fees to which Kersting project petitioners
and their counsel in Dixon V were entitled. We have currently
under consideration motions by various Kersting project taxpayers
and their counsel for awards of fees and expenses for services
rendered in the Dixon V remand proceedings in this Court.
40n July 6, 2007, Kersting project petitioners filed a
notice of appeal in Hongsermeier v. Commissioner, docket No.
29643-86, a test case. On Sept. 10, 2007, Kersting project
petitioners filed notices of appeal in Rogers v. Commissioner,
docket No. 17993-95, Huber v. Commissioner, docket No. 20119-84
and Titcomb v. Commissioner, docket No. 17992-95, all nontest
cases. On Sept. 17, 2007, Kersting project petitioners filed
notices of appeal in test cases Young v. Commissioner, docket
Nos. 4201-84, 22783-85, and 30010-85, and Owens v. Commissioner,
docket No. 40159-84, and in nontest cases Adair v. Commissioner,
docket Nos. 17642-83, 38965-84, 35608-86, 479-89, and 8070-90.
5The separate mandate of the Dixon V panel on appellate
legal fees concluded:
"The panel retains jurisdiction over all
further proceedings that may arise."

- 10 petitioners before the Court of Appeals on terms equivalent to
those provided in the secret Thompson settlement.
Petitioners signed stipulations to be bound (piggyback
agreements) in which they agreed with respondent that their cases
would be resolved in accordance with the Court's opinion in the
test cases.6

Before the test cases were tried, respondent's trial

attorney and his supervisor had entered into secret settlements
with test case petitioners John R. and Maydee Thompson (the
Thompsons) and John R. and E. Maria Cravens (the Cravenses).
Also, before the test cases were tried, petitioner Larry L.
Hartman (Hartman) settled his cases with respondent, and
stipulated decisions were entered in his cases in January 1989.
After the Court had issued its opinion in Dixon II and

entered decisions in the test cases, respondent's management
6Although no piggyback agreement signed by petitioner Larry
L. Hartman (Hartman) was filed in docket No. 16761-87, that case
was not set to be tried with the test cases, and he was
effectively bound by the results in the test cases in docket No.
16761-87, as well as in docket Nos. 1371-85 and 4116-87, in which
he had signed piggyback agreements that were filed with the
Court. Normally, petitioners in a tax shelter project who
decline or otherwise fail to sign a piggyback agreement will
either have their cases set for trial with the test cases or,
after the final decisions in the test cases, will be ordered to
show cause why their case should not be decided the same way as
the test cases.
See, e.g., Lombardo v. Commissioner, 99 T.C.
342, 343 (1992), affd. on other grounds sub nom. Davies v.
Commissioner, 68 F.3d 1129 (9th Cir. 1995); Dixon VII; Dixon v.
Commissioner, T.C. Memo. 2000-116 (Dixon IV).
In Dixon v.
Commissioner, T.C. Memo. 2006-90 (Dixon VI), we held that
Kersting project petitioners who did not sign piggyback
agreements were entitled to the same relief as those who had
signed piggyback agreements.
Dixon VI, 91 T.C.M. (CCH) 1086 at
1107, 2006 T.C.M. (RIA) par. 2006-090 at 2006-671.

- 11 discovered the secret settlements and disclosed them to the
Court.

Following that disclosure, respondent reinstated

respondent's project settlement offer, which respondent had
previously terminated before the trial that resulted in the
Court's opinion in Dixon II.

Petitioners Jesse M. and Lura L.

Lewis (the Lewises), through their counsel, and petitioners
Wilbert L. F. and Valarie W. Liu (the Lius), proceeding pro sese,
accepted respondent's posttrial settlement offer, and stipulated
decisions were entered in their cases in March and June 1993,
respectively.

The decisions in all of petitioners' cases herein

were entered, and their cases were closed, before the Court of
Appeals for the Ninth Circuit issued its opinion in DuFresne v.
Commissioner, supra, vacating and remanding Dixon II for an
evidentiary hearing to determine the full extent of respondent's
misconduct and its effect on the decisions in the remaining test
cases under Dixon II, which we did in our opinions in Dixon III
and IV.

After the opinion of the Court of Appeals in Dixon V,
reversing and remanding Dixon III and IV for entry of decisions
in the remaining test cases in accordance with Dixon V,
petitioners herein at various times in 2004 filed motions for
leave to vacate the stipulated decisions entered by this Court in

their cases.

- 12 Petitioners assert that the fraud on the Court perpetrated
by respondent's trial attorney and his supervisor in the test
cases was a fraud on the Court in their cases because they were
bound by the outcome of the test case proceedings.

Petitioners

ask the Court to vacate the decisions in their cases so that the
Court can impose on respondent in their cases the same sanctions
mandated by the Court of Appeals in Dixon V for
the fraud on the Court in the test cases as they apply to more
than 1,300 pending cases in the Kersting project that did not

settle.7
In Lewis v. Commissioner, T.C. Memo. 2005-205, we denied the
Lewises' motions for leave to file motions to vacate their
stipulated decisions on the grounds that they and. their counsel
had become aware of the misconduct of respondent's attorneys and
of the pending appeals by test case petitioners when they

stipulated the decisions.
The Lewises filed motions for reconsideration, which we
granted.

We also granted the motions for leave in the Lewis,

Hartman, and Liu casess in order to consolidate them for purposes

7As of Mar. 13, 2008, 1,173 Kersting project cases remained
on the Court's inventory of docketed cases in which decisions
have never been entered.
The number of cases referred to in the
text has been reduced by decisions that have been entered after
and in accordance with our opinions in Dixon VI and VIII on the
terms of the Thompson settlement.
See infra note 33.
8In so doing, we departed from our usual practice--which we
had followed in our Lewis opinion--of considering the merits of
(continued...)

- 13 of this opinion because they are all appealable to the Court of
Appeals for the Ninth Circuit.

We also chose to consolidate

these cases because they include cases where stipulated decisions
were entered both before the Court filed its Dixon II opinion
(the Hartman decisions) and after respondent discovered
respondent's attorneys' misconduct and disclosed it to the Court
and reinstated the 7-percent project settlement offer (the Lewis
and Liu decisions).
For purposes of these motions, we take judicial notice of
our findings in Dixon III and IV, as modified by Dixon V, VI, and
VIII (the Dixon findings) and supplemented by Lewis v.
Commissioner, supra.

Additional facts concerning earlier drafts

of respondent's posttrial settlement offer are from copies of the
drafts of the proposed settlement offer admitted into the records
in these cases as the Court's exhibits.

Otherwise, additional

pertinent facts, as set forth in petitioners' motions,
respondent's oppositions thereto, and the parties' replies to

8(...continued)
the underlying (lodged) motion to vacate decision in order to
determine whether the moving party had alleged sufficient facts
to call into question the validity of the decision. See
Brannon's of Shawnee, Inc. v. Commissioner, 69 T.C. 999, 1002
(1978); see also Kenner v. Commissioner, 387 F.2d 689, 690-691
(7th Cir. 1968); Toscano v. Commissioner, 52 T.C. 295, 296
(1969), vacated on another issue 441 F.2d 930 (9th Cir. 1971);
Campbell v. Commissioner, T.C. Memo. 1988-103.
In the cases at
hand, we granted petitioners' motions for leave in orders filed
in June 2006 (Lius and Lewises) and October 2006 (Hartman),
leaving for further proceedings our determination in this opinion
whether the decisions can and should be vacated.

- 14 -

orders of the Court raising questions addressed to the parties,
are undisputed.9
We believe that all the pending motions may be decided
without a hearing.¹°

On reflection and reconsideration, we now

decide that the motions to vacate filed by the Lewises should be
granted; we also hold that the motions to vacate filed by Hartman

and the Lius should be granted.

We conclude this opinion by

describing the procedure for implementing our determination that
all Kersting project petitioners against whom stipulated
decisions were entered on or after June 10, 1985, are entitled to
the benefits of the Thompson settlement.

Giving effect to these

decisions and that procedure will result in imposing on

respondent in all Kersting project cases the sanctions mandated
by the Court of Appeals in Dixon V.
Backcround

When the petitions in these cases were filed, Hartman
resided in Everett, Washington, the Lewises resided in Westlake
Village, California, and the Lius resided in Aiea, Hawaii.

9Decisions in these consolidated cases are appealable to the
Court of Appeals for the Ninth Circuit. Motions similar to those
under consideration herein have been filed and lodged by other
taxpayers whose decisions are appealable to Courts of Appeals for
other circuits.
¹°Respondent agrees that the Court has before it the records
that produced the Dixon findings and "strenuously opposes" the
scheduling of an evidentiary hearing.

- 15 I.

The Kersting 'Project Test Case Proceedings
In response to the large volume of cases generated by tax

shelter examinations during the late 1970s and early 1980s, the
Internal Revenue Service (IRS) and the Tax Court developed
procedures that were intended to streamline the litigation
process, economize on the use of administrative and judicial
resources, and reduce the costs incurred by taxpayers in
resolving disputes over tax shelter adjustments.
of Chief Counsel, in Washington, D.C.

The IRS, Office

(the National Office),

created the Tax Shelter Branch in the National Office to oversee
tax shelter litigation across the country and to organize and
supervise individual tax shelter projects.
One of the goals of the Tax Shelter Branch was consistent
treatment of similarly situated taxpayers.

The Tax Shelter

Branch monitored settlement offers in similar tax shelter

projects for disparities and tried to determine whether the
project settlement offers should be similar.

However, actual

supervisory responsibility in a tax shelter project was left
primarily in the Regional Counsel's office and the District

Counsel's offices to which the project was assigned.
The deficiencies, additions to tax, and.interest at issue in
the Dixon II test case proceedings arose from petitioners'
participation in tax shelter programs promoted by Henry F.K.
Kersting (Kersting) that purported to generate interest

- 16 deductions for income tax purposes that exceeded amounts paid to
participate in the programs.

Kersting's promotions of his tax

shelter programs attracted the attention of the IRS, which
instituted a tax shelter project known as the Kersting project.
Kersting actively opposed respondent's enforcement activities
against his programs.

In early 1982 Attorney Brian J. Seery

(Seery) began assisting Kersting program participants with issues
arising from audits of their income tax returns.

On March 1,

1985, Kersting sent letters informing Kersting program
participants that he had retained Seery to represent them in the
Tax Court at no charge to them.

Ultimately, more than 1,800

cases arising from taxpayers' petitions against respondent's
deficiency notices disallowing deductions claimed by participants
in the Kersting programs were filed in the Tax Court.

The bulk

of those deficiency notices were facilitated by respondent's
having obtained Kersting's client records in a search.of his
office in Honolulu, Hawaii, in January 1981.
The IRS established the Kersting project in its Honolulu
Appeals Office.

In any given tax shelter project, a project

Appeals officer typically works with a project attorney in the
District Counsel's office.
McWade

In the Kersting project, Kenneth W.

(McWade), in the Honolulu District Counsel's office, was

the project attorney.

- 17 On March 20, 1985, Seery entered his appearance for hundreds
of Kersting project taxpayers.

The Court set for trial the cases

of approximately 375 Kersting program participants to be held
before Judge William A. Goffe (Judge Goffe) at a Tax Court
session scheduled to commence on June 10, 1985, in Honolulu,
Hawaii (the June 1985 session).
It would have been a daunting task to try the cases of the
hundreds of similarly situated Kersting program participants who
had filed petitions in the Tax Court.

Before the June .1985

session, McWade and Seery agreed to use the test case procedure
whereby a few typical cases are selected and most taxpayers whose
cases are not selected execute "piggyback agreements" binding the
resolution of their cases to the outcome of the final decisions
in the test cases.

During the June 1985 session, McWade and

Seery discussed the use of the test case procedure with Judge
Goffe during a chambers conference.

Consistent with counsels'

agreement to use the test case procedure in the Kersting project,
Judge Goffe granted the parties' joint motions to continue the

cases called at the June 1985 session.

At the same time, as

early as June 1985, Kersting project petitioners began filing
piggyback agreements, which they did in most of the Kersting

project cases.
On November 21,

1985, the Chief Judge of this Court assigned

all the Kersting project cases to Judge Goffe for trial or other

- 18 disposition.

Subsequent Kersting project cases were

automatically assigned to Judge Goffe.
By letter dated June 10, 1986, McWade notified Judge Goffe
that he and Seery had selected the cases of one individual, Ralph
J. Rina (Rina), and seven couples, including the Thompsons, the
Cravenses, and Jerry and Patricia A. Dixon (the Dixons), to be
test cases.

By letter dated July 30, 1986, Judge Goffe informed

Seery and McWade that the test cases would be set for trial
during a special session of the Court commencing on February 9,

1987, in Wailuku, Maui, Hawaii (the Maui session).

Judge Goffe's

letter also informed Seery and McWade that he intended to notify
each Kersting project petitioner who had not filed a piggyback
agreement that his or her case would be set for trial during the
Maui session.
By letter dated August 5, 1986, Judge Goffe informed all
Kersting project petitioners who had not already executed

piggyback agreements that their cases would be set for trial at
the Maui session unless .they executed piggyback agreements by
September 29,

1986.

Judge Goffe's letter stated as follows:

August 5, 1986
Dkt #

Dear

:

Your case involves matters concerning promotions by
Henry Kersting.
Cases with issues identical to the
issues in your case have been set for trial on February
9, 1987, at the courtroom of the Circuit.Court for the
Second Circuit in Wailuku, Maui, Hawaii.

- 19 In order to conserve the time and expense of the
taxpayers, the government and the Court, all of the
cases with identical issues will be tried at one time
unless the parties agree in advance, in writing, to be
bound by the outcome of the cases set for trial.
In
most of the pending cases, the parties have so agreed
to be bound.
You should contact at your earliest convenience the
lawyer for the government in the Kersting cases if you
decide to agree to be bound. He is Mr. Kenneth McWade,
PJKK Federal Building, Room 3304, Box 50089, 300 Ala
Moana Boulevard, Honolulu, Hawaii 96850. His telephone
number is (808) 546-7333.
If, however, you do not wish
to be bound, you should advise my office promptly, in
writing at the above address, in order that your case
may be set for trial on February 9, 1987.
In either
event, you must advise Mr. McWade or me by September
29, 1986.
If you fail to advise Mr. McWade by September 29, 1986,
that you wish to be bound and have executed a
stipulation to be bound by that time and if you fail to
advise me by September 29, 1986, that you wish to have
your case set for trial, it will automatically be set
for trial on February 9, 1987.
If your case is set for
trial and you do not appear for trial, your case will
likely be dismissed and you will be required to pay all
of the income tax which the government contends you
owe, plus interest thereon as provided by law.
William A. Goffe
Judge

In November 1986 the Court issued orders notifying Kersting
project petitioners who had not filed piggyback agreements that

their cases were set for trial at the Maui session.

As

additional Kersting project cases were docketed and identified,
the Court issued orders setting them for trial at the Maui
session, subject to being stricken if the parties executed a
piggyback agreement.

- 20 An attorney hired by the Thompsons to prepare an estate plan
for them raised questions with Seery about his association with
Kersting.

On October 31, 1986, Seery filed a motion to withdraw

as counsel for the Thompsons in their docketed cases, which the
Court granted.

In November 1986 the Thompsons engaged Luis

DeCastro (DeCastro) to represent them before this Court.

In December 1986, following similar questions by the Court,
Seery withdrew as counsel for the other test case petitioners and
all the Kersting project nontest case petitioners for whom he had
filed notices of appearance.

In early January 1987, Kersting

engaged Attorneys Robert J. Chicoine (Chicoine) and Darrell D.
Hallett (Hallett) to represent the test case petitioners (with
the understanding they would not represent Kersting).

Chicoine

and Hallett filed entries of appearance as counsel in each of the
test cases (other than the Thompson and Cravens cases) and
promptly challenged the deficiency notices in the test cases on
the ground that the IRS search of Kersting's office in January
1981 had been illegal.
Between 1982 and 1988 respondent had in effect an official
settlement offer for the Kersting project.

In general, the

project settlement offer permitted participants in the Kersting
programs to resolve their cases by agreeing to pay deficiencies
that averaged 7 percent less than those determined in their
deficiency notices.

The project settlement offer also released

- 21 participants from negligence additions and increased interest.
Respondent's purpose in offering these concessions and
adjustments was to provide similar treatment for all Kersting
program participants who wished to settle their cases.
Respondent's 7-percent reduction project settlement offer in
the Kersting project was similar to the IRS project settlement
offer in other tax shelter projects.

The 7-percent reduction in

the deficiencies reflected allowance of an assumed deduction for
the taxpayers' out-of-pocket expenses of participating in the
shelter.¹¹

Although District Counsel generally is expected to adhere to
the terms of an official project settlement offer, once a tax
shelter project·is assigned to a particular District Counsel's
office, that office has the authority to settle any individual
case in the project.

District Counsel has the authority in

special circumstances to settle individual tax shelter project

cases on a basis different from the project settlement offer.
By September 1986 McWade and Seery had agreed to modify the
7-percent reduction project settlement offer to incorporate a new
feature, called the burnout, that would apply in cases involving

¹¹The 7-percent reduction in the deficiencies amounted to a
"nuisance value" settlement that respondent would not have
entertained or offered in a run-of-the-mill case.
See IRM sec.
8.6.1.3.3 (Feb. 18, 1999). Nuisance value is any concession that
is made solely to eliminate the inconvenience or cost of further
negotiations or litigation and is unrelated to the merits of the
issues.

- 22 more than 1 taxable year.

Under the burnout, the interest on a

taxpayer's total unpaid Kersting-related deficiencies for the
first and second years of tax liability would not begin to accrue
until the return due date for the second year.

This was

accomplished by zeroing out the taxpayer's agreed deficiency for
the first year and adding it to the agreed deficiency for the
second year.

The burnout thus postponed for a year the accrual

of interest on the first year's deficiency, thereby reducing the

total interest accrued on the taxpayer's Kersting-related
deficiencies.
In December 1986 McWade, with the knowledge and connivance
of his supervisor, Honolulu District Counsel William A. Sims
(Sims), entered into secret contingent settlement agreements with
the Cravenses regarding their test c.ases and with DeCastro

regarding the Thompsons' test cases.

The Thompsons.and the

Cravenses understood that a condition of these settlements was
that they would remain test case petitioners.
The Cravenses, who were not represented by counsel, agreed
with McWade to a reduction of about 6 percent of the originally

determined deficiencies for their taxable years 1979 and 1980.¹²
¹²In the Cravens notices of deficiency, respondent had
determined that the Cravenses were liable for deficiencies for
1979 and 1980 of $4,508 and $19,251.70, respectively, and
additions to tax for negligence under sec. 6653(a) for both
years.
The deficiencies and negligence additions so determined
were attributable, to the Cravenses' participation in Kersting tax
shelter programs.
The Cravenses' correct tax liabilities for
(continued...)

- 23 This settlement was less favorable to them than the generally
available modified 7-percent reduction settlement offer and did
not include the burnout.
The initial Thompson settlement in December 1986 reduced the
Thompsons' total deficiencies by 18.8 percent,¹³ eliminated the
additions to tax for all years,. and eliminated the increased
interest rate under section 6621(d)" for 1981.

The initial

Thompson settlement also incorporated the burnout, combining the
agreed deficiencies for the years 1979 and 1980 in the year 1980
so as to postpone for 1 year the accrual of interest on the
agreed 1979 deficiency.

On December 23, 1986, McWade sent

¹²(...continued)
1979 and 1980 were $4,508 and $5,893.45, respectively, for a
total of $10,401.45. The $5,893.45 figure for 1980 represents
the Cravenses' correct tax liability after eliminating the
dividend adjustment set forth in the notice of deficiency for
1980 and backing out the tax on the capital gain that the
Cravenses had reported on .their 1980 tax return.
Decisions
entered in the Cravens cases provided that the Cravenses were
liable for deficiencies of $3,606.40 for 1979 and $6,175.76 for
1980, totaling $9,782.16.
¹³In the Thompson notice of deficiency, respondent had
determined that the Thompsons were liable for deficiencies
totaling $79,293 for the taxable years 1979-81, for additions to
tax for negligence for 1979 and 1981, for increased interest for
1981 pursuant to sec. 6621(d), and for a late filing addition to
tax for 1981 under sec. 6651(a). The deficiencies, negligence
additions, and increased interest were attributable to the
Thompsons' participation in Kersting tax shelter programs.
"Sec. 6621(d) was redesignated sec. 6621(c) by the Tax
Reform Act of 1986 (TRA), Pub. L. 99-514, sec. 1511(c)(1), 100
Stat. 2744, and repealed by the Omnibus Budget Reconciliation Act
of 1989, Pub. L. 101-239, sec. 7721(b), 103 Stat. 2399. We will
hereinafter refer to the provision as sec. 6621(c).

- 24 -

DeCastro decision documents incorporating the above-described
settlement.

McWade's transmittal letter stated that the decision

documents in the Thompsons' cases would not be filed with the
Court until the decisions in the test cases had become final.

Around yearend 1986 the Thompsons paid $59,545 as interest
on their then-agreed deficiencies.

In March 1987 respondent and

DeCastro agreed to a revision of the initial settlement that
effectively increased the reduction in the Thompsons'
deficiencies to approximately 20 percent.

On June 15, 1987, the

Thompsons halted further accrual of interest on the deficiencies

by paying the then total amount owed of $63,000.

By June 1987

payments by the Thompsons to the IRS with respect to the taxable
years 1979-81

(less a $770 offset credited to another year)

totaled $121,770.
Between September and December 1986 McWade and Sims began to

entertain 20-percent settlements based on the same general
approach as the modified 7-percent settlement offer that included
the burnout.

In late 1986 DeCastro obtained 20-percent reduction

settlements on behalf of other Kersting project nontest case
petitioners he represented, as did Chicoine and Hallett on behalf

of other nontest case petitioners in the course of efforts to
negotiate a global project settlement.
The enhanced 20-percent settlements reflected the concerns
of McNade and Sims that Chicoine's and Hallett's challenge of the

- 25 IRS search of Kersting's office increased respondent's risks of
litigation.

The availability of the 20-percent settlements was

not disseminated in writing by either Sims or McWade.

The

availability of 20-percent settlements became known, if at all,
through a combination of Kersting's letters to program
participants and telephone inquiries to McWade from Kersting
program participants or their counsel.
In January 1987 Sims and Chicoine continued their efforts to
negotiate a global settlement of the Kersting project cases.
Iñitially, they tried to link a higher percentage settlement to
Kersting's agreement to quit the tax shelter business.

They

eventually abandoned their efforts to link a global settlement to
Kersting's future conduct.
By letter dated January 16, 1987,. Chicoine notified Kersting
that he believed he had an agreement with Sims to settle all the
Kersting cases docketed in the Tax Court by allowing 50 percent
of the claimed interest deductions.

In that letter, Chicoine

further stated that he and Hallett would agree to represent
Kersting program participants desiring to settle their cases on
these terms for a flat fee of $550 per case.

On January 19, 1987, Kersting wrote to program participants
that a 50-percent settlement had been negotiated and recommended

that they accept it.

As a result of Kersting's letter,

- 26 approximately 300 Kersting program participants contacted
Chicoine and Hallett seeking representation.
Following the release of Kersting's January 19, 1987,
letter, Sims received numerous telephone calls from Kersting
program participants and attorneys seeking to accept the
50-percent settlement.

By letter to Chicoine dated February 4,

1987, Sims denied that he had agreed to a 50-percent settlement.
During spring 1987 Chicoine continued to discuss a global
settlement with McWade.

On or about April 27, 1987, Chicoine

told Kersting he would recommend a 20-percent settlement to
Kersting program participants.

Between.May 1987 and February

1988 Kersting wrote at least seven letters to Chicoine and
Hallett strongly objecting to their dissemination of a 20-percent
settlement proposal to Kersting program participants.

On January

12, 1988, Kersting issued a letter encouraging nontest case
Kersting program participants who had paid $550 to Chicoine and
Hallett for representation in the settlement process to "recall
your funds".

On February 8, 1988, Kersting wrote to Kersting program
participants warning them that Chicoine and Hallett soon would
circulate the details of a 20-percent settlement.

Kersting urged

Kersting program participants not to hire Chicoine and Hallett to
settle their cases and instead to await the Court's opinion on
the legality of the search (the issue that had been raised and

- 27 presented by Chicoine and Hallett).

During this period, Kersting

threatened to sue Chicoine and Hallett if they reported the 20percent settlement offer to the Kersting program participants.
On February 9, 1988, Chicoine sent letters to Kersting
program participants who had contacted Chicoine and Hallett
about representation.

Chicoine reported that McWade had offered

to settle docketed Tax Court cases in accordance with the
20-percent settlement offer, recommended that program
participants seriously consider that settlement, and suggested
that those who desired to settle on those terms contact Chicoine

and Hallett.
On February 11, 1988, the Court filed Dixon v. Commissioner,
90 T.C. 237

(1988)

(Dixon I), holding that the test case

petitioners had failed to establish standing to contest the IRS
search of Kersting's office.
Kersting was displeased by Chicoine's and Hallett's

proposed overall disposition of the Kersting project cases with
only a 20-percent reduction in the deficiencies.

He fired

Chicoine and.Hallett and engaged Attorney Joe Alfred Izen, Jr.

(Izen), to represent the test case petitioners at trial.
In April 1988 Chicoine and Hallett informed their test case
petitioner clients that they were withdrawing as their counsel
because of a disagreement with Kersting.

Chicoine and Hallett,

however, continued to negotiate settlements for nontest case

- 28 petitioners, including Hartman.

By letter dated June 9, 1988,

Chicoine and Hallett informed McWade that Hartman wished to
accept the 20-percent settlement with the burnout.

McWade sent

Chicoine stipulated decisions for Hartman's cases.

Chicoine

executed the decision documents on Hartman's behalf and returned
them to McWade on November 30, 1988.
decisions on December 12, 1988.

McWade executed the

On January 13, 1989, the Court

entered the stipulated decisions in Hartman's cases at docket
Nos. 1371-85, 4116-87, and 16761-87.
In the meantime, DeCastro told McWade the Thompsons were
concerned about the legal fees they would incur as test case
petitioners.

DeCastro told McWade that it was unfair to require

the Thompsons to remain test case petitioners and that he would
attempt to remove the Thompsons' cases from the list of test
cases.

McWade wanted to keep the Thompsons as test case

petitioners.

DeCastro and McWade resolved their differences by

further modifying the Thompson settlement.

In particular, McWade

agreed to reduce the Thompsons' deficiencies by an additional
amount that would compensate them for the cost of having an

attorney represent them at the trial of the test cases.
Shortly before trial of the test cases in this Court, McWade
and DeCastro reached an oral agreement

(the final·Thompson

agreement) in the Thompsons' cases calling for reduction of the
agreed deficiencies for 1979, 1980, and 1981 to zero, $15,000,

- 29 and $15,000, respectively.

The purpose of the final Thompson

agreement was to generate a refund, estimated to exceed $60,000,
that was to be used--and the bulk of which was used--to pay
DeCastro's fees for providing the appearance of independent
representation of the Thompsons at the trial of the test cases.
Although McWade knew that IRS policy required him to treat

similarly situated taxpayers alike, the financial terms of
McWade's final settlement with DeCastro for the Thompsons were
much more advantageous to them than McWade's settlements with
other Kersting project petitioners."
After the trial of the test cases, John R. Thompson
(Thompson) expressed concern to DeCastro about incurring
DeCastro's additional fees.

DeCastro assured Thompson that

DeCastro was looking solely to the IRS for payment of his fees
and that the Thompsons would not be liable for any additional
fees.

On August 3, 1989, DeCastro wrote a letter to McWade,

reducing the final Thompson agreement to writing.

McWade signed

the letter and returned it to DeCastro.
Sims, McWade, and DeCastro did not inform the Court, the

National Office, the Regional Office, or counsel for the other
test case petitioners or any of the other Kersting project
petitioners or their counsel of the Thompson settlement or.the

"With the exception of Denis Alexander, a nontest case
petitioner with whom McWade made a special deal. See infra p.
30.

- 30 Cravens settlement.

McWade's deception continued with a coverup,

which was carefully designed to prevent the Court and other
Kersting participants from learning of the secret settlement
agreements.

At Kersting's deposition, which McWade attended,

Kersting's lawyer objected to the presence of the Thompsons'

attorney because of rumors that the Thompsons were attempting to
settle.

Although McWade knew that the Thompsons had, in fact,

already settled, he remained silent.

McWade then misled the

Court by failing to disclose the settlement on April 22, 1988,
when he moved to set aside the Thompson piggyback agreements, a

necessary pretrial motion that confirmed the inclusion of the
Thompson cases among the test cases.
Before the trial of the test cases, McWade arrived at a
general understanding with nontest case petitioner Denis
Alexander (Alexander) that the Alexanders' tax liabilities for
the taxable years 1974-77 would be reduced in exchange for

Alexander's testimony and agreement to serve as an undisclosed
consultant or assistant to McWade during the trial of the test
cases.

McWade's understanding with Alexander is reflected in

decision documents, executed by McWade on April 6, 1989, and
approved by Sims, that completely eliminated all Kersting and
other deficiencies determined against the Alexanders for those
years.

- 31 On January 10, 1989, the test cases were consolidated for
trial and opinion.

The trial of the test cases was conducted

from January 9 to 27, 1989, at Honolulu, .Hawaii, with DeCastro
representing the Thompsons and Izen representing all the other
test case petitioners except the Cravenses, who were pro sese.
McWade's deceptive silence matured into overt misconduct during
the trial of the test cases; when Thompson began to testify about
having settled his cases, McWade quickly interjécted questions
about unrelated matters.

The diversion was successful; the Court

mistakenly interpreted Thompson's remark as referring to
resolution of the Thompsons' tax liability for another year that
was not at issue.

McWade also allowed Alexander to offer

misleading testimony that prevented the Court from learning that

McWade had agreed to zero out the Alexanders' tax liabilities.
On December 11, 1991, the Court issued its opinion in Dixon
II, sustaining almost all of respondent's determinations that the
Kersting programs in issue were ineffective for tax purposes.
In March 1992 the Court entered decisions in all the test
cases in accordance with its opinion in favor of respondent.
Consequently, the decisions initially entered in the Thompson and

Cravens cases. were not in accordance with their secret settlement
agreements.

Izen appealed the decisions against the test case

- 32 petitioners (with the exception of the Thompsons, the Cravenses,
and Rina) to the Court of Appeals for the Ninth Circuit.
II.

Respondent's Discovery and Disclosure of the Thompson and
Cravens Settlements

On May 8, 1992, after this Court had entered decisions in
favor of respondent in all the test cases, McWade and Sims, by
memorandum, requested the San Francisco Appeals Office to process
the Thompsons' account administratively in accordance with the

Thompson settlement, not the Tax Court's decisions.

On May 22,

1992, Danny Cantalupo, Regional Director of Appeals for the
Western Region, informed Peter D. Bakutes (Bakutes), Deputy
Regional Counsel for Tax Litigation for the Western Region in San
Francisco, of McWade's and Sims's request to process the Thompson

settlement.

Bakutes informed Benjamin Sanchez (Sanchez), Western

Regional Counsel in San Francisco, who informed officials in the
National Office.

The circumstances of the Thompson settlement

caused widespread concern within the IRS.

On May 29, 1992, Sims, at the direction of Sanchez, informed
DeCastro by letter that the Thompson settlement would not be

honored, and that assessments would be made in accordance with
the decisions entered on March 13, 1992, pursuant to Dixon II.
The letter advised that assessment of the taxes owing, plus

statutory additions and interest, would be "approximately
$302,396.12".

The letter further noted:

"Of course, your

- 33 clients' advance payments will be credited toward the
assessments."
DeCastro had several telephone conversations with
respondent's officials, in which he maintained that the Thompson
settlement, as memorialized in the August 3, 1989, letter
agreement, was an enforceable contract, and that he would appeal
any decision to the contrary.
Soon after Sanchez and Bakutes discovered the Thompson
settlement, McWade and Sims disclosed the Cravens settlement to
them.

Sanchez promptly notified David Jordan (Jordan), Acting

Chief Counsel, about the Thompson settlement.

Sanchez and Jordan

agreed that the Tax Court had to be notified immediately.
Bakutes prepared a motion that was filed in this Court on
June 9, 1992, seeking leave to vacate the decisions entered in
the Thompson, Cravens, and Rina test cases, which had not become
final and had not been appealed.

Unlike the Thompsons and the

Cravenses, Rina had not entered into a settlement agreement with
McWade and Sims, and the decision that had been entered in his
case was in accordance with Dixon II.

In the motion, respondent

acknowledged that the existence of the secret agreements and "the
failure to divulge same to the Court and the other Test Case
petitioners prior to the trial raises questions which should be
addressed by the Court and the parties after a full hearing
before the Court."

Respondent requested the Court to conduct an

- 34 evidentiary hearing to determine whether the agreements with the
Cravenses and the Thompsons had affected the trial of the test
cases or the ensuing decisions of the Court.
On or about June 11, 1992, Sanchez decided that McWade and
Sims should no longer have any authority over the Kersting
project and that all Kersting project cases should be assigned to
other attorneys who were familiar with the Kersting project.
Bakutes accordingly reassigned the 14 test case dockets to Thomas
A. Dombrowski (Dombrowski) and the nontest cases to Henry E.

O'Neill (O'Neill).
On June 22, 19.92, the Court granted respondent's motions to
vacate in the Thompson and the Cravens cases.

The Court ordered

the parties within 30 days to file agreed decisions or otherwise

move as appropriate.

The Court denied respondent's request for

an evidentiary hearing.

In a separate order entered on the same

date, the Court denied respondent's motion to vacate the decision
in the Rina test case, stating:
The Court has reviewed the testimony of Cravens, the
testimony of Thompson, the stipulated facts and
stipulated exhibits relating to the Cravenses and the
Thompsons, and the exhibits offered through Thompson as
a witness.
The Court finds that these reviewed items
had no material effect on the opinion which the Court
filed on December ll, 1991, as that opinion relates to
petitioner Rina.
If the reviewed items were stricken
from the record, the Court would file an opinion in all
material respects like the opinion it filed on December
11, 1991 (with the exception of certain portions
relating specifically and expressly to the Cravenses or
the Thompsons), and the Court's findings, analyses, and

- 35 conclusions relating to petitioner Rina would remain
the same. * * *
The Court's order denying respondent's motion to vacate the
decision in the Rina case was consistent with this Court's

holding in Chao v. Commissioner, 92 T.C. 1141 (1989), that the
Court will not vacate a decision if a new trial would not result
in a different decision.

Rina appealed his decision to the Court

of Appeals for the Ninth Circuit, where appeals in the other
Kersting project test cases were pending.
The same day the Court acted on respondent's motions to
vacate, Bakutes telephoned DeCastro to tell him that the
decisions in the Thompson cases had been vacated.

During the

call, DeCastro told Bakutes that in 1988 McWade had reduced the

Thompsons' deficiencies to keep the Thompsons in the test case
trial.

Although DeCastro had earlier told Bakutes that

attorney's fees had not figured in the settlement, he admitted in
this conversation that the deficiencies had been reduced to pay
the Thompsons'

legal fees for his representation of them in the

test case trial.

During the summer of 1992, Jordan directed two senior
attorneys in the Tax Litigation Division in the National Office,
Thomas J. Kane (Kane) and Steven M. Miller (Miller), to
investigate the Thompson settlement on behalf of the National
Office.

Kane and Miller conducted in-house depositions and

- 36 interviewed various individuals who had participated in the test
case trial and the Thompson settlement.
Bakutes assigned Dombrowski to help Kane and Miller in their
investigation.

Dombrowski's immediate problem was how to respond

to this Court's order of June 22, 1992, that within 30 days the
parties file agreed decisions or otherwise move.
On June 24, 1992, Marlene Gross (Gross), an official in the
National Office, called Bakutes and informed him that the
Department of Justice (DOJ) would not seek remand of the test
cases that had been appealed.

The DOJ's decision was based on

the Tax Court's refusal to vacate the decision in the Rina case.
That refusal indicated to the DOJ officials that the Tax Court
would probably reject any request by respondent to vacate the
Court's decisions in the other test cases.

Gross also reported

to Bakutes that the DOJ, specifically the Tax Division's
Appellate Section Chief Gary Allen, wished to offer the same

settlement to the test case petitioners on appeal that the
Thompsons had received:

a 65-percent reduction in deficiencies

(a rough approximation of the reduction of the Thompsons'
originally determined deficiencies from $79,293.52 to.the $30,000
figure finally agreed upon).

Bakutes was opposed to settling the

appealed cases on that basis, and no settlement offer on that

basis was made to the test case petitioners on appeal.

- 37 In July 1992 DeCastro filed a motion for entry of decision
in the Thompson cases in accordance with the final agreement he
had reached with McWade shortly before trial; i.e., deficiencies
of zero, $15,000, and $15,000 for 1979-81, respectively.

On

August 20, 1992, respondent filed objections to DeCastro's motion
for entry of decision, together with respondent's own motions for
entry of decision and an accompanying memorandum.

Respondent's

motion acknowledged that the Thompsöns were entitled to the
original 18.8-percent reduction settlement agreed to by McWade
and DeCastro in December 1986 and sought decisions to that
effect; respondent argued that the "New Agreement", intended to
pay the Thompsons' legal fees, was unauthorized and had no legal
basis.

Respondent's 11-page motion for entry of decision, with a
15-page supporting memorandum, set forth the facts regarding the
Thompson settlement that had been discovered by IRS senior
officials.

Respondent informed the Court that before the test

case trial McWade and Sims had agreed to sweeten the prior
settlements of the Thompson cases by further reducing the

Thompsons' deficiencies in order to compensate them for their
projected attorney's fees.

As respondent explained to the Court,

McWade and Sims had agreed with DeCastro that
All settlement refunds in excess of the amounts
provided by the December 1986 agreement would go
ultimately to the benefit of Mr. DeCastro for payment
of his legal fees and costs. Mr. DeCastro would be

- 38 paid solely from amounts refunded by the Service to
Thompson. * * * This "New Agreement", in sum and
substance, if not .explicitly, was designed, and
constituted an agreement by Messrs. Sims and McWade to
pay Mr. DeCastro's legal fees and expenses.
Respondent's motion papers compared the amounts of the
Thompsons' deficiencies originally determined for the 3 years at
issue, totaling $79,293.52, with the unauthorized "New Agreement"
reducing the deficiencies to zero, $15,000, and $15,000, or
total deficiencies of only $30,000, thus generating the refunds
used to pay DeCastro's legal fees.

These figures, without more,

indicate that the "New Agreement" represented a 62-percent
reduction of the deficiencies respondent originally determined.
In respondent's memorandum of points and authorities in
support of respondent's motion for entry of decision, respondent

acknowledged that "counsel for both parties owed a special
obligation of candid disclosure to this court given the highly
unusual circumstances which were of their own making."
Respondent acknowledged that the Rules of this Court and the
Model Rules of Professional Conduct require the utmost candor to
the Court, "which duty would proscribe misleading the court by

silence, inaction, or failure to apprise the court of any
material fact that may affect the proceeding before the court."
Respondent further acknowledged:
as officers of the court, both the District Counsel
attorneys and petitioners' counsel owed a special duty
to disclose to this court that they had entered into an
agreement to settle the litigation and that District

- 39 Counsel William Sims agreed in substance to pay the
litigation expenses of his adversary. See·Booth v.
Mary Carter Paint Co., 202 So. 2d 8 (Fla. Dist. Ct.
App. 1967); 2 Moore's Fed. Practice Par. 23.23.
In
Reager v. Anderson, 371 S.E. 2d 619, 630 (W. Va. 1988),
the court, commenting upon the duty of candor to the
court, observed that "(i)t is critical to the fair
conduct of the trial to disclose promptly the
settlement terms to the court and to opposing counsel
so that the court can decide whether the agreement is
valid, and if so, what measure will be taken to ensure
that the nonsettling party(ies) will not be
prejudiced." We believe that this is particularly
important where the settling party remains in the
litigation, testifies with respect to the issues, and
his attorney appears to be an advocate adverse to the
party paying the fees.
On August 26, 1992, the Court entered orders and decisions
in the Thompson cases summarily denying respondent's motion for

entry of decision, granting DeCastro's motions for entry of
decision, and entering decisions in accordance with the final
Thompson agreement.
Respondent did not appeal the decisions the Court entered in
the Thompson and the Cravens cases.

As a result, those decisions

became final, while Rina and the other test case petitioners, who
had appealed the decisions entered in their cases, added the
newly revealed facts about the misconduct of respondent's
attorneys to the grounds for their appeals.
The rationale of the Office of Chief Counsel for not
appealing the Tax Court's entry of the decisions giving effect to
the Thompson settlement was set forth in a memorandum, dated
September 8, 1992, prepared by Kane:

- 40 The Chief Counsel [Abraham N.M. Shashy, Jr.] and Deputy
Chief Counsel have concluded that, under the
circumstances, we have completely fulfilled all
applicable ethical and legal obligations with respect
to this issue and this litigation. They have also
concluded that given the fact that the conduct on the
part of our attorneys is significantly less than
exemplary, there is nothing to be gained by further
prolonging this aspect of the Kersting litigation.
On September 30, 1992, Judge Goffe terminated his recall
status as a Senior Judge and retired from the bench.

.The Chief

Judge of the Tax Court reassigned the Kersting project cases to
Judge Renato Beghe.
In October 1992 Izen and Robert Patrick Sticht (Sticht),
representing various nontest case petitioners, filed separate
motions with the Tax Court to intervene in the Thompson and
Cravens cases, before the newly entered decisions in those cases
had become final.

Sticht and Izen maintained that their clients

should be allowed to intervene in those cases in order to assert
that McWade had committed fraud on the Court by arranging the

Thompson settlement and failing to inform the Court or the other
parties.
On November 6, 1992, we denied the motions to intervene.
Izen and Sticht filed notices of appeal of our denials of their

intervention motions, again alleging fraud on the Court.

- 41 III. Kersting's Responses to Dixon II and Discovery and
Disclosure of the Secret Settlements:
Letters to Kerstino
Program Participants and Formation of the Kersting Defense
Group
After the Court filed Dixon II, Kersting kept the

participants in his programs informed about the status of the
test cases.

In February 1992, Kersting sent a lengthy "Dear

Friend" letter to the participants in his programs, informing
them that Izen was.preparing an appeal of Dixon II in the test
cases to be filed with the Court of Appeals for the Ninth
Circuit.

Kersting's letter also said he had formed a defense

team of attorneys and included with the letter a copy of the

business card of "R.A.J. Limited, Robert Alan Jones, Esq.,
President".

.

Subsequently, Attorneys Robert Alan Jones (Jones) and Declan
J. O'Donnell (O'Donnell) announced the Henry Kersting Tax Defense
Group.

A defense group brochure created in May 1992 describes the

legal services O'Donnell and Jones would offer to Kersting program
participants.

The brochure included a description of the

qualifications and practice backgrounds of O'Donnell and Jones,

along with retainer agreements and copies of relevant memoranda
and correspondence.

One such memorandum, entitled "Status of the

Kersting Cases", signed by O'Donnell and dated May 12, 1992, said
that most of the Kersting program participants had executed
piggyback agreements to be bound by the results in the test cases

and that the test cases had been decided for the Government.

It

- 42 -

said that the deadline for filing an appeal was June 11, 1992, and
that Izen was representing the test case petitioners and would
handle the appeal.
After the Court had denied respondent's motions to vacate the
Rina decision and for an evidentiary hearing and had vacated the
original Thompson and Cravens decisions, Jones and O'Donnell wrote

Dombrowski a joint letter dated Júne 24, 1992.

They informed

Dombrowski that they represented approximately 100 Kersting
project taxpayers and that they understood Dombrowski had replaced
McWade as respondent's counsel because of an ethical concern
regarding the impropriety of the secret settlements with the
Cravenses and the Thompsons.
The letter acknowledged that the Court had concluded that the
newly disclosed "Contingent Settlements" would not change its
opinion in any material way and had denied a motion to vacate
decision filed in a case that was not on appeal.

The letter also

stated that motions to remand were pending before the Court of

Appeals for the Ninth Circuit in cases that had been appealed.
By letters dated June 24 and August 12, 1992, Jones and
O'Donnell asked Dombrowski to provide informal discovery regarding
the Thompson and Cravens settlements.

Respondent refused their

informal discovery requests and did not allow them to participate

in any of respondent's in-house investigations.

- 43 In a letter dated July 31, 1992, Kersting informed the
Kersting program participants that Izen and Sticht were "exposing
the government's fraud.and perfidy in a secret deal between
Cravens and Thompson on the one hand, and IRS attorney McWade (and
other government officials) on the other hand."

Kersting

explained his version of the misconduct of the Government's
attorneys as follows:

"As many of you already know, the growing

scandal in the 'piggyback' cases involves a settlement in favor of
Cravens/Thompson in exchange for their damaging testimony and
exhibits that were all put together as part of a prearranged plan
to influence and persuade Judge Goffe to rule against us."
On September 14, 1992, Kersting wrote another "Dear Friend"
letter informing the Kersting participants of further
developments.

Kersting said the misconduct of Sims, McWade, and

DeCastro "threw the appeals schedule into turmoil and motions had

to be filed to ask for an extension of time for filing the
Appeal."

Kersting advised them to ask for "the same concessions

arranged by the Revenue Service to Thompson and Cravens.

An

arrangement whereby $100,000.00 of taxes allegedly owed were
reduced to a mere $15,000.00."

This "Dear Friend" letter

concluded by disclosing that relations had soured between Kersting
and the "Henry Kersting Tax Defense Group" of O'Donnell and Jones.

- 44 IV.

Respondent's Posttrial Settlement Offer

In July 1992 respondent's National Office began in-house
discussions about offering a 7-percent reduction settlement to
Kersting project petitioners who were bound by the test cases
through piggyback agreements.
On September 9, 1992, Dombrowski sent a draft of a proposed
settlement offer letter (Dombrowski draft) to Paul Zamolo, Acting
Deputy Regional Counsel.

The Dombrowski draft explained that the

Tax Court had issued its Dixon II opinion disallowing the interest
deductions, imposing additions to tax for negligence under section
6653 and substantial understatement of tax under section 6661, and
finding that the increased interest rate under section 6621(c)
applied.

The Dombrowski draft stated that five of the test case

petitioners

(Dixon, DuFresne, Hongsermeier, Owens, and Young) were

appealing their cases in the Ninth Circuit, but that the appeals
had not yet been resolved.

The Dombrowski draft further stated

that respondent had moved to vacate the decisions in the Cravens,

Rina, and Thompson test cases because "it appeared that a
settlement agreement had been reached with two [sic] of the test
case petitioners, the Cravens [sic] and the Thompsons, prior to

the trial of the test cases."

The Dombrowski draft then described

the action taken by the Court as follows:

The Tax Court granted the Motions to Vacate
Decision which were filed in the Thompson and Cravens
cases. The Court directed the parties to either file
agreed decisions or motions regarding the decisions to

- 45 be entered in the cases. Agreed decisions were filed in
the Cravens' cases reflecting the Cravens' pre-trial
acceptance of the standard Kersting settlement offer.
The parties were unable to agree on the decisions to be
filed in the Thompson cases. Thereafter, motions for
entry of decision were filed by both the government and
the Thompsons. The Tax Court granted the Thompsons'
motions and entered decisions accordingly.
The Court denied the Motion to Vacate Decision
filed in the third case involving petitioner Ralph J.
Rina.
In denying the Motion to Vacate Decision the
Court stated that the testimony and evidence offered by
Mr. Thompson and Mr. Cravens had no material effect on
the opinion as it related to Mr. Rina and therefore the
Court's findings, analyses and conclusions relating to
him would remain the same. Accordingly, all Kersting
interest deductions were disallowed and all additions to
tax were sustained as to Mr. Rina.
* * *
* * * It is the Service's belief that the trial
Court's disallowance of interest deductions and the
imposition of the additions to tax will be upheld on
appeal.
The Dombrowski draft then stated that the IRS had decided to

renew its previous offer of the 7-percent settlement including the
burnout and enclosed a form on which the taxpayer could indicate
his/her acceptance of the offer.

The Dombrowski draft stated:

"the offer applies only to adjustments resulting from your

participation in the various Kersting programs referred to above.
Any other adjustments raised in your case will be considered on an
item by item basis and will be settled or litigated as
appropriate."
A September 30, 1992, shorter draft of a settlement proposal
prepared by Sanchez (Sanchez draft) gave much less detail than the
Dombrowski draft.

The Sanchez draft referred to the Tax Court's

- 46 decision but did not name the case or cite Dixon II.

It only

identified Cravens as one of two test cases in which "some
irregular and undisclosed agreements" had been reached.

The

Sanchez draft stated that the Tax Court had concluded that the
outcome of the trial was unaffected by the irregular activity and
that decisions had been entered in the two test cases enforcing
the undisclosed agreements.

The Sanchez draft did not identify

any of the other test cases or mention that some of those cases
were being appealed.

The Sanchez draft stated:

We believe that the Cravens situation is
indistinguishable from your own.

*

*

*

*

*

*

*

We have determined that the Cravens [sic] in good
faith believed that they had a valid settlement
agreement prior to the trial.
Because they were not
represented by counsel, they could not be expected to.
have detected any irregularity on our part.
Because the Cravens [sic] received the benefit of
this offer even after trial, we believe that fundamental
fairness compels that you should receive the same
treatment. Therefore, we will apply the benefits of
that treatment to your case.
The Sanchez draft stated that the adjustments to the
taxpayer's account with the IRS would be made administratively and
required no further action by the taxpayer.
A third draft dated October 26,

1992, prepared by Kane (Kane

draft), was also less detailed than the Dombrowski draft.

The

Kane draft cited Dixon II but did not identify any of the other
test cases.

The Kane draft stated that two of the test case

- 47 .

petitioners had entered into settlement agreements that had not
been disclosed to the other test case petitioners or the Tax Court
but did not identify the taxpayers who had entered into the
undisclosed settlement agreements.

The Kane draft stated that the.

Tax Court had concluded that the outcome of the trial was
unaffected by the testimony of the test case petitioners who had
settled their cases.

The Kane draft stated:

"This means that the

opinion of the Tax Court, as it affects you, remains unchanged."
The Kane draft did not disclose that the Dixons and some of the
other test case petitioners had filed appeals with the Court of
Appeals for the Ninth Circuit.
The Kane draft stated that "fundamental fairness dictates
that you be afforded an opportunity to settle your case on similar
grounds".

The Kane draft, like the Sanchez draft, indicated that,

if the taxpayer's case had been settled, the adjustments would be
made administratively without requiring further action from the
taxpayer.

If the case was still pending in the Tax Court, the

taxpayer had 60 days to accept the offer.

The Kane draft stated

that acceptance of the offer would "preclude any further

challenges or appeal with respect to the merits of the Dixon
opinion as applied to your case(s)."
On January 8 and 29, 1993, respondent made mass mailings
extending a global settlement proposal to all known Kersting
project nontest case petitioners and their counsel (posttrial

- 48 settlement offer).

The posttrial settlement offer informed

petitioners that the Court had issued its opinion sustaining all
the adjustments and cited Dixon II.

It explained that, after the

.trial of the test cases:
It subsequently came to our attention that two of
the test case petitioners had entered into settlement
agreements with the Service prior to the trial,.and that
these agreements were not disclosed to the Tax Court or
the other test case petitioners.
The settlement
agreements provided that these particular test case
petitioners could proceed to trial, but would receive
the benefit of the better of their pretrial settlement
agreement or the results of the trial. The Tax Court
has since been advised of this situation and has
concluded that the outcome of the trial was not affected
by the testimony of these test case petitioners. This
means that the Tax Court opinion, as it pertains to
other Kersting cases, remains unchanged.
However, in
light of these recent developments, we have concluded
that in fairness all petitioners be afforded an
opportunity to settle their cases.
In general, the posttrial settlement offer represented.a
revival of the official project settlement that respondent had
offered during 1982-86.

It permitted taxpayers to resolve their

cases by agreeing to pay deficiencies that were 7 percent less
than those determined in their deficiency notices.

Respondent

would impose no penalties or additions to tax, and taxpayers would
pay interest only at the generally applicable (i.e., non-

tax-motivated) rate under section 6621(a).

The posttrial

settlement offer did not include the burnout.
The posttrial settlement offer further stated:

"Acceptance

of this settlement offer will preclude any further challenge or

- 49 appeal with respect to the Kersting programs or the merits of the
Dixon opinion.

Any other issues involved in this case will be

resolved separately."

Taxpayers were given 60 days within which

to accept or reject the posttrial settlement offer.
V.

The Lewis and Liu Settlements

In a letter dated March 11, 1993, O'Donnell informed
respondent's counsel that the Lewises had decided to accept the
posttrial settlement offer.¹6

Thereafter, respondent forwarded a

stipulated decision document to O'Donnell and Jones reflecting a
disposition of the Lewises' cases on the terms set forth in the
posttrial settlement offer.

On May 17, 1993, O'Donnell signed the

decision documents in docket Nos. 15673-87 and 18551-88; on May
18, 1993, Jones signed the decision document in docket No. 2942988.

On June 16, 1993, O'Neill signed the Lewises' decision

documents on behalf of respondent.

On June 23,

1993, the Court

entered the decisions in the Lewises' three dockets.

On September

22, 1993, the decisions became final under section 7481.
The Lius, proceeding pro sese," also accepted the posttrial
settlement offer.

On March 10, 1993, the Court entered the

¹60'Donnell and Jones had entered their appearances on
behalf of the Lewises in the present cases on July 6, 1992.
"The Lius were represented by Thomas P. Dunn from May 26,
1987, to July 21, 1989.
Their present counsel, Matthew K. Chung,
entered his appearance in these proceedings on Oct. 18, 2004,
when he filed the Lius' motion for leave to file motion to vacate
their stipulated decision.

- 50 stipulated decision in the Lius' case, docket No. 48690-86.

On

June 8, 1993, the decision became final under section 74B1.
When respondent submitted the stipulated decision documents
obtained through the posttrial settlement offer to the Tax Court
and asked the Court to enter those stipulated decisions,
respondent did not file a copy of the posttrial settlement offer
with the Court.
VI.

Disciplinary Actions Against McWade and Sims

On July 29, 1993, respondent's management sent notices of
proposed disciplinary action to McWade and Sims.
asserted that McWade and Sims had violated:

The notices

(1) Department of the

Treasury.Minimum Standards of Conduct, section 0.735-30(a)(2)

(an

employee shall avoid any action which might result in or create
the appearance of giving preferential treatment to any person);
(2) Department of the Treasury Minimum Standards of Conduct,
section 0.735-30(a)(6)

(an employee shall avoid any action that

might adversely affect the confidence of the public in the
integrity of the Government); and (3) IRS Rule of Conduct 214.5
(an employee will not intentionally make false or misleading oral

or written statements in matters of official interest).

The

notices proposed to suspend both McWade and Sims for 14 calendar
days without pay.
The Notices of Proposed Disciplinary Action .to McWade and
Sims listed the following reasons for the proposed disciplinary

- 51 actions:

(1) Negotiating an unauthorized settlement agreement

with the Thompsons;

(2) basing the Thompson settlement on

unaudited and insufficiently documented losses from an unrelated
shelter;

(3) allowing the Thompsons a settlement that provided

them more favorable treatment than other taxpayers;
(4) compensating the Thompsons for their attorney's fees; and
(5) not informing the Tax Court of the Thompson settlement
arrangements.
McWade and Sims were both suspended for 2 weeks without pay
and transferred from the Honolulu Division.

Sims accepted these

disciplinary actions and was transferred to the San Francisco
Regional Counsel's Office, where he was assigned nonsupervisory
duties as a Special Litigation Assistant in the General
Litigation area.

Rather than accept.a transfer to the Los

Angeles District Counsel's office, McWade retired from the IRS,
effective October 2, 1993.

On April 1, 1999, the day immediately following the issuance
of the Dixon III opinion, we referred the misconduct of Sims,
McWade, and DeCastro to the Committee on Admissions, Ethics, and

Discipline of the Tax Court.

On April 22, 2003, following the

issuance of the Court of Appeals opinion in Dixon V and entry of
its primary mandate, the Tax Court, through the Committee on
Admissions, Ethics, and Discipline, issued orders to Sims,
McWade, and DeCastro to show cause why they should not be

- 52 suspended or disbarred from practice before the Court or

otherwise further disciplined.

On July 1, 2003, DeCastro .

resigned from practice before the Court.
The Tax Court, acting on the orders to show cause and the
recommendations of the Committee on Admissions, Ethics, and
Discipline, suspended McWade and Sims from practice before the
Court for 2 years, commencing February 20, 2004.

The Arkansas

State Bar suspended Sims's license to practice law for 1 year in
February 2004, and the Oregon State Bar suspended McWade's
license to practice for 2 years in August 2004.

The Director of

the IRS Office of Professional Responsibility suspended McWade

and Sims indefinitely from practice before the IRS, effective
June 9, 2004.¹8
VII. Appeals to the Court of Appeals for the Ninth Circuit and
Proceedings on Remand
Respondent did not appeal the decisions this Court entered
in the Thompson and the Cravens cases in accordance with the
secret settlement agreements.¹9

closed.

As a result, those cases were

The remaining test case petitioners, including Rina,

appealed the decisions entered in their cases to the Court of

18Following what Attorney Michael Louis Minns interpreted as
a suggestion or order by a member of the panel that heard oral
argument on the appeal that resulted in Dixon V, Minns filed the
complaints that resulted in the disciplinary actions by the
Arkansas and Oregon Bars and the IRS Office of Professional
Responsibility.
¹9See the Kane memorandum dated Sept. 8, 1992, supra p. 40.

- 53 Appeals for the Ninth Circuit; they included facts about the
misconduct of respondent's attorneys as grounds for their
appeals, which they characterized as fraud on the court.
Additionally, Izen and Sticht separately appealed to the Court of
Appeals for the Ninth Circuit our orders denying their motions to
intervene in the Thompson and Cravens cases on behalf of various
Kersting project nontest case petitioners.2°
A.

Ninth Circuit Remand: DuFresne v. Commissioner and
Adair v. Commissioner

In DuFresne v. Commissioner, 26 F.3d 105 (9th Cir. 1994),
the Court of Appeals for the Ninth Circuit vacated the decisions
entered against the test case petitioners (other than the
Thompsons and Cravenses) on the ground that the misconduct of
McWade and Sims required further inquiry.
The Court of Appeals noted that in respondent's motions to
vacate decision filed in the Tax Court respondent had "presented
a telling case of corruption of the process of the tax court and
the rights of both the government and the taxpayers" and that the
parties wrongly believed that the test cases were fairly
representative of all the other cases and were not sham or
collusive proceedings.

The Court of Appeals found that the

taxpayers, the Government, and the Tax Court had all been cheated
2°Izen and Sticht also filed appeals of our orders denying
their motions to intervene in the Thompson and Cravens cases in
the Courts of Appeals for the Second and Tenth Circuits. Those
appeals were dismissed for procedural reasons and not on the
merits.

- 54 by the conduct described in the appeal; i.e., that a secret
settlement agreement entered into between respondent and the
Thompsons was contiñgent upon the Thompsons' not prevailing in

their cases, and that, in effect, the Government agreed to pay
the Thompsons' legal fees, and that the Cravenses had entered
into a similar agreement.

The Court of Appeals also noted that

Rina had alleged, in a motion for reconsideration in the Tax
Court, that the Thompsons' attorney (who was the main beneficiary
of the settlement) was privy, at his insistence, to the test case
trial strategy, read counsel's trial notes, and overheard
communications with clients.
The Court of Appeals stated that it could not determine from
the appellate record "whether the extent of misconduct rises to

the level of a structural defect voiding the judgment as
fundamentally unfair, or whether, despite the government's
misconduct, the judgment can be upheld as harmless error.
Arizona v. Fulminante, 499 U.S. 279, 309 (1991)."

See

Id. at 107.

The Court of Appeals vacated the decisions entered in the
remaining test cases and remanded the cases to this Court with
directions to hold an evidentiary hearing to determine the full

extent of the misconduct of McWade and Sims.

The Court of

Appeals also directed the Tax Court to consider on the merits all
motions of intervention filed by affected parties and stated that
all subsequent appeals would be scheduled before the same panel.

- 55 In Adair v. Commissioner, 26 F.3d 129 (9th Cir. 1994), an
unpublished opinion filed the same day as the DuFresne opinion,
the DuFresne panel also dismissed the Kersting project nontest
case petitioners' appeals of our orders denying their motions to
intervene in the Thompson and Cravens cases.

Notwithstanding (1)

the Kersting project nontest case petitioners' allegations that
the misconduct of the Government attorneys was a fraud on the Tax
Court,

(2) the DuFresne panel's conclusions in DuFresne that the

process of the Tax Court had been corrupted and that the test
case trial was a sham or collusive proceeding, and (3) the
holding in Toscano v. Commissioner, 441 F.2d 930, 934 (9th Cir.
1971), vacating 52 T.C. 295 (1969), that the Tax Court has
jurisdiction to set aside a final decision where a fraud has been
perpetrated on the Court, the DuFresne panel held that the
decisions entered in the Cravens and Thompson cases were final
and that the Tax Court lacked jurisdiction to vacate them, citing

Billingsley v. Commissioner, 868 F.2d 1081, 1084 (9th Cir. 1989).
B.

Evidentiary Hearing and Opinions on DuFresne Remand:
Dixon III and IV

In May-June 1996 we conducted the evidentiary hearing
directed by the Court of Appeals in DuFresne.

To give effect to

the directive of the Court of Appeals that the Tax Court consider
on the merits all motions of intervention filed by affected
parties, we ordered the consolidation of 10 nontest cases, each

- 56 represented by Izen, Sticht, or Jones, with the remaining test
cases for purposes of the evidentiary hearing.2¹
Shortly before the evidentiary hearing, held in May-June
1996, the parties discovered that decisions entered in the
Alexander cases zeroed out the Alexanders' deficiencies for 197477.

In Dixon III, filed March 30, 1999, we made detailed
findings of fact concerning McWade's and Sims's misconduct during
the Kersting test case proceedings.

Our ultimate findings

included the following.
(1) McWade and Sims negotiated a series of contingent
settlement agreements with DeCastro in respect of the Thompsons'
tax liabilities in advance of the trial of the test cases.

The

final Thompson settlement agreement provided for a reduction in
the Thompsons' tax liabilities for the purpose of generating

refunds to pay DeCastro's attorney's fees.
(2) McWade and Sims negotiated a contingent settlement
agreement with John R. Cravens (Cravens) in respect of the
Cravenses' tax liabilities in advance of the trial of the test
cases.

McWade and Sims misled Cravens about the nature and legal

2¹The Gridleys and the Fleers, Kersting project nontest case
petitioners who were represented by O'Donnell, were originally
included in the consolidation for the evidentiary hearing.
However, before the hearing, we severed their cases from the
consolidation, at O'Donnell's request, so they could
independently pursue their summary judgment motions described
infra Part VII.C.

- 57 effect of his settlement and his need for counsel at the trial of
the test cases.

In so doing, they foreclosed the possibility

that the Cravenses would obtain counsel, thereby reducing the
effectiveness of Cravens's testimony and presentations to the
Court from the point of view of all test case petitioners.

The

Cravenses' lack of counsel also reduced the likelihood that they
would inform counsel for test case petitioners that their cases
had settled.

(3) Before the trial of the test cases, McWade intentionally
misled the Court, with the complicity of DeCastro, by not
disclosing the settlement of the Thompson.cases when he moved to
set aside the Thompson piggyback agreements.

At the trial of the

test cases, Sims, McWade, and DeCastro intentionally misled the
Court about the status of the Thompson. cases by not disclosing

that they had been settled.

They intentionally misled the Court

in similar fashion about the"Cravens cases.

McWade allowed

Alexander to offer misleading testimony denying that his.tax
liabilities would be zeroed out in exchange for his testimony and
other assistance to McWade.

(4)

Izen had no knowledge, before and at the trial of the

test cases through the times that the Court issued the Dixon II
opinion and entered the initial decisions in the test cases, that
the Thompsons and the Cravenses had .entered into settlement
agreements with McWade.

However, DeCastro did not act as a

- 58 Government "mole" during the trial of the test cases or convey
any of Izen's trial strategies or confidential information to the
Government.

Having made detailed findings of fact describing the
misconduct of the Government attorneys and DeCastro during the
test case proceedings, we evaluated that misconduct under Arizona
v. Fulminante, 479 U.S. 279, 309-310 (1991), as mandated by the
Court of Appeals, citing Chapman v. California, 386 U.S. 18
(1967), for the proposition that the presence of a structural
defect in a criminal trial requires automatic reversal of the
conviction and a new trial; we held that the misconduct of the
Government attorneys did not create a structural defect that

would invalidate the judgments in the test cases.22

We reasoned

that the Thompson and Cravens settlements did not alter the basic
22In Dixon III, we observed that the term "structural
defect" normally refers to the violation of a fundamental
constitutional right occurring during a criminal trial that
affects the very framework within which the trial proceeds so
that the trial cannot reliably serve its function as a vehicle
for determination of guilt or Innocence. Not all constitutional
errors occurring during a trial result in a structural defect in
the proceedings.
In fact most constitutional errors,
characterized as lesser "trial errors", are amenable to harmlesserror analysis. A constitutional violation is harmless if it did
not have a "'substantial and injurious effect or influence'" in
determining the jury's verdict.
Rice v. Wood, 77 F.3d 1138, 1144
(9th Cir. 1996) (quoting Brecht v. Abrahamson, 507 U.S. 619, 623
(1993)).
In civil cases an error related to admission of
evidence or attorney misconduct is considered harmless if there
is no prejudicial effect and/or the error did not affect the
judgment.
See Chalmers v. City of Los Angeles, 762 F.2d 753,
761-762 (9th Cir. 1985); see also Mateyko v. Felix, 924 F.2d 824,
827-828 (9th Cir. 1991) (new trial is warranted only if
misconduct affected the verdict).

- 59 framework within which the.trial of the test cases was conducted
and that the outcome of the retrial of the test cases would be
the same if we were to order a new trial.
Next we considered the merits of the motions of intervention
filed by Kersting project nontest case petitioners whose cases
were bound by Dixon II.

We concluded that the Government

misconduct did not provide any other basis for invalidating the
Court's decisions in the remaining test cases or for setting
aside the piggyback agreements.
In Dixon III we found that the Kersting project nontest case
petitioners who signed piggyback agreements received what they

bargained for, an opinion and decisions on the merits in Dixon
II.

We reviewed the Court's Dixon II opinion and then considered

the relative importance of the testimony and evidence of the
Thompsons, the Cravenses, and the Alexanders to the Court's
holdings.in Dixon II.

In Dixon II the Court had relied upon

substantial objective evidence in concluding that the test case
petitioners had no business purpose for entering into the
Kersting programs other than tax avoidance and that the
transactions lacked economic substance.
In Dixon III we held that the Government misconduct resulted
in harmless error in the trial of the test cases insofar as the

Court had concluded in Dixon II that:
transactions were shams;

(1) The Kersting

(2) the Kersting promissory notes did

- 60 not constitute genuine debt; and (3) interest on Kersting loans
was not paid within the meaning of section 163(a).
Because the.outcome in the trial of the test cases would not
have changed had the Cravens and Thompson cases been removed from

the test case array, we concluded that the taxpayers were not
entitled to a new trial, concluding that the misconduct resulted
in harmless error rather than reversible error.

See Arizona v.

Fulminante, supra at 307-308; Drobny v. Commissioner, 113 F.3d
670,

678

(7th Cir. 1997), affg. T.C. Memo. 1995-209.

In Dixon III we also held that the Government misconduct in
the trial o.f the test cases did not amount to fraud,
misrepresentation, or misconduct under rule 60(b)(3) of the
Federal Rules of Civil Procedure or fraud on the Court that would
require the Court either to order a new trial or to enter

decisions eliminating all tax liability.
In Dixon III we found that the test case petitioners were
afforded a fair trial despite the Government misconduct,23 and
therefore justice would not be served if we were to adopt the
extraordinary remedy of renouncing the Court's deficiency

23Although we observed that respondent promptly reported
McNade's and Sims's misconduct to the Court upon discovery and
that respondent's overall conduct in the proceedings exhibited
respondent's institutional good faith, Dixon IV, 79 T.C.M. (CCH)
1803, 1810, 2000 T.C.M. (RIA) par. 2000-116, at 2000-641; Dixon
III,

77 T.C.M.

(CCH)

1630,

1720,

1999 T.C.M.

(RIA) par.

99,101,

at 99-652, we had no occasion in the Dixon III and IV proceedings
to examine or address the circumstances surrounding respondent's
posttrial settlement offer.

- 61 determinations in Dixon II, thereby eliminating all tax liability
of the taxpayers.

Our conclusion that the misconduct was not a

fraud on the Court appeared to us to be consistent with the
DuFresne panel's holding in Adair v. Commissioner, 26 F.3d 129
(9th Cir. 1994), that the decisions in the Cravens and Thompson
cases were final and that the Tax Court.lacked jurisdiction to
vacate them.

Under Ninth Circuit precedent, the Tax Court has

jurisdiction to set aside a final decision where a fraud has been
perpetrated on the Court.

Toscano v. Commissioner, 441 F.2d at

934.
We also concluded that the piggyback agreements executed by
Kersting project hontest case petitioners should not be set aside
under the theory of fraudulent inducement or for breach of
contract.

Although we held in Dixon III that Kersting project test
case and nontest case petitioners were not entitled to a new
trial or the elimination of all their tax liabilities, we
recognized that the misconduct of McWade and Sims had harmed the

judicial process, and we found it appropriate to impose sanctions
against respondent under Rule 123(a).

We held that Kersting

project petitioners who either had not had decisions entered in
their cases or whose decisions had not yet become final were not
liable for the interest component of the addition to tax for

- 62 negligence under section 6653(a)(2) or (1) (B) or interest
computed at the increased rate prescribed in section 6621(c).
In Dixon IV we imposed additional sanctions pursuant to
section 6673(a) (2) (B) by ordering respondent to pay the
attorney's fees the Kersting project petitioners had incurred to
investigate McWade's and Sims's misconduct and present the

evidence of that misconduct to the Court.

We also held that

further sanctions against respondent were not warranted to reduce
Kersting project petitioners' tax liabilities to match
respondent's earlier 20-percent settlement offer.

The remaining

test case petitioners (except the Thompsons, the Cravenses, and
Rina24) and the Kersting project nontest case petitioners who had
participated in the evidentiary hearing mandated by DuFresne

appealed Dixon III and IV to the Court of Appeals for the Ninth
Circuit.
C.

Gridlev v. Commissioner

The Gridleys and the Fleers, nontest case Kersting project
petitioners who were bound by the outcome of the test cases

through piggyback agreements, filed motions for summary judgment
that they were entitled to entry of decisions providing for zero
deficiencies, consistent with the decision entered in the
Thompsons' case for 1979, docket No. 19321-83

(all versions of

240n June 13, 1995, shortly before the evidentiary hearing
on remand from DuFresne, Rina agreed to entry of a stipulated
decision in the amounts respondent originally determined in his
deficiency notice.

- 63 the Thompson settlement applied the burnout to provide a zero
deficiency for 1979, the Thompsons' first taxable year), citing
Estate of Satin v. Commissioner, T.C. Memo. 1994-435, and Fisher
v. Commissioner, T.C. Memo. 1994-434.

We denied their motions in

Gridley v. Commissioner, T.C. Memo. 1997-210.

We distinguished

Estate of Satin and Fisher on the ground that the piggyback
agreements in those cases bound the taxpayers to the resolution
of the test cases "whether by litigation or settlement", whereas
the Gridleys' and Fleers' piggyback agreements did not mention
settlement of the test cases.

The Gridleys and Fleers appealed

to the Court of Appeals for the Ninth Circuit; by mandate dated
May 6, 2003, the Court of Appeals remanded for further
proceedings consistent with Dixon V.25
D.

Dixon V:

Court of Appeals Again Reverses and Remands

Consistent with the concluding statement in DuFresne v.
Commissioner, 26 F.3d at 107, that all subsequent appeals would

be scheduled before the DuFresne panel, the DuFresne panel, on
25By orders entered July 11, 2000, we had certified the
Gridley and Fleer cases, as well as the cases of nontest case
Kersting project who had participated in the evidentiary hearing,
for interlocutory appeal to the Court of Appeals for the Ninth
Circuit.
The Court of Appeals permitted thóse appeals.
However,
the Court of Appeals thereafter stayed appellate proceedings in
all the appealed nontest cases, while briefing, argument, and
review of the appeals in the test cases went forward. After its
Dixon V opinion, the Court of Appeals, recognizing that the
Gridley and Fleer cases were related to the Dixon cases and the
other nontest cases, remanded the Gridley and Fleer cases and the
other nontest cases to this Court for further proceedings
consistent with Dixon V.

- 64 -

November 21, 2001, set the original briefing schedule for the
appeals of Dixon III and IV and received the opening and reply
briefs.

On July 29, 2002, the DuFresne panel issued an order

that "Upon reconsideration of the original panel that heard this
matter will not retain jurisdiction of any subsequent appeals.
Accordingly, the Clerk of the court is hereby directed to

schedule the current appeal in the normal course of events".

The

appeals were assigned to a new panel of the Court of Appeals for

the Ninth Circuit (the Dixon V panel), which heard oral
arguments.

On January 17, 2003, the Dixon V panel issued Dixon V
(amended March 18, 2003), vacating and remanding the Tax Court's
decisions in the remaining test cases.
316 F.3d 1041 (9th Cir. 2003).

Dixon v. Commissioner,

The Court of Appeals held we had

applied the wrong law in Dixon III26 and held the misconduct of
McWade and Sims was a fraud on both the Kersting project
petitioners and the Tax Court, "a fraud, plainly designed to
corrupt the legitimacy of the truth-seeking process".
1046.

Id. at

"Fraud on the court occurs when the misconduct harms the

integrity of the judicial process, regardless of whether the

opposing party is prejudiced."
Robertson, 882 F.2d 421, 424

Id.

(citing

Alexander v.

(9th Cir. 1989)).

The Court of

26Dixon V distinguished and held inapplicable the contrary
decision of the Court of Appeals for the Seventh Circuit in
Drobny v. Commissioner,'ll3 F.3d 670, 678 (7th Cir. 1997).

- 65 Appeals held that the fraud not only defiled the sanctity of the
Court and the confidence of all futúre litigants, but also
violated the rights of more than 1,300 Kersting project
petitioners who had agreed to be bound by the outcome of the test
cases.

Id. at 1047.

Rather than ordering a new trial or entering decisions
eliminating all tax liabilities of the Kersting project
petitioners, the Court of Appeals directed that terms equivalent
to those provided in the Thompson settlement agreement be
extended to "Appellants and all other taxpayers properly before
this Court".27

Id.

The Court of Appeals left to the Tax Court's

discretion "the fashioning of such judgments which, to the extent
possible and practicable, should put these taxpayers in the same

position as provided for in the Thompson settlement."

Id. n.11.

On January 17, 2003, the same day as its original Dixon V
opinion, the Court of Appeals filed its primary mandate,
reversing and remanding with directions.

.

On May 28, 2003, the

Court of Appeals, acting through the Dixon V panel, filed a
supplemental mandate sending the test case petitioners' appellate
fee requests to the Tax Court for a determination of entitlement

27In setting forth the factual background and procedural
history of the Kersting project, the Court of Appeals noted
without comment that several hundred taxpayers had settled their
cases. Dixon V at 1043.

- 66 and, if warranted, amount.28

The supplemental mandate also stated

that the Dixon V panel "retains jurisdiction over all further
proceedings that may arise".
E.

Responses to Dixon V by the Office of Chief Counsel

On January 21, 2003, at the annual meeting of the New York
State Bar Association Tax Section, then IRS Chief Counsel B. John
Williams (Williams) spoke about the role of the professional
adviser in preserving the public's confidence in our·tax system.
See B. John Williams, Jr., Chief Counsel, Internal Revenue
Service, Remarks at the Meeting of the New York State Bar
Association Tax Section (Jan. 21, 2003), in 2003 TNT 15-20,
excerpts from which are set forth in appendix A.

Williams said

that he expected attorneys in the Office of Chief Counsel to
adhere to the highest professional standards.

He discussed the

fraud committed on the Tax Court in the Kersting test case
proceedings and his endorsement of the opinion and mandate of the

Court of Appeals in Dixon V.

He announced that the Office of

Chief Counsel would "expeditiously implement the Ninth Circuit's
mandate to extend to all affected taxpayers the terms of the

settlement that were effected in the lead test case.

We will

also assure that no interest is charged on deficiencies for the
period of the appeals to the Ninth Circuit."

2aSee supra note 3.

Id.

- 67 Williams acknowledged that the goal of IRS attorneys cannot
be to collect the most revenue for the Government or to win cases
at all costs.

Rather, the goal is to ensure that the tax system

is administered fairly and impartially.

He recognized that

"confidence in the integrity and fairness of the tax system is
vital to our democracy.

The tax system touches more people in

this country than any other part of the government or our laws.
The loss of confidence in its 'integrity is the loss of confidence
in the government itself."

Id.

On February 3, 2003, Deborah Butler, IRS Associate Chief
Counsel for Procedure and Administration, issued Chief Counsel
Notice CC-2003-008 (excerpts set forth in.appendix B), reminding
all Chief Counsel attorneys, in the.light of the opinion of the
Court of Appeals in Dixon V, of their obligation to adhere to the
highest ethical standards when performing their duties, including
representing the IRS before the Tax Court.

The notice reminded

Chief Counsel attorneys that their role is to ensure the uniform
application of the tax laws and the fair disposition of cases and
that, as officers of the court, they have a special duty to avoid
conduct that undermines the integrity of the adjudicative

process.

Chief Counsel attorneys must ensure that their actions

(or failure to act) preserve the sanctity of the court and
safeguard the public's confidence in the judicial process.

Id.

- 68 The notice explained that Chief Counsel attorneys must
conduct their activities in accordance with the letter and spirit
of the Model Rules of Professional Conduct of the American Bar
Association (ABA Model Rules).

The notice specifically discussed

ABA Model Rules 4.1 and 8.4.

ABA Model Rule 4.1 provides in part

that in the course of representing a client, a lawyer shall not

knowingly make a false statement of material fact or law to a
third person, or fail to disclose a material fact when disclosure
is necessary to avoid assisting a criminal or fraudulent act by a
client, unless disclosure is prohibited under ABA Model Rule 1.6
regarding client-lawyer confidentiality.

It is also professional

misconduct under ABA Model Rule 8.4 for a lawyer to engage in
conduct involving dishonesty, fraud, deceit or misrepresentation
or to engage in conduct that is prejudicial to the administration
of justice.
The notice concluded:

"All Chief Counsel attorneys are

expected to carry out their responsibilities with the utmost
integrity.

Clearly, the conduct of the Chief Counsel attorneys

in Dixon fell far short of those high standards."
F.

CC-2003-008.

Determination on Remand of Terms of the Thompson
Settlement by Dixon VI and VIII

Our Dixon VI opinion responded to the directions of the
Dixon V opinion and primary mandate to determine how the Thompson
settlement would be imposed against respondent in favor of the
test case petitioners and all parties properly before the Court.

- 69 In Dixon VI, we held that:

(1) The final Thompson settlement is

to be regarded as resulting in a 63.37-percent reduction of the
Thompsons' deficiencies, as well as elimination of all
Kersting-related penalties and additions;

(2) the Thompson

settlement encompasses and requires the vacating of the portion
or portions of the deficiencies determined against any Kersting
project petitioners that may be attributable to the "Bauspar"
shelter that was also promoted by Kersting;

(3) the Thompson

settlement's cancellation of the Thompsons'

1981 late-filing

addition justifies cancellation of not only all
non-Kersting-related penalties and .additions but also all other

substantive adjustments not arising from shelters promoted by
Kersting;

(4) interest on the reduced deficiencies shall not be

charged beyond the date in June 1992 fixed by respondent's

concession.29
29Respondent conceded that the accrual of interest on
Kersting project deficiencies ultimately determined by this Court
should be tolled as of June 1992, in accordance with the Jan. 21,
2003 public announcement of then IRS Chief Counsel B. John
Williams.
In a speech on that date at the annual meeting of the
New York State Bar Association Tax Section, Williams assured the
public that no interest would be charged on Kersting project
deficiencies for the period of the appeals. As indicated by
Dixon VI n.30:
"The original decisions in Dixon II were entered
Mar. 13, 1992; the [original) notices of appeal were filed May
14, 1992; the 90-day appeal period would have expired June 11,
1992." Stipulated decisions and decisions entered under Rule 155
following Dixon VI and VIII provide that "No interest shall
accrue [on deficiencies] during the period from May 14, 1992,
through the date that is 90 days after the decision in this case
is entered." Motions are pending before the Tax Court in 16
cases of Kersting project nontest case petitioners with
(continued...)

- 70 -

Respondent and the Kersting project petitioners had agreed
in a stipulation of settled issues that the relief extended to
all docketed cases in the Kersting project remaining open,
whether or not the Kersting project petitioners had signed
piggyback agreements.3°

In Dixon VIII we denied the motion of the Hongsermeier test
case petitioners for reconsideration of Dixon VI.

The

Hongermeiers alleged that respondent engaged in attempts at a
continued coverup of the fraud of respondent's attorneys, and
they asked the Court to impose additional sanctions on respondent
for respondent's alleged continued misconduct.3¹

The alleged

29(...continued)
deficiencies, as of Sept. 13, 2007, in cases in which decisions
giving effect to the Thompson settlement have not yet been
entered, to stop further accrual of interest on their
deficiencies after Sept. 13, 2007.

2006-090, at 2 06-671
3¹Kersting project petitioners who settled their cases and
have filed motions for leave to file motions to vacate (see Part
VIII infra) make similar allegations. They ask the Court to
conduct an evidentiary hearing to determine whether, following
the trial of the test cases, the conduct of respondent's
management related to the posttrial settlement offer continued
the fraud on the Court (or constituted a new fraud on the Court)
and, if the Court so finds, to impose the Dixon V sanction on
respondent for that conduct. Another evidentiary hearing is
unnecessary because of our holding herein that the fraud
committed on the Court by respondent's counsel during the test
case proceeding was a fraud on the Court in the case of every
Kersting project petitioner who was bound by the test cases and
that the Dixon V sanction is to be imposed against respondent in
each such case. We impose sanctions in all cases where decisions
(continued...)

- 71 misconduct of respondent's managers following the trial of the
test cases was directly in issue in the prior proceedings before
this Court in the DuFrense remand and before the Court of Appeals
in the Dixon V appeal.

We therefore held that the issue of any

continuing misconduct was covered by necessary implication by the
opinion of the Court of Appeals in Dixon V and by its most recent
primary mandate.

In Dixon VIII, we concluded that the law of the

case and the primary mandate of the Court of Appeals in Dixon V
precluded us from conducting any further inquiry into

respondent's misconduct and from imposing any additional sanction
on respondent with respect to cases of Kersting project
petitioners who were properly before the Court of Appeals.
The Hongsermeiers

(represented by Minns) and Kersting

project petitioners in 12 other test and nontest cases
(represented by Izen and Sticht) have appealed to the Court of
Appeals for the Ninth Circuit our decisions giving effect to the
Thompson settlement sanctions as formulated in our Dixon VI and

VIII opinions.
In Dixon VII and Young v. Commissioner, T.C. Memo. 2006-189,
we responded to the Dixon V supplemental mandate with regard to

Kersting project petitioners' appellate attorney's fees and costs
incurred in Dixon V.

We have determined that both test case and

3¹(...continued)
were entered on or after June 10, 1985, the date the Court agreed
to use the test case procedure in the Kersting project cases.

- 72 nontest case Kersting project petitioners represented by various
counsel are entitled to appellate attorney's fees and have
determined the amounts of those fees.
The Court now has under consideration various Kersting
project petitioners' applications for post Dixon V attorney' s
fees and costs incurred in the Dixon V remand proceedings.

VIII.

Motions To Vacate
In 71 of the more than 500 Kersting-related nontest cases in

which stipulated decisions were entered both before and after
respondent' s discovery and disclosure to the Court of McWade' s

and Sims' s misconduct, Kersting project petitioners have filed
motions for leave to file motions to vacate the decisions.
Petitioners and the other Kersting project petitioners filirig or
attempting32 to file such motions seek new decisions reflecting
the benefits of the Thompson settlement as mandated by the Court
of Appeals in Dixon V.

The Lewises, in their motions, ask us to

vacate their stipulated decisions so they can "participate in the
benefits to be generated by the subsequent proceedings mandated
by the Court of Appeals in Dixon V".

In Lewis v. Commissioner,

T.C. Memo. 2005-205, we denied the Lewises' motions for leave to

file motions to vacate stipulated decisions.
In Lewis, we focused on the legal consequences of the
Lewises' acceptance of respondent's posttrial settlement offer,
32The Court has returned unfiled numerous other such motions
because of procedural defects.

- 73 applying general principles of contract law.

We found that the

Lewises, who settled after respondent disclosed the secret
settlements to the Court, abandoned any opportunity to benefit
from the mandate of the Court of Appeals in Dixon V, issued 10
years after respondent's posttrial settlement offer.

We found

that knowledge of the Lewises and their counsel of the secret
settlements and allegations of fraud on the Court made in the
appeals of Dixon II filed in the Court of Appeals for the Ninth
Circuit precluded a claim of fraud and that, by settling as they
did, the Lewises assumed the risk that, as a result of the thenpending appeals, other Kersting project petitioners might become
entitled to a more favorable outcome.
The Lewises timely filed motions for reconsideration.

We

now believe that we applied the wrong law in Lewis, as the Court
of Appeals in Dixon V held we did in Dixon III and IV, and that
we failed to appreciate and apply the full scope of the holding
of Dixon V in accordance with its rationale.

We have therefore

granted the Lewises' motions for reconsideration, granted the
motions for leave in the Lewis, Hartman, and Liu cases, and
consolidated them for the purpose of this opinion, in which we

hold that the underlying motions to vacate should be granted.

- 74 Discussion
I.

Preliminary Comments

Respondent, Kersting project petitioners, the opinionreading public, and the Court of Appeals for the Ninth Circuit
might well consider this opinion a surprising about-face from our
opinion in Lewis v. Commissioner, supra.

We therefore indicate

some of the considerations that have led to our change of
position.
Hartman's and the Lius' motions for leave to vacate and the
Lewises' motions for reconsideration led us to reread the Dixon V
opinion.

Our rereading prompted us to compare the different

situations of the 400-500 settling Kersting project petitioners,
who at various times were induced to agree to entry of stipulated
decisions, with the situations of the more than 1,300 nonsettling
petitioners who have delayed entry of decisions in their cases
through the appeal process in the Court of Appeals for the Ninth
Circuit.33

33These more than 1,300 Kersting project petitioners have
sorted into three groups:
(1) Those who, after issuance of our
opinions in Dixon VI and VIII responding to the mandate of Dixon
V to determine and apply the Thompson settlement to the Kersting
project cases, have agreed to entry of stipulated decisions in
accordance with our opinions in Dixon VI and VIII and waived
their appeal rights; (2) those who have had decisions entered in
accordance with the terms of the Thompson settlement as
determined by our opinions in Dixon VI and VIII, and have filed
appeals to the Court of Appeals for the Ninth Circuit; and (3)
those who continue to await the final outcome of those test cases
that have been appealed to the Court of Appeals for the Ninth
Circuit.
We assume that all Kersting project test cases and
(continued...)

- 75 The observation of the Court of Appeals in Dixon V that the
misconduct of respondent's attorneys violated the rights of all
petitioner participants in the Kersting project to a fair trial
of the test cases brought home to us more keenly than we had
previously appreciated that our Lewis opinion would result in
disparate treatment of those who have agreed to entry of
stipulated decisions at various times along the way, as compared
with those who have awaited the final outcome.

We had a visceral

reaction that our Lewis opinion violated some sense of
distributive justice,34 whether derived from notions of equality35
or of fairness,36 and that the Dixon V opinion and mandate

required a contrary result.

Recognizing the incompatibility of

the various formulations of distributive justice by political
philosophers over the years,37 we mention those formulations as no

33(...continued)
nontest cases on appeal to the Court of Appeals for the Ninth
Circuit will be reviewed by the panel that issued the opinion in
Dixon V.
See supra note 5 and accompanying text.

34See Aristotle, "Nichomachean Ethics", bk. V, chs. 2 and 3,
Introduction to Aristotle (Richard McKeon, ed., Modern Library
1947). Aristotle's original formulation of distributive justice
in terms of the relative merits or virtuousness of the
individuals among whom goods are to be apportioned might be
deemed to be more in line with our opinion in Lewis, than the
more recent formulations mentioned infra notes 35 and 36.
35See Hobbes, Leviathan (1651), ch. xv, at 208 (Pelican
Classics 1968).
36See Rawls, A Theory of Justice (rev. ed. 1999).
37See MacIntyre, After Virtue, 246-257

(2d ed. 1984).

- 76 more than intimations that we should reconsider our Lewis

position in the light of our rereading of the Dixon V opinion.
Those intimations have led us to reflect on the various

situations of those Kersting project petitioners who were part of
the test case proceedings and who agreed to entry of stipulated
decisions at different times along the way after the test case
proceedings began.38
First, there are Kersting project petitioners who settled
with respondent before the misconduct had begun or who, like
Hartman, settled after the misconduct had begun but before the
Court issued Dixon II and before respondent's management

discovered the misconduct and disclosed it to the Court.

Such

petitioners, irrespective of whether they had concluded that
their position on the merits was well-nigh hopeless or had some
chance of success, were entitled to assume that the test cases
whose outcome would determine the tax effects of the Kersting

programs would be well and fairly tried.

That assumption was

defeated by McWade's and Sims's intervening misconduct.
Second, there is a small group of Kersting project
petitioners who agreed to entry of stipulated decisions during
what respondent calls the "gap period", after the Court issued
3aAny Kersting project taxpayers who settled with respondent
before the Court agreed to use the test case procedure in
resolving the bulk of the Kersting project cases were not part of
the test case proceedings.
Those taxpayers were not affected by
the fraud on the Court, and sanctions are not warranted in their
cases.

- 77 Dixon II and before respondent's management discovered the
misconduct and disclosed it to the Court.

Respondent has

conceded that Kersting project petitioners in this category are
entitled to have their stipulated decisions vacated so they can
avail themselves of the benefits of the Thompson settlement."
Third, there were Kersting project petitioners, such as the
Lius and the Lewises, who accepted the reinstated project
settlement offer after respondent had disclosed the misconduct to
the Court, and who, actually or through counsel, had or may have

become aware of the Cravens and Thompson settlements and of the
pending appeals.

However, they may well have been discouraged by

the Court's denial of respondent's motion for an evidentiary
hearing and his conclusion that the misconduct had not affected
the outcome of the test cases.

They may have been disheartened

"Respondent has made this concession on the record in Kahle
v. Commissioner, docket Nos. 24558-84 and 38976-84, cases in
which stipulated decisions conceding respondent's adjustments in
full were entered in the "gap period" with respect to which
petitioner has filed motions for leave to file motions to vacate.
On Oct. 2, 1991, Terrence Kahle (Kahle), proceeding pro se,
contacted McWade conceding the Kersting issues and requesting
that McWade send decision.documents. McWade sent decision
documents to Kahle on Oct. 9, 1991, and Kahle signed them on Dec.
20, 1991, 9 days after the Court published Dixon II.
The
decisions in Kahle's cases were entered on Jan. 6, 1992, and
became final before respondent discovered the misconduct of
McWade and Sims and disclosed it to the Court. On Feb. 24, 1994,
respondent administratively abated Kahle's deficiencies and
additions and attempted to give him the benefit of the 7-percent
reduction of the posttrial settlement offer.
Respondent has
conceded that the stipulated decisions entered in Kahle's cases
and any other stipulated decisions entered during the gap period
should be vacated and new decisions entered in accordance with
Dixon VI.

- 78 by the Court's apparent failure to appreciate or consider that

McWade's and Sim

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3Aabfb0f66b4d1feca. Public record. Not legal advice.